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Learning how to read a financial statement is a bit like learning a new language. There are several terms you need to know, and they all have very specific purposes.
If you accidentally use the wrong term, you can get yourself into some trouble. This is doubly true if you’re the accounting manager putting together your company’s financials.
For those just hoping to understand what is being said in these financial statements, “net income” is an important term to know, and we’ll guide you through the specifics.
What is Net Income?
Net income is also called “net earnings,” depending on who you talk to. This is the company’s actual profit after it pays for all of the expenses involved in running the company.
Understanding Net Income
Net income can be a bit tricky depending on how a company makes its money. At least one term on a financial statement can be easily confused with net income.
That being said, understanding net income might help understand where it falls in the hierarchy of financials.
To better understand net income, it might help to start with knowing exactly how to calculate it.
How to Calculate Net Income
Calculating net income is surprisingly easy. One must first start by finding the net revenue, which is the company’s gross money less any discounts on products.
From net revenue, you simply subtract out any and all expenses, including the cost of buying materials, cost of equipment, wages and benefits paid to employees, taxes, general and administrative costs, operating expenses, and anything else that is money paid out by the company to run the business.
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Why is Net Income Important?
Financial statements are made up of numbers. These numbers are a bit like the colors that make up the whole picture.
While one number by itself doesn’t paint much of a picture (depending on who you talk to), net income is one of the most important figures.
Looking at the net income will tell investors how much money the company is making that can be paid out to said investors or reinvested back into the company to keep growing.
If you see a company reporting a $500 million net income, this is obviously a very good thing.
Companies also report negative income, which is typical of a newer startup. These companies are usually doing research and development and may take time to report positive net income.
However, investors compare net income reported in past statements and will generally view any less-negative net income as a good thing, potentially propping up that company’s stock price.
However, to better understand what this means, you need to look further and compare it to other numbers in the statement, such as gross income.
>> More: What Is Operating Revenue?
Gross Income vs. Net Income
As we mentioned, the financial terms need to be just right, or you may paint the wrong picture of a company’s financial health. One of the easiest mistakes to make is confusing gross income and net income.
Gross income is not the same as gross revenue. An easy way to think about it is to use the terms “income” and “profit” interchangeably. Gross income might also be called gross margin.
So, gross income is the gross profit, and all profit implies that something has to be subtracted. In this case, gross income is the money made for selling products less the costs of goods sold.
This will tell investors how much a company is spending on actually producing its products.
If, for example, an iPhone sells for $1,000, but it costs Apple $999 to actually make and distribute, this is not a good business plan (it is also made up – Apple’s margins are significantly better than that).
On the other hand, net income is not as close to gross income as you might imagine.
It is derived from the net revenue of the company, including all income sources such as interest received, capital gains (unless it’s a real estate company), etc., whereas gross income is related to profits on specific goods.
Net income is also calculated by subtracting all costs and expenses the company pays out, whereas gross income is only calculated by subtracting the costs associated with building, producing, and distributing the goods.
>> More: Gross Profit vs. Net Income
Net Income FAQs
What is meant by net income?
Net income is the profit a company makes. It can also be called net profit, and it can be positive or negative.
While negative profit isn’t exactly good, it should be compared with the company’s age and what they are trying to do in the near future before deciding it is bad news.
>> More: Earnings vs. Revenue
What is the formula for net income?
Net Income = (Net Revenue – operating expenses – overhead – interest payments) – income tax paid
What is net income for dummies?
Net income is the gross profit after subtracting expenses. A company makes money by selling goods or services.
It costs money for the company to pay for everything they need to make those goods or offer those services.
To be a profitable company, they need to sell more goods or services than they spend on making goods or selling services.
You get the net income or net profit when you subtract all expenses from the total amount of money made.
What is the difference between gross and net income?
Gross income is just the amount of profit made just on selling goods or services, whereas net income is the bottom-line profit the company made on everything it does.
Bottom Line: Net Income Definition
Net income is an important metric for any investor to understand. It’s worth taking a bit of time to understand net income and how it compares with gross income because you might get the wrong idea if you confuse the two.
By subtracting all the expenses, a company pays to do business from the total amount of money the company makes, you will arrive at the net income.
