What is net income?
Net income is a measure of how much money a person, or a business, makes after accounting for all costs.
In the business sense, net income is the money a company makes, minus the money it spends. This includes money spent on things that are directly related to producing that income, such as raw materials and wages, and money reserved to pay taxes.
For the individual, net income is the money one receives from a paycheck after accounting for deductions such as taxes, retirement plan contributions and health insurance. If, for example, you get paid $1,000 per week, you might only receive $600 in your weekly check with the remaining $400 allocated toward payroll deductions: $1,000 is your gross income but the $600 you receive is your net income.
For a business, positive net income is good because it means that it’s making more money than it’s spending. That leaves it with money to save and reinvest. A negative net income is the opposite; it spends more than it makes, which means it may need to borrow money to make ends meet or spend out of savings.
The same is true for the individual. You want your net income to be higher than your expenses. If, for example, your net income for the month is $2,400, spending less than that amount means you can save money every month. Spending $2,400 or more means, at best, going even, or at worst, borrowing money to fund your spending.
How to calculate net income
To calculate net income, take the gross income — the total amount of money earned — then subtract expenses, such as taxes and interest payments.
For the individual, net income is the money you actually get from your paycheck each month rather than the gross amount you get paid before payroll deductions. You may have some other sources of income such as Social Security checks, side jobs or investment income which can add to your net income.
Example of net income
To understand the net income of a business, let’s look at Coca-Cola. The company, like all publicly traded companies in the U.S., regularly reports its revenues and expenses to the SEC four times per year.
For the three months ended April 2, 2021, Coca-Cola reported $9.02 billion in revenue. It also earned $66 million in interest and $417 million in equity and other income. The company spent $3.505 billion on the cost of goods sold, which includes raw material and direct labor costs, $2.669 billion on general and administrative expenses, $124 million on other operating expenses, $442 million on interest payments, and $508 million on taxes.
Overall, this brings Coca-Cola’s net income to $2.255 billion. Here’s the math:
($9.02 billion + $66 million + $417 million) – ($3.505 billion + $2.669 billion + $124 million + $442 million + $508 million) = $2.255 billion.
As for an individual’s income, imagine that Jane receives a biweekly paycheck with gross pay of $3,350. She pays $272.51 in federal taxes, $46.61 in Medicare taxes, $193.31 in Social Security taxes, $102.48 in state taxes, and $125 for insurance. This leaves her with a net income of:
$3,350 – $272.51 – $46.61 – $193.31 – $102.48 – $125 = $2,610.09 every paycheck or $67,862.34 per year.
Why understanding net income is important
Understanding net income is important because it helps clarify how much can be spent on living expenses as well as discretionary spending.
For an individual, net income is important because it’s the number that one should be thinking about when spending and building a budget. Someone who gets a new job earning $4,000 each month might only have $3,000, or less, to spend after taxes and other payroll deductions. If the individual immediately spends $4,000 each month, he’d find himself in a deep financial hole very quickly. If he looked at net income instead and made sure that his budgeted spending was below his net income, he could instead start saving money for the future.
You can sign up for Bankrate’s myMoney to categorize your spending transactions, identify ways to cut back and improve your financial health.
Here’s a business example. Let’s say a business reports a gross revenue of $2 billion per month. That may seem like a relatively healthy business that may be worth investing in. But if the company reports a net loss of $200 million, you’ll likely have a very different view of the financial health and viability of the business.