For small business owners, understanding your numbers is vital. While there are several important metrics you can track, perhaps one of the most important numbers to pay attention to is net income.
What is net income?
Net income is the amount of profit your company has left over after paying all expenses.
The formula for calculating net income is:
Total revenues – total expenses = net income
In this equation, total revenue is the total amount earned from sales of products or services, as well as income from other sources, such as interest and gains or losses from sales of fixed assets. Total expenses include the cost of goods sold, operating expenses, depreciation and amortization, interest expense, taxes, and other costs. The cost of goods sold can be calculated by using the following formula: beginning inventory plus purchases minus ending inventory equals the cost of goods sold.
People often refer to net income as “the bottom line" because it appears at the bottom of an income statement. It may also be called “net profit" or “net earnings." Whatever term you use, they all refer to a company's profits that remain after subtracting business expenses from revenues.
When your net income is negative, it's called a net loss.
Why is net income important?
Net income is an important business metric because it represents the money left over that you can distribute to shareholders, invest back into the business, or save for future use.
Net income helps determine:
- Whether your business appeals to investors. Investors look at a company's net income when deciding whether to invest in the company. A company with a history of consistent net income is appealing to investors because they know they're more likely to receive a return on their investment.
- Whether you can get a small business loan. Banks and other lenders look at a company's net income when deciding whether they should approve a business loan or line of credit. Lenders are more willing to extend credit to companies with high net income because the company is more likely to pay the loan back.
- Whether your business is sustainable. Many small businesses generate net losses initially. But eventually, your business will need to generate revenues and control expenses to survive in the long term. Tracking your net income can help you understand whether you're charging enough for your products and services to cover the costs of running the business.
Net income vs. cash flow
It's also important for business owners to understand the difference between net income and cash flow. While net income represents a company's profits during the accounting period, cash flow represents the amount of cash that comes in or goes out of the business over the period.
It's possible to have a positive net income but have a negative cash flow. This can happen if you use the accrual accounting method and sell your products or services on credit.
For example, say you have sales of $100,000 during January and expenses of $75,000. Your net income for the month is $25,000. However, you only received $50,000 in cash from those sales in January. Your customers will pay the remaining $50,000 in February. Although your net income is positive, you have negative cash flow because $75,000 in cash went out to pay expenses while only $50,000 in cash came in from January's sales.
For that reason, lenders, investors and other stakeholders usually look at net income on your company's Profit & Loss Statement in tandem with your Statement of Cash Flows. The Statement of Cash Flows provides a picture of your business's actual cash position in addition to its profitability.
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FAQs
Net income refers to the amount an individual or business makes after deducting costs, allowances and taxes. In commerce, net income is what the business has left over after all expenses, including salary and wages, cost of goods or raw material and taxes.
What is my net income? ›
Calculating net income is pretty simple. Just take your gross income—which is the total amount of money you've earned—and subtract deductions, such as taxes, insurance and retirement contributions.
Is net income before or after taxes? ›
Is Net Income Before Taxes or After? Net income is what a business or individual makes after taxes, deductions, and other expenses are taken out, In business, net income is what a company has left after all expenses are subtracted, including taxes, wages, and the cost of goods.
Is net income your paycheck? ›
Gross pay is what employees earn before taxes, benefits and other payroll deductions are withheld from their wages. The amount remaining after all withholdings are accounted for is net pay or take-home pay.
Is net income good or bad? ›
Net income is one of the first things that investors and financial institutions will look at. Good net income indicates that a company is financially stable, with enough money left over to pay their bills. It also provides good insight into whether a company is likely to remain successful.
Is net income real money? ›
Net income is often called the bottom-line profit. It's what remains after business expenses are pulled away from gross income. Expenses you'll subtract include the cost of goods sold, as well as advertising, rent, utilities, wages, taxes, and other fees.
Is net income before gross? ›
Definition: Net income is the profit your business earns after expenses and allowable deductions. How to calculate: To calculate net income, take your gross income and subtract all of your business expenses—marketing or advertising costs, travel or office expenses, tax payments, etc.
What's the difference between gross and net income? ›
Essentially, net income is your gross income minus taxes and other paycheck deductions. It's what you take home on payday. To calculate it, begin with your gross income or the amount you earn from all taxable wages, tips and any income you make from investments, like interest and dividends.
How much taxes are taken out of a $1200 paycheck? ›
However , on average , approximately 22 % of a $ 1200 paycheck would be deducted for taxes , which amounts to $ 264 . This includes federal income tax , state income tax , and FICA taxes ( Social Security and Medicare ) .
Why is my net pay so low? ›
Different factors impact your net pay, such as your tax filing status, the number of dependents, federal and state income taxes withheld, as well as Social Security and Medicare taxes. Various deductions, such as for retirement, health insurance and a flexible spending account (FSAs) will also reduce your net pay.
First, to find your annual pay, multiply your hourly wage by the number of hours you work each week and then multiply the total by 52. Now that you know your annual gross income, divide it by 12 to find the monthly amount.
What does the net income represent? ›
Net income represents a company's overall profitability after all expenses and costs have been deducted from total revenue. Net income also includes any other types of income that a company earns, such as interest income from investments or income received from the sale of an asset.
What is another word for net income? ›
Definition. Net income can be distributed among holders of common stock as a dividend or held by the firm as an addition to retained earnings. As profit and earnings are used synonymously for income (also depending on UK and US usage), net earnings and net profit are commonly found as synonyms for net income.
What is the difference between net and gross profit? ›
A business's gross profit is the money it has left after paying for the goods and services it sold. Its net profit is the money left after paying absolutely all expenses and taxes.
