How to use the net income formula for a business
Anyone who has seen taxes deducted from their paycheck knows that you don’t get to keep all of the income you earn, even if you’re a business owner. Companies must buy raw materials and equipment, pay employees, and often take out loans in order to make sales in the first place. After you subtract these business expenses from your total revenue, known as gross income, you’re left with net income, a truer measure of profitability.
In this article, we’ll give you multiple ways to find your company’s net income: the net income formula, the simplified versions, and the operating income formula. You’ll also learn how to calculate net profit margin and understand your business’ bottom line.
What is net income?
Net income is the amount of profit a company has left after paying all of its expenses. These expenses might be directly related to operations, like rent and utility bills, or indirectly related, like loan repayments.
Net income is also referred to as net earnings, net profit, or a business’ “bottom line.” That last expression emerged because net income is usually the final line of a company's income statement, one of the three standard financial statements. (The other two are the balance sheet and the cash flow statement.)
While net income resides at the bottom of the income statement, gross income resides at the top, so it’s known as the company’s “top line.” Gross income, or total revenue, represents all the money a company receives during a given period.
Revenue doesn’t just refer to product or service sales. Like many companies, you may have other revenue streams like stock dividends, rent income, or asset sales. All of this combined adds up to total revenue.
To calculate net income, you’ll need to tally up all your business costs and deduct them from your total revenue. It’s time to use the net income formula.
How to calculate net income
Business owners have to understand and anticipate what they’ll really be left with—a profit or loss—after everything is accounted for. Luckily, figuring out a company’s net income is fairly straightforward. If you’re already tracking your expenses digitally and practicing diligent business accounting, it’s even easier.
What you need for the net income formula
Before you can start calculating, it may be helpful to review what’s included in an income statement because it’s what you’ll use to calculate net income. You need to have the following financial figures on hand:
- Revenue: The income received by your company, including product or service sales, interest earnings, stock dividends, asset sales, rent income, etc.
- Cost of Goods Sold (COGS): The cost of creating or developing the goods or services you successfully sold, including materials, labor, factory overhead, credit card processing fees, etc.
- Operating Expenses: The cost of operating your business, including payroll, rent and utilities, banking fees, equipment, advertising, fulfillment, and any non-recurring expenses.
- Other Expenses: Any other expenses not mentioned, including interest payments on credit cards or loans, personal or business income taxes, amortization, and depreciation.
3 options for your net income formula
Here is the full version of the net income formula:
Net Income = Revenue – Cost of Goods Sold (COGS) – Expenses
The first section of the formula, revenue minus COGS, is actually the formula for gross income. So a simplified version of this formula is:
Net Income = Gross Income – Expenses
And you can simplify that formula even further:
Net Income = Total Revenue – Total Expenses
It’s possible to have a positive net income (a net profit) or a negative net income (a net loss). Use these formulas to assess your current financial condition, compare past business periods, or even project future revenues.
It’s also useful to know how well your company is doing strictly from an operations perspective — minus the gains or losses from things like investments and assets. The operating net income formula is the answer.
Operating net income formula
Operating net income only takes into account income and expenses related to operations, your core business activities. The idea is to separate the revenue you make from your service or product from your other financial activities. Operating income is often called EBIT, or “Earnings Before Interest and Taxes.”
Here is the most common operating net income formula:
Operating Net Income = Gross Profit – Operating Expenses – Depreciation – Amortization
The distinction between net income and operating income is an important one. For instance, a company could have an unprofitable subscription service and be struggling to stay afloat. But if the company sells off high-value property, it could appear to have a net profit. The company’s operating net income, however, would reveal their true financial standing.
An example using the net income formula
Let’s put the net income formula into practice. Imagine that the founders of “Zender,” a smart watch company, are calculating their net income for 2020. They also want to determine if they have funds to hire two more software developers with $90,000 salaries.
Here are Zender’s financials:
2020 Fiscal Year
- Sales: $2,100,000
- Asset sales: $100,000
Cost of Goods Sold: $980,000
- Raw materials: $275,000
- Equipment costs: $325,000
- Labor costs: $180,000
- Packaging and shipping: $200,000
- Rent: $30,000
- Utilities: $9,000
- Payroll: $750,000
- Supplies: $40,000
- Advertising: $200,000
- Interest expenses: $10,000
They plug those figures into the net income formula:
Net Income = Revenue – Cost of Goods Sold (COGS) – Expenses
Net Income = $2,200,000 – $980,000 – $1,039,000
Net income = $181,000
Zender’s net income for the 2020 fiscal year is $181,000. As you can see, they have just enough cash to hire two developers for a total of $180,000, but can’t invest in other areas of their business. With this data, they’re able to course-correct and scale back their hiring plans.
You don’t have to run these numbers by hand and leave yourself prone to risky manual data errors. You can use accounting software, Excel, or a net income calculator. But with a Brex account, you can skip the hassle altogether. Simply generate a profit and loss statement, and other financial reports, in a few clicks.
Net income vs. cash flow
Although cash flow is a key metric for a healthy business, it’s not the same thing as net income. Net income is the profit a company has earned after all expenses have been deducted. Cash flow, on the other hand, represents the money flowing in and out of a company on a daily basis.
Net income can also include non-cash income and expenses like stock dividends and depreciation. As a result, it’s not a proper indicator of a company’s cash flow.
How to find net profit margin
Once you’ve calculated your net income, you can easily figure out your company’s net profit margin. Net profit margin goes to the heart of a company’s profitability. While net income tells you the amount of money you have left after expenditures, net profit margin can reveal how well you’re turning sales into profit.
Net profit margin is expressed as a percentage. Generally, the higher the profit margin, the better. High margins signal that a company is pricing its products well and controlling costs. That said, some industries naturally have high margins, like jewelry, or low margins, like grocery stores.
To calculate your margin, you can use one of two net profit margin formulas:
Net Profit Margin = (Net Income ÷ Net Sales) × 100
Or, you can use:
Net Profit Margin = (Net Income ÷ Revenue) × 100
Let’s go back to Zender as our example. Their 2020 net profit was $181,000 and their sales revenue (not including their asset sale) was $2,100,000.
Net Profit Margin = ($181,000 ÷ $2,100,000) × 100
Net Profit Margin = (.086) x 100
Net Profit Margin = 8.6%
Zender’s net profit margin is 8.6%.
What’s a good net profit margin?
This is the million-dollar question for entrepreneurs, investors, and lenders. The fact is that net profit margins vary widely by industry. A U.S. report on profit margins by sector showed that the average net margin is 7.71%. And the blended net profit margin for the S&P 500 was 10.7% in Q4 of 2019.
But examining each industry paints a much clearer picture. For instance, Electronics had a –3.14% net profit margin while Restaurant/Dining was at 10.57%. Soft Beverage companies had a 18.5% profit margin while Recreation was at 1.15%.
As you can see, across-the-board comparisons don’t offer much value. If you want to gauge your company’s profit margin against others, it’s best to analyze competitors in your vertical.
The real bottom line
To recap, gross income is a company’s total revenue while net income is total revenue minus business expenses. Of the two, net income is the more accurate representation of a company’s financial health. It’s a comprehensive look at all the money earned and costs incurred by your business, down to every last revenue source and expense.
There are several different net income formulas you can utilize, including the operating income formula. With your net profit numbers, you can also determine your profit margin. Margins vary greatly by industry but offer valuable insight into a company’s product pricing, profitability, and cost control.
All together, these calculations help you build a better financial infrastructure, discover areas for improvement, and boost your bottom line.