If you’re thinking of starting a small business or own a microbusiness, it’s important to know how to calculate your net income. While understanding your overall revenue can give you a good sense of where your business is going, net income helps you understand your company’s total profits.
Net income is the metric used when analyzing a company’s stock because it gives a more accurate representation of profit margins. Even if you’re not yet profitable — or haven’t even fully put your business plans into practice yet — attempting to calculate your net income can help you better understand what kind of operating income your business will need to keep the lights on and allow you to comprehend your company’s budget fully.
In this guide, we’ll take a closer look at net income and what it means for your business’s operating cash flow. Trust us, you’ll be grateful you did.
What is net income or net profit?
Net income refers to the money your company makes after subtracting any business and operating expenses, basically the “bottom line.” If you’re a freelance photographer, for instance, your net income will be the profit you make minus any expenses, such as equipment, mileage, and photography assistance. Another word for net income is net profit.
Net income is sometimes confused with gross profit, which is your company’s profit after deducting the cost of making or marketing goods — also known as the cost of goods sold (COGS) — from your revenue (but before you pay taxes). You can have a positive net income or a negative net income, depending on how well your company performed that year.
Knowing your net income or net loss can help you better understand your actual take-home pay so that you have a realistic idea of what you’re making and how much it costs to keep your business operational. This is an important figure to have, for instance, if you’re looking to potential lenders for a loan — something many early-stage small business owners pursue as they get up and running.
If nothing else, your company’s net income is also important when filing taxes, since you can claim many business expenses and costs on your federal income tax return you file with the Internal Revenue Service (IRS).
How to Calculate Net Income
You can calculate your net income by taking the total amount of revenue generated by the sale of products or services generated by your business and subtracting COGS. From there, you’ll begin subtracting business expenses (did you spend money on marketing and administration costs? office rent? travel expenses? legal fees? etc.). Once you’ve subtracted all of your business expenses, you’ll arrive at your net income.
Note that you can generate your net income for any given period you choose. If you do this calculation over a year’s time, you’ll be determining your net annual income. If done over the span of a month, you’ll be calculating your monthly net income.
If you’re early in your business journey and aren’t making money yet, you can still use figures from your business plan to calculate an anticipated net income. Just making this educated guess can help you plan for expenses and get realistic about your company’s financial goals. You can calculate your net income manually by inputting information into spreadsheets or a calculator, or you can use professional accounting software to help.
Here’s the actual formula for calculating net income when you’re ready:
Revenue – Cost of Goods Sold – Expenses = Net Profit/Net Income
Your company’s revenue refers to the amount of money your company brings in based on sales of services or products. You can find this number by totaling all of your company’s sales, paid invoices, or bank statements. Your revenue might also be referred to as your gross income, which is the amount of money you make before taxes and expenses are deducted.
Cost of Goods Sold
If your company sells products, you’ll pay an expense for ordering these products. When calculating your net income, you’ll need to deduct the cost of these goods from your revenue. You can typically find this cost on your order sheets or vendor invoices. Save those records!
Lastly, you’ll deduct your expenses. Depending on the type of company you own, these expenses can range. Typical expenses might include the cost of office space, equipment rental, employee salaries, contractor pay, insurance, administrative costs, legal retainers, software costs, and marketing expenses. You’ll also want to account for taxes in these expenses, which can be done by estimating your taxes quarterly.
Net Income Formula in Practice
To help you better understand net income and how it’s calculated, we’ll walk you through two scenarios.
Example 1: Calculating Net Income of an LLC
Jessie owns “Catskill Catering,” which is a limited liability company (LLC). She runs this business full time and needs to calculate her company’s net income to find out how profitable her business has been over the past year.
She has a chef who makes $30,000 per year and an assistant who grosses $25,000 per year. She also paid over $22,000 in supplies and groceries for the various events she’s hosted. Lastly, she’s accrued travel, software, and business expenses totaling $11,000 for the year. She has made ,000 in tax payments.
Her bank statements indicate she’s made $175,000 for the year.
To find Jessie’s net income, we’ll first add her expenses:
$30,000 + $25,000 + $22,000 + $11,000 + $45,000 = $133,000 total expenses
Next, we’ll subtract the total expenses from her total revenue or total income.
$175,000 – $133,000 = $42,000 net income
Therefore, Jessie’s company generated $42,000 of profit (after taxes) over the past year.
Example 2: Calculating the Net Income for Part-Time Freelancers
Rob has been working as a freelance editor for the past three years in addition to his full-time job as a bookstore cashier. He’s wondering if his business is generating enough income to transition to working full time and decides to review his net income.
Over the past year, Rob’s expenses include $130 for his website and hosting, $55 for editing software, $80 for invoicing software, $1,000 for a new computer and home office setup, and $4,000 in taxes.
After tallying up his invoice payments, Rob has brought in $20,500 in revenue.
To find his net income, we’ll first add up his expenses.
$130 + $55 + $80 + $1,000 + $4,000 = $5,265 total expenses
Next, we’ll subtract the total expenses from total revenue or total income.
$20,500 – $5,265 = $15,235 net income
Rob’s positive net income is $15,235 from his freelance editing business. He believes he can double this take-home revenue if he were to work full time and decides this number is high enough for him to quit his cashier job and transition to freelancing full time.
Net Income’s Bottom Line
It’s important for business owners to know their net income to determine their company’s profitability or figure out how profitable their business could be. You’ll also need your net income when reporting on your company’s income statements throughout the year as part of your business’s larger financial statements.
Net income is also important when reporting on your company’s taxable income. Deducting your expenses from the actual money your company earned is the simplest way to determine if your business is running successfully.
If you need help understanding your net earnings or net income, setting up your small business, or remaining compliant with state laws, ZenBusiness can help. We’ll work with you to ensure all administrative functions are running smoothly, so you can concentrate on growing your business.