Financial analysis helps you determine if you are making enough money and can afford to pay your bills. Whether you apply this analysis to a small business or to your personal financial affairs, taking stock of your income and comparing it to your expenses is the only way to determine if you're coming out ahead or losing money. Net income is calculated as part of a financial document called an income statement. This financial statement is one of the main documents loan officers, investors and other people interested in your business use to determine how much your business is worth.
TL;DR (Too Long; Didn't Read)
A business's net income (or net profit) is its gross income (revenues/sales) minus expenses (product costs, returns and discounts). The net profit after taxes is the net profit value with any state and federal taxes get subtracted.
What Is Gross Profit?
Net income, also called net profit or net earnings, is a bottom-line calculation that factors in many other financial components. To understand net income, start with gross income, also known as gross revenue or sales: the amount of money that you take in from your main business activities. You arrive at this number by simply counting up all your receipts from sales.
If you subtract your product costs – the amount you spend to buy inventory or on manufacturing, plus direct labor and any other direct cost that made it possible for you to make a sale – and any returns or discounts, you are left with your gross profit. The shorthand calculation for gross profit is sales minus the cost of goods sold.
What Is Operating Profit?
After calculating gross profit, calculate operating profit. Subtract all selling, general and administrative expenses necessary to run the business from gross profit. Examples of operating expenses include the salaries of general office personnel, rent and utilities on office space, insurance, advertising, sales commissions and depreciation on administrative assets.
Other Income and Expenses
The category of “Other Income and Expenses” comprises items that don't relate to the company's core business, such as interest income and expenses related to investments. These items are offset against each other to reach a net income or loss figure for this category.
Net Profit Before Taxes
The company's operating profit – or loss – plus or minus the “Other Income and Expenses” category equals net income when the value is positive. When the value is negative, the company has a net loss. Net income is typically split into net income or profit before taxes and net income or profit after taxes. Whenever anyone references “net income,” determine whether they are referring to net income before or after taxes.
Net Profit After Taxes
Subtracting the total amount of state and federal income taxes paid by the company from net income before taxes results in net income after taxes. This amount is the company's bottom line, the amount of money the company's owners can consider as their return on investment, or the money that can be distributed to them as profits. On an income statement, the last line is labeled “net income,” and it equals net income – profits – after taxes.
Terry Masters has been writing for law firms, corporations and nonprofit organizations since 1995. Her online articles specialize in legal, business and finance topics. She holds a Juris Doctor and a Bachelor of Science in business administration with a minor in finance.