How To Calculate Net Income for Your Business

As an independent professional or small business owner, it’s important to remain aware of changing business finances. Without doing so, you may find that you get unexpected tax bills or have trouble paying suppliers. 

While there are several financial figures that independent professionals need to be familiar with, one of the most important is net income. In this guide, we’ll cover what you need to know about net income—and how to get help calculating this number if needed. 

What is net income?

Net income is the amount of money your business has left after accounting for all business supplies, inventory, materials, wages, professional services, taxes, and other expenses. 

If you’ve never calculated your net income before, don’t worry—it’s easy. By the end of this article, you’ll have a solid understanding of what net income is, why you need to know this number, and how to calculate your net income. 

Other names for net income

When talking to other business owners or financial professionals, you may hear them refer to net income by other names. These typically include “net profit,” “net earnings," and “the bottom line,” as net income usually appears at the very bottom of a company’s income statement.

Regardless of what it’s called, net income is a very important value to know when making decisions about your business operations. 

Why you need to know your net income

Knowing your company’s net income is essential, as it’s a financial health metric used to determine whether or not a business is profitable. You can track changes in a company’s profitability over a given period of time by regularly calculating and recording net income.

Additionally, if you have employees or shareholders, tracking net income can help predict that you will have enough money for future wages, salaries, bonuses, taxes, and other necessary payments. 

Gross income versus net income

Gross income (also called gross profit) and net income are two financial figures that reflect business income after certain costs and expenses. The two numbers are calculated differently, though, and aren’t used in the same way. 

Gross income is the amount of money your business has left over after deducting what’s known as “cost of goods sold” or COGS. 

Net income is the amount of money you have left over after deducting all qualified business expenses and taxes.

Components of the net income formula

Throughout this guide, we’ll refer to different components of the net income formula for businesses. These components all refer to different values that you can obtain from your accountant, bookkeeper, or financial software. 

Revenue

Revenue is the amount of money you are paid for selling products or services to customers and clients. 

Let’s say you’re a freelance web designer who charges $100 per hour, and you bill 10 hours in a month; your revenue for that month is calculated as follows: 

10 hours worked x $100 per hour = $1,000 revenue

If you’re running a plumbing company, your revenue calculation for the month might look something like this:

35 service calls x $500 per call = $17,500 revenue

If you use a bookkeeping program like Quickbooks or Wave, the software will automatically calculate your revenue for you.

Cost of goods sold (COGS)

Cost of goods sold is typically relevant to companies that manufacture products. COGS includes materials and supplies required to produce the goods that you sell.

The COGS expense category includes all of the following:

• Products sourced for resale 
• Materials used to make products for sale
• Packaging to ship products
• Cost of labor to produce products

Here’s a closer look at what COGS might look like for three types of independent business owners:

Total expenses

While not all businesses incur COGS expenses, most businesses typically do have some type of expense that must be accounted for. These expenses generally fall into one of three categories. 

Operating expenses

Operating expenses are any overhead costs incurred in order to run your business. This could include everything from hiring a lawyer and paying payroll taxes to buying paperclips for your office. Operating expenses are also sometimes called OPEX or selling, general, and administrative (SG&A) expenses. If you have any costs for research and development, you’ll also include R&D expenses.

Capital expenses 

Capital expenses are often large, one-time purchases like real estate, vehicles, and heavy equipment. Your business might have a large capital expense one year, and then no capital expenses for several years after that. Or, you may incur capital expenses every year—it all depends on the nature of your business. Only the allowed annual depreciation will be “expensed” (subtracted from revenue) in a given year.

Other non-operating expenses and taxes

Your business may also incur additional non-operating expenses, such as interest payments or legal settlements. In addition, the taxes you pay are included with expenses when calculating your net income. 

When combined, all of the above items make up your total expenses. This number can vary greatly depending on your business. Someone running a retail storefront may have to purchase a variety of insurance policies, contract for regular maintenance, and hire a cleaning service. An independent professional working from home may only need to pay for a computer, internet, and business income taxes.

The net income formula

To calculate net income for small businesses, you’ll need to take total revenue and reduce it by the cost of goods sold (if applicable) and total expenses. The formula looks like this:

Revenue - COGS - expenses = net income

If you know the gross income for your business, you can also calculate net income like this: 

Gross income - expenses = net income

The gross income formula

The reason that the second net income formula works is because the calculated gross income has already removed money spent on COGS. To calculate your gross income, you can use this equation: 

Revenue - COGS = gross income

Make sure you clearly record all values that you calculate, so you don’t mix up your revenue, COGS, gross income, expenses, and net income. 

It’s also a good idea to pick one net income formula and stick with it, so you don’t accidentally subtract COGS more than once.

How to calculate net income in 3 easy steps

You can calculate net income yourself using these three steps:

1. Identify revenue, cost of goods sold, and expenses
2. Subtract COGS and expenses from revenue
3. Calculate and verify net income

1. Identify revenue, cost of goods sold, and total expenses

To begin calculating net income, you’ll first need to identify the following values:

• Revenue
• Cost of goods sold
• Total expenses 

2. Subtract COGS and expenses from revenue

Next, take your total revenue figure and subtract both COGS and expenses from it.

3. Calculate and verify net income

The number you have after subtracting COGS and expenses from revenue is your net income. 

Make sure that you’ve used values from the same time period when calculating net income. For example, if you want to determine your net income for an entire year, make sure you calculate revenue, COGS, and expenses for that same length of time.

Net income calculation example

Here’s what a net income calculation might look like for two different business owners:

‍

While business owner #1 brought in more revenue, they had the same net income as business owner #2. This is due to the differences in expenses incurred by both professionals.

Recording your net income

It’s important to regularly calculate and record your net income. This way, you can monitor whether or not your COGS and expenses are eating up too much of your revenue. 

There are a few different ways to keep track of net income. If you use bookkeeping software to record your incomes and expenses, your program of choice can calculate your net income on demand and report it on financial statements. Alternatively, you can set up a spreadsheet to track your net income over time.

What does positive net income mean?

Positive net income is a great sign! When you regularly see positive net incomes for your business, you know you’re on the right track and bringing in profit.

What does negative net income mean?

If you calculate your net income and discover that it’s negative, this means that your business is not profitable. It’s possible to have positive sales (meaning that your sales exceed your COGS) and negative net income at the same time. 

It’s fairly normal for independent professionals and small business owners to have short periods of time where their net income dips into the negative, but you don’t want this to become the norm. If you discover that your net income is trending downward, you may want to consider working with a financial planner or business consultant to identify and execute improvement strategies.

Understanding your net income

For many business owners, the easiest way to understand and track their net income is to engage the services of an independent bookkeeper or accountant. Whether you’d like help setting up your bookkeeping software for the first time or want someone to monitor your business finances on an ongoing basis, you can find the help you need right now by posting a job on Upwork.

‍

Upwork is not affiliated with and does not sponsor or endorse any of the tools or services discussed in this section. These tools and services are provided only as potential options, and each reader and company should take the time needed to adequately analyze and determine the tools or services that would best fit their specific needs and situation. This article is intended for educational purposes and should not be viewed as legal or tax advice. Please consult a professional to find the solution that best fits your situation.