11 Steps How To Determine Net Income In Accounting

doylc.com - Net income is usually the final figure in an income statement — the “bottom line” that provides business owners with crucial information about how much money is left once their company’s expenses have been paid. It is therefore a crucial measure of the profitability of a business. A company's net income can also be referred to as its net profit, and may just be called its profit in everyday conversation.[1] X Research source Despite its importance, net income is relatively easy to calculate using simple accounting procedures that subtract expenses from revenue.

Gathering and Organizing Information

Set up an income statement. In order to correctly calculate net income, you will have to go through the steps of filling out an income statement. Actually filling out an income statement while calculating net income is an easy way to organize your information. This can be done either by hand or using a data management program. See how to write an income statement for more information.

An income statement covers a specific period of time, i.e, January 1, 2014 to December 31, 2014. The time can be any period, but is usually monthly, quarterly, or annually.

Gather the required information. In order to calculate net income, you will need all of the information required on the income statement. This includes a large amount of information about the business's revenues and expenses. Again, see how to write an income statement for more information on the requisite information. The required information is also covered in more detail in the next section.

In general, an income statement will include a business's sources of income (mainly sales but also things like interest income) and a list of expenses by category, including costs of creating products, operations, administrations, interest paid on debts, and income taxes.

Make sure that you are using the proper formula. The calculation of net income follows a very specific formula. This formula parallels the organization of the income statement. However, should you choose to simply calculate net income without creating a balance sheet, you will need to be sure you are subtracting the right expenses at the right points in the calculation. The general structure of the calculation is as follows:

Calculate "net sales" — Gross sales less returns and discounts.

Subtract cost of goods sold from net sales to get gross profit.

Subtract selling, general, and administrative expenses from gross profit to get EBITDA (earnings before interest, taxes, depreciation, and amortization).

Subtract depreciation and amortization expenses from EBITDA to get EBIT (earnings before interest and taxes).

Subtract interest expenses from EBIT to get EBT (earnings before taxes).

Subtract tax expense from EBT to get net income.

Make sure that you have a calculator handy. Depending on the size of the business, calculating net income may involve large numbers or advanced calculations. To ensure accuracy, keep a simple calculator nearby when doing your calculations.

Calculating Net Income

Determine the net sales. To get net sales, also known as "gross revenue" or simply "revenue," add up all cash received and increases in accounts receivable for products and services sold during the income statement period. These revenues are recorded when the product or service is delivered to the customer, not necessarily when it is paid for. This will be the first item on your income statement and calculation of net income.

Note that some companies use the terms "revenue" and "sales" interchangeably, but others use "sales" only to identify the number of products sold (excluding income from other sources).

Establish the cost of goods sold. These are the expenses associated with producing or purchasing the goods that a company sells. Retail and manufacturing businesses will have considerable expenses in this category. To arrive at a total for this number, add up the cost of raw materials used in production, the cost of direct labor (including wages for personnel not involved in administrative or sales roles), and any expenses associated with production, like electricity.

If you are a service-based business, "cost of goods sold" may be replaced with "cost of revenue" for clarity. This figure follows the same general concept, though, and includes expenses like wages, sales commissions, any costs used in delivering your services (like transportation or shipping), and any other expenses incurred by making sales.

Once you have found this number, subtract it from net sales. The resulting number is called gross profit and serves as a measure of a company's manufacturing efficiency.

Calculate SGA expenses. SGA (selling, general, and administrative) expenses are subtracted in the next step. These are costs like rent, salaries, wages (of administrative or sales personnel), advertising, and marketing, as well as any other costs associated with a company’s primary operations. These expenses may also be known simply as operating expenses.

When you have calculated this number, subtract it from gross profit to get earnings before interest, taxes, depreciation, and amortization (EBITDA). EBITDA is used to measure overall profitability between companies and industries because it ignores the effects of financial and accounting decisions on profit.

Find depreciation and amortization (DA) expenses. These numbers generally reflect an asset from the balance sheet that is expensed over time. Depreciation costs refer to the loss in value of a tangible asset (like a machine); amortization costs refer to the loss in value of an intangible asset (like a patent). Accounting for these expenses as DA expenses on the income statement for several years allows a company to spread out the impact of an expensive investment, like a new vehicle or factory, on their net income.

DA expenses are complicated accounting concepts. See how to calculate depreciation on fixed assets and how to amortize assets for more information.

Once you have calculated DA expenses, subtract them from EBITDA to get EBIT (earnings before income and taxes). EBIT, also known as operating income, is another common measure of business's profitability.

Calculate interest expense. These are costs related to any interest a company is paying (on a loan, for example). This can also include any money paid out to bondholders. When calculating this figure, be sure to also add back in any money earned in interest income. Interest income can include interest earned by placing money in short-term investment such as certificates of deposit, savings, and money-market accounts.

When you have calculated interest expense, subtract (or add if the interest income was greater interest expenses) it from EBIT to obtain EBT (earnings before taxes). EBT allows investors to compare the profitability of similar business that operate under different tax laws.

Calculate tax expense. The tax expense will be the income tax paid by the business during the income statement's reporting period. This will vary based on a number of factors, including the size of the business and how its taxes are filed. Bear in mind that this does not include other taxes paid by the company, like property tax. Property taxes are instead included as a part of operating expenses.

Subtract tax expense from EBT to get net income. After subtracting tax expenses, you have calculated net income!