A net income is the funds an individual or company earns after subtracting expenses, allowances, and taxes. In commerce, net income refers to what a business or firm has left after expenditures, such as salary and wages, cost of goods or materials used in operations, and taxes. On the other hand, individuals define net income as their take-home pay after deducting taxes, health insurance, and retirement contributions.
Learning more about net income
Usually, a higher net income amount than their expenditures indicate good financial health.
A net income equals a company’s profit within an accounting period. It includes the total amount of how much was spent, subtracting it from the revenue. Other times, it is also called the bottom line since it is usually positioned at the bottom of the income statement.
Every company’s income statement differs depending on the items listed and its industry. Most of the time, it subtracts factors like operating expenditures, interests, overhead, income taxes, and depreciation. Additional sources of income are included in net income too. For instance, when a company invests its money in a short-term investment, what is earned is considered income. Moreover, earnings from sales of assets and securities are also a form of income.
Differentiating gross profit and net income
When you talk about gross income, it provides an understanding of the efficiency of a company in managing its production costs, labor, and supplies in generating income from its sales and services. You can compute it by subtracting the expenses of goods being sold from the total revenue in the accounting period.
Gross income is also an excellent metric for business owners in measuring their total sales and monitoring over time. It can also show their market share, trends, or seasonality of sales, if there are any.
Net income is considered a better option for tracking a business’ profitability or how much a company earns in a given period. Although it does not indicate if sales are going up or down, it still helps determine ways to improve businesses.
It represents the profit from all company operations and services sectors. Therefore, it is more inclusive compared to gross profit.
Most of the time, gross income always comes out higher than net income because it does not account for costs such as taxes, charges, and depreciation.
Importance of net income
Companies need to monitor their net income besides their gross income to analyze their profitability. Knowing their net income can also enable them to total their profit margin or how much they make in sales or services. Calculating it helps managers and business owners learn how to improve their business and make it more profitable by increasing sales or reducing expenses.
Regarding investors, net income will tell them whether a firm is profitable. Suppose a company can retain most of its revenue. In that case, handing out profits to shareholders as dividends or reinvesting these funds into their business without dealing with debt is likelier.
As for individuals, their net income is necessary because it shows how much they would work within their daily expenses and when building a budget. Analyzing their take-home pay after costs can help them create a budgeting plan without risking spending all of their money and being unable to cover all their payments and expenses. In other words, it would give them a visual limit showing how much they can only pull out and how much they can set aside in emergencies.
Learning about this business metric is crucial since it represents the funds left for distributing to shareholders, investing, or setting aside for further use. It can also indicate your business’ appeal to investors. Before investing, they usually evaluate a company’s net income before making decisions. Having a consistent positive net income record adds appeal to investors because there are higher chances that they would receive returns when they invest.
In owning a company, whether big or small, banks and lenders look at your firm’s net income before deciding to allow you to get a business loan or line of credit. Lenders prefer extending credit to companies with high net income because it would mean they are more likely to pay them back.
Net income can also help you determine if your business is sustainable. A lot of small businesses could experience net losses. However, your business needs to generate enough profits and manage expenses to survive in the industry in the long term. Keeping track of your net income can help you understand if you are charging enough for your products or services to cover the operating costs of keeping your business alive.
Take note of this
A high net income on your financial statement gives you confidence that you have a lot of money to cover your daily expenses and much to splurge on leisure or luxury expenditures. Although it seems like a high amount to the eyes, it might not be enough for the pocket. Just because you got a high net income does not give you a reason to go all out on whatever you want.
Regarding personal finances, your net income will be set as a guide or limitation showing how much you can spend and save if you can. In other words, it can be considered a stop sign or a pause button when covering expenditures.
Once you know your net income for the period, it is highly recommended that you calculate the total amount of payments you should prioritize in covering first, then subtract it from your net income. With what is left, set aside a reasonable amount for your savings. This would reduce your instances of leaning towards debt. After subtracting the desired amount of savings, that would leave you with the amount you can spend on your wants.
Still, being financially wise plays a significant role in working with your net income. Do not get too comfortable after receiving a higher-than-expected take-home pay. Remember that you have priorities to put higher on your list before proceeding with your wants.
