What Is Net Income?

What It Is, Examples & How It Works

Net income is a primary financial measure that tells you the bottom-line profit of a company or individual after all the expenses and deductions. If you’ve ever asked yourself “what is net income” or needed a specific net income definition, this article explains the concept in detail, provides examples and answers how it works in real life.

Net income explained

Net income — sometimes referred to as net profit or the bottom line — is what’s left from revenue after costs, operating expenses, interest charges, taxes and other expenses are deducted. In layman’s terms, it answers the question: how much profit is left after paying everything necessary to operate your business and cover debts?

Why net income matters

Net income is an essential measure of companies’ financial health. For business owners, it guides decisions on reinvesting in the business or distributing dividends or hiring more people and expanding. For investors and lenders, net income indicates if a corporation is getting enough return on its revenue and expenses. A person’s version, net income, is shown on paychecks as take-home pay after taxes and withholdings.

How to calculate net income

The basic formula for net income is simple:

Net Income = Total Revenue – Total Expenses

One more detailed breakdown, often used with companies is:

Net income + Δrevenue from business/COGS/operating expenses/interest/bank fees/taxes+gains/losses

Steps to calculate:

1. Begin with total revenue: all the money produced from sales or services.
2. COGS: The direct costs associated with making products that are sold or delivered services.
3. Subtract operating expenses: selling, general and administrative expenses (SG&A), rent, utilities and salaries not included in cost of goods sold (COGS).
4. You should also take into account non-operating items: those are gains or losses resulting from investments, asset sales or one-time events.

Deduct interest and taxes: The costs of financing the business and income taxes take a bite out of what’s left to the owners.

Example 1: Simple small-business calculation

For example, let's say there is a small retailer doing $200,000 in sales over the year. The cost of goods sold amount to $120,000, operating expenses are $40,000, and interest expense is $2,000 while taxes total $6,000. Using the formula:

Net income = $200,000 – $120,000 – $40,000 – $2,000 – $6,000 = $32,000

That $32,000 is the net income — the profit available to the owner or shareholders.

Example 2: An individual’s net income

For an individual, take home pay is similar to net income. For example, consider a gross salary of $60,000 with pre-tax deductions (such as for retirement contributions and health plans) totaling $5,000, taxes withheld totaling $10,000 and other deductions that total to $1,000. Net income (take-home pay) becomes:

Net income = $60,000 − $5,000 − $10,000 − $1,000; which = $44,000

This is what the individual actually brings home after mandatory deductions.

Difference Between Net income vs gross income vs operating income

• Net income should be differentiated from related measures:
• Gross income (or gross profit for companies) is revenue less the direct cost of goods sold. This indicates how efficiently the company is producing goods or services.
• Operating income (or operating profit) also subtracts operating expenses from gross profit but not interest and taxes. It indicates the earnings potential of core business.
• Net income is after all operating and non-operating items, interest, and taxes. It is the most encompassing measure of profitability.

Typical adjustments with an impact on net income

Net income can be higher or lower than average due to several items:

• One-time gains or losses: the sale of an asset can generate a large gain or loss that has an impact on net income but is not representative of normal operating performance.
• Depreciation and amortization: Non-cash charges that reduce net income, but do not impact cash flow.
• Interest expense — High levels of debt can eat into net income via those interest payments.
• Adjustments for tax: differences in tax law or deferred tax items can move net income from one period to another

Net income and cash flow

One important caveat is that net income is not cash flow. Net income consists of non-cash items such as depreciation, and accrual accounting entries. Cash flow statements show how net income is reconciled to actual cash that a business generated or used in a period. Net income can be positive while cash flow is negative, and vice versa.

Analyzing Performance Using Net Income

There are a few ratios that investors and managers utilize, which revolve around net income:

Net profit margin = (Net income / Revenue) × 100 — indicates how much revenue is converted to profit.

EPS (Earnings per share) = Net income ÷ Number of outstanding shares — used to identify the profitability for public companies on a per-share basis

These measures allow for comparison between companies with different sizes and in different industries.

Limitations of net income

Although net income is essential, it does have some drawbacks:

• Susceptible to accounting decisions: different depreciation methods or revenue recognition processes can impact net earnings.
• No nonrecurring items: one-time events can skew net income contributions as an indicator of ongoing performance.
• Not a cash measure: net income does not always represent liquidity, as it includes non-cash charges.

Practical tips

• For investors: to get proper figures about someone’s net income check trends over multiple periods and focus on net profit margin instead of looking into a single periodली.
• For business owners: separate out regular operating results from writeoffs to see what sustainable net income would be.
• For individuals: log net income (actual earnings) to develop budgets and save.

Conclusion

Net income is a bottom-line summary of profitability after all expenses, taxes and gains or losses. Understanding what net income means, how to calculate net income, and the differences between net income and gross income and cash flow can empower you to accurately assess financial health. Consider net income in concert with other metrics and watch for accounting tweaks and one-time items that could mislead assessments of a single period.