Net income is the total profit a business makes in a given reporting period after all of its expenses are paid. It’s often referred to as a company’s “bottom line” because it appears at the bottom line of the income statement.
Read on for a closer look at what net income is, how to calculate net income, the pros and cons of using net income as a performance gauge, plus an example that includes routine business expenses.
Key Points
• Net income is a company’s total profit — what’s left after adding up all revenue and subtracting all expenses, including taxes.
• Net income is a key profitability metric for analysts, investors, and lenders.
• It appears on the income statement, and affects equity on the balance sheet.
• While net income includes all expenses (for a complete financial picture), it may not reflect actual cash flow.
• Net income is less useful than EBITDA for comparing the profitability of companies across an industry.
What Is Net Income?
Net income (NI) is defined as the total amount of money a business makes during a reporting period after deducting all costs, allowances, and taxes.
Also referred to as “net profit” or “net earnings,” net income is calculated by taking the company’s total sales and subtracting the cost of goods sold (COGS); selling, general and administrative (SG&A) expenses; operating expenses (OPEX); interest on debt (such as small business financing); taxes; and other expenses. In other words, it is a measurement of profit after a business has covered all of its costs.
Net income appears on the bottom line of a company’s income statement.
What Is Net Income Used for?
Net income is a measure of a company’s profitability. It tells you exactly how much money a company has left over after subtracting all costs from total revenue that can be invested back into the business, distributed to shareholders, or saved for a future use.
Overall, a company’s profit (or lack thereof) determines its future operations. Therefore, net income can determine whether a company:
• Needs to restructure
• Is able to pay its current and future liabilities
• Needs access to alternative capital (such as debt or equity financing)
• Should consider expanding its operations for further growth
Lenders will also look at a company’s net income when deciding whether to approve or deny a company for a loan, such as business term loan or equipment financing. While assets and credit scores are important, lenders also want to see whether a company has enough profit to pay upon its debts.
Pros and Cons of Using Net Income as a Metric
| Pros | Cons |
|---|---|
| Includes all company expenses | Can suggest a company is or is not doing well, even though that may not be the case |
| Accepted by GAAP | Not useful for comparing the profitability of two different companies with different capital structures |
| Needed for multiple financial statements | Doesn’t reflect actual cash flow |
Pros
One of the biggest benefits of using net income as a performance metric is that it includes all of a company’s expenses. Because of this, it provides a complete picture of how much a company is making vs. how much it is spending.
Another plus is that net income is recognized under the Generally Accepted Accounting Principles (GAAP), which means companies don’t have much flexibility when it comes to calculating and interpreting net income. All publicly traded companies must report financial results that meet GAAP.
In addition, net income is a central line item to all three of a firm’s primary financial statements — the income statement, balance sheet, and cash flow statements.
Cons
One drawback of net income is that it can be misleading. A company with a low net income may actually be doing well. If it made a large asset purchase or decided to expand, for example, those types of expenses would temporarily drive down its net income.
Also, because net income includes variable deductions like interest on business financing and taxes, it’s not particularly useful for comparing a company’s financial performance across an industry. EBITDA (earnings before interest, taxes, depreciation, and amortization) is generally a better way to determine a firm’s operational efficacy or an appropriate profit level.
In addition, net income doesn’t reveal a company’s actual flow, since there may be a delay between making sales and collecting on those sales.
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Calculating Net Income
Before you can calculate net income, it’s important to understand the following terms.
• Revenue: Total amount of money a company brings in from its business operations
• Cost of Goods Sold (COGS): All costs associated with the manufacturing of a product or delivery of a service. Examples include:
◦ Factory labor
◦ Freight costs
◦ Production parts
◦ Raw materials
◦ Storage costs
• Gross income: Revenue minus COGS
• Operating expenses (OPEX): All costs associated with the day-to-day running of a business not related to COGS. Examples include:
◦ Office supplies
◦ Payroll
◦ Property taxes
◦ Rent
◦ Repairs
◦ Travel
◦ Utilities
To calculate net income for a business, you start with a company’s total revenue, then subtract the business’s COGS and OPEX to calculate the company’s earnings before tax. You then deduct tax from this amount to find the net income.
Net Income Formula
There are three different formulas for net income, which are all slight variations on the same equation: income minus expenses equals net income.
Option 1:
Total Revenue – COGS – Operating Expenses = Net Income
Option 2:
Total Revenue – Total Expenses = Net Income
Option 3:
Gross Income – Expenses = Net Income
Net Income vs Gross Income
Net income is how much a company makes (or nets) after all expenses are paid. Gross income, on the other hand, is how much money a company makes from its sales after accounting for COGS. The difference between the two is that gross income does not include operating expenses, interest, or taxes, whereas net income does.
Net Income Calculation Example
Let’s say Company ABC wants to calculate its net income for the first quarter of this year. Here are the numbers Company ABC is working with:
Total revenue: $300,000
COGS: $100,000
OPEX: $15,000
Interest Expense: $10,000
Taxes: $60,000
Net Income = $300,000- $100,000- $15,000- $10,000- $60,000
Net Income = $115,000
Net Income vs Cash Flow
When comparing a company’s cash flow vs. profit, the numbers can differ dramatically.
One reason is that there is typically a time gap between documented sales and actual payments. Another factor is that net income includes a variety of non-cash expenses, such as depreciation/amortization and stock-based compensation. These are real expenses and reduce a company’s earnings. However, they don’t actually affect its bank account.
Net Income vs Operating Net Income
Operating net income is similar to net income, but there are a few key differences.
Unlike net income, operating net income looks at a company’s profits from operations alone without accounting for income and expenses that aren’t related to the company’s core activities. So unlike net income, operating net income does not include income tax, interest expenses, interest income, or gains or losses from sales of fixed assets.
Sometimes referred to as EBIT (earnings before interest and taxes), the formula for operating net income is:
Net Income + Interest Expense + Taxes = Operating Net Income
How Net Income Is Used on a Balance Sheet
Once you’ve calculated your company’s net income, you can use that figure to start creating your balance sheet.
The balance sheet reports a business’s assets, liabilities, and equity at a specific point in time. It is divided into two main sections: assets on one side and liabilities and equity on the other side. The two sides must balance out, meaning they should be equal to one another.
Net income affects how much equity a business reports on the balance sheet. It appears in the retained earnings line item of the balance sheet.
The Takeaway
Net income is the amount of money a business has left over after all revenue and expenses are accounted for. Unlike gross income, it also includes interest, taxes, non-cash expenses, as well as non-recurring revenue and expenses.
Net income is a key metric of profitability used by analysts, investors, and lenders.
If you’re seeking financing for your business, SoFi is here to support you. On SoFi’s marketplace, you can shop and compare financing options for your business in minutes.
FAQ
How are net income and gross income different?
Net income takes total revenue and subtracts all expenses a business may have, which include the cost of goods sold (COGS), operating expenses (OPEX), taxes, interest on debt, and non-cash expenses. Gross income, on the other hand, takes total revenues and only subtracts COGS.
Are profit and net income the same thing?
Yes. Both profit and net income refer to the amount of money that a business has left over after expenses have been paid.
What is the formula for net income?
The formula for net income is:
Total Revenue – Total Expenses = Net income
Can you find net income without revenue?
No. The formula for net income starts with total revenue. It’s possible, however, for that number to be zero in the event that the company did not make any sales.
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