What is net income?
Net income is the amount an individual takes home from her salary after subtracting taxes and other deductions. For a business, net income is the amount of revenue it earns after subtracting expenses like taxes and the cost of goods sold (COGS).
For an individual, net income can be calculated with the equation Total Amount Earned (Gross Income) – Paycheck Deductions = Net Income.
The total amount earned includes all taxable wages, tips, and investment income like dividends and interest. Paycheck deductions include income tax; Social Security tax, including Medicare and Medicaid, which is called the Federal Insurance Contributions Act (FICA) tax; health insurance; any contributions to a retirement account, such as a 401(k); and any legal obligations, like wage garnishments, loan payments, or child support.
For a business, the equation is the same, but it also includes all expenses like COGS and factors like earnings before interest, taxes, depreciation, and amortization (EBITDA): Total Revenue – All Business Expenses = Net Income.
The business’s net income is used by investors and shareholders when they determine the health of their investment as well as banks when determining a business’s eligibility for a loan. Low or even negative net income results in a big drop in the value of the company’s shares.
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Net income example
Jason is an employee at BusinessCorp. His employment contract specifies that he’s to be paid $40,000 per year, divided up over 24 paychecks. Federal and state income taxes, combined with the FICA tax, amount to exactly $350 per paycheck. He also pays a $40 health insurance premium out of each paycheck. His gross income is $1,666.67, so to find his net income, Jason subtracts the $350 and the $40 from that amount, arriving at $1,276.67 net income per paycheck, or $30,640 per year.