Also referred to as “net profit,” “net earnings,” or simply “profit,” a company’s net income measures the company’s profitability. Net income is the opposite of a net loss, which is when a business loses money. Next to revenue, net income is the most important number in accounting.
Ever heard someone say that a business was “in the red” or “in the black”? That’s because accountants used to record a net loss in red ink, and net income in black ink.
Net income importance in financial analysis
Although many small businesses don’t start calculating their profitability until they’re forced to by a lender or investor, keeping track of your net income is one of the best ways to monitor the financial health of your business.
If your net income is increasing, you’re probably on the right track. If it isn’t, it might be time to cut costs.
It’s also an important metric for your lenders and investors. Lenders want to make sure you have enough money to pay back all of your debts. Investors want to know how much money the business will have leftover to pay dividends, reinvest in the business, or set aside for a rainy day.
For now, we’ll get right into how to calculate net income using the net income formula.
Net income formula in a infographic
Calculating net income with a formula
Net income is your company’s total profits after deducting all business expenses. Some people refer to net income as net earnings, net profit, or simply your “bottom line” (nicknamed from its location at the bottom of the income statement). It’s the amount of money you have left to pay shareholders, invest in new projects or equipment, pay off debts, or save for future use.
The formula for calculating net income is:
Revenue – Cost of Goods Sold – Expenses = Net Income
The first part of the formula, revenue minus cost of goods sold, is also the formula for gross income. (Check out our simple guide for how to calculate cost of goods sold).
So put another way, the net income formula is:
Gross Income – Expenses = Net Income
Or, if you really want to simplify things, you can express the net income formula as:
Total Revenues – Total Expenses = Net Income
Net income can be positive or negative. When your company has more revenues than expenses, you have a positive net income. If your total expenses are more than your revenues, you have a negative net income, also known as a net loss.
Using the formula above, you can find your company’s net income for any given period: annual, quarterly, or monthly—whichever timeframe works for your business.
Net income formula: an example
Let’s say Wyatt’s Saddle Shop wants to find its net income for the first quarter of 2023. Here are the numbers Wyatt is working with:
- Total revenues: $60,000
- Cost of goods sold (COGS): $20,000
- Rent: $6,000
- Utilities: $2,000
- Payroll: $10,000
- Advertising: $1,000
- Interest expense: $1,000
First, Wyatt could calculate his gross income by taking his total revenues, and subtracting COGS:
Gross income = $60,000 - $20,000 = $40,000
Next, Wyatt adds up his expenses for the quarter.
Expenses = $6,000 + $2,000 + $10,000 + $1,000 + $1,000 = $20,000
Now, Wyatt can calculate his net income by taking his gross income, and subtracting expenses:
Net income = $40,000 - $20,000 = $20,000
Wyatt’s net income for the quarter is $20,000
Net income vs gross income
It’s important not to mix up gross income and net income. Also called gross earnings or gross profits, gross income is your revenues minus your cost of goods sold (COGS), which are the direct expenses involved in producing your products or services.
In equation form, this is:
Gross income = revenue – cost of goods sold (COGS)
You’ll usually find your business’ COGS listed near the top of your income statement, just under revenues.
Common examples of COGS include:
- Raw materials
- Labour
- Packaging, freight, and shipping
- Energy and utility expenses for a production facility
- Depreciation expenses on production equipment and machinery
Keep in mind that COGS doesn’t include indirect expenses (also called ‘overhead’ ‘operating costs’ or ‘operating expenses’). These operating expenses include things like salaries for lawyers, accountants, management, administrative expenses, utilities, insurance, and interest.
Net income relationship with operating income
Operating income is another, more conservative measure of profitability that goes one step further than gross income. It includes operating expenses (also known as Selling, General, and Administrative (SG&A) expenses) which are any costs a company generates that don’t relate to production. Operating expenses don’t include non-operating costs like interest expenses, taxes, amortization, and depreciation.
The equation for operating income is:
Operating income = Gross income – Operating expenses
Gross income, operating income, and net income are the three most popular ways to measure the profitability of a company, and they’re all related too.
By writing out all three formulas you can see how gross profit, operating income, and net income are different but increasingly conservative measures of profitability over a given accounting period:
Revenues - COGS = Gross profit
Revenues - COGS - Operating expenses = Operating income
Revenues - COGS - Operating expenses - Non-operating expenses = Net income
Notice how the equation for net income includes all three major expense types: COGS, operating, and non-operating expenses? That’s because it’s the most conservative, most reliable measure of profitability we’ve got.
Operating net income formula
Another useful net income number to track is operating net income. Operating net income is similar to net income. However, it looks at a company’s profits from operations alone without accounting for income and expenses that aren’t related to the core activities of the business. This can include things like income tax, interest expense, interest income, and gains or losses from sales of fixed assets.
Operating income is sometimes referred to as EBIT, or “earnings before interest and taxes.”
The formula for operating net income is:
Net Income + Interest Expense + Taxes = Operating Net Income
Or, put another way, you can calculate operating net income as:
Gross Profit – Operating Expenses – Depreciation – Amortization = Operating Income
Investors and lenders sometimes prefer to look at operating net income rather than net income. This gives them a better idea of how profitable the company’s core business activities are.
For example, a company might be losing money on its core operations. But if the company sells a valuable piece of machinery, the gain from that sale will be included in the company’s net income. That gain might make it appear that the company is doing well, when in fact, they’re struggling to stay afloat. Operating net income takes the gain out of consideration, so users of the financial statements get a clearer picture of the company’s profitability and valuation.
This is information that can be taken from a cash flow statement. Learn about cash flow statements and why they are the ideal report to understand the health of a company.
Operating net income formula: an example
Let’s return to Wyatt’s Saddle Shop. If Wyatt wants to calculate his operating net income for the first quarter of 2021, he could simply add back the interest expense to his net income.
$20,000 net income + $1,000 of interest expense = $21,000 operating net income
Calculating net income and operating net income is easy if you have good bookkeeping. In that case, you likely already have a profit and loss statement or income statement that shows your net income. Get a refresher on income statements in our CPA-reviewed guide. Your company’s income statement might even break out operating net income as a separate line item before adding other income and expenses to arrive at net income.
Net income as a line item on an income statement
Net income is one of the most important line items on an income statement.
Business owners need to create an income statement, which is one of the three main financial statements. Also called a ‘profit and loss statement,’ or ‘p&l,’ the point of a company’s income statement is to show how you arrived at your net income. More importantly, it tells you how much money is entering and leaving your business.
Here’s an example income statement for Coffee Roaster Enterprises Inc., with net income listed at the very bottom:
Coffee Roaster Enterprises Inc.
Income Statement
For Year Ended Dec. 31, 2023
Income statements—and other financial statements—are built from your monthly books.
Income statement as a line item at Bench Accounting
At Bench, we do your bookkeeping and generate monthly financial statements for you. An up-to-date income statement is just one of the financial reports small business owners gain access to through Bench.
With Bench, you can see what your money is up to in easy-to-read reports. Your income statement, balance sheet, and visual reports provide the data you need to grow your business. Spend less time wondering how your business is doing and more time making decisions based on crystal-clear financial insights. Learn more.
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