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Net Income: Definition, Explanation, Calculation and Examples

To anyone who has never worked in business, the phrase net income can seem mystifying. If you think about it, this term actually means different things to different people.

This is usually the most commonly reported figure because it can be seen in a single monthly, quarterly, or yearly report. When you have figured out your expenses and profits, you will need to figure out the difference. The difference will be your net income.

What is net income?

Net income is your profit after accounting for the expenses and other income. A business owner has to decide which item should be excluded when figuring his or her income. It includes the income from wages, salaries, commissions, capital gains, interest, rents, and royalties. For example, if a salesperson took home a commission of five hundred dollars, he or she would have an income of five hundred plus five hundred minus the commission rate.

Net-Income
Net Income

Net Income Formula

It is the total of all income received minus the expenses associated with it. It will also include the income taxes that are deducted from your paycheck each month.

It is calculated on the basis of your annual gross receipts. Gross receipts are the actual cash value of the merchandise or services that you sold. Once you subtract your inventory costs, advertising and marketing costs, and other miscellaneous costs, you will have your net income.

It will be different if you subtract out your selling costs from your gross receipts. These expenses could include such items as business insurance, payroll taxes, equipment leasing, rent, and legal fees.

Understanding

The first step in understanding the is to learn how to interpret financial statements. This process includes looking at your income statement, balance sheet, and cash flow statement.

Balanced income statement is the most basic income statement for a company or an individual. It reports the balance of your assets and liabilities. In this section, you would see the Company’s assets and their value.

The cash flow statement shows your cash inflow and outflow and the rate at which your cash is generated. This is a good way to get an overview of the cash generation. To interpret it, you must know the amount of money that flows into and out of your business.

To understand our concept, the next step is to look at the dividends that the Company pays. Dividends are one of the major sources of cash. For further understanding, we must look at the characteristics of a dividend. The profit of the dividend is a percentage of the cost of the shares paid.

The higher the profit margin of the Company, the higher the net income of the Company. As we know it is the difference between the cost of the investment and the actual profit of the investment.

The next step is to understand how to calculate net income. To find out the net operating income of a particular Company, you can use a comparative analysis. For example, if you analyze the prices of the stock of Company A in different time periods, you will get the gross profit of Company A.

You will also get to find out the differences in net income of Company A and other companies in its category. If you analyze the turnover of Company A from its inception to present, you will get the turnover of Company A. You will get to get information about how much income Company A makes by selling a certain product. By looking at these financial statements, you will get to understand what profit the Company is making from its sales.

How to calculate net income from balance sheet

It is essential to understand the total assets and liabilities for the company and then proceed to the calculation of net income from this. As we know it is basically profit that is earned by the company. To know more about this, the details of the company can be known. Nowadays, many companies are closing down so it is important to learn about the details of such companies so that your company can survive in the market.

  1. In the first step, take the total revenue figure which can be founded on the balance sheet.
  2. Now, in the next step all you have to do is to subtract two figures from the revenue figure. These two are; the cost of goods sold (COGS) + any overhead or other costs incurred to produce the goods. This will result in the gross profit for the company.
  3. Now, you have the gross profit figure with you. Just subtract all the administrative expenses and selling expenses. This will result in net income before taxes
  4. Finally, we are in the last step of calculating net figure from balance sheet. All you have to do is to subtract income taxes paid (if any) from the net income before taxes. This will result in net income after taxes.

All companies have a financial statement in which you can find out the exact details of their income and expenses. The financial statement is the condensed version of the balance sheet. The balance sheet will show the finances of the company. The balance sheet tells you the amount of cash and non-cash working capital present in the business. It also tells you the income and expenses of the company. This is the first part of the financial statement that you have to study.

In the next part of the financial statement, the operating statement will tell the details of the gross and net income. Income is the profit that the company generates from all its activities. Net income is the profit that is earned by the company by selling, owning, and trading of shares, as well as any other earning. This is also called a residual income. Then comes the income statement, and this is the one that gives the financial statement in brief form.

How-to-calculate-net-income-from-balance-sheet
How to calculate net income from balance sheet?

Gross vs Net Income

Although gross income and net income have many similarities, they have some major differences as well. What are these differences?

A gross income is income that is not taxable and that is the only income a person will make. A gross income will only be taxed if and when someone receives more income. Net income on the other hand, is the income that a person actually receives.

The second difference between gross income and net income is that net income is determined by subtracting the taxes owed from the gross income. This difference is significant because it means that there is no chance of an individual paying tax twice. It is only the gross income that are taxed, but that will be paid with the tax returns. It can also be used to compare an individual’s income to that of someone else.

The third difference between gross income and net income is that it takes into account the expenses that are incurred. This can be a disadvantageous or helpful thing for an individual. It is a disadvantageous thing because it means that a person who has expenses may end up paying more taxes than the actual amount they spent.

The fourth difference is that in a case of gross income a person is not required to pay any taxes. However, when it comes to net income there is an obligation to pay taxes. This may work to the advantage of a person in that they are not obligated to pay any taxes at all and are also not forced to pay off their debts.

The fifth difference is that the first three of these differences are required on a monthly basis. They require that a person to file their taxes and this may mean that a person has to spend several months filing their taxes. This is something that must be considered, because even if the person may not have spent many months filing their taxes, it can still add up-to many months of a person’s life.

The sixth difference is that gross income includes the earned income and net income includes the unearned income. Unearned income is income that a person makes without putting in any work. This income can be anything, such as the sales of a product, the wages a person earns from doing free work, or any sort of sales that a person may get from selling a product.

net income vs net profit

Differences between net income and net profit in the financial statement is a key aspect that should be considered by anyone who has some responsibility to look at the financial statements of his or her company. The differences between net income and net profit in the financial statement is that the former is the difference between earnings before interest, taxes, depreciation, and amortization (EBITDA) and earnings before tax (EBT). EBITDA is the most common way of calculating earnings and EBT is a way of accounting for the effect of all the tax deductions.

Net income is the profit after tax and net profit is the difference between the gross income and tax deduction. If net income is greater than the net profit, then the gross income will show higher than the tax deduction. On the other hand, if the net profit is less than net income then gross income will show lower than the tax deduction. One or both of these situations can happen with the same entity.

Because of the differences between net income and net profit, it is necessary to calculate the profit after tax using a different method than the net income calculation. This makes the process of calculating the profit after tax more complex and time consuming. A better option would be to use a net income and net profit calculator to simplify the calculation.

It has been stated that net income is a method of calculating the net profit after tax. In this method, you first subtract depreciation from the income before tax and add the net income figure. The difference between net income and net profit will be your gross income and the gross profit after tax. This will give you the net profit after tax. Therefore, it is important to consider the gross income before tax and the net income after tax to arrive at the net profit. It is also important to consider the depreciation and amortization during the reporting period.

Net Profit Is A Different Method of Calculating The Difference Between Gross Income and Tax Deduction The difference between net profit and net income is the difference between gross income and tax deduction. When calculating net profit, the gross income and tax deduction are both subtracted from net income to get the net profit. Therefore, the net profit is the difference between gross income and tax deduction.

A better option would be to use a net income and net profit calculator to simplify the calculation. Net income and net profit calculators are good ways to help you determine the gross income and tax deduction. By using a net income and net profit calculator, you will be able to calculate the net profit after tax.

Net Income and Accounting Equation

Net income is defined as the difference between total sales and the total expenses of the company. In other words, it is the amount of money that the company spends on product purchases and in order to make money from them. It is defined as revenue minus cost of products. The revenue or net income of the company is usually expressed as a percentage of the net sales or the operating expenses. It is very important to note that net income is not the only thing which can be used to evaluate the financial performance of a company, it is just one of the many measures which are used for that purpose.

For example, when you talk about net income the first thing that comes to your mind is that of business or profit. Net income, of course, should always be higher than the expenses because its income is more than what is spent on marketing or profit. The importance of net income is that it helps the business owner to make sure that the expenses of the company are at par with the revenue. As mentioned above, it is always considered as a percentage of the company’s net sales or operating expenses.

The equation for net income is very simple. The net income is calculated by dividing the total sales by the total expenses. You will have to provide some input in this equation for net income.

In order to get the real picture of the income equation for net income, you can do a simple calculation using net income as an example. The net income will include all profits (minus the expenses). The next part of the equation for net income is the percentage of sales that is being attributed to the net income. This part of the equation for net income includes the number of years in which the business is going to earn the net income.

YOY- Definition, Explanation and Real-World Examples

YOY stands for year-over-year. It is used to compare two or more measurable events on an annual/yearly basis. As the name year-over-year suggests, it is a method of comparison on a yearly basis. Suppose, you’re the sales manager of ABC Ltd. Now you want to compare annual sales of year ended 31st Dec 2020 with the previous year I.e. 31st December 2019, this practice is called yoy analysis as you are comparing sales for 2020 with the sales of 2019.

In this article, directory of finance will teach you the detailed definition, analysis, real world examples, calculation and difference from mom (month over month), QoQ (Quarter-over-Quarter) and YTD (Year-to-date).

Year-Over-Year (YOY)

Year-Over-Year is a method of comparison between two or more events on an annual or yearly basis. The conditions are:

The events should be measurable (like we cannot compare non-measurable events)

The analysis should be made on yearly basis. (Its not year-over-year if its not done on yearly basis).

yoy
YOY stands for year-over-year. It is used to compare two or more measurable events on an annual/yearly basis

What is YOY?

YOY and Year-over-Year are the same thing denoting a method of comparison. This comparison is most commonly used in finance/accounting world. It is most frequently used during the comparison of sales, operating expenses, distribution expenses, profit margins and margin percentage etc.

Year-Over-Year (YOY) Explained

This method was introduced to make the life of ‘user of financial statements’ easier. As you know, financial statements are very complex to understand for a common user. This is why different types of financial comparisons are used in the finance world. These comparisons make it easy to understand. Let me support my reasoning with a simple example:

  1. If I say, operating expenses for the month ended 31st December 2020 are $200,000.
  2. And If I say, operating expenses for month ended 31st Dec 2020 are $200,000 and for December 2019, these were $150,000.

Which of the above statements are more understandable to you? Let me tell the meaning of the both statements;

By first statement, I have no idea about whether this figure of $200,000 is good or not as I have no data of prior years. Hence, as an Investor I cannot decide about investing in the company as I don’t know of this is a good figure or not.

While, if I look at the second statement, I have more data to rely on. I can conclude that operating expenses for December 2020 has increased by almost 33.3% as compared to the same month of prior year.

Now, I can make an informed decision about investing in the company or not.

Note: Please note that this is just an example, a lot of other factors are also taken into consideration while deciding about investing in a company.

Benefits of Year-Over-Year (YOY)

  • Such a financial comparison makes it easy to understand the complex figure of financial statements.
  • Investors and Creditors can make more informed decisions about the financial statements when they have a clear view of what has happened or changed since last year.
  • It makes the performance of the company easy to understand. You can easily tell if the performance is good or bad if you have prior years data with you.
  • This analysis is useful to mitigate the factor of seasonality. By looking at the data of different years, quarters etc. one can differentiate between seasonal products and evergreen products.

Real world Examples of YOY

Starbucks: No of Stores YoY analysis

Following is the analysis of company operated stores of Starbucks for the year ended 29th September 2019.

CountryNo of Stores as of Sep 30, 2018 (A)No of Stores as of Sep 30, 2019 (B)YoY Change (B-A)
U.S.8,5758791+216
Canada1,1091,175+66
China3,5214.123+602
Japan1,2861,379+93
Thailand3520-352
U.K.335288-47
All other15565-90
Siren Retail813+5
YOY Example

Source: https://s22.q4cdn.com/869488222/files/doc_financials/2019/2019-Annual-Report.pdf

yoy examples
Examples of Year Over Year

How is YOY Calculated?

Its calculated in 3 easy steps:

  1. You’ll be given two figure i.e. figure for current period and figure for prior period. Subtract current period figure from prior period figure.
  2. Now divide the result by prior year figure.
  3. Multiply it by 100 if you want your result in percentages.

We have discussed this formula with examples in our coming sections.

how-to-calculate-yoy-growth

YOY Growth Importance

Year over year growth compares the percentage changes for current period to past periods. This period can be any month or a Quarter. For example, suppose sales of ABC Ltd are $300,000 for December 2020 and these were $250,000 for December 2019. We can conclude that yoy growth is 20%. Wondering how to calculate this growth? no worries as we’ll see this in our next section.

Calculation of Growth is important as it make us understand the performance of a company better. Data is more understandable when changes or comparisons are made in percentages. The end goal is to make the life of potential investors, creditors, shareholders etc. easy. They can digest data easily if it is presented in more organized way.

How to calculate YOY Growth in Excel?

Formula for YOY Growth is as follows:

  
Figure for event A =X
Figure for event B=Y
Change (B-A) =Z
Y-O-Y growth(Z/X) *100
  
How to calculate YOY Growth in Excel?

Where event A is any prior year period (December 2019 in our sales example)

Event B is current period (December 2020 in our sales example)

Let me calculate it for you for our sales example:

  
Sales for event A (December 2019) =$250,000
Figure for event B (Dec 2020) =$300,000
Change (B-A)=$50,000
Y-O-Y growth($50,000/$250,000) *100
 20%
How to calculate YOY Growth in Excel?

Year over Year Analysis (YoY) Template

Download the Free YoY analysis Template. You’re allowed to use it anywhere it’s completely free! You can even use it for commercial purposes.

YOY, MOM

MoM stands for month over month, whilst y-o-y stands for year over year. Month over Month is another financial comparison used to compare measurable events at two different Months of the same period. Whilst year-over-year is comparison of two events at two different periods i.e. one of the current periods and one of the previous periods. For example, comparing sales for December of current year with sales for November of current year is MoM analysis. However, if we compare sales for December of current year with sales for December of previous year, it is what we call y-o-y analysis.

What is QoQ and YOY?

QoQ stands for Quarter over Quarter, whilst the latter one stands for year over year. Quarter over Quarter is another financial comparison used to compare measurable events at two quarters of the same period. Whilst year-over-year is comparison of two events at two different periods i.e. one of the current periods and one of the previous periods. For example, comparing sales for Quarter 4 of current year with sales for Quarter 3 of current year is QoQ analysis. However, if we compare sales transactions for Q4 of current year with sales for Q4 of previous year, it is what we call y-o-y analysis. Keep in mind that we cannot compare Quarter 3 of current year with Quarter 2 of previous year as it’ll not render fruitful results.

Is it year on year or year over year?

Its year over year which is used in financial comparisons. This term is widely used in accounting/finance to compare two measurable events at two different periods.

What is YOY and YTD?

YOY stands for year-over-year while YTD stands for year-to-date. YTD means the period starting from the first day of current year up-to the current date. For example, suppose its 31st August 2020, the period of time between the start of calendar year I.e. 1st January 2020 and current date i.e. 31st August 2020 is year-to-date or YTD.

Which of the following costs are not included in finished goods inventory?

Which of the following costs are not included in finished goods inventory?

  1. Factory Overhead
  2. Direct Labor
  3. Direct Materials
  4. Company president’s salary.

Answer

Answer to this question is option D which is company president salary.

Finished goods inventory contains only direct costs. Direct costs are those costs which can be directly attributed to the cost of finished goods. As we can see, option A “factory overhead” is directly attributable to the finished goods inventory.

Similarly, option B which is direct labor is directly attributable to finished goods inventory.

The same goes with option C which states direct materials. Direct materials are also direct costs.

Now, we are left with only one option i.e. option D which which says “company president salary”. It is in Admin expense. It should be charged to profit and loss under admin expenses. It has no direct relationship with finished goods inventory so it should not be included in the cost of finished goods inventory.

we study 2 types of costs in cost accounting. These are direct costs and indirect costs. Direct costs are those costs that are directly attributable to the cost of the product. Example of direct costs are materials, labours, overheads (these are the type of costs that can be directly attributed to the cost of the product.)

Now the key question here is how we know if a cost is directly attributable to the cost of the product or not.

I’m giving you a hint here. If you think that this particular cost would not have occurred if we weren’t producing that particular product then this means that this is a direct cost because this cost is occurring solely for the product being manufactured. As you can see, direct labor, direct materials and Factory Overheads are incurred because we are producing a particular product. But as for the company president salary, if this product wasn’t being manufactured we would have incurred that cost anyhow.

Which of the following accounts’ balance is carried forward to the next accounting period?

Which of the following accounts’ balance is carried forward to the next accounting period?

A. Accumulated Depreciation

B. Depreciation Expense

C. Dividends

D. Service Revenue

Answer

The correct answer to this question is option a that is accumulated depreciation .

As for the other options remember the following key points

profit and loss items are always closed at the current period we do not carry forward their balances to the next accounting. Whilst on the other hand the balance sheet items are carried forward to the next accounting. You might have seen this in T account for balance sheet items we have brought down (b/d) and carried down (c/d). While in profit and loss items, we do not have such b/d and c/d .

Now let me explain all the options for you;

option B says depreciation expense is stated earlier deposition expense is a profit and loss item. So, we do not carry forward its balance to the next accounting period.

Similarly, option C says dividends; it is also related to profit and loss. So, we do not carry forward it. There is no balance in profit and loss items. As PnL items are closed at the end of accounting period. The next period is started from Zero.

 Similarly, service revenue has the same explanation.

While if we analyze option A i.e. accumulated depreciation, we see it is a balance sheet item we do have a balance so we could forward it to the next accounting period.

An ordinary annuity is best defined by which one of the following?

An ordinary annuity is best defined by which one of the following?
A. Increasing payments paid for a definitive period of time.
B. Increasing payments paid forever.
C. Equal payments paid at the end of regular intervals over a stated time period.
D. Equal payments paid at the beginning of regular intervals for a limited time period.
E. Equal payments that occur at set intervals for an unlimited period of time.

The correct answer to this question is option C. We define ordinary annuity as equal payments paid at the end of regular intervals or a stated period of time.

Let me discuss the other options for you:

Option A says that increasing payments paid for a definitive period of time which is not correct because annuity is what we call as an equal amount.

The second option says that increasing payments paid forever that is not correct as I mentioned earlier that in annuity, we pay equal amount at regular intervals.

Option C says equal payments paid at the end of regular intervals over a stated period of time which is correct because annuity is what we call “equity payments”. if these equal payments are made at the beginning of the period, we call it is due annuity. Similarly, if such equal payments are made at the end of the period, we call it as ordinary entity.

Now let me make my point clear with some example;

 Suppose company ABC is paying an amount of $5000 each year to a leasing company. Now if this amount is paid at the beginning of the period i.e. January 2020, we call it as due annuity. It is due in a sense that you are paying it in advance. Your leasing period has just started.

On the other hand, if you are paying the same amount at the end of the year i.e. December 2020 then we record it as ordinary annuity.