Net income refers to a company’s revenues less all expenses.
Net income is also called net profit. A company generates a net profit when its revenues are greater than its expenses. A company generates a net loss when its expenses are greater than its revenues.
Net income differs from gross income in that gross income deducts from revenue cost of goods sold while net income deducts from revenue all expenses the company has incurred, including interest expense, depreciation, and taxes (if applicable). Net income can be calculated from gross income by subtracting from gross income the remaining expenses.
C-corporations pay taxes at the corporate level and recognize tax expense on the income statement. Many smaller businesses, however, are structured as pass-through entities. This means that the company does not pay income tax. Rather, the profit or loss is “passed through” to the equity holders, who then pay taxes individually on their portion of the company’s profit or loss.
For example, suppose in the month of January, a company has $1 million in sales, $600,000 in cost of goods sold, $200,000 in selling, general, administrative expenses (SG&A), $25,000 in interest expense, and $5,000 in depreciation. The company pays income tax at a combined federal and state rate of 26%. What is the company’s gross income and net income for January?
First, we calculate gross income by subtracting $600,000 in cost of goods sold from the $1 million in revenue. Gross income is $400,000. To calculate net income, we first calculate pretax income by subtracting from gross income the $200,000 in SG&A, $25,000 in interest expense, and $5,000 in depreciation. Pretax income is $170,000 and taxes at 26% of taxable income are $44,200. Net income is thus $125,800.
