# How to Calculate Net Income: Formulas and Examples

Free Financial Statements Template

A strong business knows its numbers, but a great one leverages them.

To build a successful business and keep it successful, entrepreneurs must have a clear understanding of their financial health and operational efficiency.

This is exactly what the metrics net income helps with. It provides necessary insights about profitability, costs, and sustainability, helping the owners make informed strategic decisions for their business.

In this blog post, we’ll understand how to calculate net income by discussing formulas, components, and their importance. We’ll also understand what operational net income is with its formula.

But before that, let’s clarify the basics.

Let’s now understand how to calculate the net income from the balance sheet using a formula.

## Net Income Formula

You can calculate net income using the comprehensive method and the simplified method.

### Comprehensive Method

In this method, net income is derived by deducting the cost of goods sold (COGS) and expenses from the business’s total revenue. You can calculate the net income using the below formula:

Net Income = Revenue – Cost of Goods Sold – Expenses

Net income is often referred to as net profit, net earnings, or bottom line as it appears at the bottom of the income statement. To calculate your net income, subtract all expenses from the total revenue generated in the specified period.

Net income is used to cover daily costs, pay off your business debts, make capital investments, or distribute dividends to shareholders.

### Simplified Method

This method of calculating net income uses gross income and deducts total expenses from the same. The simplified formula for net income is listed below:

Net Income = Gross Income – Expenses
or,
Net Income = Total Income – Total Expenses

The simplified method focuses on the difference between the total income received and the total expenses incurred, making it the easiest way to measure a business’s profitability

Net income may not always be positive. Pre-revenue startups mostly have a negative net income, called a net loss.

Your net income can be positive or negative. When it’s negative, it indicates that your expenses were higher than the income you generated for your business.

Let’s understand the net income formula with the help of an example:

## Net Income Formula: An Example

Suppose a clothing retailer in Houston, Green Leaf LLC, wants to calculate his net business income for 2021. Here are the details:

Particulars Amount
Total Revenue \$85,000
Cost of Goods Sold \$33,000
Salary \$12,000
Electricity \$2,500
Office Rent \$5,500
Marketing Expenses \$1,900
Interest on Loan \$1,100
Taxes \$1,000

Let’s help the retailer in calculating his business net income using both methods:

### Net Income Calculation Using Comprehensive Formula

Net Income = Revenue – Cost of Goods Sold – Expenses

Hence, \$85,000 – \$33,000 – (\$12,000+\$2,500+\$5,500+\$1,900+\$1,100+\$1,000) = \$28,000

The net income of Green Leaf LLC is \$28,000.

### Net Income Calculation Using Simplified Formula

Net Income = Gross Income – Expenses

Now, Gross Income = Revenue – Cost of Goods Sold

Hence, \$85,000-\$33,000 = \$52,000

Expenses = \$12,000+\$2,500+\$5,500+\$1,900+\$1,100+\$1,000 = \$24,000

Net Income = Gross Income – Expenses

\$52,000 – \$24,000 = \$28,000

## Key Components of Net Income

Here are a few components you need to understand to accurately calculate your business’s net income.

### Revenue

Revenue refers to the income you generate from your business, and it will include all other revenues, such as profit from the sale of an asset.

### Cost of Goods Sold

The cost of goods sold (COGS) refers to the expenses incurred to run your business’s main operations, such as raw material costs.

### Expenses

These expenses include all the costs that are not directly tied to the production, i.e. office rent, utility expenses, etc.

## Why is Business Net Income So Important?

Apart from measuring business profitability, net income helps understand how efficiently you use the resources to generate revenue for your business.

While negative net income is unfavorable for any business, it’s quite normal for a new startup to have negative net income during the first 2-3 years.

However, if it continues longer, it’s an alarming signal that the business may not be successful.

## Operating Net Income Formula

Since the operating net income is an income before deducting interest and tax expenses, you can calculate it by adding these expenses to the net income.

Operating Net Income = Net Income + Interest + Taxes

Alternatively, the formula to calculate operating net income can also be as follows:

Operating Net Income = Revenue – Cost of Goods Sold – Expenses except for interest and Taxes

## Operating Net Income Formula: An Example

Let’s continue with our previous clothing retailer’s example.

According to the table, the interest expense during that period was \$1,100 and the retailer’s tax expense was \$1,000.

The net operating income in this case would be

\$28,000(net income) + \$1,100(interest) + \$1,000(tax) = \$30,100.

Or

Net operating income = \$85,000(revenue) – \$33,000(COGS) – (\$24,000-\$1,100-\$1,000) = \$30,100

While net income measures the overall profitability of your business, the operating net income calculates the profitability of the main operations of your business.

## Concluding Thoughts

Calculating the net income is quite easy if you have all the necessary details. However, calculation alone isn’t enough. You need to interpret your net income and take strategic actions to improve your business’s performance.

Remember, net income can be used to calculate multiple ratios which can offer insights to improve the financial performance of your business. It’s important to calculate it accurately as it forms the base for various other financial ratios.

With the Upmetrics business planning app, you can create detailed financial statements for your business and calculate essential ratios and net income in a jiffy. It’s efficient, time-saving, and eliminates the possibility of manual errors.

with step-by-step Guidance & AI Assistance.