Your business’s net income is the metric that will tell you how much you earned in a particular period (year, month, or quarter). An income statement of your financial statement will provide you with an insight into your operating income and net income.
While the operating profit is your income generated out of the primary operations of your business, the net income is a measurement that will indicate how much money you have after deducting all expenses from your income.
Many accountants confuse net income with operating and cash income, but net income is not one of them.
Let’s learn how to calculate net income from the balance sheet, its components, net income formula, and operating net income.
What is Net Income?
Net income is the profitability metric that calculates your business’s total income made during a period minus total business expenses, interest expenses, taxes, and depreciation. Your net income measures how profitable your business is.
The majority of the pre-revenue companies have negative net income (net loss) because initially, they spend and invest money in product development.
In contrast, significant revenue starts flowing into the business after some period.
Let’s study the net income formula and understand how to calculate the net income from the balance sheet.
Net Income Formula
You can calculate net income using the comprehensive method and the simplified method.
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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:
Revenue – Cost of Goods Sold – Expenses = Net Income Net income is often referred to as ‘net profit,’ or ‘net earnings,’ or many calls it ‘bottom line’ since it appears at the bottom of the income statement. You simply need to take all income you earned and deduct all expenses you incurred in a specified period for which you want to calculate your net income.
Net income is used to incur daily costs, pay off your business debts, make capital investments, and pay shareholders or retained them for future use.
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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:
Gross Income – Expenses = Net Income or, Total Income – Total Expenses = Net Income The simplified method works on the logic to deduct all expenses from the total income received for your business. It is the simplest way to measure the profitability of your startup.
Your net income can be positive or negative, and when it is 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 the calendar year 2021. He has the following details with him:
| 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:
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Net Income Calculation Using Comprehensive Formula
Revenue – Cost of Goods Sold – Expenses = Net Income 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.
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Net Income Calculation Using Simplified Formula
Gross Income – Expenses = Net Income Where, Gross Income = Revenue – Cost of Goods Sold = $85,000-$33,000 = $52,000
And Expenses = $12,000+$2,500+$5,500+$1,900+$1,100+$1,000 = $24,000
Net Income = $52,000 – $24,000 = $28,000
Key Components of Net Income
You will need certain minimum items from the balance sheet to calculate the net income of your business. Let us break down the formula and understand each component of the net income formula to calculate your net income accurately.
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Revenue:
You need to know your business’s total revenue to derive how much net income you have generated in a period. 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.
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Cost of Goods Sold
When you deduct the cost of goods sold from the revenue, you get the gross income. The cost of goods sold (COGS) refers to the expenses incurred to run your business’s main operations, such as raw material costs.
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Expenses
From the gross income, you must deduct the other expenses to derive the net income. These expenses include office rent, utility expenses, etc.
Why is Business Net Income So Important?
Apart from measuring the business profitability, your business net income will help you understand how efficiently you used your resources to generate revenue for your business.
While negative net income is unfavorable for any business, for new startup businesses, it is quite normal to have negative net income in the initial 2-3 years.
However, if it continues longer, it is an alarming signal that the business may not be successful. Hence, your business’s success lies within your income statement. Your income statement analysis will allow you to manage your expenses and put effort into increasing your net income.
What is Operating Net Income?
The operating net income refers to your business’s net income from main operations without considering the income and expenses unrelated to your main business. It requires operating revenue and operating expenses to calculate the operating net income. It is also referred to as ‘Earnings Before Interest and Taxes (EBIT)’.
Operating Net Income Formula
Since the operating net income is a net income before deducting interest and tax expenses, you can calculate it by adding these expenses to the net income:
Alternatively, your operating net income can also be derived as follows:
Operating Net Income Formula: An Example
Let’s take the same clothing retailer’s example where his interest expense is already given in the table amounting to $1,100 and his tax expense of $1,000 for that period.
In this case, his net operating income = $28,000 + $1,100 + $1,000 = $30,100.
Or, net operating income = $85,000 – $33,000 – ($24,000-$1,100-$1,000) = $30,100
Concluding Thoughts
It is quite simple to calculate the net income if you have all the necessary details. However, interpreting your net income and taking the right actions after calculating your net income makes a huge difference.
Your net income can be used to calculate multiple ratios, and these ratios can help you understand the financial performance of your business. Calculate your net income accurately and use it wisely because that will lead you to a successful business.
How Can Upmetrics Help?
At Upmetrics, we have smart solutions to help you calculate your net income and provide insightful analysis of the operating efficiency of your business. We have developed user-friendly software that will require minimal effort from you as the maximum work is done using various tools in our software.
