How to Calculate Business Income From Revenue and Expenses

Calculating business income is a fundamental process for any enterprise, providing a clear picture of its financial performance. This metric helps owners understand whether their operations are generating a profit or a loss over a specific period. It serves as a guide for making informed business decisions, from pricing strategies to expense management. Understanding this calculation is also important for fulfilling tax obligations, as tax authorities base a business’s income tax on this reported figure.

Understanding Your Revenue

The first step in determining business income is to identify and total all money earned. This sum, known as gross revenue or gross sales, represents the total amount received from business activities before any reductions. For instance, a retail store’s revenue comes from product sales, while a consulting firm earns revenue from services rendered. Some businesses might also generate income from other sources, such as interest earned on bank accounts or rental income from owned property. Tracking these figures through sales records, invoices, and bank statements forms the foundation for all subsequent calculations.

Accounting for Direct Costs (Cost of Goods Sold)

After establishing gross revenue, the next step is to account for direct costs associated with producing goods or services. This is known as Cost of Goods Sold (COGS). COGS includes expenses directly tied to production, such as raw materials, wages for manufacturing labor, and related overhead costs like factory utilities. For businesses that sell physical products, COGS can be calculated using a formula: beginning inventory plus purchases made during the period, minus the ending inventory. Subtracting COGS from gross revenue yields gross profit, indicating the profitability of core operations before other overheads.

Identifying Operating Expenses

Beyond direct production costs, businesses incur other expenses necessary for daily operations. These are operating expenses, costs not directly linked to creating goods or services but essential for running the business. Common operating expenses include rent, utilities, salaries for administrative or sales staff, marketing, advertising, and business insurance. Office supplies, professional fees, and depreciation on business assets are also typical operating expenses. Subtracting these operating expenses from gross profit reveals operating income, showing profit from normal operations.

Determining Net Income

After accounting for all operating expenses, the calculation moves to determining net income, often called the “bottom line” or net profit. Net income represents the final profit remaining after all standard business costs have been deducted from revenue. This stage also incorporates non-operating income, such as interest earned on investments, and non-operating expenses, like interest paid on business loans or losses from selling assets. The formula for net income is total revenue minus Cost of Goods Sold, minus all operating expenses, plus non-operating income, and minus non-operating expenses. This figure provides a complete picture of a business’s profitability.

Adjusting for Taxable Income and Deductions

While net income provides accounting profit, taxable income is the amount on which a business’s income tax liability is calculated. Net income often requires tax adjustments, as certain deductions can reduce income subject to tax. For instance, Internal Revenue Code Section 179 allows businesses to deduct the full purchase price of qualifying equipment and software in the year of purchase, rather than depreciating it over several years. For 2025, the maximum Section 179 deduction is $1,250,000, phasing out if total equipment purchases exceed $3,130,000. Vehicles over 6,000 pounds Gross Vehicle Weight Rating (GVWR) can qualify for a deduction cap of $31,300 for 2025.

Another common deduction is for home office expenses, available to self-employed individuals who use a portion of their home exclusively and regularly for business. This can be calculated using a simplified option of $5 per square foot, up to a maximum of 300 square feet, for a maximum deduction of $1,500. Alternatively, the regular method allows deductions based on the actual percentage of the home used for business, covering mortgage interest, utilities, and depreciation.

Businesses can also deduct car expenses for business use. This can be done using either the standard mileage rate (70 cents per mile for 2025) or the actual expense method, which accounts for costs like fuel, oil, repairs, and insurance. Parking fees and tolls for business purposes are deductible under both methods. For vehicles used for both business and personal reasons, only the business portion is deductible.

Finally, the Qualified Business Income (QBI) deduction, also known as Section 199A, allows eligible self-employed individuals and owners of pass-through entities (like sole proprietorships, partnerships, and S corporations) to deduct up to 20% of their qualified business income. For 2025, the full QBI deduction generally applies if a taxpayer’s total taxable income is below $197,300 for single filers or $394,600 for joint filers. This deduction is set to expire on December 31, 2025, unless Congress extends it. These deductions reduce income subject to tax, lowering the overall tax liability.