How To Calculate Net Income: Definition and Formulas

By Indeed Editorial Team

Updated September 28, 2022

Published September 25, 2020

The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.

Whether starting or maintaining a business, learning about net income can help organizations understand profits and losses and help plan for future changes. Small businesses and self-employed individuals can project their earnings by learning how to gather those numbers and examine them appropriately.

In this article, we explain how to calculate net income and operating net income, show why net income is vital for a business and include examples.

Key takeaways:

  • Net income is important for organizations to understand their general costs.

  • A business can make responsible financial decisions in its best interest by knowing its net income.

  • The net income formula measures the total income over total costs.\

Net income formula

The net income formula deducts total costs from all earnings. Costs go into subcategories like the expense of merchandise sold, working fees, interest and taxes. All incomes and all expenses enter this equation. The basic formula for calculating net income is:

Net income = total revenues − total expenses

Total revenue is the total amount of money an organization or individual earns. In contrast, total expenses are the money an organization or individual pays to other organizations or individuals. The net income formula measures the total income over total costs, which helps financial specialists, lenders and executives determine how effective the organization was in creating a profit.

Related: Calculating Net Income for Businesses and Individuals (With Formulas)

How to calculate take-home pay

Employers withhold funds for federal and state income taxes from your paycheck. The amount by which your income reduces from your earned pay depends on several factors, including:

  • Income amount

  • Number of dependents

  • Filing status

  • Health care plan

  • 401(k) investments

  • Health savings account

  • Flexible savings account

Below are steps you can use to calculate take-home pay:

1. Determine your gross pay

To calculate your take-home pay, figure out your gross yearly pay. Multiply your monthly salary by 12. For example, an employee receives $7,000 per month in gross pay from their employer. Here's the simple calculation they can do: 

$7,000 x 12 months = $84,000

They determine their annual gross income is $84,000.

Related: Operating Income, Net Income and Net Operating Income: Definitions

2. Calculate deductions

Next, determine the amount you owe in state and federal taxes. The most accurate way to calculate is by visiting the federal IRS site and using their Tax withholding estimator tool. By plugging in your annual salary and location, you can estimate how much your take-home pay is, at least before optional deductions such as healthcare, 401(k) and flexible savings. You determine these amounts by referencing your human resources department.

How to calculate operating net income

Operating net income, or earnings before interest and taxes (EBIT), is very similar to net income, but it prioritizes company profits from operations over any income or expenses not directly related to the business. Here's the standard formula for calculating operating net income:

Operating net income = gross profit − operating expenses − depreciation − amortization

Below are steps you can use to calculate operating net income:

1. Calculate or find gross profit

Gross profit for an organization is any money it earns before it calculates deductions. You can find this value by looking at the accounting statements for an organization or adding its sources of revenue and other income together. This value is important because it can help you gauge the amount of funding an organization uses compared to what it earns.

Related: Gross Pay vs. Net Pay: Definitions and Examples

2. Calculate or find operating expenses

Operating expenses are items an organization pays to continue its regular operations. These expenses can include rent, machinery upkeep and regular wages to professionals. This is often one of the largest expenses an organization experiences. Like gross profit, you can often find this value on the accounting statements of an organization.

3. Calculate or find depreciation

Depreciation is the amount by which an organization's assets decrease in value. This amount can differ depending on the organization, industry and assets themselves. For example, a machine may depreciate more or less because of how frequently an organization uses it.

4. Calculate or find amortization

Amortization is how an organization writes off the initial cost of an asset. This differs from depreciation because it accounts only for the initial cost and not the amount by which the asset loses value. You can typically find this value in accounting statements.

Why net income is important

Net income is essential because it exhibits the accomplishments of a business. It's important to be aware of the net profit because it allows companies to determine where they can reinvest or make more deals for the organization. It also gives companies an understanding of what funds are accessible. Net income is important for these reasons:

It encourages businesses to understand their general costs

Net income is important for organizations to understand their general costs. It helps businesses and individuals calculate the amount of taxes paid. Banks and creditors use a company's net income to determine the loan it may need. This is a good gauge of the ability to pay back the loan.

Having a good sense of net income also helps reduce overhead. For example, understanding a budget would allow for savings that would benefit the savings on utilities, salaries and other expenses. It can also help negotiate better prices with suppliers which can help boost sales volumes and increase profit.

Related: Everything You Need To Know About Income Statements

It helps businesses understand their competitors

If a business is a limited company, competitors have the option to get to their net benefit by examining the return submitted with the tax revenue. This gives the business a good understanding of the business and how fruitful it is. This helps an organization understand competitors as well.

It allows for growth opportunities

It's natural for a business or individual to want to grow. Knowing the net income and understanding the net profit is crucial if a business wants to seek further investments in its organization. It's also crucial if the company has present shareholders because having a healthy and consistent net profit gives investors and shareholders the confidence that they will likely receive a return on their involvement with the business. They may wish to invest or continue their participation in the business relationship.

Along with looking for growth opportunities, understanding net income can help an organization decide on the number of employees needed in their company and their pay and benefits rate. It allows a company to plan on what to charge for services or goods. If there is room for company growth, it's important to evaluate or plan on any needed brick-and-mortar space to allow the business to grow and run efficiently. By knowing and understanding net income, a business can make responsible financial decisions that are in the organization's best interest.

Related: How To Write a Business Plan (With 5 Types and Example)

It ensures accurate business reporting

Exact and accurate bookkeeping allows an organization to take care of expenses effectively to maintain a strategic plan with the business' direction. It encourages companies to determine any projected liabilities to plan to ensure payments on taxes, bills or even payments for investors and shareholders are on time.

Understanding net income allows a business to determine how the organization works. Knowing the net income each year encourages a company to track patterns in the organization and leaves them room to make changes by examining outside components, such as market patterns or what clients an organization needs to help make future investments.

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