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Learn About Net Income: Definition, How to Calculate Net Income, and the Difference Between Net Income and Gross Income

Written by MasterClass

Last updated: Oct 2, 2020 • 3 min read

Net Income is one of the simplest concepts in economics and one that most people have a basic understanding of. That being said, understanding net income and being able to differentiate it from other similar concepts is very important in order to analyze your own finances and track your financial progress.

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What Is Net Income?

Sometimes referred to colloquially as a business’s bottom line, net income is all profits a business receives after all expenses have been subtracted, including administrative costs, taxes, cost of goods sold, interest, etc.

  • Net income is a baseline tool for evaluating a business’s economic health and long term viability.
  • It’s very important for business owners to track their operating income and profit margin by calculating net income at regular intervals.
  • Understanding net income and how it’s different from other measures of revenue is very important to running a solvent and successful business.

How Do You Calculate Net Income?

To calculate net income, you need to determine your business’s net revenue and then subtracting total expenses. This means you need to calculate all business expenses including employee gross pay, administrative expenses, utility bills, etc. All of this is recorded in an income statement.

The formula for net income is:

Total revenue - (cost of goods + operating expenses + depreciation + taxes)

Why Is Net Income Important?

Calculating net income is a vitally important number for taking stock of a business’s overall viability and health.

  • Small business owners need to carefully track their net earnings to better understand their net profit margin and to determine how they can generate higher revenues.
  • Some business owners expect to operate at a loss, especially in the early years of a business. Determining net income means that they can still have a precise idea of exactly how much of a net loss they are expecting and how long they expect to sustain losses.
  • As an individual, changes in net income could affect a variety of other financial considerations from how much you put into a savings account to how you structure your retirement plan.
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What Is Personal Net Income?

In personal finance, net income is often referred to colloquially as take-home pay, or the amount of money an individual is paid after taxes and other deductions are taken out of their gross income. (Gross income is the amount of money you get paid before any deductions.)

It’s important to keep track of your cumulative total income and track retained earnings on a balance sheet for filing your tax returns.

What Is the Difference Between Gross Income and Net Income?

Net income refers to an individual’s or business’s income after all expenses have been paid. As such, net income will invariably be a lower number than gross income for that same person or business.

When it comes to taxes paid in the United States (whether to the IRS or state agencies), taxable income tends to be based on some form of net income, rather than gross intake that doesn’t account for expenses. This can affect the amount owed in capital gains taxes, social security taxes, and more.

Factors that can make one’s net income lower than one’s gross income include:

  • Cost of living expenses
  • Contributions to retirement accounts (such as an IRA)
  • Health insurance premiums
  • Payments on student loan interest
  • Upkeep of rental property

Such expenses are documented on a tax return form and will affect what the government considers to be a person’s or business’s total taxable income for the year.

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Want to Learn More About Economics and Business?

Learning to think like an economist takes time and practice. For Nobel Prize-winner Paul Krugman, economics is not a set of answers—it’s a way of understanding the world. In Paul Krugman’s MasterClass on economics and society, he talks about the principles that shape political and social issues, including access to health care, the tax debate, globalization, and political polarization.

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