Net income is a company’s total profits after subtracting all business expenses incurred. Some people call it net earnings, net profit, or the company’s bottom line. It is the total amount of money you have left over to distribute to shareholders, invest in new company projects or buy equipment, pay off debts, or save for future use.
The formula for net income is:
Net Income = Revenue – CGS – Expenses
In the first part of the formula for net income, the formula for calculating gross income is revenue minus cost of goods sold (CGS).
But we can still calculate net income, in another way, which is:
Net Income = Gross income – Expenses
Or we can also simplify the formula for easy understanding, we express it as:
Net Income = Total Revenues – Total Expenses
Net income can either be positive or negative depending on your company's performance in the period under review. You have a positive net income if your company's revenues are greater than expenses. On the other hand, if your total expenses are greater than your revenues, then you have a negative net income, also called net loss.
Through any of the formulas written above, you can learn your company’s net profit for any given period: annually, quarterly, monthly or weekly—whichever time frame works well for your business, However, I suggest monthly if you are a small business owner. This will enable you track your expenses so you can cut it when necessary.
How too calculate net income: an example
Let’s say OnyemaDonald's supermarket wants to calculate its net profit for the second quarter of 2020. Below are the numbers he is working with:
- Total revenues: $60,000
- Cost of goods sold (COGS): $20,000
- Rent: $6,000
- Utilities: $2,000
- Payroll: $10,000
- Other expenses: $1,000
- Interest expense: $1,000
Firstly, Donald can calculate his gross income by subtracting Cost of goods sold (COGS) from the total revenues:
Therefore, Gross income = $60,000 - $20,000 = $40,000
Next, Donald adds up all his expenses for the quarter.
Total Expenses = $6,000 + $2,000 + $10,000 + $1,000 + $1,000 = $20,000
Lastly, Donald can calculate his net income by subtracting expenses from gross income:
Net income = $40,000 - $20,000 = $20,000
Operating net income formula
Operating net income is another useful income number to track in your business. It is similar to net income, the difference is that operating net income looks at a company’s profits from operations alone, without considering income and expenses that are not related to the core business activities. This includes things like income tax, interest expense, interest income, and gains or losses from sales of fixed assets, etc. It is also called EBIT, which means “earnings before interest and taxes.”
The formula for operating net income is:
Operating Net Income = Net Income + Interest Expense + Taxes
Or, put another way of calculating it as:
Operating Income = Gross Profit – Operating Expenses – Depreciation – Amortization
Investors and lenders prefer to check operating net income and not net income. This gives them a better understanding of the profitability of the company’s core business activities.
For instance, a company might be running at loss on its core operations. But if the company sells a valuable piece of machinery, the gain from that sale will be added to the company’s net income. That gain might make it look like the company is doing well, when in fact, they’re struggling to stay afloat.
Operating net income takes the profit out of consideration, so users of the financial statements can get a clearer view of the company’s profitability.
Operating net income formula: an example
Let’s return to OnyemaDonald's supermarket. If Donald wants to calculate his operating net income for the second quarter of 2020, he can simply add back the interest expense to his net income.
$20,000 net income + $1,000 of interest expense = $21,000 operating net income
Net income is very easy to calculate with a good bookkeeping system. In this case, you likely already have an income statement that shows your net income.