net income formula

How to Calculate Net Income (Formula and Examples)

23/06/2022Accounting

Many of you might be wondering how to use the net income formula for calculating the accurate net income at the end of a financial year. Different types of incomes create confusion for people when they want to analyse the total worth of a business while deciding about the investment and equity shareholding in that company.

On the other hand, the financial managers also determine the net income for a specific company to analyse how much profit a company has earned during a particular year. For that reason, net income is an important part of the financial statements as it provides useful insights into the financial health and performance of a company.

In this blog, we will discuss what net income is and why it is important for the growth of a company. Moreover, we will walk you through the net income formula with the help of simple examples. So, let’s start our insightful financial discussion!

 

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What is Net Income?

Every individual or organisation earns income in return for their services. However, all of this income is spent on other goods and services. For example, an individual is liable to pay taxes, insurance contributions and other allowances.

Similarly, a company has to incur operational and non-operational costs for the management and production of goods and services. All of these expenditures are paid with the income the individuals and the firms receive.

When all of these costs and expenses are deducted from the gross income, the leftover income is known as the net income.

Net income indicates how profitable a company is and it helps the investors and lenders if they should invest or provide loans to a specific company or not.

 

What is the Net Income Formula?

The net income formula is simple to calculate. A layman or an investor can easily calculate the net income of any company by getting specific information about the gross income and the expenses of a company.

Net Income = Total Revenue – Cost of Goods Sold (COGS) – Total Expenses

It can be stated as follows

Net Income = Gross Income – Total Expenses

Where:

Gross Income = Total Revenue – Cost of Goods Sold (COGS)

Total revenue is the income obtained from the sale of goods and services.

Cost of Goods Sold is the type of cost incurred on the production of the goods and services.

The total expenses are the expenses for managing and operating the business activities.

If the net income result is positive, it means the company is earning a higher income than the expense and covering the expense smoothly. On the contrary, the negative income, also known as net loss, reflects the weak financial position of a company.

 

Example of Net Income

Let’s suppose Company A wants to calculate the net income for the first quarter of the financial year 2022. Its revenue, Cost of Goods Sold (COGS) and other expenses are as follows:

Total Revenue £ 50 000
Cost of Goods Sold (COGS) £ 10 000
Rent £ 5 000
Utilities £ 1 000
Payroll £ 5 000
Advertising £ 5 000
Interest Expense £ 1 000

Let’s calculate net income from this information for the first quarter of Company A!

First of all the company will calculate the gross income

Gross Income = Total Revenue – Cost of Goods Sold

Gross Income = £ 50 000 – £ 10 000

Gross Income = £ 40 000

Net Income = Gross Income – Total Expenses

Net Income =  £ 40 000 – (£ 5 000 + £ 1 000 + £ 5 000 + £ 5 000 + £ 1 000)

Net Income = £ 40 000 – £ 17 000

Net Income = £ 23 000

The calculation of the net income using the net income formula reflects the company is earning profits and it is in a good financial position.

 

Why is Net Income Important For Your Business?

The calculation is important for a business as it provides information about the overall health of a business. For example, a company is earning gross revenue of £100 000. At the same time, it has incurred a net loss of £ 20 000.

If someone looks at the gross revenue only, it will not provide the actual performance of a company. So, gross revenues and gross incomes do not give a complete picture of a company. Instead, you need to look at the broader picture and calculate if the company is able to pay its interest payments and the other expenses.

As a result, it is important for making key financial decisions regarding the costs and the production of goods and services. Moreover, it helps in deciding where the company needs to focus to increase the net income.

 

Bottom Line

Finally, we can say that no company can grow by ignoring the net income in the financial statement. The net income formula is easy to calculate and you need only the gross income and the expenses of a company.

On the other hand, the net income reflects the actual picture of the financial position of a company. Therefore, it is essential to calculate the total expenses and the total revenues. The revenues alone or the expenses alone do not tell us about the financial position of a company.

 

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Disclaimer: All the information provided in this article on Net Income Formula is general in nature. It does not intend to disregard any of the professional advice.


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