Net income is an important term that you need to be intimately acquainted with if you are looking for achieving desired success in life. It will tell you about your earnings and whether the decisions you have been making have proved worthwhile or not.
Net Income is the final earnings of the business belonging to the owners after deducting all the expenses, depreciation, interest payments and direct taxes.
It determines the actual health of a company as it will let the shareholders and investors discern about the exact financial condition of that entity.
It is this figure that makes the company eligible for a loan.
If the net income is on the rise and shows a healthy figure, then its credibility rises, and it can easily access loans or debts against the business. Low income drops the share prices and makes it vulnerable in front of its investors.
The net income is generally calculated every year and is related to a particular financial year, for instance, net income of the year ending March 2018.
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What is Net Income?
To understand net income, we have to know about the revenue of a company. The most important facet of any business organization is the revenues which mean total sales.
It is also referred to as the top line because it is the first line written on the income statement.
Whereas net income is referred to as the bottom line as it is the last line written on that statement and signifies the actual profit that organization is made after it has paid all its expenses. The net income or total earnings is the income after subtracting the expenditure.
What is net income?
Net income is known by several names like the bottom line, net earnings, or net profit. It is referred to as the net profit that remains after deducting all the expenses.
The entrepreneur must know about his net income because it will prove significant in paying dividends and in determining the amount that he can re-invest or kept aside as cash.
Net income helps in formatting the actual worth of a company, and the investors look up to it to know whether their investment is in safe hands or not.
How to calculate net income?
Are you looking for ways to calculate net income or net profit? It is a simple process that is easy to understand and follow. You just need to take the steps one by one as described in the equation and reach your destination successfully.
Net Income Formula is
Total Revenues – Expenses = Net Income
In the Above formula, finding revenues is important. And then later we need to calculate our expenses.
To calculate Revenue, we have to take into account all the receipts and payments the company has received. All the funds flowing into the company are its revenue.
All the funds flowing out are its expenses which can be categorized in many ways (Explained below). Thus if you deduct the expenses from revenue, you have the net income value in hand.
If you are not able to calculate net income with Revenues of the company, you can also use the gross profit method. In the gross profit formula, you need the
- Gross profit formula
- Operating income and
- Expenses.
We will guide you how to calculate each of them individually.
What is Gross profit and its Formula?
Gross profit is the income of a business entity that remains with it after paying the initial manufacturing and production expenses. To calculate gross profits deduct the cost of goods sold or COGS from the revenue figure. COGS include
- Material cost
- Supply cost
- Labour costs of those labours that are involved directly with the manufacturing process
- Shipping expenses
- Packaging expenses
- Machinery and equipment that is used in manufacturing products.
The Gross Profit Formula is
Gross Profit = Total Revenue – COGS (Cost of Goods Sold)
Operating income
The next step is to find the operating income. To find it, you need to know about all the operating expenses and deduct it from the gross profit. It includes expenses that incurred while running the business regularly like
- Overhead costs
- Operating costs
- Administrative expenses
- Expenses related to sales
- Depreciation of assets
- Amortization of assets
The formula for operating income is
Operating Income = Gross Profit – Operating Expenses
Net income is the actual revenues left after you have accounted for all the additional income and all other related expenses. The income includes
- Investments
- Incomes from secondary investment
The expenses include
- Debts
- Taxes
- One-time payments
- Healthcare premium
- Other related expenditure
After doing all of the above, you have the values or operating income in hand, and you have all values of expenses in hand. Thus, with those values, the formula for net income is
Net Income = (Operating Income + Additional Income) – Other Expenses
Example
Let me explain this process with the help of a simple example. We are going to use the gross profit method for calculating the net income.
A company has posted its revenue figures at Rs 100000 along with its COGS at 30000 and operating expenses at Rs 10000.
Its other expenses related to taxes, interest, and debts amount to Rs 20000. To find net income, we first need to know the gross income of that company.
The formula of gross profit will prove a blessing and make the calculation much easier.
Here the revenue is 100000, and the COGS is 30000 hence the gross profit is
Gross profit = 100000 – 30000
Gross Profit = 70000
The next step is to find the operating income. As we know operating income formula is
The gross profit is now 70000, and the operating expenses are posted at 10000 hence the operating income is
The next and last stage is finding the net income. As we know the formula is
The operating income is Rs 60000 and other expenses related to taxes, interest, and debts are posted at Rs 20000. There are no additional income shown on the statement hence the net income is
You have finally arrived at your net income. Remember it is a gradual process and you have to follow all the steps in the given order.
What does negative net income mean?
When a company posts its net income as very low or shows less than it means that the expenses have exceeded the revenue figures. There can be several reasons for the negative net income like
- Decreasing sales figures
- Small customer base
- Inadequate management policies
- Excess overhead costs
You must keep track of your incomes and expenses throughout the year. Do not wait for the last minute to know about the actual figures. This will give you time to make the necessary changes if your net income starts dropping.
Better scrutinize every facet properly and instead of blame-game, take positive steps so that the company can show a healthy net income at the end of the year.
Does high net income mean high cash flow?
It is considered as an accounting metric and not a reflection of economic profit. It includes both cash and non-cash income and expenses. Net income is not a measure of only cash but income and expenses that can be both tangible and intangible.
Amortization, depreciation, brand value are such examples. Hence even if your net income is showing high figures, it does not mean that the company has a high cash flow.
Comparing Income between companies
Every company and its related industry are different.
Although the basis of calculations of net income is same, the figures vary greatly from industry to industry and company to company as one multinational company might be related to a small-scale industry or another small company might be related to an automobile sector.
If you start comparing one with another, you will not be able to gain a true and clear picture.
Net income Formula for businesses
Remember it is imperative to disclose your net income because of the following reasons-
- It is an important figure for a business entity as the details over some time like annual, monthly, and quarterly figures are posted in the profit and loss statement.
- The net income is used to analyze the success of the business venture
- Without the net income, you cannot derive the net profit margin of your company
- Net earnings are required to calculate income tax. The amount of tax a business entity pays cannot start without net income.
Conclusion
Net income is the metric that measures the profitability of a company. In simple terms, it is the total earnings less total expenses, including both tangible and intangible assets and liabilities.
An entrepreneur is interested in his net income because it will show him the financial position of his company and tell him about his actual earnings that are left after paying all the expenses.
An investor is interested in net income because it will help him to gain knowledge about the actual worth of that entity, and he can determine whether to invest in it or not.
