Net Income vs. Net Profit and How to Calculate Them
By Indeed Editorial Team
Published June 5, 2022
The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.
While similar in nature, both net income and net profit have unique differences that set them apart. Net profit fails to account for equity released to shareholders, while net income reflects the entire financial picture. If you're looking to learn more about the financial side of a business, understanding their differences can help you distinguish between the two. In this article, we discuss what net income vs. net profit is, discover their differences, learn how to calculate them, and provide examples of both.
Understanding net income vs. net profit
Understanding what net income vs. net profit is can help you distinguish the differences between the two. Both net income and net profit reflect a positive cash flow in a business and both show a healthy financial balance. Both values reflect the same business position, but at different times in the business cycle, and we can draw different implications from each. As they are like each other, it's helpful to understand how each value differs from the other.
Businesses can calculate net income by taking the total sales of a business and subtracting the cost of goods sold, expenses, depreciation, taxes, and interest. Expenses can include operating, general, administrative, and any other expenses. Investors can use net income to understand how the revenue of a business exceeds the expenses of a business. This number can reflect the overall health of a business and can show whether it's a good investment to make. Businesses can find this value at the bottom of an income statement after they deduct all taxes and expenses.
After subtracting costs, net profit is the amount of money a business makes. Businesses calculate net profit by taking the total sales of a business and subtracting the cost of goods sold. Net profit reflects how well a business manages its operating and material costs in relation to the income they generate. Investors use net profit to make judgements on the efficiency of a business's operations to see whether it's a responsible investment. Consultants can also use net profit to determine if operating costs are too high in relation to earnings.
Differences between net income vs. net profit
While net profit shows the ability of a business to generate income despite operating expenses and the cost of goods sold, net income shows an overall picture of the business, considering all its expenses. Investors are typically more concerned with the net income of a business, as they factor net profit into that calculation. Net income provides insight into management's ability to run a business, while net profit shows the effectiveness of managing the production process.
Limitations of net income and net profit
The primary limitation to net profit is that it doesn't apply to all companies across all industries. Companies that provide a service have much lower operating costs and don't always have a cost of goods sold. This makes this value difficult to compare across businesses and it's not applicable to every investor analyzing the health of a business. For example, a graphic design business may have limited expenses in relation to their earnings, making net profit an inaccurate metric to analyze.
Net income can have limitations in businesses that have delayed earnings. The period in which they receive income may have different income calculations than the periods in which they are reporting the expenses for those earnings. For example, a business that specializes in constructing houses may have different net income amounts each year, depending on how many houses they completed. At the end of some fiscal years, there may be more expenses than earnings as they haven't finished construction.
The relationship between net income vs. net profit
The financial side of a business relates to both net profit and net income. Businesses derive net income from taking the net profit of their business and subtracting the expenses involved outside of the cost of goods sold. Financial records don't always show net profit and if a business doesn't publically trade, it can withhold it from investors. Financial statements show net income at the bottom, but can be difficult to calculate if you don't have access to net profit.
Calculating net income vs. net profit
The best way to calculate both net profit and net income is through an income statement. This is an important financial document that nearly every business uses to understand its profitability and expenses.
Some companies use a single-step income statement to share their net income, net profit, and total expenses. This document is concise and does not include individual line items, but it instead offers the totals for each category. The multi-step income statement includes line items for each type of revenue and cost, making it much more useful for companies or stakeholders who want a deeper understanding of the organization's financials. Multi-step income statements usually provide data for these items:
Sales revenue: Sales revenue is the total amount of money brought in from sales. It's a positive entry on the income statement.
Cost of goods sold: The cost of goods sold accounts for any expenses the company incurred in making or distributing their product. It's a deduction from the sales revenue.
Gross profit: The gross profit is the remainder after subtracting the cost of goods sold from the sales revenue.
Administrative expenses: Administrative expenses include any overhead costs the company incurred during the period expressed on the income statement. It's a deduction from gross profit.
Earnings before interest, tax, depreciation, and amortization: Earnings before interest, tax, depreciation and amortization, or EBITDA, is the remainder after subtracting the administrative expenses from the gross profit.
Depreciation and amortization: Depreciation and amortization are any financial losses attributed to physical equipment or intangible assets the company owns. They're deductions from EBITDA.
Operating income: Operating income is the remainder after subtracting depreciation and amortization from EBITDA.
Interest expenses: Interest expenses are any costs associated with interest payments on a loan. They're deductions from operating income.
Earnings before taxes: Earnings before taxes is the remainder after subtracting interest expenses from operating income.
Tax expenses: Tax expenses are any costs associated with taxation. They're deductions from earnings before taxes.
Net income: Net income is the remainder after subtracting tax expenses from earnings before taxes. For companies without shareholders, this is the bottom line of the income statement.
Shareholder dividends: For companies with equity shareholders, shareholder dividends are the total earnings provided to shareholders. They're deductions from net income.
Net profit: Net profit is the remainder after subtracting shareholder dividends from net income.
Example of net profit
Review this example income statement to see how to calculate net profit:
Driveway Home Repair
Tax Year 2020
Sales revenue: $874,000
Cost of goods sold: $167,000
Gross profit: $707,000
Administrative expenses: $43,000
Depreciation and amortization: $17,200
Operating income: $646,800
Interest expenses: $5,490
Earnings before taxes: $641,310
Tax expenses: $29,810
Net profit: $611,500
Example of net income
Consider this example income statement to see how to calculate net income, which is the third line from the bottom of the income statement. Net profit is the final figure on the income statement, calculated after accounting for shareholder dividends:
Tax Year 2019
Sales revenue: $1,500,000
Cost of goods sold: $500,000
Gross profit: $1,000,000
Administrative expenses: $180,000
Depreciation and amortization: $30,000
Operating income: $790,000
Interest expenses: $9,000
Earnings before taxes: $781,000
Tax expenses: $56,310
Net income: $724,690
Shareholder dividends: $134,000
Net profit: $590,690
Other profitability metrics
While net income and net profit are the primary metrics used to show the overall health of a business, investors may use several metrics in their calculations. In addition to net profit and net income, there are several metrics investors use, including:
Net profit margin
Net profit margin shows how much profit a business generates as a percentage of revenue. It's the ratio of total profit to total revenue and can give a clear account of what percentage of revenue is being allocated to expenses. This can give investors insight into the operational efficiency of a business and its overall health.
Return on investment
Return on investment is the amount an investor earns after investing capital into a business. A high return on investment shows that businesses are performing well, making them a desirable investment. Low return on investment shows that operational changes may take place before an investor can see the rewards of their investment.
Earnings before interest and taxes
Earnings before interest and taxes indicate the operational profitability of a business. It's calculated by taking the revenue and subtracting all expenses except interest and taxes. While interest and taxes are expenses that affect the bottom line of a business, they're not a direct result of operations and removing them from net income gives a clearer account of operational stability.
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