What Is the Formula for Determining Net Income?

Net income is a measure of a company’s profitability, reflecting its financial success over a specific period. It indicates how much money a business has earned after accounting for all its costs. This figure is a key financial indicator for understanding a company’s performance.

Understanding Income Statement Components

Revenue, often called sales, represents the total income a business generates from selling its goods or services. Directly related to revenue is the cost of goods sold (COGS), which includes the direct costs of producing goods or services. These direct costs encompass raw materials, direct labor, and manufacturing overhead.

Subtracting COGS from revenue yields gross profit, which indicates the profitability of a company’s core operations. Following gross profit are operating expenses, sometimes called SG&A expenses. These are the indirect costs required to run the business, such as salaries, rent, utilities, and marketing expenses, which are not directly tied to production. When operating expenses are subtracted from gross profit, the result is operating income, showing the profitability of a company’s primary business activities.

Beyond core operations, businesses may have non-operating income and expenses. These include items not directly related to the main business activities, such as interest earned from investments or interest paid on loans. Income tax expense represents the amount of tax a company owes on its taxable income. This expense is calculated based on the company’s earnings before taxes.

The Net Income Calculation

The calculation of net income systematically subtracts all expenses from a company’s total revenue, revealing the “bottom line” profit. This process follows several key steps.

First, cost of goods sold is subtracted from revenue to arrive at gross profit. From gross profit, operating expenses are deducted to determine operating income. Non-operating income is added, and non-operating expenses are subtracted to yield earnings before tax (EBT). Finally, income tax expense is subtracted from EBT to arrive at net income.

For example, a business with $500,000 in revenue and $150,000 in cost of goods sold yields a gross profit of $350,000. With operating expenses of $100,000, operating income is $250,000. Adding $10,000 in non-operating income and subtracting $5,000 in non-operating expenses results in earnings before tax of $255,000. After deducting an income tax expense of $55,000, the net income is $200,000.

Interpreting Net Income

Net income signifies the profit a business has generated after all revenues and expenses have been accounted for. This figure is often called the “bottom line” as it is the last line item on an income statement. A positive net income indicates a company earned more revenue than its total expenses. Conversely, a negative net income, or net loss, means expenses exceeded revenues during the period.

Net income provides insight into a company’s financial health and operational efficiency. It reflects how effectively management has controlled costs and generated revenue. Stakeholders use net income to assess performance and make informed decisions.

Investors analyze net income to evaluate profitability and potential returns. Management uses it to assess business performance and guide strategic decisions. Lenders and creditors also consider net income when evaluating a company’s ability to repay debts.