Net income, also known as net profit or net earnings, is the amount of revenue left over after deducting total expenses. It’s the amount of money left that a company can use to reinvest, pay dividends to shareholders, pay off debt, or save for future use.
Another commonly used term for net income is the bottom line, which comes from the fact that net income is generally the last line on a company’s income statement.
It’s an important metric for investors, creditors and management because it shows at a glance the financial performance of the company and how efficiently it can manage its assets. A healthy net income can give an investor confidence that their investment will continue to appreciate and earn them a return.
Similarly, a creditor will look to net income as a way to determine whether the company is healthy and able to use its net income to pay back its debts. Management will also use want to use net income so they are able to effectively communicate with investors and creditors about the performance of the company, as well as to pay salaries and bonuses.
Net Income Formula
To calculate the net income for a company, you will need to subtract the total expenses from revenue. Since a company has multiple expenses, they will categorize these expenses as the cost of goods sold (COGS), taxes, operating expenses, etc. Regardless of how the categorization is done, to calculate the net income, you will need to total all revenues and expenses to use in the formula.
Net Income Analysis
The calculation of net income is very simple and can be done without the need for a calculator (though we have provided one below), it’s a very useful metric for many parties when making important decisions in a company.
A higher net income is favorable to a low net income in most cases. A high net income could be considered unfavorable though if you factor in the larger amount of tax a company needs to pay, compared to a low net income.
This is why you’ll see a lot of large companies, like Amazon, that reinvest earnings back into the company. They reduce the net income to reduce the amount of taxes they pay.
For businesses that are looking for funding, a higher net income will help with a loan application because creditors often have loan covenants that require a certain profit threshold each year. This can pose a problem to management because they want to show less profit to reduce taxes, but also maintain enough profitability to ensure they meet the lender requirements.
What does this mean in practical terms? From an accounting perspective, earnings and net profit can be manipulated to suit the goals of the business. There are certain revenue recognition rules that can be used to record revenue in their books before it has earned the revenue. This can allow management to meet the requirements for both tax and lender purposes.
The footnotes of the company financial statement will explain what measures were used and how net income was calculated.
Net Income Example
Ian runs an educational publishing business from his home and gets customers through Google search results. It’s a very passive income business and he is able to earn a large amount of revenue with few expenses. Here are the important items from his income statement:
- Revenue: $300,000
- Salary: $60,000
- Utilities: $5,000
- Taxes: $2,500
- Computer expenses: $5,000
To calculate the net income, we first need to total the expenses:
Now we have total expenses, it’s a very simple calculation to get net income:
Put simply, Ian’s revenues exceed his expenses, which means the company has a profit of $227,500. It’s important to understand that even if the company only made $50,000 in revenue, it’s not negative earnings. The correct term for this is a net loss of $12,500.
Net Income Conclusion
When calculating the net income for any company or business, the below points are worth bearing in mind as a quick recap of what it is, why it’s used, and how to use it:
- Net income is also referred to as net profits, bottom-line, or net earnings
- It is the revenue generated by a business after paying off its taxes, expenses, and other costs.
- Companies that operate profitably register a higher level of net income enabling them to pay off their debts, shareholder’s dividends, and acquire new stock.
- To calculate the net profit for a company simply subtract its total expenses from total revenue
- Higher net income value can be of benefit to a company when it wants to borrow money from lenders or attract new investors
- Higher levels of net income by a company would also indicate that it would have to pay off a large amount of taxes
- When business expenses are greater than its revenue, it would not register a negative net income, but a loss. It would register a positive net income, termed as profits when revenues are greater than expenses
- Companies can manipulate net income values by manipulating the components of the income statement where a business's total revenue and expenses are recorded
Net Income Calculator
Do you really need a net income calculator? It’s one of the most simple calculations you can make that deducts total expenses from revenue. Oh, okay then, here’s the calculator for you.
1. What is a net income?
Net income is the amount of revenue generated by a business after paying off its taxes, expenses, and other costs. It is the amount of money left over after all the expenses have been paid.
2. What is the importance of a net income?
Net income is important because it is a measure of a company's profitability. It is used to determine whether a company is making money or losing money. It can also be used to make decisions about whether to borrow money or attract new investors.
3. How is the net income calculated?
Net income is calculated by subtracting a company's total expenses from its total revenue.
The formula is:
Net Income = Total Revenue − Total Expenses
4. What is an example of a net income?
An example of net income would be a business that has generated $300,000 in revenue but has paid $72,500 in taxes, expenses, and costs. This would leave a net income of $227,500.
5. What implications does a high or low net income have for a business?
A high net income means that a company is profitable and can repay its debts, shareholders' dividends, and may have the ability to expand. A low net income would suggest the opposite.