Net income is the total amount of money that a business earns in an interval of time, excluding all the basic expenses, including the cost of goods, taxes, interest, salary, and wages. But, if we talk about an individual’s net income, then it’s their ‘take-home’ money that they get after the deduction of health insurance, taxes, and retirement contribution. To have strong financial health, net income should be greater than spending.
Net income is also the bottom line because it emerges at the income statement’s bottom.
How to calculate net income?
To obtain the net income, you may subtract the expenditure from the gross income, which is the earned amount.
However, for the individual net income means the money a person gets in the form of a paycheck, monthly. A person could have different sources of income, meant by part-time jobs or investment income that could add to your basics.
There are two ways to calculate your net earnings;
- Elementary Method: Gross earning – Cost of living = Net Income.
- Full Method: Income – Cost of sales – Expenses = Net Income
Why is the understanding of net income important?
When you know your budget, it becomes convenient for you to figure out how your saving cycle should begin and could work smoothly in the future.
Similarly, understanding net income means you’ll be aware and prepared about the daily expenses and uncertain situations that could only be dealt with if you have enough budget for it.
The banks have considered net income during the approval of business loan applications. Net profit margin and operating cash flow are calculated through net income, as do investors searching for a suitable company for the investment. Organizations use a widely used productive metric to calculate earnings per share (EPS) via net income to inform stakeholders, VCs, and other venture capitalists.
Also, profit margins are calculated through net incomes, which is the percentage of yield. This highlights cash flow progress to actual gain after the expenditure is paid.
Here’s a business example:
A business reports a total profit of $2 billion per month. That seems to be a healthy business and worth investing in. But suppose the same company reports a total loss of $200 million. In that case, you’ll find it difficult not only for the investment. But your point of view about financial health. And workability will be questionable for it too.
An Individual’s example:
Net salary is important because the budget and spending are scheduled if a man gets a job earning $6,000. Might only have $5,000 or maybe less of it to spend after paying all the essential bills. Suppose the same person wastes all of his salaries every month. In that case, he won’t have enough balance to keep aside for the saving purpose. But, if the net income is considered and the spending becomes budgeted, then money could be saved as per the budget.
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