Net Income Formula

The net Income formula is used for the calculation of the net income of the Company. It is the most important number for the Company, analysts, investors, and shareholders of the Company as it measures the profit earned by the Company over some time.

It can also be referred to as net profit or net earnings, which is the total profit that the business has earned when all expenses are deducted from its total sales revenue. It is an essential metric that is very useful for both management and stakeholders of the company to evaluate its financial condition and make investment-related decisions.

The net income formula in accounting calculates the net earning or profit of the company, represents the amount remaining in the books of accounts after subtracting all its expenses from the sales made during that period.  The formula for the calculation is as follows:

• Net Income or Net profit is calculated so that investors can measure the amount by which the total revenue exceeds the company's total expenses.
• Total revenue includes earnings from the sale of goods and services, interest income, and income from the sale of the business or other income. So, target net income formula represents the revenue that is earned from the main business activity. In other words, it is the income that is generated from the core operation of the business.
• Total expenses include the cost of goods and services sold, operating expenses like salaries and wages, office maintenance, utilities and depreciation, and amortization, interest income, and taxes. Thus, they are the cost that the entity incurs while running its business operations. Apart from the above types, the expenses can also be any other cost that are directly or indirectly incurred while conducting the business.

Thus, net income formula in accounting represents how efficiently and effectively the management of the company is able to run the organization, keep a control over the costs and earn profits. If the formula depicts an increase in the year-on-year net profit, it is a good sign regarding the financial health of the company.

Investors will be interested in investment in such an entity with the expectation of getting good returns. It also shows that the business has good future prospects related to growth and expansion because it has funds to invest in upgradation, technological improvement and overall growth.  

Using the formula given above the net income can be calculated through the following steps.

• Revenue determination – The first step is to collect all the information related to total revenue earned for the specific period. This may include, the sales figures, and interest income, service fees or any other sources that represent revenue from the core business operations.
• Expense calculation – Next step is to identify and calculate the total expenses. The expenses related to administrative or operating procedures, any interest or tax related expense, etc fall in this category along with the cost of goods sold. All these figures need to be summed up for that particular period.
• Calculate net income - The final step is to calculate net income formula by deducting the expense form the revenue.

The final figure will help us evaluate the profitability and the earning capacity of the business. However, if the figure is negative, then it will indicate loss. The formula depicts a very simple and straightforward process, but the entire procedure for calculation can be relatively complex, depending on the type and size of the business. The accounting principles, which are the cash basis and accrual basis, also plays an important role.

Let us understand the concept of how to calculate net income formula with the help of some suitable examples.

Example #1

Company ABC Inc. had revenue from the sale of $ 100,000 for 2017. It paid $ 20,000 in employee wages, $ 50,000 for raw materials and goods, and $ 5,000 for other office and factory maintenance expenses. In addition, the Company had an interest income of $ 3000 and paid $ 2500 in taxes. What is the net income of the Company ABC Inc.?

The Total revenue of the Company = Revenue from sale + Interest Income

• Total revenue = 100000 + 3000 = 103,000

The Total expenses = Employee wages + raw materials + office and factory maintenance + interest income + taxes

• Total expenses = 20000 + 50000 + 5000 + 3000 + 2500 = $ 80, 500

The Net Income = Total revenue – total expenses.

• Net income = 103000 – 80500
• Net income = $ 22,500

Example #2

Let us see Apple's Profit and Loss statement and the company's net income.

Snapshots from the annual 10-K filing of the Company to the SEC are as below. Calculating net income is done as the bottom line of the profit and loss statement or the statement of operations. The net income of the Company is highlighted in yellow

source: Apple SEC filings

The above examples give us a clear idea about how the formula is used for calculation of net income while preparing the financial statement of an organization. They explain in detail what are the items that are taken into consideration while arriving at the figure by using the formula.

Some important and relevant uses of the annual net income formula in the financial market are highlighted below. Let us analyse the same in details.

• Net Income is the most looked after the number in the financial statement of a Company.
• A lot of financial ratios are impacted by the net income number. Shareholders follow this metric as the dividend paid to the shareholders depends on the net income the Company earns.
• Although net income is an important metric in terms of profit earned by the Company is not the actual cash earned by the Company. The statement of operations or the company's profit and loss includes many non-cash items such as depreciation and amortization. Thus, any change in the net income or the financial ratios, as such, should be properly analyzed.
• Lower net income may be due to many factors, including poor sales, poor management, high expenses, etc.
• Net Income varies from Company to Company and industry to industry. It can vary due to the size of the Company and the industry in which it works. Some Companies have heavy asset business models; thus, the depreciation expenses will be high, while others may have light asset models. Further, growth factors in industries, debt levels, and government taxes affect the net income numbers of the Company.

Let us have a look at another example of annual net income formula and try to solve it in excel.

A Company XYZ has a total revenue of $ 500,000, and the Cost of goods sold by the Company is $ 120,000. The Company paid salaries and wages to its employees to $ 30,000. In addition, it spent $ 20,000 on rent and other utilities. The Company records $ 15,000 as a depreciation expense. The Company also pays interest on the long-term debt of $ 10,000 and pays taxes of $ 20,000.

Net income can be calculated simply by subtracting all the expenses from the revenue. For example, the calculation of net income is shown in the below template.

In the below given excel template, we used the Net Income formula to calculate Net Income.

The Net Income of the Company will be -