What is net income and how do you calculate and use this formula in your personal finances?
When creating a personal budget, a business budget, or filing taxes, you'll come across the term net income. It's important to learn what is net income so that you can calculate your personal net earnings, the profit a company accumulates, and how gross income and net income work together.
Net income can also be referred to as net pay, net profit, net earnings, take home pay, or simply NI. It is the opposite of gross pay. For individual people, net income refers to someone's earnings after taxes and other deductions have been taken out. For businesses, net income or net profit is the amount of profit after taxes and expenses have been deducted.
Net profit is like net income for businesses. Businesses make an income known as profit, and their net profit is how much of this income they actually take in after all the expenses to run a business are taken into account. The money that the company actually sees from their sales is referred to as net profit.
Net pay and net profit are different from one another. Net pay is something used to calculate how much an employee takes home in their paycheck. Net profit is something used to calculate a business's bottom line. So when you hear this term, you can think of the pay you actually take home at the end of each pay cycle.
Individuals need to learn how to calculate net income so they can create a more accurate personal budget. Businesses need to calculate net profit so they can see their accurate sales revenue.
For individuals, the deductions taken out before you are left with net pay are expenses including social security taxes. For businesses, these expenses include business expenses like the cost to produce goods, operating expenses, along with business taxes.
Individuals can find their income statement with their bank account or in the details of their paycheck. Their net pay is the amount they actually receive in their account each pay period.
Businesses will need to look for net pay in financial statements that outline all the business expenses, operating expenses, and costs of good sold. But what are the net income formulas you need to calculate these amounts for yourself?
Net profit is the sales minus the cost of goods sold.
Total Revenue – (Business Expenses + Operating Expenses + Taxes) = Net Profit
So if you are a business that made $100,000 in total revenue, or gross income, that year and your business expenses were $5,000, your operating expenses were another $10,000, and business taxes totaled up to about $20,000, then you would do the following equation to calculate net profit for that year:
$100,000 – ($10,000 + $5,000 + $20,000) = $65,000
Net income is the gross income minus taxes and deductions that come out of each paycheck. This is how to find net income.
Gross Pay – (Taxes + Benefits) = Net Income
So if you are an individual who makes $20 an hour, that means that you are making $3,200 a month in gross pay, your total pay before deductions are taken out of it. If you pay about $200 in taxes and about $150 in employee benefits like health insurance, then you would do the following equation to find your take home pay for the month:
$3,200 – ($200 + $150) = $2,850
The above examples are just rough estimates to give you an idea of how these formulas might work for you and your take home pay or the profit of your small business. Actual calculations for take home pay can get a little more complicated than this, but these formulas can give you a rough idea of the money making its way into your wallet.
For example, depending on your tax situation, not all of your gross pay will be liable to taxes. When you have tax exemptions to consider for you or your business, this can decrease how much is deducted from gross pay for taxes. This would then increase how much money you take home.
Use the formulas with your own numbers to calculate net income and net profit as an employee or as a small business owner.
Once you know the net profit and net pay definition you can start managing your household budget and any personal businesses with more know-how. Tax forms generally ask for gross income rather than net income, but it's still a good idea to know these definitions and formulas so you can calculate your expenses more accurately.
If you use gross income for a monthly budget instead, you may run into trouble with overspending. But if you use net income, you'll know exactly how much you actually have to spend each month.
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