The Basics: What Is Net Income And How Do You Calculate It?
What is the difference between gross income and net income? If you have wondered before and are perhaps even curious to find out how to find net income, then you have come to the right place!
In the most basic terms, net income — whether in your business or your personal paycheck — is what is leftover after all deductions, but how exactly do we calculate it?
Finding out that amount can be tricky if you don’t know how. So we will share how individuals and businesses can understand their net income, and we will also mention various types of expenses and deductions that they have to consider.
What Is Net Income?
So what exactly is net income? Net income usually refers to a person’s income, after removing any taxes and deductions from the equation. However, it also relates to operations in businesses. Gross income, on the other hand, is what a company or individual earns in total. The net income is, therefore, any profit made.
All the additional expenses are considered, and this makes net income the money leftover after everything else has been deducted. If, after the subtraction, there is still a profit, then it’s a net income. It the leftover result is a negative amount, then the net income is a loss.
Gross Income Vs Net Income
There are two important terms that you may have come across when getting paid, or when working on behalf of your business. These are gross income and net income.
When referring to an individual’s total labor earnings, or a business’s sales, the term ‘gross income’ is usually used. This equals the full amount of money that has been earned without having anything taken away from it, such as tax, net income, and other things.
Net income, on the other hand, is any profit made from sales where total expenses are removed. With regards to individuals, gross income refers to your standard salary amount, and net income refers to the amount you take home on your paycheck.
Example:
If your salary is $100K per year, that is your gross income.
After the government and other things take 33% what is left is your net income.
(Although that net income number probably looks gross to you, because seeing that you lose 33% of your income for taxes and such is disgusting. Finance jokes!)
Being able to understand the contrast between each is very useful to keep on top of how much money is coming in and how well you are performing, and if perhaps saving some cash would be a good idea.
For businesses, gross income figures can help understand how well the company generates revenue in a given year, and at the same time net income can allow them to see how all the expenses contribute. If net income is too high, then this allows for costs to be cut and will enable businesses to see precisely where it might need to be done.
How To Find Net Income
We will now take a look at how to actually calculate net income, both for an individual and for businesses.
Calculating Net Income for Individuals
When referring to an individual’s earnings after deductions and taxes have been removed, it is seen as net income. In order to calculate taxable income, taxpayers should therefore simply subtract any deductions from their gross income. The variation between taxable income and income tax is, therefore, the individual’s net income amount.
Calculating Net Income for Businesses
If instead, you want to calculate net income on behalf of a company, simply start with the company’s total revenue. From the total revenue, minus the business’s total operating costs and expenses (like employee training, office expenses, healthcare, insurance etc), calculate the businesses earnings before taxation. Finally, deduct tax from this amount to reveal the business’s final net income.
When subtracting certain expenses, it usually involves more than the basic costs relating to the product itself. Selling expenses incorporating all expenses required for the labor in selling the product, are also taken into consideration. This includes things like employee benefits and wages, any travel expenses, and costs related to the business’s office, which are also subtracted from the entire revenue. Anything extra spent on things like marketing, advertising, events, and client expenses are also subtracted.
Only after such expenses are removed, can the business receive a good indication of how profitable they really are. This is because it allows them to see if the final profit amounts to more than they spend on the company itself.
Of course, like many other accounting measures, net income is susceptible to some manipulation, perhaps through hiding any expenses, or aggressive revenue recognition.
When it comes to basing an important investment decision on net income alone, it’s crucial to review the numbers the company has used to arrive at the taxable and net income, in order to make sure it’s entirely correct.
Tax Returns and Net Income
In some places, people are required to submit a form, such as Form 1040, to report their annual earnings, usually to the IRS. This form, however, does not include a line for net income and instead has lines mentioning gross income, adjusted gross income and taxable income.
Therefore, after making a note of their various gross incomes, individuals subtract specific income sources, including benefits from social security, and qualifying deductions such as student loan interest. The difference is their AGI which taxpayers deduct itemized deductions from in order to find out their taxable income.
If not made clear previously, the difference between taxable income and income tax is the individual’s ‘net income’.
Final Say
So there you have it! We genuinely hope our article on how to find net income has been helpful to you and that hopefully now you will understand how to calculate it for yourself, or on behalf of the business you work for, or even run yourself.