Following on from our accruals blog a week ago, we’re continuing with the commonly asked accounting questions blog series. This week, we’re focusing on ‘What is net income?’ and a handy step by step guide for how to calculate the net income of your business.
What Is Net Income?
In business, the net income or (NI) of a company is the total earnings made over an accounting period or financial year. Also known as net profit, the net income is calculated by taking total revenues and adjusting depending on the cost of goods sold, interest, taxes, depreciation and other expenses.
In America, you may also see the net income referred to as “the bottom line”, as it’s listed at the bottom of the income statement.
7 Step Guide for Calculating Net Income
1. Firstly, you have to find out your gross income for the last year. This is the total amount of money you make in a financial year before deducting anything else, such as taxes.
2. Secondly, you need to add up the cost of goods sold. As most businesses involve selling products, it’s important to account for what those products originally cost.
Cost of Goods Sold = Price of Each Unit x The Number of Units Sold
*Note* If your business is selling a service, please skip Step 2. This is because anything you use to provide the service falls under operating costs in Step 3.
3. Next, you have to find out the total operating costs for your business. These will vary from business to business, but some examples of common expenses are:
- Employees pay
- Depreciation on equipment
4. In addition, you have to add up any tax credits or write-offs you have.
5. Then, it’s crucial to calculate your taxable income. This is done by adding your product cost (Step 2), operating expenses (Step 3) and tax breaks (Step 4). And subtracting that number from your gross income (Step 1).
Taxable Income = Gross Income – (Product Cost + Operating Expenses + Tax Breaks)
6. Step 6 is to calculate what you owe in taxes. You can see this by looking at your taxable income (Step 5), but this number will vary depending your income, size of your business, etc.
*Note* If you currently have an accountant, it will make this step much simpler.
7. Lastly, you have to subtract your tax obligations (Step 6) from your taxable income (Step 5)
Business Net Income = (Taxable Income – Tax Obligations)