What is net income?
Net income refers to the amount an individual or business makes after deducting costs, allowances and taxes.
In commerce, net income is what the business has left over after all expenses, including salary and wages, cost of goods or raw material and taxes. For an individual, net income is the “take-home” money after deductions for taxes, health insurance and retirement contributions. Net income should ideally be greater than the expenditure to be indicative of financial health.
How to calculate net income
To calculate net income, take the gross income — the total amount of money earned — then subtract expenses, such as taxes and interest payments.
For the individual, net income is the money you actually get from your paycheck each month rather than the gross amount you get paid before payroll deductions. You may have some other sources of income such as Social Security checks, side jobs or investment income which can add to your net income.
Example of net income
Here are examples of net income for both a business and an individual.
Net income of a business
To understand the net income of a business, let’s look at Coca-Cola. The company, like all publicly traded companies in the U.S., regularly reports its revenues and expenses to the SEC four times per year.
For the three months ended April 2, 2021, Coca-Cola reported $9.02 billion in revenue. It also earned $66 million in interest and $417 million in equity and other income. The company spent $3.505 billion on the cost of goods sold, which includes raw material and direct labor costs, $2.669 billion on general and administrative expenses, $124 million on other operating expenses, $442 million on interest payments and $508 million on taxes.
Overall, this brings Coca-Cola’s net income to $2.255 billion. Here’s the math:
( $9.02 billion + $66 million + $417 million ) – ( $3.505 billion + $2.669 billion + $124 million + $442 million + $508 million ) = $2.255 billion
Net income of an individual
As for an individual’s income, imagine that Jane receives a biweekly paycheck with gross pay of $3,350. She pays $272.51 in federal taxes, $46.61 in Medicare taxes, $193.31 in Social Security taxes, $102.48 in state taxes, and $125 for insurance. This leaves her with a net income of:
$3,350 – $272.51 – $46.61 – $193.31 – $102.48 – $125 = $2,610.09 every paycheck or $67,862.34 per year
Why understanding net income is important
Understanding net income is important because it helps clarify how much can be spent on living expenses as well as discretionary spending.
Here’s a business example. Let’s say a business reports a gross revenue of $2 billion per month. That may seem like a relatively healthy business that may be worth investing in. But if the company reports a net loss of $200 million, you’ll likely have a very different view of the financial health and viability of the business.
For an individual, net income is important because it’s the number an individual should think about when spending and building a budget. Someone who gets a new job earning $4,000 each month might only have $3,000 (or less) to spend after taxes and other payroll deductions. If they spend $4,000 each month, they’ll find themselves in a deep financial hole very quickly. If they look at net income instead and make sure budgeted spending is below their net income, they could instead start saving money for the future.
Learn more:
Net income serves as a pivotal metric in both personal finance and business accounting. In essence, it represents the final earnings after deducting all expenses, allowances, and taxes. For businesses, it's a critical indicator of financial performance, and for individuals, it's what remains after various deductions from their earnings.
Let's break down the concepts referenced in the article:
Gross Income
Definition: Gross income refers to the total earnings or revenue before any deductions or expenses are taken out. Relation to Net Income: Net income is derived from gross income by subtracting expenses such as taxes, operating costs, and other deductions.
Gross vs. Net Income
Difference: Gross income is the total revenue earned, whereas net income reflects the earnings after subtracting all expenses, taxes, and deductions. Significance: Understanding this contrast is vital as it signifies the difference between total revenue and actual earnings after costs, providing a clear financial picture.
Taxes
In the Context: Both businesses and individuals have taxes that need to be deducted from their earnings or revenue. Impact: Taxes reduce the overall income, affecting net income significantly. Different tax types, like federal, state, Social Security, and Medicare, are applicable to individuals.
Calculation of Net Income
Formula: Net Income = Gross Income - Expenses (such as taxes, interest payments, cost of goods sold, etc.) Importance: Calculating net income provides a precise understanding of profitability for businesses or the actual take-home pay for individuals.
Importance of Understanding Net Income
Business Perspective: Net income is crucial for assessing a company's financial health. A positive net income indicates profitability, while a negative one signifies losses. Individual Perspective: For personal finance, understanding net income is essential in creating budgets and making financial decisions. It's the amount available for living expenses and discretionary spending after deductions.
Taxes Due
Significance: Taxes are crucial for both businesses and individuals. Businesses have specific tax liabilities, while individuals have to pay federal, state, Social Security, and Medicare taxes based on their earnings. Timing: Tax deadlines vary, with individuals usually facing yearly deadlines (April 15 in the U.S.) and businesses following different schedules based on their structure.
Understanding these concepts is pivotal in making informed financial decisions, whether it's managing personal finances or evaluating the performance and health of a business.
