What is Net Income?
Net income can be considered in several ways. Both businesses and individuals look at their net income and their gross income. Gross income is very easy to understand because it is simply all that a person or business makes, without consideration of any expenditures or deductions. When people look at net income, they factor in any deductions to arrive at a net amount.
In business net income would be the number arrived at after certain things occur, like paying taxes, paying employees, paying rent or upkeep on buildings, and purchasing any needed supplies. The net income may also be considered the company’s profit, or what the company gets to keep after all accounts are settled.
Sometimes companies speak of “netting” a certain amount of money, and this refers to looking at net profits or income. It is usually a far different number than gross profits, and much lower. Theoretically a company can net virtually nothing, if after meeting all expenses, they have no money left over.
An individual’s net income is calculated in a slightly different manner. People don’t get to deduct their rent payments or the cost of living when they are calculating this figure. Instead, it’s a simpler process.
Most people pay state and federal taxes, social security payments, and disability taxes. Some contribute money to a 401k, and may pay some money for health insurance payments. They may also contribute to a health savings account. All of these things come out of the paycheck reducing gross income.
Essentially, all deductions subtracted from the gross amount become the net income. This may be referred to as take home pay, and might be significantly reduced from the gross amount. Consideration of what people will actually take home is very important when thinking about a salary; what is left when all paycheck taxes or contributions are removed? Understanding tax code and likely contribution to other programs can help people determine how much they need to make so they can meet their daily expenses, and this could form an important part of salary negotiation.
Percentage of income people get to keep can vary when taxes are constructed on a progressive plan. In a flat tax system, everyone pays the same percentage, but in progressive taxes, percentage goes up as wages increase, meaning potentially lower netted amounts. Another variable can be things like contributions to voluntary programs or to pay for health insurance. People can decide, most of the time, how much they want to contribute to a 401k or health savings account, but companies can presently choose how much people will pay for insurance if they elect to purchase it.
One thing some people find odd is the number of social programs that are determined based on gross income instead of net income. People who might qualify otherwise for social assistance may make too much when gross is considered. The other side of the coin is eligibility for loans, rentals and credit often is partly determined on gross income, where people may gross much more than they net, and really not be able to afford a loan or a highly priced rental.
@ Fiorite- I can help answer your questions. Analysts and investors use the different types of net income on financial statements to compute financial ratios. Analysts determine profitability ratios (profit margin, return on assets, and return on equity) by using a company’s net income, sales, assets, stockholder's equity, or debt. For example, the return on assets of a company is simply the net income divided by total assets.
Analysts determine debt utilization ratios, like "times interest earned" and "fixed charge coverage", by using the "income before interest and taxes" and the "income before fixed charges and taxes". For example, times interest earned is the ratio of income before interest and taxes to interest.
Investors use these financial ratios as markers to benchmark a business against its industry peers. You can use them to determine the strength, liquidity, and operational efficiency of a business.
@ GenevaMech- Why are all of these different types of net income on an income statement necessary? Why doesn't a business just call net income profit and leave it at that? What is the significance of these income figures to investors and financial analysts?
In the business world, net income is very important. There are also more than one type of net income that a business will track, all for various reasons. Business will track net income before taxes, net income before interest and taxes, net income before fixed charges and taxes, and net income.
These different types of net income appear on a company's income statement, or investors and financial officers can compute them with information on a company's income statement. This information is also important for people who are analyzing a company that they would like to add to their investment portfolio.
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