Net income and net profit are two terms frequently used by accounting professionals and business owners alike. But what do they really mean? Follow along as we explain each term.
As a business owner, one of your primary goals is to make money. There are many things you can do to help your business accomplish this, from creating a business budget to using various accounting ratios.
But how do you determine how successful your business is? By calculating your net income or net profit — the single best indicator for determining just how successful your business really is.
Net income and net profit are two important financial metrics for any business, but they are not the same thing Understanding the key differences between net income and net profit is crucial for making sound financial decisions and accurately evaluating a company’s profitability In this comprehensive guide, we’ll break down exactly what net income and net profit are, how to calculate them, and when you need each one.
What is Net Income?
Net income, sometimes called net earnings or net profit, refers to a company’s total earnings after subtracting all expenses, operating costs, interest, taxes and other deductions It is calculated by taking total revenue and subtracting total expenses over a set time period, such as a quarter or fiscal year Net income appears as the last line on a company’s income statement and is often considered the “bottom line” for determining profitability.
Here is the formula to calculate net income
Net Income = Total Revenue – Total Expenses
This means that net income factors in all costs associated with running a business, including:
- Cost of goods sold (COGS)
- Operating expenses like rent, utilities, payroll
- Depreciation and amortization
- Interest expenses
- Taxes
Net income shows how much actual profit a company made after covering all its expenses in a given time period. It allows investors and analysts to assess both a company’s revenues and costs to determine profitability.
What is Net Profit?
Net profit refers to the amount of money a company makes after accounting for all expenses, interest, taxes and other deductions. So at first glance, it seems identical to net income. However, there are some key differences between net income and net profit:
- Net profit focuses on profitability, while net income is the “bottom line” number.
- Net profit can be calculated at multiple stages, such as gross profit and operating profit. Net income is one final number.
- Net profit calculates profitability for tax and investment purposes. Net income reports total earnings.
With net profit, you can calculate profitability at different points by deducting different expenses. For example:
- Gross profit = Total Revenue – Cost of Goods Sold
- Operating profit = Gross profit – Operating expenses – Depreciation/Amortization
- Net profit = Total Revenue – ALL expenses
Looking at net profit at various stages allows companies to see how much different types of expenses affect profitability. This helps with tax planning and making strategic business decisions.
Key Differences Between Net Income and Net Profit
While net income and net profit are similar metrics, there are some important ways they differ:
-
Net income is the final bottom line number on the income statement after subtracting all expenses. Net profit looks at profitability at different points.
-
Net income depends on revenue and expenses only. Net profit is based solely on revenue.
-
Net income shows total earnings after costs. Net profit shows profitability for taxes and investment purposes.
-
Net income is the actual total profit for a time period.** Net profit** indicates profitability at different stages.
-
Net income is a concrete earnings number after all deductions.
-
Net profit analyzes profitability for tax liability and business performance.
Both metrics provide valuable, but different, insights into a company’s financial health.
A Real World Example
Let’s look at a real world example to see net income vs net profit in action. Imagine a fictional company called Zebra Technologies has the following financials for 2022:
- Total Revenue: $5,000,000
- Cost of Goods Sold: $2,000,000
- Operating Expenses: $1,000,000
- Depreciation: $200,000
- Interest Expenses: $100,000
- Taxes: $500,000
Zebra Tech’s net income would be calculated as:
Total Revenue – All Expenses
$5,000,000 – $2,000,000 – $1,000,000 – $200,000 – $100,000 – $500,000 = $1,200,000
So Zebra Technologies’ net income for 2022 is $1,200,000.
To calculate net profit, we would look at it in stages:
-
Gross Profit:
- Revenue – COGS
- $5,000,000 – $2,000,000 = $3,000,000
-
Operating Profit:
- Gross Profit – Operating Expenses – Depreciation/Amortization
- $3,000,000 – $1,000,000 – $200,000 = $1,800,000
-
Net Profit:
- Total Revenue – ALL Expenses
- $5,000,000 – $2,000,000 – $1,000,000 – $200,000 – $100,000 – $500,000 = $1,200,000
So Zebra Tech’s net profit is $1,200,000, but we can see their profitability at different stages of deductions as well.
Looking at both net income and net profit gives a more complete picture of Zebra Technologies’ financial situation.
When to Use Net Income vs Net Profit
Both net income and net profit provide valuable insights into a company’s earnings and profitability. Here are some guidelines on when each metric is most useful:
Use Net Income to:
- Evaluate overall profitability for a time period
- Determine earnings per share (EPS)
- Calculate profit margins
- Assess revenue and costs
- Provide info to investors on financial performance
Use Net Profit to:
- Determine tax liability
- Analyze profitability at different expense stages
- Make strategic business decisions
- Compare profitability across businesses
- Plan tax strategies
The Bottom Line
While they sound similar, net income and net profit measure different things. Net income looks at total earnings after all deductions for a set time period. Net profit analyzes profitability after different expense stages, especially for taxes and investment decisions. Both are important metrics for determining a company’s financial health. By understanding the differences between net income and net profit, you can make smarter financial assessments and decisions for your business.
What is net income?
In order to understand what net income is, you also have to understand these accounting terms:
- Accounting Cycle: Understanding the accounting cycle helps ensure that your financial statements are accurate. Whether you’re calculating earnings vs revenue or reconciling your bank statement, everything is part of the accounting cycle.
- Revenue: Revenue is the money received from providing services or selling products to customers. Though many people use revenue and income interchangeably, they are two very different things. When tracking revenue, be sure to use the revenue recognition principle, which explains exactly how and when revenues should be recognized.
- Expenses: Expenses are things that are paid by your business. Expenses include employee payroll, rent, and the day-to-day expenses your business incurs such as printing, postage, utilities, and office supplies.
- Cost of goods sold: Cost of goods sold are all of the related costs of creating a product or service. If you’re providing consulting services, your cost of goods sold would include any related labor costs, payroll taxes, and benefits paid to employees providing that service. If you sell products, your cost of goods sold includes the cost of the product that you are selling. For instance, if you buy 100 leather wallets for $5 each from the manufacturer, and sell them for $15 each, your cost of goods sold is $500.
- Depreciation expense: Depreciation expense is used to properly allocate the cost of an asset over its useful life, indicating the portion of the asset that has been used or consumed in that period.
- Taxes: Businesses need to pay taxes just like the rest of us. Some of the taxes that a business may need to pay include income tax, sales tax, property tax, self-employment tax, and payroll tax. All of the taxes paid by your business will need to be included with your total expenses when calculating net income.
Net income is calculated much like pretax income is, except that you’re also including your taxes in the calculation. Here is the formula for calculating net income:
Net income = Total revenues – Total expenses
It provides a good indicator of how successful the business is
Net income indicates that a company is making money. If expenses and taxes outweighed revenues, the company would experience a net loss. Net income, unlike gross income, shows you just how much money you have left over after all of your expenses have been paid; providing you with useful information on the health of your business.
In order to track net income for your business, it’s important that you’re able to track both revenues and expenses properly.
