How to calculate Net Income (NI): formula and guide

Have you ever wondered if your business is profitable?

And do you know how to figure it out?

You can’t assume your business is profitable just from revenue, since every operation comes with costs like taxes, software subscriptions, and wages.

To fully understand business profitability, you need to calculate net income.

Net income is what remains after subtracting all expenses.

This number matters, and not just for your peace of mind.

It’s the ultimate scorecard for your business’s financial health, which you can use to make informed decisions, prove your value to investors, and help you plan for growth.

This article will walk you through the concept of net income.

We’ll cover what it means, why it matters, where it lives on your income statement, and most importantly, how to calculate it.

Get ready to make smarter financial decisions for your business.

Here’s what we’ll cover

What is net income (NI)?

Net income (NI) is the profit remaining after covering all expenses, such as operational costs, cost of goods sold (COGS), taxes, and labor.

Think of it as what’s left after paying all your business bills.

Net income is also referred to as net profit, net earnings, or simply the “bottom line”.

If your total revenue from sales is higher than your expenses, you have a positive net income.

However, if your expenses are more than your revenue, you’re running at a loss. In other words, your business spends more than it earns.

Net income reflects how much revenue your business generates and how much you can count as pure profit.

You can calculate this using a net income calculator or formula.

Lucky for you, the net income equation is fairly straightforward.

How to calculate net income

The net income formula is the simplest way to calculate net income for a given period.

Make sure your revenue, expenses and other variables are accurate before getting started.

The basic formula for calculating net income is:

Total Revenue – Cost of Goods Sold – Expenses = Net Income

Another, simpler way of expressing the net income formula is:

Total Revenue – Total Expenses = Net Income

Before we continue, let’s get some basic definitions out of the way: 

• Total revenue: The total amount of money your business brings in from selling your products or services over a certain period.
• Cost of goods sold (COGS): Direct costs associated with producing or acquiring the goods and services (this might include raw materials or manufacturing costs, or the cost of purchasing inventory). Cost of goods sold is an expense.
• Total expenses: This is the sum of the amount spent to run your business. Operating and other expenses include things like payroll, rent, utilities, office supplies, taxes, and bank fees.
• Gross income: Gross income, also known as gross margin or gross profit, is your total income from all sources. Minus COGS, but before deducting any operating expenses and taxes.

Net income formula example

To better understand how the net income formula works, let’s go through a quick example using both formulas. 

Imagine you run a retail store that brings in $500,000 in total revenue for the year.

Your COGS for the same year is $200,000.

Your operating expenses like rent, employee salaries, utilities, and supplies add up to $160,000.

On top of that, you pay $11,000 in taxes and $9,000 in interest.

Here’s how you’d calculate the store’s net income using the formula.

Total Revenue – Cost of Goods Sold – Expenses = Net Income

Total Revenue = $500,000 

Cost of Goods Sold (COGS) = $200,000

Gross income = $300,000

Expenses = ($160,000 + $11,000 + $9,000) = $180,000

Net Income =  $500,000 – $200,000 – $180,000 = $120,000

Total Revenue – Total Expenses = Net Income

Using the second net income formula (Total Revenue – Total Expenses = Net Income), you would calculate it as follows:

Total Revenue = $500,000

Expenses = ($200,000 + $180,000) = $380,000

Net Income = $500,000 – $380,000 = $120,000

Net income for the year under review will be $120,000.

This is the amount your business has made after subtracting all expenses.  

Where is net income shown on an income statement?

The income statement (a ledger showing money in versus money out) starts with total revenue at the top and then works its way down, subtracting expenses in each category.

After all the calculations, you end up with net income at the bottom. Hence, the expression: “bottom line”

This layout gives you and your stakeholders a clear view of how revenue turns into profit, showing exactly where every expense chips away at the final net income figure.

How to calculate net income from the balance sheet

Net income usually doesn’t appear directly on the balance sheet.

The balance sheet is more about showing what your business owns (assets), owes (liabilities), and what’s left for the owners (equity), at a certain point in time.

Net income, on the other hand, tracks your profits over a period and is typically found on the income statement.

But don’t worry, you can still calculate net income using balance sheet information.

Although the best way to calculate NI is by using your income statement, you can still use this method when the income statement isn’t available. Here’s how you can do it:

1. Find your retained earnings: This sits in the equity section of your balance sheet and shows the cumulative profits your business has made over time, minus any dividends paid out to shareholders.
2. Calculate the change in retained earnings: Compare the beginning and ending retained earnings for the period. The difference will tell you how much net income has been added to your business.
3. Account for dividends paid: If your business paid dividends during the period, add that back to the retained earnings difference. Why? Because dividends come out of net income, so adding them back gives you the true profit for the period.

The resulting formula looks like this:

Ending Retained Earnings – Beginning Retained Earnings + Dividends Paid = Net Income

Here’s an example to put it in perspective:

Suppose you started the year with $300,000 in retained earnings.

Had $450,000 at the end of the year.

During that period, you also handed out $50,000 in dividends.

$450,000 – $300,000 + $50,000 = $200,000

Based on the figures on your balance sheet, your net income for the year is $200,000.

What’s the difference between net income and gross income?

Net income and gross income are both important profitability metrics, but they measure different aspects of a business’s financial performance.

In simple terms, gross income (also known as gross profit or gross margin) is the total money you make from selling goods or services, before subtracting other expenses.

It’s calculated by deducting the direct costs of producing goods or of providing services (COGS), from total revenue

Gross Income = Total Revenue – Cost of Goods Sold (COGS)

For instance: Say, your total revenue is $500,000 and your COGS is $200,000, then your gross income would be $300,000.

Gross income matters because it shows how much money you’re making from core business activities before expenses like taxes and interest.

It’s a key measure of how profitable and efficient your business is, and it helps you calculate other important numbers, like net income and taxes.

Net income? That’s the “take-home” cash, the amount you actually get to keep after all the bills are paid.

It’s what’s left after subtracting all costs from gross income, including operating expenses, interest, taxes, and any other costs (but before subtracting dividends).

Net income gives you the full picture of how profitable your business is and it helps stakeholders gauge the long-term viability of your company.

What’s the difference between net income and operating income?

Net income and operating income are both crucial for understanding your business’s financial health.

But when it comes to financial analysis, they give you insight into different things.

Operating income, also called EBIT (Earnings Before Interest and Taxes), shows the profit you make from your core business activities, before factoring in taxes and interest.

It’s calculated by subtracting operating expenses from gross income.

Operating Income = Gross Income – Operating Expenses

For example, if your business generates $500,000 in revenue, has $200,000 in COGS and $150,000 in operating expenses, your operating income would be $150,000.

Operating income is useful because it lets you evaluate the profitability of your day-to-day operations without the noise of taxes and interest, giving you a clearer view of how well your core business is performing.

Net income, as we mentioned earlier, is your business’s total profitability.

It includes operating income but also factors in non-operating expenses like taxes, interest, and any one-time costs or gains.

So, it’s the measure of how much money you actually made after everything is accounted for.

What’s the difference between net income and EBIT and EBITDA?

Net income, EBIT (Earnings Before Interest and Taxes), and EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) are all important profitability metrics, but they each give you different insights into your business’s performance.

EBIT focuses on the profit generated from your core business activities, excluding the impact of interest and taxes.

This gives you a clearer picture of how efficiently your business is operating without factoring in how it’s financed or taxed.

EBIT = Revenue – (COGS + Operating Expenses) 

Alternatively, you can calculate EBIT by adding interest and taxes back to net income:

EBIT = Net Income + Interest + Taxes

For example: If your business has a net income of $120,000, interest expenses of $10,000, and taxes of $20,000, your EBIT would be $150,000.

EBIT is especially useful for comparing profitability across companies with different tax rates and financing structures because it focuses on operating income only.

EBITDA takes it a step further by also excluding non-cash expenses like depreciation and amortization.

By removing these non-cash charges, EBITDA gives you an even more accurate look at a company’s operational cash flow, particularly in industries with large capital investments that lead to significant depreciation.

EBITDA = Revenue – (COGS + Operating Expenses + Non-Cash Expenses)

Or, you can calculate it by adding depreciation and amortization to EBIT:

EBITDA = EBIT + Depreciation + Amortization

Say your business has an EBIT of $150,000 and $30,000 in depreciation and amortization.

Your EBITDA would be $180,000.

Investors and analysts will often use this metric to compare a company’s cash flow from operations, especially when businesses have different asset bases and depreciation rates.

Net income provides the best picture of profitability because it includes all expenses.

Operating, non-operating, taxes, interest, and even one-time costs or gains, so it reflects the true bottom line.

Net Income = EBIT – (Interest + Taxes)

Why is net income an important measurement of financial health?

Net income is one of the most important ways to gauge how healthy your business is financially.

Here’s why it matters:

Comprehensive profit picture

Unlike gross or operating income, net income includes every cost: operational, financial, and tax-related.

This gives you the full picture of your profitability, showing exactly how much you’re making after all expenses are covered.

Shows resource management

Net income measures how much money you’re bringing in and also how well you’re managing resources.

A strong net income means your business is balancing revenue with expenses and keeping non-operating costs like taxes and interest in check, and making the most of operational spending.

Decision-making power

Net income helps guide your decisions, whether it’s reinvesting in growth, expanding operations, or entering new markets.

Plus, a healthy net income is a good sign to investors, showing that your business has a stable financial position and strong returns.

Valuation insight

Net income is often used in business valuations, especially for calculations like price-to-earnings (P/E) ratios.

Buyers, investors, and lenders look at net income to understand how much cash flow your business generates after all costs.

A higher net income leads to a higher business valuation, making it easier to secure loans or attract buyers.

Track performance over time

Analyzing your net income year-over-year helps you spot patterns, identify profitable and lean periods, and adjust your strategies accordingly.

It’s an essential tool for understanding where you stand financially and knowing when to make changes.

Compliance and reporting

Net income is a critical number for compliance and financial reporting.

It’s reported on the income statement, which means it’s necessary for keeping up with legal and regulatory standards.

Financial health cornerstone

Ultimately, net income is a touchstone of financial health that tells you how much profit is left after all expenses.

It acts as a guide for profitability, growth potential, and big-picture business decisions.

Keeping an eye on net income is especially important if your business is in expansion mode or if you’re looking to attract investors.

What are the limitations of net income?

Like every metric, net income has its limitations.

Here are some of the realities for business owners to keep in mind:

Net income doesn’t equal cash flow

Net income is a handy benchmark for determining “How is my business doing?”, but it doesn’t always reflect the actual cash moving in and out of your business.

Because net income follows accrual accounting, it records revenue and expenses when they’re earned or incurred, not when the cash is actually received or paid.

For example, if you make a sale on credit, the revenue shows up in your net income right away, even though you won’t receive payment until the following month.

So, while your net income looks higher for the period, your cash balance stays the same until the payment hits your bank account.

On top of that, net income includes non-cash items like depreciation and amortization, which affect profitability on paper, but don’t touch your actual cash flow.

That’s a big deal because if your cash flow isn’t in good shape, you could have a high net income but still struggle to pay your bills.

The lesson there is, cash (flow) is king. Without it, even a profitable business can run into trouble.

It doesn’t capture all expenses

Net income doesn’t always paint a full picture of business expenses.

This is because some costs, like future liabilities, might not show up in your net income until they’re confirmed.

For example, contingent liabilities such as potential legal fees from an ongoing lawsuit can arise and affect your financial performance, but they’re not recorded until they become certain.

When certain expenses are left out, your business might look more profitable than it actually is.

It’s important to remember that not all costs are accounted for in net income, so you will want to dig a bit deeper to make sure you have a complete picture.

Subject to accounting assumptions

Net income can be heavily influenced by accounting rules and assumptions, and that’s something you need to keep in mind.

Different accounting methods like how you handle depreciation, when you recognize expenses, or how you value inventory can change your net income.

For example, accelerated depreciation spreads costs over a shorter period, which is better for industries with assets that lose value quickly.

On the other hand, straight-line depreciation spreads costs evenly, which works for businesses with long-lasting assets.

Inventory valuation methods, such as First-In, First-Out (FIFO) and Last-In, First-Out (LIFO), can also affect your COGS and net income.

During inflation, LIFO generally results in higher COGS and lower net income, but as it’s not allowed under International Financial Reporting Standards (IFRS), it can make comparing your numbers a bit complicated.

And let’s not forget about revenue recognition, whether you recognize revenue when it’s earned or when it’s received, can impact your perceived profitability.

For medium-sized businesses, failing to understand these factors could lead to misconceptions about your financial health.

What you see in your net income might not be the full story, as it’s dependent on the accounting assumptions driving those numbers.

Can be influenced by one-time items

Net income can be affected by one-off events that don’t represent your business’s normal operations.

Sometimes you might see a big spike in net income due to a one-time gain, like selling an asset.

While that boosts your numbers for the year, it doesn’t reflect how well your company is running day-to-day.

On the flip side, if you pay a large restructuring charge, it could lower net income in that period, but that charge might be necessary for long-term growth.

To get a clearer picture of ongoing performance, many businesses turn to adjusted net income or non-GAAP earnings, which exclude these one-time items and focus only on regular operations.

Doesn’t indicate operational efficiency alone

Net income alone doesn’t tell you how efficiently your business is running.

If you want to evaluate that, metrics like gross income, operating income, or EBITDA are more useful because they focus on your core business operations without the distraction of taxes, interest, or accounting adjustments.

Take control of your finances with accurate net income tracking

Calculating your net income will help you know how your business is doing.

It shows you whether you’re turning a profit, keeping expenses in check, and staying on track with your financial goals.

Knowing how to calculate net profit gives you control, but keeping it accurate and consistent can feel like a lot of work.

That’s where we step in. Sage accounting software takes the guesswork out of your financials by handling calculations, tracking expenses, and generating financial statements automatically.

By automating the process, you’ll make better decisions and free up time to focus on growing your business.

With Sage, managing your finances becomes simple, so you can scale with confidence.

FAQ

Does net income include taxes?

Net income does not include taxes.

Net income is the profit remaining after all expenses, including taxes, have been deducted from total revenue.

Is net profit the same as net income?

Yes, they are the same.

While “net income” is commonly used in financial statements, “net profit” is used interchangeably in business discussions to describe the same concept.