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Net Income

Updated on January 5, 2024
Article byPrakhar Gajendrakar
Edited byAshish Kumar Srivastav
Reviewed byDheeraj Vaidya, CFA, FRM

What Is Net Income?

Net income for individuals and businesses refers to the amount of money left after subtracting direct and indirect expenses, taxes, and other deductions from their gross income. The income statement typically mentions it as the last line item, reflecting the profits made by an entity.

Net income, also known as net profit or earnings, helps people manage their finances, businesses estimate their earnings per share, and investors analyze the company’s financial status. It also represents a net growth in company shareholder equity from business activities. It differs from gross income, which merely excludes the cost of products or services sold from revenue.

Net Income

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Key Takeaways

  • Net income refers to the money remaining with individuals and businesses after deducting direct and indirect expenses and taxes from their gross income.
  • It usually appears as the last line item on an income statement, showing an entity’s earnings and helping it in financial modeling, budgeting, investments, and policymaking.
  • Investors, shareholders, and creditors examine the company’s net earnings to make investment decisions or determine its ability to pay dividends, repay loans, and repurchase stock.
  • Net profit should not be confused with gross income, which only deducts the cost of goods or services sold from revenue.

Understanding Net Income

Net income describes funds available for an individual or business to spend after paying taxes and other expensesOther ExpensesOther expenses comprise all the non-operating costs incurred for the supporting business operations. Such payments like rent, insurance and taxes have no direct connection with the mainstream business activities.read more. Whether a manufacturer or service provider, they require substantial capital to operate and earn profits. Furthermore, it has to incur lots of costs, such as office rent, employee salaries, machinery, transportation, raw materials, cost of goods and services, electricity, taxes, logistics, etc. Therefore, total earnings excluding direct or indirect costsIndirect CostsIndirect cost is the cost that cannot be directly attributed to the production. These are the necessary expenditures and can be fixed or variable in nature like the office expenses, administration, sales promotion expense, etc.read more help the firm find its net profit. The company can either keep the profits or distribute them as dividendsDividendsDividends refer to the portion of business earnings paid to the shareholders as gratitude for investing in the company’s equity.read more among its stockholders.

The business world is quite unpredictable and involves significant money and risks. Hence, investors, shareholdersShareholdersA shareholder is an individual or an institution that owns one or more shares of stock in a public or a private corporation and, therefore, are the legal owners of the company. The ownership percentage depends on the number of shares they hold against the company's total shares.read more, and creditorsCreditorsA creditor refers to a party involving an individual, institution, or the government that extends credit or lends goods, property, services, or money to another party known as a debtor. The credit made through a legal contract guarantees repayment within a specified period as mutually agreed upon by both parties. read more analyze the company’s income statementIncome StatementThe income statement is one of the company's financial reports that summarizes all of the company's revenues and expenses over time in order to determine the company's profit or loss and measure its business activity over time based on user requirements.read more to understand its net earnings, i.e., gross incomeGross IncomeThe difference between revenue and cost of goods sold is gross income, which is a profit margin made by a corporation from its operating activities. It is the amount of money an entity makes before paying non-operating expenses like interest, rent, and electricity.read more minus expenses. It allows them to make investment-related decisions or the company’s ability to pay dividends, repay loans, repurchase shares, etc.

Importance of Net Income

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For eg:
Source: Net Income (wallstreetmojo.com)

Due to time, inflation, supply chain management, smart investments, and prudent spending planning, the net earnings may increase or decrease. When comparing net income vs gross incomeNet Income Vs Gross IncomeGross income refers to the income left after deducting the cost of the goods sold from the revenue earned. In contrast, net income is the amount left as the earning after deducting all the expenses, including other expenses as dividends from the gross income.read more, the latter is the total revenue from various income sources, such as discounts, allowances, return on investment, etc.

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Sources of Income

The different sources of income that are subject to certain deductions before giving out net profit or income include:

Expenses Deducted From Net Income

The calculation of net earnings necessitates subtracting certain expenses from the gross income, including:

How to Find Net Income?

The calculation of the price of the goods takes into account all costs associated with their production. When a company sells a product or receives payment for its services, it accounts for its revenue. The net profit occurs after deducting all expenses plus taxes incurred during the process from the gross revenue. It is usually determined annually for each fiscal yearFiscal YearFiscal Year (FY) is referred to as a period lasting for twelve months and is used for budgeting, account keeping and all the other financial reporting for industries. Some of the most commonly used Fiscal Years by businesses all over the world are: 1st January to 31st December, 1st April to 31st March, 1st July to 30th June and 1st October to 30th Septemberread more and reflected on the income statement. Let us find net income for individuals and companies:

  • For individuals –

Net earnings or income = Income from various sources (gross income) – Payroll taxes – Other expenses

  • For businesses –

Net profits or income = Net sales revenue (gross income) – Cost of goods and services sold – Administration, operating, marketing, and advertising costs, taxes, interests, and other expenses

  • Another way to find net income as used by many companies is – 

Net profits or income = (Operating income + Non-operating income) – Taxes

Net Income Examples

Let us look at the following net income examples to understand the concept better:

Example #1

Jessica runs a small factory manufacturing plastic drinking water bottles. She also rents small office space for administration and contact purposes. The office houses laborers and a small staff to look after the premises, invite clients, and hold business meetings. The plant produces 20000 bottles every month. Each bottle is labeled with a $2 retail price.

Jessica earns $40,000 in sales in a month after shipping finished bottles to wholesalers, distributors, and suppliers. She has to pay expenses incurred, like raw materialsRaw MaterialsRaw materials refer to unfinished substances or unrefined natural resources used to manufacture finished goods.read more, rent, machinery, inventory, labor wages, and other general and operational costs of the office and the factory. She then pays interest on her loans, taxes and calibrates the depreciation. After all this, Jessica is left with $18,000. It will be the net profit of her business for a month.

Example #2

Tesla’s net profitability surpassed $1 billion in the second quarter of 2021. Given the hurdles the company experienced, such as supply chain disruptions, a lack of vehicle parts and energy storage items, consumer reaction in China, product recalls in the United States and China and delayed deliveries, the achievement was extraordinary. As a result, Tesla’s share prices increased by around 2% after making the earnings public.

Importance of Net Income

Net profit indicates a company’s profitabilityProfitabilityProfitability refers to a company's ability to generate revenue and maximize profit above its expenditure and operational costs. It is measured using specific ratios such as gross profit margin, EBITDA, and net profit margin. It aids investors in analyzing the company's performance.read more, making it crucial for investors and stockholders. They often take both gross and net income to understand the company’s financial stability. Here are some other reasons that make net profits so important for a business:

Frequently Asked Questions (FAQs)

How to calculate net income?

The net profit is the amount left over after all expenses and taxes have been deducted from the gross revenue. The net income formula for individuals and companies are as follows:

• For individuals –
Net earnings or income = Income from various sources (gross income) – payroll taxes – Other expenses
• For businesses –
Net profits or income = Net sales revenue (gross income) – Cost of goods and services sold – Administration, operating, marketing, and advertising costs, taxes, interests, and other expenses
• Another net income calculator used by many companies is –
Net profits or income = (Operating income + Non-operating income) – Taxes

Does net income include tax?

No. The net profit or income does not include taxes. Instead, it appears on the company’s income statement, and its calculation subtracts all types of interest, loans, credit, expenses, and taxes paid by the business. For example, state, federal, and social security taxes.

Is net income the same as gross income?

No. Net earnings or income is not confused with gross income, which is simply revenue less than the cost of products or services sold. When comparing net profit to gross revenue, the latter refers to the sum of earnings from multiple sources, such as discounts, allowances, return on investment, etc.

This has been a guide to what is Net Income and its Meaning. Here we explain how to find net income along with its sources, importance, and examples. You may learn more about our articles below on accounting –

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