How to calculate net income
Learn the net income formula and how to calculate it for your small business.
December 2023 | Published by Xero
Published Thursday 23 July 2026
Table of contents
Net income (and its equation) is the same as net profit.
Key takeaways
- Net income is the profit left over after you subtract all expenses, taxes, and deductions from your total revenue. It's often called "the bottom line."
- The basic formula is: Net Income = Total Revenue - Total Expenses. You can also calculate it as Gross Profit - Operating Expenses - Taxes - Interest.
- Net income is different from gross income. Gross income only subtracts direct production costs, while net income accounts for every business expense.
- Tracking net income helps you understand your true profitability, plan for taxes, make smarter spending decisions, and show lenders or investors how your business performs.
What is net income?
Net income is the profit your business keeps after subtracting all expenses, taxes, and deductions from total revenue. It's also known as "net profit," "net earnings," or "the bottom line."
Think of it this way: your revenue is the total money coming into your business from sales. But you have costs to cover, including rent, salaries, materials, loan interest, and taxes. Net income is what's left after you pay for all of it.
Net income gives you the clearest picture of how profitable your business actually is. A business can have strong revenue but still lose money if expenses are too high. That's why net income matters more than revenue alone when you're evaluating financial health.
The net income formula
There are 2 common ways to calculate net income. Both give you the same result, but they start from different points.
The basic formula is:
Net Income = Total Revenue - Total Expenses
Total expenses include everything: cost of goods sold (COGS), operating expenses, interest, and taxes.
The expanded formula breaks it down further:
Net Income = Gross Profit - Operating Expenses - Taxes - Interest
Here's what each component means:
- Total revenue: all the money your business earns from sales before any deductions.
- Cost of goods sold (COGS): the direct costs of producing or delivering your product or service, such as materials or manufacturing labor.
- Gross profit: your revenue minus COGS. This shows profit before overhead costs.
- Operating expenses: the day-to-day costs of running your business, including rent, utilities, salaries, marketing, and insurance.
- Interest: payments on business loans or lines of credit.
- Taxes: income taxes your business owes to federal, state, and local governments.
How to calculate net income step by step
Follow these 4 steps to calculate your net income. You'll need your revenue figures and a full list of expenses for the period you're measuring.
- Add up your total revenue. Start with all the income your business earned during the period. This includes sales revenue, service fees, and any other income like interest earned or rental income. If your business brought in $200,000 in sales over a quarter, that's your starting number.
- Calculate your cost of goods sold (COGS). Add up the direct costs tied to producing your goods or services. For a product-based business, this includes raw materials, manufacturing labor, and shipping. For a service business, it's the direct labor costs to deliver your service.
- Subtract operating expenses. Take your gross profit (revenue minus COGS) and subtract your operating expenses. These are the ongoing costs of running your business: rent, utilities, office supplies, marketing, software subscriptions, and employee salaries not included in COGS.
- Subtract taxes and interest. Finally, subtract any interest payments on business debt and your income tax obligations. The number you're left with is your net income.
Net income calculation example
Let's walk through a realistic example. Imagine you run a small bakery and want to calculate net income for the quarter.
Here are your numbers for Q1:
- Total revenue from sales: $120,000
- Cost of goods sold (flour, sugar, packaging, baker wages): $45,000
- Operating expenses (rent, utilities, marketing, admin salaries): $35,000
- Interest on a business loan: $2,000
- Income taxes: $8,000
Now apply the formula step by step:
- Gross profit = $120,000 - $45,000 = $75,000
- Operating income = $75,000 - $35,000 = $40,000
- Net income = $40,000 - $2,000 - $8,000 = $30,000
Your bakery's net income for Q1 is $30,000. That's the actual profit you earned after covering every expense.
Calculating net income from gross profit
If you already know your gross profit, you can skip straight to the second part of the calculation. Using the same bakery example, your gross profit is $75,000.
From there: Net Income = $75,000 - $35,000 (operating expenses) - $2,000 (interest) - $8,000 (taxes) = $30,000.
This approach is useful when you pull figures from your profit and loss report, which often shows gross profit as a subtotal. In Xero, your profit and loss report calculates gross profit automatically, so you can focus on understanding what's being subtracted below it.
Net income vs. gross income
Gross income and net income measure profitability at different stages. Understanding the difference helps you pinpoint where your money goes.
Gross income (also called gross profit) is your revenue minus the direct costs of producing your goods or services (COGS). It tells you how much you earn from your core business activities before overhead costs come into play.
Net income goes further. It subtracts everything: operating expenses, interest, and taxes on top of COGS. Net income shows your true profit after all obligations are met.
Here's a quick comparison:
- Gross income = Revenue - COGS
- Net income = Revenue - COGS - Operating expenses - Interest - Taxes
Both numbers are valuable. Gross income helps you evaluate your pricing and production costs. If your gross income is shrinking, your direct costs may be rising faster than your prices.
Net income tells you whether your business is profitable overall. You could have strong gross income but low net income if your rent, salaries, or loan payments are eating into your margins. Tracking both gives you a clearer view of your gross profit margin and overall financial health.
Net income vs. operating income
Operating income and net income are closely related, but they measure different things. Knowing the distinction helps you understand which costs are dragging down your profitability.
Operating income (also called operating profit) is what you earn from your core business operations after subtracting COGS and operating expenses. It excludes interest payments and taxes.
Net income is the final number after subtracting interest and taxes from operating income. It reflects your total profit.
- Operating income = Revenue - COGS - Operating expenses
- Net income = Operating income - Interest - Taxes
Operating income is useful for evaluating how well your business runs day to day, without the influence of financing decisions or tax obligations. Net income gives you the complete picture. If your operating income is healthy but your net income is low, your debt payments or tax burden may need attention.
Where net income appears on the income statement
Net income is the last line on your income statement (also called a profit and loss statement, or P&L). That's why it's called "the bottom line."
The income statement starts with revenue at the top. It then subtracts costs in layers: first COGS, then operating expenses, then interest and taxes. Each subtraction produces a subtotal (gross profit, then operating income). The final subtotal is net income.
Reading your income statement from top to bottom shows you exactly where your revenue goes. If your net income is lower than expected, you can trace the problem back to whichever cost category grew. You can use a free income statement template to structure your numbers before moving to accounting software.
In Xero, your profit and loss report lays this out clearly. It calculates each subtotal automatically, so you can see your net income in real time. You can also compare periods side by side to spot trends in your expenses or margins.
Why net income matters for your business
Net income is one of the most telling numbers in your financial reports. It goes beyond revenue to show whether your business is genuinely profitable after all costs are accounted for.
Here are the key reasons to track it closely:
- Profitability check: net income confirms whether you're earning more than you're spending. Positive net income means your business is profitable. Negative net income (a net loss) means expenses are outpacing revenue.
- Smarter decisions: when you know your true profit, you can decide whether to hire, invest in new equipment, raise prices, or cut costs. Net income gives you a factual basis for those decisions.
- Lender and investor confidence: banks and investors look at net income to assess your ability to repay loans or generate returns. A consistent, positive net income makes your business more attractive for funding.
- Tax planning: your tax obligations are based on taxable income, which closely relates to net income. Understanding it helps you plan for quarterly and annual payments.
- Cash flow planning: while net income isn't the same as cash flow, it's a starting point. Knowing your profit helps you forecast how much cash you'll have available for operations and growth.
Monitoring net income is especially critical when revenue growth slows. According to Xero Small Business Insights, US small business sales growth averaged 2.4% in 2025, well below the long-term average of 5.5%. When top-line growth stalls, your profitability depends on controlling costs, and net income is the metric that tells you whether you're succeeding.
Common mistakes when calculating net income
Getting your net income wrong can lead to poor decisions about spending, taxes, and growth. Here are the most common mistakes small business owners make.
- Confusing gross income with net income: gross income only accounts for direct production costs. If you treat gross income as your actual profit, you'll overestimate how much money you have available. Always subtract operating expenses, interest, and taxes to get net income.
- Forgetting non-cash expenses: depreciation and amortization reduce your net income on paper even though no cash leaves your account. Skipping these expenses overstates your profit and can cause tax reporting issues.
- Mixing personal and business finances: if personal expenses flow through your business accounts, your net income calculation will be inaccurate. Keep personal and business finances separate for a clean picture.
- Equating net income with cash flow: net income and cash flow are related but different. You can show a positive net income and still face a cash shortage if customers haven't paid their invoices yet. Use both metrics together. Good cash flow management helps you avoid that shortfall.
- Ignoring tax obligations: some business owners calculate profit before taxes and assume that's their net income. Tax is a real expense. Your true net income reflects what you keep after the government takes its share.
Simplify your net income tracking with Xero
Calculating net income by hand takes time, and mistakes are easy to make when you're juggling spreadsheets. Xero's cloud accounting software helps do the work for you.
Your profit and loss report in Xero updates in real time as transactions flow in. It helps categorize revenue and expenses, calculates subtotals like gross profit and operating income, and shows your net income at the bottom. You can filter by date range, compare periods, and spot trends without building formulas.
Xero also connects to your bank accounts, so transactions are imported and matched automatically. That means your net income figure stays current without manual data entry. Explore Xero's accounting plans and Get one month free.
FAQs on net income
Here are answers to frequently asked questions about net income.
What is the difference between net income and gross income?
Gross income is your revenue minus the direct costs of producing goods or services (COGS). Net income goes further by also subtracting operating expenses, interest, and taxes. Net income reflects your total profit; gross income reflects profit from production alone.
Is net income before or after taxes?
Net income is after taxes. It's the profit remaining once all expenses, including income taxes, have been subtracted from revenue. The figure before taxes is called "pre-tax income" or "earnings before tax."
Can net income be negative?
Yes. When your total expenses exceed your total revenue, the result is a negative net income, also called a net loss. This can happen during slow sales periods, heavy investment phases, or unexpected cost increases.
Is net income the same as profit?
Net income is one type of profit, often called "net profit." Other profit measures include gross profit (revenue minus COGS) and operating profit (revenue minus COGS and operating expenses). When people refer to "profit" without a qualifier, they usually mean net income.
Where does net income appear on financial statements?
Net income appears at the bottom of the income statement (profit and loss statement). It's the last line after all revenue and expense categories have been accounted for. It also carries over to the balance sheet through retained earnings.
Related terms
Explore related accounting terms in the Xero glossary:
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Disclaimer
This glossary is for small business owners. The definitions are written with their requirements in mind. More detailed definitions can be found in accounting textbooks or from an accounting professional. Xero does not provide accounting, tax, business or legal advice.