In simple terms, Net Income is the total revenue a business generates after deducting the running expenses. These expenses include depreciation, interest, taxes and every other miscellaneous spending. The amount that is declared by a company on their income statement is critical in measuring its profitability over a period of time.
In case of an individual, net income refers to the total income after taking into taxes and other expenses into account.
In very basic terms, Net Income Formula is described as follows:
Net Income = Total revenue/income – Total Expenses
As the net income is found on the bottom-most line of the income statement, it is often termed as the bottom line. For example, let’s take a look at a simple representation of an income statement.
|Income Statement for ABC, Inc.|
|(For years ended December 31st, 2017)|
|Cost of Goods Sold||($80,000)|
|Rent for Office Space||($15,000)|
|Total Operating Expenses||($50,000)|
|Total Operating Expenses||($12,000)|
Using the Net Income formula,
Net Income = $200,000 – $80,000 – $50,000 – $12,000 – $8,000 – $10,000 = $40,000
Significance of Net Income
Net income is an important number in the financial circuits as it plays a crucial role in ratio analysis and the financial statement analysis. As it is the main source of compensation for the shareholders, they especially follow it closely and make a decision to sell or buy the shares of a particular company. This directly affects the price of a company’s shares. If the company generates steady income and compensates the shareholders, the value of its shares increases. Conversely, if the company is not able to show substantial net income, the shareholders abandon ship and start selling their shares, resulting in a sharp decline in the share prices.
As a result, any changes in the net income are highly scrutinized by a company’s managers. Usually, there are a variety of problems to blame for a low net income, such as decreasing sales, poor customer satisfaction, faulty expense management or inadequate infrastructure. If the management does not put an end to these problems, Net income helps the shareholders to step in and keep their property from falling apart.
In case of an individual, net income calculation through the net income formula helps a person understand their expenses. They then have the option to keep a check on these expenses so that their total worth steadily increases. It helps considerably as often most of us spend our money without keeping track of where it is going. More often than not, young people tend to spend carelessly. Calculating net income from time to time helps them understand their expenses and the effect they are going to have in their net income. It might serve as a wake-up call for most of us to start saving and investing our money so that we can have a considerable amount in the future when we need it more. It is rightly said that you need to plan today for a better future.