The gross income for a company or a person is easy enough to figure without using business accounting software — simply add the total of all forms of revenue from all sources. However, this may not be most accurate measure of income. Net income may present a more realistic financial picture.
To get this realistic financial picture, you’ll need to know how to calculate net pay from gross pay. To figure net income, expenditures such as operating costs, taxes, interest, and certain dividends are deducted from the gross income. Net income is the amount of available money left over after all such deductions have been made.
Why calculate net income?
There are numerous reasons for companies and individuals to calculate their net incomes. Businesses require calculation of their net income to determine profits, expand or reduce operations, determine employee bonuses, and inform investors. Individuals can benefit from calculating their net income to better plan their budgets, determine investment profits, apply for loans, and to satisfy court rulings (i.e., child support, alimony, etc.).
Individual net income
To calculate net income, individuals first determine their gross annual income by taking their pay and multiplying it by the number of pay periods in a year. In most cases, employees will multiply their base pay by either 52 (if paid every week), 26 (if paid every two weeks), 24 (if paid twice a month, regardless of the number of weeks in the month), or 12 (if paid every month). They can determine monthly gross income by dividing the yearly figure by 12 (the number of months in the year).
The next step is to determine the total amount of deductions taken from each paycheck. This includes all Social Security tax, Medicare, withholdings for insurance of all types (health, vision, life, etc.), and anything withheld by the government for back taxes, child support, etc. Subtract these amounts from the gross pay to arrive at an employee’s net income.
In some cases, lenders may ask specifically for net pay minus all monthly expenses. In this case, applicants would subtract their monthly mortgage or rent payment, car payment, average utility payments, and any other standard expense.
Business net income
The process for calculating the net income of businesses is a little more complicated, but it still consists of taking the business’s gross income and subtracting expenditures. These figures will be recorded in the business’s income statement.
First, determine the gross margin by subtracting the total expense for goods sold from the total sales. This includes the manufacturing costs, shipping costs, and storage costs.
The next figure required is for total operating expenses. This is calculated by adding all costs for general, administrative, and sales to any research and development expenditures. This includes employee salaries, building rent, building utilities, and any other cost that is necessary for the business to operate.
Next, the business will need to subtract any income taxes and other non-operating expenses, such as fees, fines, application payments, etc., from the running total. This provides the business with its net income, which can also be thought of as the business’s total profit for that quarter (or whatever time frame is being used).
This is the basic formula for arriving at the net income of a company, but there may also be other adjustments necessary to arrive at an accurate bottom line. These can include accounting principle changes, extraordinary items, and discontinued operations.