What is net income?

Have you ever looked at your paycheck or a company's financial report and wondered why the final number seems so much smaller than you expected? That's the work of net income. Put simply, net income is what's left after taxes, deductions, and expenses have taken their share.

It's the money that lands in your bank account each month, and if you're running a business, it's the profit that remains once you've paid the bills. Understanding net income is key to making smart financial choices, whether you're planning a household budget, applying for a loan, or deciding if a company is worth investing in.

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When you receive a paycheck, the amount printed on your contract isn't the same as what you take home. Many people make this common mistake when receiving their first paycheck. In reality, your gross salary is the total you've earned before any deductions. From that, your employer withholds:

• Income taxes
• Social Security contributions
• Retirement or pension contributions
• Health insurance or other benefits

What's left is your net income.

Example: If your gross monthly salary is $4,000 and your total deductions add up to $800, your net income would be: $4,000 – $800 = $3,200.

This is the amount you can use for rent, groceries, savings, and other expenses. If you have side gigs or variable income, your net income may change month to month. Tracking fluctuations helps you plan for irregular expenses or set aside savings during higher-earning months.

For companies, net income, sometimes called the bottom line, is calculated by subtracting all expenses from total revenue. These expenses can include:

• Cost of goods sold (COGS)
• Employee wages
• Rent and utilities
• Marketing expenses
• Loan interest
• Taxes

Example: A small artisan bakery earns $200,000 in sales over the year. Its expenses include $70,000 for ingredients and packaging, $60,000 for wages, $20,000 for rent and utilities, $10,000 for marketing, and $5,000 in taxes.

Net income = $200,000 – ($70,000 + $60,000 + $20,000 + $10,000 + $5,000)
Net income = $35,000

That $35,000 represents the bakery's profit for the year. If you're a business owner and need to prepare your taxes or apply for a business loan, knowing this number is essential. 

If the bakery's expenses had been higher than its sales — say $210,000 in total costs against $200,000 in revenue — it would have a negative net income of -$10,000. This is called a net loss. A consistent net loss can signal the need to cut expenses, increase revenue, or rethink the business model. 

Think of net income as your financial reality check. It's the number that tells you how much money you have to work with after everything else gets taken out.

For individuals, it's your day-to-day decision-maker:

• Budgeting without surprises: If you plan your spending based on your gross pay, you'll almost always overestimate. Net income gives you the real number you can count on.
• Getting approved for loans: Banks and lenders don't care about your job offer letter. They care about what hits your account each month.
• Planning for taxes: If you're self-employed or have a side gig, knowing your net income helps you set aside enough for tax season instead of scrambling later.

For businesses, net income is like the scoreboard at the end of the game. It tells you if all that effort, investment, and risk paid off, and it can help with:

• Measuring profitability: If it's consistently positive, you're in good shape. If not, you might need to rethink spending or strategy.
• Guiding big decisions: Want to expand, hire more people, or launch a new product? Your net income will tell you if you can afford it.
• Building investor confidence: Steady net income growth can make your business a magnet for investment.

If you ignore net income, you risk overspending, overcommitting, or steering your finances, personal or business, straight into trouble.

Gross income and net income might sound like two ways of saying what you earn, but they're miles apart.

Gross income is the big, impressive number before any deductions. Net income is what's left after expenses are deducted. Taxes, retirement contributions, bills, and other expenses chip away at this number, reducing it significantly. 

Here's how they differ:

• Order of appearance: Gross comes first, net comes after all the deductions.
• What they show: Gross shows potential. Net shows the amount you actually take home.
• Use cases: You might brag about your gross salary, but you budget your life around your net income.
• For businesses: Gross income (or gross profit) is revenue minus the direct costs of making goods or delivering services. Net income factors in everything, including rent, salaries, marketing, taxes, and more.

If you've ever been puzzled by why your paycheck feels smaller than your salary suggests, or why a successful company struggles with cash flow, you've seen the difference in action.

Adjusted gross income, or AGI, is a term that shows up during tax season and often gets confused with net income. They're related, but they serve very different purposes.

AGI starts with your gross income, then subtracts certain tax-approved adjustments, such as contributions to a retirement account, student loan interest, or specific deductions, to figure out how much of your income is taxable.

Think of it like this:

1. Gross income – adjustments = AGI
2. AGI – taxes and withholdings = Net income

AGI is mainly a U.S. tax tool. It doesn't tell you how much money you have to spend each month, but it's a step in the tax calculation process. Net income, on the other hand, is the number you see in your bank balance.

You don't need an accounting degree to figure out your net income. It's about knowing what to subtract from what. Once you know how to calculate this sum, you'll never be caught off guard by net income again. 

Start with your gross income (the total before deductions). Subtract taxes, insurance premiums, retirement contributions, and any other withholdings.

Formula: Gross income – deductions/taxes = Net income

Example: If you earn $5,000 a month and your deductions total $1,200, your net income is: $5,000 – $1,200 = $3,800. That's the number to use when setting your budget or deciding how much you can realistically save each month.

Take your total revenue and subtract every expense, not just the obvious ones such as payroll or rent, but also interest on loans, marketing costs, and taxes.

Formula: Revenue – expenses = Net income

Example: If your shop brings in $100,000 in sales but spends $70,000 on supplies, salaries, rent, and taxes, your net income is $30,000.

Whether you're checking a pay stub or reviewing a company's financial statement, the process is the same: start with the big number, take away the costs, and you're left with the figure that matters.