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Net Income: Definition, Formula, and Importance

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8 septembre 2022
Temps de lecture : 5 min
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Net Income is the amount of money the company earns within a specific period. The expenses are deducted from the money. The net income is computed as follows: revenue minus the cost of goods sold minus the expenses. It is important to know the net income of the business for the owner to know the financial condition of the company or business. That way, the company will know if its business is gaining or losing money. Knowing the net income can make the company think of solutions if its business is losing money. Thus, it may prevent the bankruptcy of the company in the long run. They can easily come up with a backup plan for the company to generate more money and prevent losing more than what they will gain. In addition to that, the financiers and investors of the company will be aware of whether the company will be able to pay their loans or if the business is worth investing in.

What is Net Income?

Net Income, sometimes called Net Profit or Net Earnings, is the term used to define the earnings that the company has gained. The expenses of the company will then be deducted from the revenue the company earned. These expenses are costs of goods sold, non-operating expenses, operating expenses, taxes, and salaries of the employees. Additionally, it includes depreciation, amortization, and equity compensation. Moreover, companies use net income to compute each share of the shareholders in the company. Typically, it can be found at the end of their income statement. When it comes to individuals, net income is the term used as well for the money an individual makes after deducting their taxes, insurance, and other expenses.

What are examples of net income?

In July 2021, a company whose business earned a net income of $5 billion. Then, the company earned $20 million in interest and $400 million worth of company assets and other income. Then, the price of manufacturing the goods is about $2 billion. Furthermore, the company paid $200 million on other operating expenses and $1 billion on other expenses. Additionally, the company loaned some money and paid $300 million in interest. Moreover, some taxes are needed to be paid that cost about $450 million. The computation of the net income of the company is what follows.

($5 billion + $20 million + $400 million) – ($2 billion + $1 billion + $200 million + $300 million + $450 million)

$5,420 billion - $3,950 billion = 1,470 billion

Another example is the net income of an individual. An individual receives a biweekly paycheck of $5,000. That individual still has to pay $350 for federal taxes, $70 in Medicare taxes, $200 in Social Security taxes, $110 in state taxes, and $100 for insurance. The computation of the net income of the individual is stated below.

$5,000 – $350 – $70 – $110 – $200 – $100 = $4,170

How to calculate net income?

Listed below are the steps on how to calculate the net income.

  1. List down the total revenue, cost of goods sold, and expenses of the company.

  2. Compute the gross income by subtracting the cost of goods sold from the profit. The cost of goods sold pertains to the materials and labor of manufacturing the product.

  3. Combine all the expenses. Rent, utilities, and advertising are a few of the expenses that the company encounters.

  4. Once the gross income and expenses have been calculated, deduct the expenses from the gross income to get the net income of the company. That is how to calculate net income.

What is the net income formula?

There are two methods of computing the net income formula, full and simplified. Below is the full net income method, wherein net income can be computed by subtracting the costs of goods sold and expenses from the total profit or revenue.

Net Income = Revenue - Cost of Goods Sold - Expenses

Below is the simplified net income method formula. The net income can be computed by subtracting the expenses from the gross income of the company or business. It is considered the simplified form because the Gross Income of a company is computed by deducting the cost of goods sold from the profit or revenue.

Net Income = Gross Income - Expenses

Is a Low Net Income Good?

Low Net Income is bad. Low net income means that the company is losing money. Their cost of expenses is greater than the amount of money they keep. It is not good for the company to have a low net income because their company will be deemed less efficient. Meaning, putting the company or business at a higher risk of failing or bankruptcy.

What is the importance of knowing net income?

Knowing the net income is important because, as a company owner, it can help keep track of the financial condition of the business. Furthermore, the financiers and investors may want to know the financial condition of the company as well. It is essential part for them to know if they will grant loan money to the company and invest in their business. Additionally, knowing the net income of a business can help indicate how much money needs to be set aside for expenses. Moreover, it is important to know how much tax is needed to be paid as well. It could mean that the higher the net income, the higher the taxes. For the competitors, the net income of a company can indicate how successful the business and company are. In that way, they would know the status of their competitors and how they will compete with them.

What is considered a good net income percentage?

A good net income percentage is about 20%. 10% net profit margin is considered average, while a 5% margin is considered low. A low net income percentage means that the company has more expenses than revenue . It means that there is a decrease in the money that has been left in the company. Thus, indicating that the company is not gaining any profit and losing more than what they gain.

Can net income come from cash from investing activities?

No, because cash from investing activities is part of the cash flow. Investing activities are part of the three main categories of Cash Flow. It is the transactions of the business’ investments in long-term assets. Typically, it is the changes in the Fixed Assets portion of the company’s statement.

Do cash flow financing activities affect net income?

No, cash flow financing activities do not affect the net income. The only two activities are Operating and Non-Operating activities. Operating activities are the activities of the company that is associated with its products and services. These include producing goods, advertising, and sales. Non-operating activities, on the other hand, are the opposite of operating activities. These are activities that are not related to the main function of the company. It includes loans, shares, capital assets, and relocation.

What is the difference between net income and cash flow?

Based on the Cash Flow Analysis, cash flow will dictate the money available in the business for it to run its operations, services, and transactions. Additionally, it will foresee if the business can pay the bills and produce enough money for it to continue its operation. There are two different kinds of cash flow namely inflows and outflows. Inflows are the money that the business gets, while outflows are the money the company spends. With that being said, based on the cash flow analysis, cash flow differs from net income.

Listed below are the differences between net income and cash flow.

  • Cash flow is the movement of the cash of the business, while net income is the end money or profit of the business

  • Cash flow is the total amount of money the business earned, while net income is the total amount of money gained minus the expenses of the business

  • Cash flow pertains to only cash items, while net income pertains to all revenue and expenses that are either cash or non-cash.

  • Cash flow determines the cash position and solvency, working capital, and management efficiency, while net income determines the profit and earnings per share.

  • Cash flow is prepared through a balance sheet and income statement, while net income is prepared through Trial Balance and accounts ledgers.

What is the difference between personal gross income and net income?

Personal Gross Income is the total amount of money an individual makes without deducting their taxes, while net income is their money minus their taxes. Additionally, the gross income of a company is computed by deducting the cost of goods sold from profit, while net income is the personal gross income minus the expenses, payments, and taxes of the company.