Net income or net earnings is a useful metric for both business owners and investors that allows them to gauge the revenue generated from any venture. Furthermore, it aids business owners to account for their venture’s profitability in a given period and enables investors to assess the ratio of revenue and expenses of a company much better.
The net income of an entity popularly indicates the net profit or net earnings. Typically, net earning denotes the sum of money an individual or entity accrues after taxes, and other forms of deductions are subtracted from the gross income.
It must be noted that the net income meaning for business tends to be more encompassing when compared to the individual net income. To elaborate, for business entities, net income tends to indicate the efficiency of a firm in managing its earnings and expenses. On the other hand, for individuals, net income may simply refer to their gross income minus expenses or the amount they take home.
In simple words, it is the amount left to pay company shareholders, pay off existing debts, invest in new projects, purchase new equipment or save for the future.
In a broader sense, net income is of two types, namely –
In the case of businesses, net earnings are also termed as “bottom line” owing to their positioning at the bottom of the company’s income statement. Companies that are traded publicly rely on net income to compute their earnings per share accurately.
Ideally, the net income of a firm is reported on the company’s income statement and is examined extensively by shareholders, potential investors, and lending institutions. It indicates a company’s solvency and its ability to shoulder additional financial obligations. Notably, negative or low net income may lead to a substantial drop in the valuation of a company’s shares.
Here is a list of things that are subtracted from the total revenue of a company to ascertain its net earnings –
In the case of individuals, net income equals earnings accrued in a given period minus a few specific expenses and financial obligations. In other words, the difference between one’s taxable income and income tax, among other obligations is their net income.
Usually, these following are subtracted to find out one’s net earnings –
One can easily calculate the net income of a company if they have information about the following items–
Subsequently, one must be familiar with these basic formulas to compute the same easily.
Formula 1:
Net income = Revenue – Cost of goods sold – Expenses
or,
Formula 2:
Net income = Gross income – Expenses
or,
Formula 3:
Net income = Total Revenue – Total Expenses
Net income example: This table is an excerpt of the income statement of ABCL as in the first quarter of 2018. Using the information given in the table below, calculate the net income of the company.
| Particulars | Amount (Rs.) |
| Total Revenue | 60000 |
| Cost of Goods Sold | 20000 |
| Rent | 6000 |
| Utilities | 2000 |
| Commission | 10000 |
| Advertising | 1000 |
| Interest Expense | 1000 |
As per the given information,
Net income = Gross Income – Expenses
= Rs. (40000 – 20000)
= Rs.20000
A positive net income indicates that a company has good standing in terms of its profitability. It signifies that a company is liquid and is capable enough to pay off its financial liabilities and operating expenses, among others.
Once individuals ascertain the net income of a firm, they can proceed to find out about its operating income or earnings before income tax as well.
Typically, it is expressed as –
Operating net income = Net income + Interest expense + Taxes
or,
Operating income = Gross profit – Operating expenses – Depreciation – Amortisation
The following pointers highlight the significance of net income-
Nonetheless, there are a few limitations of using the net income of a firm as a potent financial metric. To elaborate, net income can be manipulated easily, and it often fails to project a company’s financial status accurately.
For instance, a company may be struggling to keep its everyday operations running. Still, it may project a healthy net income in the financial statements if it had sold high-value machinery recently. This is why many investors and financial analysts prefer operating net income over net earnings as a metric to gain a better idea about a company’s actual profitability.
Gross income plays a vital role in determining a company’s net income. However, it is crucial that one is familiar with the differences between the two concepts to gain a better idea about their role and significance in financial statements.
Typically, gross income defines the total earnings of a business entity before expenses like taxes and deductions are accounted for. On the other hand, net income is the earnings one generates after expenses like taxes and deductions have been subtracted from total income.
The net income of a firm helps to project a robust financial image and enhances its market valuation significantly. This is why business entities must make it a point to devise measures to increase their net income and also look for ways to boost their operating income sustainably.