Knowing your company’s net income is important for financial statements and diagnosing the overall health of your business. However, knowing exactly what net income is can be confusing—especially for new business owners. Basically, net income is the number resulting from subtracting a company’s expenses from its revenue. We’ll cover how to calculate your net income, what to count as expenses, and where to report net income in this article.
How to Calculate Net Income
Net income is a straightforward calculation: add up your company’s revenue and subtract total expenses. (Revenue is the total amount of money your business generates over a defined period of time.) The amount left over is your net income—either a net profit if your revenue exceeds expenses, or a net loss if your expenses outpace your sales.
In order to calculate your net income, you first need to add up your total expenses, which will include:
- Cost of goods sold. The direct cost of manufacturing goods or acquiring goods to resell—including labor wages, the cost of raw materials, freight and storage costs.
- Operating costs. The overhead expenses of operating your business—like rent, administrative pay, insurance, marketing and equipment purchases.
- Taxes, debts and interest.
- Non-cash items like equipment depreciation, resource depletion and stock-based compensation.
Once you’ve added up your total expenses, you’ll subtract that number from your revenue.
Here’s an example. Rick’s screenprinting business earns $115,000 in sales revenue in a year. His cost of goods sold is $5,000 for t-shirts, $1,500 for inks, adhesives and other supplies, and $15,000 paid to a part-time assistant. That puts his total costs of goods sold at $21,500.
His operating expenses are the $24,000 he paid in rent for his shop, $7,000 for insurance, and $1,750 for advertising in local newspapers, totaling $32,750.
Lastly, he had $14,500 in debt and interest, and owed $9,000 in taxes for the previous year—so his remaining expenses came to $23,500.
That means Rick’s total expenses this year are $77,750 ($21,500 + $32,750 + $23,500 = $77,750).
Subtracting his expenses from his $115,000 in revenue leaves him with a net income of $37,250, a net profit.
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What is my net profit margin?
Net profit margin is the percentage of revenue remaining after total expenses. It’s a useful figure, because it can illustrate how much profit is generated from every dollar earned in sales. To calculate your net profit margin, divide your net income by your revenue, then multiply that by 100.
In our example above, Rick’s screenprinting business has $37,250 in net income, against $115,000 in revenue. That means Rick’s net profit margin is a little over 32% (37,250 ÷ 115,000 = 0.3239, 0.32 × 100 = 32.39), and his business earns 32 cents in profit for every dollar it generates in sales.
What’s the difference between net income and gross income?
Net income is a business’s revenue minus total expenses, while gross income is revenue minus only the cost of goods sold. Gross income is helpful for determining how much a company’s production and labor costs subtract from its profits. On the other hand, net income, by including any additional expenses or revenue from sources other than the manufacture and sale of goods, is a good way to see how well a management team runs a company and how profitable the company is overall.
Where to Report Net Income
Net income is reported on certain tax returns. It is also recorded in your company’s financial statements.
Net income on tax returns
Pass-through businesses (like sole proprietorships, partnerships, LLCs with default tax status, and businesses that elect S-corp status) don’t pay income tax directly. The profits or losses pass through the business and are reported as income on the individual tax returns of the business owners. You’ll need to report net income on Schedule C (profit or loss from business) and Schedule 1 (additional income and adjustments to income) of Form 1040, and partnerships will also report net income on Form 1065 (return of partnership income).
Net income on financial statements
Your business will report financial statements to creditors and investors, and statements are sometimes audited by government agencies for accuracy.
There are several financial statements a business may use—such as income statements, balance sheets, and cash flow statements—but net income is primarily relevant for your company’s income statement. Income statements report company profits and losses over a period of time—usually monthly, quarterly or annually.
An income statement should include this information:
- Revenue
- Cost of goods sold
- Gross income
- Itemized list of operating costs and other expenses
- Net profit or loss