Your comprehensive guide to calculating net income
What is net income (often called “NI”), when is it relevant, and how is it calculated? Discover everything you need to know.
Summary
Sometimes called net earnings or shortened to NI, net income comes in two varieties – individual net income and business net income.
Calculating net income is calculating gross income and subtracting the relevant expenses.
NI is a vital piece of knowledge for business owners, shareholders, and investors.
A financial advisor can help you create a financial plan for the future.
What is net income?
Sometimes called net earnings or shortened to NI, net income comes in two varieties – individual net income and business net income. A person’s individual NI is how much they’ve earned after tax and other deductions in a given timeframe (usually a tax year). By reducing your gross income figure accordingly (we’ll discuss the critical differences between net and gross in more detail below), you’ll discover your net income figure.
A business’s net income figure is similar, but there are generally more deductions to subtract from the final total on top of taxes, including the following:
Administrative/operating/misc expenses
Cost of goods sold (COGS, also subtracted from a business’s gross income figure)
Interest
Raw materials
How to calculate net income
Calculating net income is calculating gross income and subtracting the relevant expenses. For an individual, this means subtracting tax and any other deductions from your pre-tax income amount. For a business, the gross income calculation is as follows:
Total revenue – COGS = Gross income
Thus, the net income calculation is either:
Total revenue – COGS – Expenses (taxes and other examples listed above) = Net income
Or, to simplify further:
Total revenue – Total expenses (including COGS) = Net income
Whether you’re a new business owner trying to calculate net income or an investor hoping to make sense of it in the context of a possible financial decision, let’s make things as straightforward as possible. Let’s create an example:
Jane owns a company that sells vegan shoes. She feels that the first quarter of 2023 went very well compared to her brand’s previous performance, and she’d now like to calculate her NI for this period and see her success on paper. The numbers are as follows:
Total revenue stands at $60,000
COGS stands at $20,000
Rent and utility expenditure for the company warehouse/office stands at $8,000
Payroll stands at $10,000
Advertising expenditure stands at $1,000
Interest stands at $1,000
Jane begins by determining gross income. She subtracts the COGS figure from the total revenue figure to reach a total gross income for Q1 2023 of $40,000. Then, Jane adds up her remaining expenses, from rent to interest, reaching a total (minus COGS) of $20,000. Thus, to calculate her NI for Q1, she will do the following sum:
$40,000 – $20,000 = $20,000 net income
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Why is net income important?
Net income is an extremely important metric, distinct from gross income. Some experts argue that net income is the figure to pay attention to over gross because it gives a more authentic, complete picture of a business’s financial health.
NI tells you how much profit is being generated rather than how much revenue is being pulled in, accounting for the many applicable company expenses. It’s a vital piece of knowledge for business owners, shareholders, investors, etc., and it can determine whether a business:
Is worthy of an investment.
Is sustainable in the long term.
Is over-spending for the amount of revenue they’re generating.
Is growing, shrinking or stagnating in terms of profitability.
Is eligible for a business loan (based on the above)
When you want to look at one figure and get a clear picture of how a company performs, that figure should be NI. That said, if you plan to start investing in a company, it definitely shouldn’t be the only figure you look at. The more research you do and the more you know, the better placed you’ll be to decide if a financial commitment is right for you.
Net income versus gross income
It’s worth touching on gross income in greater detail to comprehend the distinction fully.
Individual gross income equals a person’s pre-tax earnings in a given timeframe, including wages/salary and other income sources like pensions, dividends, and rental income. Business gross income is used interchangeably with “gross margin” or “gross profit,” and it’s calculated by subtracting COGS from the total revenue amount (in a given timeframe).
Both income calculation options (gross and net) come with advantages and disadvantages, and one will usually be helpful where the other isn’t. For instance, gross income will often be used internally within a business to determine things such as product-specific performance.
Overall, gross income indicates a company’s ability to generate revenue. In contrast, net income indicates how much of that revenue remains untouched after expenses, taxes, running costs, etc. (and thus how financially healthy a company truly is).
How does net income work for individuals?
Earnings per share for publicly traded companies are calculated using business NI. If you’re looking into a company to invest in/purchase shares, NI is a number you’ll likely pay a lot of attention to.
As you do, carefully review the figures you’re given. Some companies hide their actual expenses by utilizing specific accounting methods or artificially inflating their revenue amount to account for a poor NI figure.
In terms of individual NI, this figure can help you to do for your personal finances what you’d do for a business. It can help you determine how much your deductions are eating into your income and make it much easier to set an accurate, adequately informed budget.
How does net income work for businesses?
NI figures appear on company income statements. As mentioned above, they’re referred to by investors looking to assess how much revenue exceeds expenses within a specific organization. The better a business’s NI figures are, the more prestige it can command in the marketplace.
NI is also a useful internal metric that will flag to a business owner when someone isn’t right/an expense is eating too far into the company’s profitability.
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Senior Content Writer
Rachel is a Senior Content Writer at Unbiased. She has nearly a decade of experience writing and producing content across a range of different sectors.