Net income is the profit a company earns after covering all of its business expenses, including taxes and deductions.
You’ll find net income at the very bottom of the income statement—which is why it’s often referred to as the “bottom line.”
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Net income is one of the clearest indicators of a company’s overall profitability, showing how much value the business has created for its shareholders during a given period.
But there’s more to net income than meets the eye. For example, dividends paid to preferred shareholders aren’t considered expenses and therefore don’t reduce net income.
Let’s take a closer look at how net income works, how it’s calculated, and why it matters.
How to calculate net income
The net income calculation involves taking total revenue and subtracting all expenses, including depreciation, amortization, and interest expenses.
Here’s the net income formula:
If you want to break the formula out further, it becomes:
- Net Income = [Revenue + Other Income] – Cost of Goods Sold (COGS) – Operating Expenses – Other Expenses – Interest – Taxes
Let’s use Netflix’s income statement as an example:
The statement starts with Netflix’s revenue for the quarter. It then subtracts the cost of revenues (which includes the cost of raw materials or COGS), marketing expenses, administrative expenses, and technology expenses to get the net operating income.
Then, you see other expenses and incomes (which includes just the interest expense and income in Netflix’s case). Finally, it deducts the taxes.
The net income is the last line item in the company’s income statement. For more information on this check out our page on revenue vs. profit.
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Key takeaways
- Net income is the profit a company retains after all expenses, taxes, and deductions, serving as a crucial indicator of financial health and profitability
- Calculating net income involves subtracting total expenses from total revenue, providing a clear view of a company’s bottom line
- Understanding net income helps businesses monitor financial trends, assess profitability, and plan for future growth
- Limitations of net income include non-cash expenses and accounting assumptions that can skew figures, requiring careful analysis alongside other financial statements
- Differentiating net income from similar terms like gross income, EBITDA, and EBIT is essential for accurate financial analysis and decision-making
3 reasons net income is important for a business
Net income (or net profit) is key to several decisions you make as a business. Here are some examples of net income’s importance:
1. Determine trends toward profitability
For VC-backed startups and high-growth businesses, turning a profit isn’t always the short-term goal. These companies often run at a net loss as they invest heavily in growth.
Still, tracking net income trends can help you understand if the business is moving toward profitability. Even in the early stages, those trends can signal whether your financial strategy is working.
2. Monitor financial health
Net income is a high-level view of financial health—especially important for public companies. If your net income is consistently low or negative, it could point to operational inefficiencies or overspending.
It also impacts other areas. For instance, a company that issues cumulative preference shares accrues a liability if it can’t pay dividends. Once profitability stabilizes, those unpaid dividends need to be addressed before equity shareholders receive payouts.
Accurate revenue forecasting makes it easier to identify challenges, manage costs, and protect net income.
3. Plan for growth
High-growth companies, especially in industries like SaaS, need capital to scale. Profits can be reinvested into the business through retained earnings, supporting everything from R&D to hiring.
Net income helps you understand how much you can retain and reinvest, giving your team more confidence in planning for the future.
Net income limitations: 3 things to be aware of
While net income is useful, it doesn’t tell the whole story. Here are three limitations to keep in mind:
1. Effect of accounting for non-cash expenses
Expenses like depreciation and amortization aren’t cash expenses. You don’t pay money for those expenses. While they play a valuable role in accounting, they often skew the net income figure.
This is especially true if the value of your assets decreases. For example, suppose your certified public accountant (CPA) recommends that you revalue your asset from $10,000 to $7,500. In that case, you’ll see a $2,500 expense on your income statement (and the asset’s value will reduce by the same amount on the balance sheet). However, you won’t pay that $2,500 to anyone.
In other words, non-cash expenses will decrease your net income but won’t affect your earnings outside the books.
2. Multiple assumptions
Net income can also be influenced by the assumptions used in financial reporting. Asset depreciation methods, for instance, can vary depending on business strategy.
A company may opt for aggressive depreciation to lower its tax burden—which reduces reported net income. Meanwhile, another business may use more conservative methods to present a stronger profit to potential investors.
These variations make it harder to compare net income across companies without digging into their accounting practices.
3. No fix correlation with cash
A company may report $100,000 in net income—but that doesn’t mean it has $100,000 in cash.
That’s because net income is calculated using accrual accounting, which records revenue and expenses when they’re earned or incurred, not when cash changes hands.
To understand actual cash flow, compare the income statement with the cash flow statement. The latter starts with net income and then adjusts for non-cash items and changes in working capital. For example, look at Netflix’s net income versus the cash flow:
Notice how the cash flow starts with the net income.
The cash flow statement is essentially a reconciliation between the net income and the cash generated by the business.
Other financial terms commonly mistaken for net income
Net income is not the only type of profit that appears on the financial statements. You’ll see gross income, EBITDA, and EBIT as well. And if you’re looking at the tax books, you’ll also encounter taxable income.
Gross income
Gross income (or total income) appears at the beginning of the income statement. It’s calculated as:
As a SaaS company, you can calculate the gross profit by deducting the costs of providing the service from the total revenue.
For example, you can calculate the gross profit by deducting expenses like the cost of servers and payments made to freelance software developers from the revenue.
Gross profit is a measure of financial efficiency that helps you understand how effectively your company provides its services.
EBITDA
EBITDA is an abbreviation for “earnings before interest, taxes, depreciation, and amortization.”
It’s calculated as:
With EBITDA, you can see a company’s profitability without the effects of tax provisions, cost of financing, and capital expenditure.
The U.S. GAAP, SEC, and IRS don’t require companies to show EBITDA on their financial statements.
But many companies include EBITDA on their financial statements since it’s commonly used for the valuation of a company. For example, investors often use EV/EBITDA to compare companies and find promising investment options.
For SaaS valuation, investors typically rely on revenue multiples, so EBITDA isn’t as helpful in the context of SaaS companies.
EBIT
EBIT is an abbreviation for “earnings before interest and taxes.” It is calculated as:
EBIT helps you understand how efficient you’re at managing your business. For instance, if you’ve got a low EBIT but a high gross income, you’re spending too much on administrative expenses. And you need to look for alternatives.
Like EBITDA, companies don’t need to show EBIT on their financial statements.
However, many do share it since EBIT is also used for valuation. EV/EBIT is a common EBIT valuation metric.
Net income FAQs
What is net vs gross income?
In business, net income is the final amount of remaining income a company has after all expenses, including taxes and payroll, have been deducted. Gross income, on the other hand, is the amount of total income before such expenses are deducted.
Is net income before or after taxes?
Net income for a business is the amount of income the business makes after tax expenses and other expenses are taken out.
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What is the difference between net operating income and net income?
Net operating income is calculated by subtracting only operating expenses from total income, while net income is calculated by subtracting all expenses (not just operating expenses) from total income.
What is the difference between net profit and net income?
Net income and net profit are interchangeable terms: they both refer to the amount of income or profit a business has available after all expenses have been deducted.
