What is net income?
Net income (profit) is one of the most important economic and financial concepts because it represents capitalism’s core or fundamental goal and the market economy. It is the financial data that is most studied and analyzed. Net income is actually the excess of total revenue over total expenses that the company realizes in a given period. In other words, net income shows us how much of the revenue is left at the disposal of companies and owners after all expenses have been deducted. It is stated in the income statement and is expressed in monetary units. This is the most essential item of this report and represents the amount that the company can use for various purposes such as:
- reserves for difficult weather,
- payment of loans and other debts,
- investments in new projects,
- payment to owners (dividend).
How to calculate net income?
The amount of net income is calculated in several stages.
- First of all, it is necessary to calculate how much money was spent on the production of goods (the value of the material is also taken into account).
- Then, calculate the calculation. Gross revenue is the result of deducting production costs from revenue (I.E., funds received by the company as a result of the sale of goods).
- Additionally, this is enough to find out the amount of net income: To calculate net income, you have to deduct mandatory deductions from gross income (taxes, etc.)
Net income formula
The point of calculating net income is to evaluate a company’s performance in creating value for its owners. Additionally, the formula for calculating net income is also simple:
Net income = Total income – Total expenses (including tax)
Calculating net income for businesses
Net income for enterprises is the amount of money earned after all expenditures have been subtracted. Expenses might include items, operating expenses, taxes, and other expenditures associated with running a firm. We may find the net income on your company’s income statement. Your company’s net income can show you how much profit it is making. You may also calculate a firm’s net income over time to show potential investors or stakeholders how well your company performs financially.
Here are the procedures to calculating your company’s net income:
Total revenue refers to all sources of money earned by your company. Also, remember that this figure does not include any deductions. Add up all of your business expenses, such as the cost of items, suppliers, and operational expenses. Subtract the entire number of costs from the total number of revenues. Your costs may be more than your overall earnings in some instances. As a result, the net income will be negative. You are generating a profit when your income exceeds your costs. Deduct any relevant taxes after calculating the difference between your company’s total income and business costs.
(Total revenue – expenses) – taxes = net income
For economists, profit is the surplus that remains to the company after all the bills have been paid. Also, profit is the entrepreneur’s reward for the risks he has taken. For more practical accountants, profit is also the difference between sales revenue and the total cost of making that sale. Net income before tax is what is left when all cash costs are deducted from sales revenue, i.e., wages and salaries, rent, fuel, raw materials, interest, and depreciation. Gross profit is the net income before tax and before interest and depreciation.
Also, gross profit refers to the amount of money remaining after deducting all production costs from income. One of the importance of gross profit is also to show how efficient the organization is in production and pricing activities. To calculate gross profit, you must subtract the cost of the goods from the amount the company received due to its application. What, in this case, is the gross profit different from the net one? And the fact that all tax and other deductions are included in the gross “included.”
In order to correctly calculate the gross profit, it is necessary to calculate the number of costs, including accurately.
Factors affecting net income
Factors affecting gross profit are: internal and external. Internal depends on the management of the company. Furthermore, they are:
- professional performance;
- improving the quality characteristics of goods;
- increase in production;
- reduction of production costs;
- rational (most efficient) application of production capacity;
- work on expanding the range;
- effective advertising campaign.
As for external factors, they cannot be influenced by them. They are:
- company location;
- ecological situation in the region;
- natural characteristics;
- business support of the state;
- the political situation in the country and the world;
- features of the economy (state and world);
- providing transportation and necessary resources.
The difference between gross and net income
1. Meaning of gross and net profit
One of the main differences between gross profit and net income is also that the two accounting conditions are defined differently. Additionally, gross profit describes the profit left by the organization after deducting all direct costs associated with the production process.
It is important to note that only those costs that are directly related to the production process are deducted.
On the other hand, net income is the residual income that an organization receives after deducting all deductions of all expenses that the organization incurs during the production period of a particular year or financial period. All direct and indirect costs must be deducted in order for the entity to make a net profit
2. Gross and net profit target
Another difference is that the two concepts of profit differ in their objectivity.
Organization management calculates gross profit to determine a rough estimate of a company’s profitability. Moreover, the entity can also calculate net income to determine the operational efficiency and ability to convert finished products into sales.
On the other hand, net income is an organization’s actual profit after deducting all costs. A company uses the net profit to determine an organization’s profitability which can sometimes be a loss. The goal of calculating net profit is to determine whether a company is profitable or not.
The third difference between gross profit and net income arises additionally from the purpose or their functions.
Besides, the organization’s accounting departments calculate gross profit to be able to understand the impact of production costs on a company’s profit. The company thus controls excess production costs to ensure that it receives maximum revenues while using minimum costs.
On the other hand, organizations calculate net income to determine a company’s performance in a particular financial year. The calculation of net profit can also be used as a strategy to determine whether an investment is worthwhile or has a shorter payback period.
4. Reliability / Real gross and net profit
Another difference that individuals need to understand is that gross profit is not a company’s real profit and should not rely on making decisions about the company’s future.
In addition to this, we calculate gross profit after deducting only production costs, ignoring other costs, taxes, and interest on loans. Besides, this means that this type of profit is not realistic.
On the other hand, net incomeis the organization’s real profit, and the organization’s management can use this type of profit to make future decisions about the development of the company. When calculating net profit, all types of cash outflows that give a true and realistic picture of the company’s performance are deducted.
5. Loan balance
The two terms are also used differently in the presentation of an organization’s credit balance.
Besides, we use the entity’s gross profit materially to present the balance on the trading account. Furthermore, this means that gross profit is the balance between the components that the organization bought and those that it sold.
On the other hand, we use the net operating profit to present the credit balance of the income statement. Net income will appear as the profit or loss of the organization, whichever is also greater between the income and total expenses of the company along with taxes and interest on loans. Moreover, this means that two types of profits appear in different financial statements.
6. Progress and profitability
Finally, gross profit and net income are different by the fact that we use the gross profit to show business progress and assess by comparing gross profit and net sales. On the other hand, net sales show a company’s profitability and can be assessed by comparing net income with net sales.
|Sales revenue |
Other operating income
|Material expenses |
|Financial income |
|Income before tax |
It is first necessary to calculate total revenues and total expenditures, furthermore:
Total revenues = Operating revenues + Financial revenues + Extraordinary revenues
= 265,000 + 2,000 + 1,000
Total expenses = Operating expenses + Financial expenses + Extraordinary expenses + Tax
= 225,000 + 5,000 + 100 + 3,790
NI = Total income – total expenses
= 268,000 – 233,890
Subtract operating expenditures from revenue produced by a property to get net operating income.
Your net monthly income is the sum of your two paychecks if you get paid twice a month. If you are paid weekly, multiply your payment by 52 to annualize it, then divide by 12 months to get your monthly net income. Multiply the paycheck amount by 26, then divide by 12 months for bi-weekly payouts.
Take gross sales revenue and deduct the cost of products sold to determine net income after taxes (NIAT). Then deduct the following: business expenditures, depreciation, interest, amortization, and taxes.
To determine a company’s net income, begin with its entire sales. Subtract the business’s expenses and operational costs from this amount to get at the company’s earnings before taxes. Subtract tax from this figure to get the NI.
Net loss is calculated as revenue minus costs equal net loss or net profit.
Companies may boost their net margins by increasing revenues by selling more goods or services or raising pricing. Companies may boost their net margins by cutting costs.
Operating income is defined as revenue minus any operating expenditures, whereas net income is defined as operating income less any additional non-operating expenses such as interest and taxes. Selling, general and administrative costs (SG&A), and depreciation and amortization are all operating income.
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