Career Coach, Professional Resume Writer, Freelance Writer
Understanding your finances can be daunting even if you’re good with numbers. Your net income, in particular, is a key metric for determining how well you’re doing financially and whether your current way of operating is sustainable or not.
Depending on whether you’re looking at it from a business or personal finance perspective, there are different metrics you should be looking at to determine your net income. Where a business would be looking at its costs and expenses, an individual needs to take into account its personal deductions and tax contributions.
Either way, both approaches will give you a good idea of the disposable cash you have. It will also show you if you need to negotiate for a higher salary or come up with a different pricing strategy for your products and services.
In this article, we look at how to calculate net income, and we share a few examples both from a company and a personal finance perspective.
What is Net Income?
Net income, also referred to as net earnings or net profit, is the amount of money a business has after deducting the cost of goods sold (COGS), employees’ salaries, utility bills etc. It’s essentially the money a business has left in the bank after taking care of its outgoing expenses.
In the context of a personal net income, it’s the revenue you receive minus any deductions or taxes you have to pay. This revenue can come from a single salary in the case of a full-time employee, or it can come from multiple sources if you work several part time jobs or as a freelancer.
How to Calculate Net Income? The Formula!
Calculating net income as a business as opposed to an individual looks slightly different.
Business Net Income
As a business, you can easily calculate your net income as long as you know your revenue, COGS and expenses. Here’s how to do it:
Net Income = Revenue – COGS – Expenses
Revenue is all the money you earn from sales AND non-core business activities, such as property rental, selling off equipment or delivering ad hoc services.
COGS refers to all costs related to the production, storage and delivery of your products. Examples can be raw materials, storage and shipping expenses, factory labor etc.
Finally, expenses encompass all business expenses related to operating the business such as rent, payroll and inventory purchase.
Personal Net Income
Personal net income is similar to business net income. However, you’ll analyze personal deductions and tax contributions instead of business expenses:
Personal Net Income = Gross Revenue – Deductions – Tax
Your gross revenue is all salaries and payments you receive before taxes and deductions.
Deductions can refer to your pension contributions or healthcare insurance. Meanwhile, taxes include your local, state and federal tax payments.
Let’s look at a few examples to see how these work.
Business Net Income Example
Let’s say Sapphire Cosmetics wants to calculate its net income for Q1 of this year. They have a small shop with a staff of two where they resell cosmetics and other beauty products.
|Gross Revenue ($ earned through sales)||$32,000.00|
|Cost of Goods Sold ($ spent to buy products & pay for shipping)||$9,000.00|
|Expenses ($ rent, utility bills, and salaries for two employees)||$11,000.00|
Business Net Income Calculation: $32,000 – $9,000 – $11,000 = $12,000
If you are strictly a service-based business, like house cleaning or a marketing agency, you wouldn’t have traditional product-based COGS, but your costs might be linked to paying an hourly rate for someone to deliver the service.
Personal Net Income Example
Now let’s look at what your personal net income might look like. Let’s say that your gross pay before taxes is $56,000. Many states want to encourage citizens to put money aside for retirement, so people are able to make pension contributions before tax. Let’s say you make $5,000 in pension contributions each year.
That leaves you with $51,000 of taxable income. Here, you’d need to pay social security taxes, Medicare taxes as well as state and federal taxes. Currently, both employers and employees pay 6.2% each in social security taxes and 1.45% in Medicare taxes. The federal tax rate for an income of $56K is $4662 plus 22% of any earnings beyond $40,525. State taxes can vary, but for the purposes of this example let’s say they’re 5%.
|Gross Income (salaries and payments you get from work)||$56,000|
|Deductions (pension contributions)||$5,000|
|Taxes (social security, Medicare, state, federal)||$13,418|
Personal Net Income Calculation: $56,000 – $5,000 – ($3,162 + $739.5 + $6,966.5 + $2,550) = $37,582
This translates to a bit over $3.1K take-home salary per month.
Why Having a Clear Concept of Net Income is Crucial?
Understanding your net income is absolutely important for understanding how well you’re doing financially. As a business, you might be making millions in revenue, but if your costs and expenses are high you can be left with very little in the bank. Likewise, you might have a healthy gross pay as an individual. However, if your taxes and deductions are very high you could be left with very little money to spend.
Looking at your net income both as an individual and a business is a great way to determine what changes can improve your finances. For example, a business might realize that the COGS and expenses are too high. Then, they may need to raise their prices to stay in business. Or, an individual might decide that they need to move to a different state with lower taxes or even find a higher-paying job if they want to maintain their lifestyle.
Related: Gross Profit
Gross profit is an important metric to ensure that, as a business, you can maintain low production costs and maximize profits. The metric looks at all your revenue minus the cost of goods sold:
Gross Profit = Revenue – Costs of Goods Sold
Once you know this you can go further and calculate your gross profit margin to see how profitable you are:
Gross Profit Margin = (Revenue – COGS) / Revenue x 100
Example: Say your revenue is $60 per item, your COGS is $13.
($60 – $13) / $60 x 100 = 78.3%
Depending on the type of business you have and the industry you operate in, you can determine if that profit margin is good or if you need to tweak your prices a bit.
Gross Profit vs. Net Income
While gross profit looks at the available revenue after deducting the cost of goods sold, net income looks at the final figure which deducts the costs of goods sold as well as any other business expenses.
Both are important for understanding how well you’re performing as a business. Looking at your gross profit can give you a good idea if you perhaps need to switch suppliers for raw materials, raise prices or scale production to maximize profits. Your net income can show you if your business model is sustainable or if you’re amassing losses after you’ve paid all your expenses.
Related: Operating Net Income
Operating income takes into account the remaining income after operating expenses are taken into account.
Operating Income = Revenue – Operating Expenses
While COGS looks are the production costs for your products, operating expenses look at the ongoing expenses you have for running a business. These include salaries for your employees, investing in marketing activities, office rent etc. This figure is important to understand your monthly spending and see where you need to make adjustments.
Operating income doesn’t take into account one-off payments like lawsuit settlements, investments in other firms or tax and interest.
Whether we like it or not, how well we manage our finances can determine how successful and comfortable we’re in life. As a business, having a clear idea of your net income can give you insights into how well you’re doing and what changes you need to make to achieve your business goals.
As an individual, keeping a close eye on your net income can help you understand if you’re making enough to sustain the lifestyle you like or if you need to make some changes in order to secure your financial future.
|Business Net Income||= Revenue – COGS – Expense|
|Personal Net Income||= Gross Revenue – Deductions – Tax|
|Gross Profit||= Revenue – COGS|
|Gross Profit Margin||= (Revenue – COGS) / Revenue x 100|
|Operating Income||= Revenue – Operating Expenses|