The bottom line on a company’s income statement is often the best way to gauge its financial health and foresee a profitable future – if any. The net income indicates whether your company is on track, and heading towards better prospects and long-term viability.
To know whether your business is making a profit or incurring loss, you need to know how much revenues you are left with after all Expenses have been paid in a given period. But do those revenues equal your profits or net income? What’s the catch when calculating net income?
See Also: Top 6 Small Business Bookkeeping Tips For Steady Financial Success
Small business owners need to know how to calculate net income in detail. We’ve outlined all the basics for you.
How To Calculate Net Income?
– Net Income Formula
In layman terms, profit is simply: Revenue minus Expenses
For business owners, it’s better understood as Net Income = Total Revenue – Total Expenses
Total Revenue is the sum of a company’s total Earnings generated from the sales of goods and services, deposits and investments, etc., and other income.
Total Expenses is the sum of all the non-production costs directly related to the operating activities of the business and includes:
- Selling, General, and Administrative Expenses (SG&A).
These constitute all operating or overhead costs, including salaries, advertising, utilities, rents, and selling expenses.
It’s the non-cash expense resulting from the deterioration of the operating fixed assets of a company over a reporting period.
- Taxes and any other expenses.
As there are direct costs involved in producing the goods sold by a company, such as the cost of the materials and labor that are directly used to create the goods, such cost of sales, called Cost of Goods Sold, is deducted from the total revenues (sales) to see how much profit, or Gross Profit, the company, made from its products’ sale. Hence, the above equation will take the following form as an initial step of the number-crunching exercise of calculating net income.
Revenue – Cost of Goods Sold – SG&A Expenses = Earnings Before depreciation, tax, and interest/EBITDA
Simplifying it further, we get
Gross Profit– SG&A Expenses = Earnings Before depreciation, tax, and interest/EBITDA
Deducting the depreciation gives us
EBITDA-Depreciation Expense= Earnings before Interest & Tax (EBIT) or Net Operating Income
Net operating income is linked to the revenue generated by the core operations and the operating expenses directly incurred to generate this revenue. It, however, doesn’t equal the Net Income. Instead, net operating income views the company’s profits from the angle of operations alone, without accounting for income and expenses that aren’t linked to business core activities. These include expenses like income tax, interest expense, and gains or losses from sales of fixed assets.
So, naturally, you might ask: how to calculate net income?
To arrive at net earnings, we deduct the non-operating expenses, that is, interest and taxes from the Net Operating Income.
Let’s work it out:
Net Operating Income-Interest= Earnings Before Tax
This finally leads to,
Earnings Before Tax- Taxes= Net Income
With the help of the above formula, you can calculate the net income of your company for any given period: annual, quarterly, or monthly. You will be earning Net Profit or Net income when your company’s gross profit exceeds your total expenses. It’s the amount of money you end up with to pay dividends, pay off debts, invest, or save for future use. If, however, your total expenses are more than your revenues or gross profit, you will end up having a net loss.
|Less: Cost of Goods sold|
|Less: selling, general and administrative expense|
|Earnings Before depreciation, tax, and interest or Net Operating Income|
|Less: Depreciation and amortization expenses|
|Earnings before Interest & Tax (EBIT)|
|Less: Interest expenses|
|Earnings before tax|
|Less: tax expenses|
|Profit after tax or Net income|
Illustration of Calculation of Net Income as it appears on an Income Statement
Let’s now learn how to calculate net income in light of some examples.
How To Calculate Net Income- Example 1:
Let’s consider an example of net profit:
Say Peter’s runs a retail store and wants to calculate its net income for the first quarter of 2021. His calculations for the net income lead to generating the following income statement as of the given period:
|Particulars||Amount in $|
|Less: Cost of Goods sold||2,00,000|
|Less: rent,utilities,payroll expense,and administrative expenses||100,000|
|Earnings Before depreciation, tax and interest (EBITDA)||2,00,000|
|Less: Depreciation and amortization expenses||20,000|
|Earnings before Interest & Tax (EBIT) or Net Operating Income||1,80,000|
|Less: Interest expenses||10,000|
|Earning before tax||1,70,000|
|Less: tax expenses||80,000|
|Profit after tax or Net income||90,000|
So, Peter’s net income for the quarter of 2021 shows a profit of $5,000
How To Calculate Net Income- Example 2:
Say you run a seafood business. Your revenues stood up at $50,000 this quarter. Is that take-home money? Not really. Your revenues represent your gross income, but not net income. Don’t forget; you need to pay your employees, buy the supplies, pay the store rent, taxes, and other operating expenses.
Let’s say you sum up all your expenses, and they come to $90,000 for this quarter. Now, what do the numbers tell you?
Net Income [-40,000] = Total Revenue [50,000] – Total Expenses [90,000]
Is your business giving you profits? The negative net income shows that you are in the red!
What does it call for? Well, you need to reassess your financials, revise your business strategy, or improve financial controls.
The Implication of Net Profit
- As discussed above, a company’s net earnings are an indicator of the profit-earning potential of the business. It acts as an essential determinant of the decisions a company takes for its operations.
- It holds great value and significance for the investors and lenders too. However, they prefer to consider operating net income rather than net income to evaluate its core business activities’ profitability.
- The net earnings become the main reference point and crucial figure for the calculation of various financial ratios. So whether it’s net profit margin or earnings per share of the company, the stakeholders closely follow the net earnings.
Turn to Monily to find your net income
You don’t need to get into the nitty-gritty of calculating the net income for your business. Finding your net income is easy if you have good bookkeeping. At Monily, you get a dedicated bookkeeper to do your books and prepare your financial statements, including the income statement every month, giving you the accurate net income of your business.
Get your financials in a hassle-free way.
See Also: How to Read and Understand the Balance Sheet
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