Net income refers to a company’s earnings minus business and operating expenses. An individual’s net income is equal to total income minus applicable deductions and taxes paid. Net income helps you understand how profitable your business is. If you’re an investor, it can help you analyze a company’s stock. And as an individual, it can help you understand your actual take-home pay. If you want hands-on guidance as a business owner or investor with net income, check out our free financial advisor matching tool to link up with up to three advisors in your area best suited to your particular needs.
Why Net Income Matters
If you run a business, you know the success of it relies on more than how much you make from sales of services provided. You also have to consider what you’re paying to keep the lights on. So net income can help you understand the true cost of running your company.
For individuals, net income helps them understand how much of their earnings they actually get to keep. If you’d like to see your personal net income, you can use our paycheck calculator.
Calculating Net Income for Your Business
Net income would appear on your company’s income statement. It begins with total revenue or the money your business generated through the services it provided. From there, you can start chopping down all business expenses, taxes paid and allowable deductions. This can include the following:
- Marketing expenses
- Administrative expenses
- Travel and office costs
- Dividends and interest paid
- Deductions like retirement plan management
- Legal and professional fees
As you can see, net income zeroes in on how profitable your business actually is. So if your net income is significantly lower than your total revenue, you may want to start cutting back on some operating costs. Calculating net income and developing a detailed income statement can help you figure out where to start.
And if you’re investing in a company, net income is crucial to deciding whether it’s worth the risk. For instance, net income can help you calculate a company’s price-to-earnings ratio. This tells you how much you’re paying in stock price for each dollar the company made in net income.
But keep in mind that a business may misrepresent its net income. So a careful analysis of a firm’s income statement should serve as a key component of your investing strategy.
Calculating Personal Net Income
Your personal net income for the year is the amount of money you earned minus allowable deductions and taxes you paid.
To calculate net income, start with your gross income. This is the total money you’ve earned from working, investing and any other source of revenue before taxes. Next, start subtracting any deductions you might be eligible for. These can include interest paid on student loans and contributions to individual retirement accounts (IRAs) up to a certain point. You can also either subtract what the IRS calls a standard deduction or itemized deductions.
Tax law changes that President Donald Trump signed in 2017 doubled the standard deduction to $12,400 for single filers ($24,800 if married filing jointly) for the 2020 tax year, and $12,550 for single filers ($25,100 if married filing jointly) for the 2021 tax year. These are the taxes you’ll be filing for in early 2021 and 2022.
However, you may only either take the standard deduction or itemize deductions. Most people take the former. Because the standard deduction got increased to such a high point after 2017, many more Americans were expected to take it for the 2019 tax year and beyond.
Once you’ve subtracted all deductions from your gross income, you’re left with your taxable income. Depending on how much your taxable income is, you owe the federal government a marginal tax rate that can range anywhere from 10% to 37%.
So after you’ve subtracted income taxes, including the payroll taxes withheld from your paycheck for programs like Social Security and Medicare, from your taxable income, you’re left with net income.
This essentially tells you how much money you actually made and kept. It’s a helpful indicator of how big of a tax burden you face. It can help you find ways to reduce that burden through strategies like careful estate planning and investing in tax-advantaged savings vehicles like 401(k) plans or Roth IRAs.
Bottom Line
Net income is important for several reasons. For an individual, it indicates your take-home pay after taxes. If you run a business, it can give you insight into how profitable your company truly is and what business expenses you can cut back on. For investors looking toward equities, it helps determine the true value of a company’s stock.
Tips on Understanding Net Income
- Net income is a big factor of what you end up paying in taxes each year. To help you figure out your situation, we developed a federal income tax calculator.
- If you’re overwhelmed by your tax burden, a financial advisor can help optimize your financial plan to reduce it. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
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