What is net income?
Net income, also termed as profit or income, represents a company's total profit or loss within a specific period. It's calculated by deducting a company's expenses from its total revenue, holding significance for both investors and company managers to gauge revenue generation and cost management efficiency.
How to calculate net income
Determining net income involves several steps:
- Initiate with the total revenue.
- Deduct the cost of goods sold used to generate revenue.
- Include additional income like interest earned.
- Subtract various expenses, such as employee salaries.
- Compute the company's tax liability.
- Derive the net income as the final profit after accounting for all expenses.
The formula for net income
Net income results from subtracting total expenses from total revenue. While revenue constitutes the earnings from business activities, expenses encompass operational costs like goods sold, salaries, rent, and utilities. This formula provides the net income for a given period.
Understanding gross profit vs. net income
Gross profit and net income, the primary metrics for measuring a company's profitability, differ in fundamental ways:
- Gross profit excludes operating expenses, unlike net income, which incorporates all expenses, irrespective of their relation to goods sold.
- Gross profit remains positive even with negative revenue, whereas net income is negative with negative revenue but positive with positive revenue.
- Gross profit can be negative if the cost of goods sold exceeds revenue, unlike net income, which includes all expenses and thus never reaches a negative value.
- Gross profit is consistently lower than net income because it disregards operating expenses, which are encompassed within net income calculations.