How Net Income Is Calculated

A company’s or business’s net income is one of the most critical line items on its Income Statement. It is a favourite figure for most stakeholders. Through net income, stakeholders can establish a company’s profitability. Similarly, companies may also use the net income figure for various purposes, such as decision-making or technical analysis.

What is Net Income?

If companies can’t generate revenues, they can’t stay in business. It is because they are crucial in keeping a company successful and running. However, even if a company generates significant revenues, it may still fail. It is because a company’s success primarily comes down to its profitability. If a company generates revenues while its expenses exceed them, it cannot be profitable.

Mostly, the success of a company comes down to its net income. A company’s net income is an indicator of its profitability. In short, it is the difference between the revenues and expenses of a company. The higher the net income of a company is, the better it is for long-term success. It is, therefore, necessary to use the net income formula to calculate the figure.

How is the Net Income of a company calculated?

The net income of a company represents the residual amount after deducting its expenses from its revenues. For profit-making businesses, the net income will always be positive. Similarly, the higher the net income of a company is, the more profitable it is. Usually, companies present their net income at the bottom of their Income Statement.

The formula to calculate the net income figure is as follows.

Net Income = Revenues – Expenses

In the above formula, revenues represent all the sales proceeds a company receives from selling its products or services. Similarly, expenses denote all those expenses incurred by a company. Usually, the net income of a company represents its profitability for a single period. Mostly, companies calculate their net income annually. However, companies may also use the above formula to calculate the net income for shorter or longer periods.

Similarly, there’s another formula used in calculating the net income of a company, as below.

Net Income = Revenues – Cost of Goods Sold – Operating Expenses – Non-operating Expenses

The above formula is an expansion of the previous one. However, through this formula, companies can also further expand the net income formula. Firstly, companies can calculate net income using their gross income.

Net income = Gross Income – Operating Expenses – Non-operating Expenses

Similarly, companies may also use the above formula to calculate net income using operating income.

Net Income = Operating Income – Non-operating Expenses

All these formulas can help the net income of a company. However, all of these formulas will produce the same result.

Example

A company, Blue Co., generated revenues of $75,000 in the previous accounting period. It had the following expenses during the year.

Expense Amount
Cost of goods sold  $  25,000
Rent  $    5,000
Utilities  $    3,000
Salaries and wages  $    8,000
Repair and maintenance  $    4,000
Interest expense  $    2,000
Taxes  $    3,000

Therefore, the company’s net income will be as follows.

Net Income = Revenues – Cost of Sales – Operating Expenses – Non-operating Expenses

Net Income = $75,000 – $25,000 – $20,000 – $5,000

Net Income = $25,000

Conclusion

A company’s revenues play a crucial role in its success. However, it is even more vital that the company’s expenses don’t exceed its revenues. It is, therefore, necessary to calculate a company’s net income to ensure that. The net income is the residual amount after deducting a company’s expenses from its revenues.

Leave a Reply