What is Net Income?
Net income is the earnings of a person or business after all relevant expenses and taxes have been deducted.
It’s important to know your net income for budget purposes, as basing your spending habits on your overall income (without taking deductions into account) could have serious financial consequences.
In this post, we look at how you can calculate net income to give you the most realistic picture of your financial position.
What does net income mean?
Net income is what you’re left with when you take your earnings as a whole and subtract certain necessary expenses and taxes.
Businesses and individuals define net income in slightly different ways.
Net income for businesses
The net income of a business is equal to the company’s gross income (sales revenue minus cost of goods) minus all expenses, taxes, and interest. For a business, net income is the same as net profit.
If a business’s expenses and deductions add up to more than its income, we say that the business has a net loss.
It’s useful to work out a company’s net income if you’re thinking of investing in it. That’s because net income is a good indication of the company’s profitability and how quickly it’s growing.
Let’s look at a couple of examples of the net income formula in action.
Sam runs a company selling stationery to other businesses. She rents a small office for her sales team, as well as warehouse space for storing the stationery.
Sam’s income statement for the year looks like this:
- Revenues: £300,000
- Office rent: £6,000
- Warehouse rent: £6,000
- Salaries: £200,000
- Computer expenses: £5,000
- Taxes: £5,000
Sam works out her net income by calculating her total expenses (£222,000) and subtracting this from her revenues: £300,000 - £222,000 = £78,000
So the net income, or net profit, of Sam’s business is £78,000.
Bob runs an online gardening supplies company. He runs his business from an office set in beautiful landscaped grounds, and he rents an enormous warehouse for holding the gardening supplies.
Bob’s income statement for the year looks like this:
- Revenues: £200,000
- Office rent: £20,000
- Warehouse rent: £40,000
- Salaries: £150,000
- Computer expenses: £7,000
- Taxes: £3,000
Bob works out his net income by subtracting his total expenses (£220,000) from his revenues: £200,000 - £220,000 = -£20,000
So, in fact, Bob’s company is running at a loss of £20,000. He needs to cut his expenses or increase his revenues if he wants to make the business sustainable and start achieving a net profit.
Tips: How to improve net profit
In order to increase its net profit, a business can try to do a number of things:
Increase sales revenue:
Boost your overall incoming cash from sales to new and existing customers. Think about adding value with deals, new products, and investigating fresh markets.
Increase customer retention and loyalty:
Focus efforts on keeping your current customers, and increasing the number of returning customers. How can you keep people interested for the long haul? This is especially important for subscription-based businesses, but it’s a vital principle for all sectors.
Reduce expenses on utilities:
Look for cost-cutting measures on electricity, gas, water, and other utilities. Try switching providers, or finding ways to be more energy efficient in the building or out on the road.
Minimise operational costs:
Are you overpaying for office supplies? Do you have business software that isn’t being used? Are there ways to streamline your bookkeeping or invoicing processes? These are all questions that will help you minimise operating costs and increase net profit.
Optimise labour costs:
You may want to limit overtime, consolidate projects, or renegotiate agreements with contractors. Naturally, always remain sensitive and pay attention to the human effects of this approach.
Analyse your insurance premiums:
Check out what you’re paying in insurance premiums on equipment, vehicles, contents, and other aspects of your business. Try switching providers.
Net income for individuals
As an individual, your net income is often referred to as your “take-home pay”, because that’s the amount of money that reaches your bank account once your employer has subtracted tax and made other deductions.
If you look at your pay slip, you should see the various amounts that have been deducted from your overall salary (or gross salary) to determine your net income. This will often include:
- National Insurance contributions
- Income tax
- Pension scheme contributions
- Student loan repayments
If you’re self-employed or you carry out other freelance work in addition to your main job, you’ll probably be asked to submit a tax return to HMRC. Once you’ve detailed all your sources of income and any work expenses, HMRC will calculate how much you owe in National Insurance, income tax, etc.
The amount of money left after these deductions will be your net income.
Let’s look at an example of how to calculate net income for an individual:
Sarah has a salary of £45,000 per year from her office job. On her pay slip it lists the deductions from her gross wage:
- Income tax: £6,050
- National Insurance: £4,260
- Company pension scheme: £2,250
- State pension: £560
- Student loan: £1,660
Sarah’s salary of £45,000 has £14,780 of deductions subtracted from it, so her net income (take-home pay) is £30,220.
Net Income: Key takeaways
As an individual wage earner, your net income is simply the money you have available to spend once tax and other deductions are taken into account.
So, if you’re considering a new job with a different salary, it’s useful to calculate what your net income will be from that employment. It will give you a more realistic picture of the lifestyle you can enjoy with that salary.
You can calculate net income yourself using the most up-to-date information from HMRC, or you can use an online take-home pay calculator.
To find out more about net income, check out our other blog post:
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