First, subtract selling, general, and administrative (SG&A) expenses, as well as any research and development (R&D) costs. For example, if you hire part-time employees to staff your store or rent the building you occupy, it would be an example of an SG&A expense. This will produce a figure known as operating income. Then, add any non-operating income, such as interest, and subtract any interest you pay on debts, as well as income taxes paid by the business. This will produce net income.
Because net income is typically the final number that is produced in a business's income statement, it is often referred to as bottom-line income or simply as "the bottom line." On an income statement, you can typically see the line-by-line calculation of net income, starting with gross income and net sales on the top.
For an easy-to-follow methodology, here are the steps to calculate net income:
- Start with net sales.
- Subtract the cost of goods sold.
- Subtract depreciation, depletion, and amortization.
- Subtract selling, general, and administrative (SG&A) expenses.
- Subtract any research and development (R&D) costs.
- Add any other forms of income, such as interest on cash reserves.
- Subtract the interest you pay on debts.
- Subtract income taxes (state, federal, foreign, etc.).
Gross and net income can be calculated for a variety of time frames. Gross annual income and gross monthly income are two common time frames, but it's entirely possible for businesses and individuals to calculate income over multiyear periods, as well as over the short term.
It's also worth noting that gross income is often used in the context of individual income to describe the total amount of money a person (or couple) earns in a given year. This can include salary, bonus, wages, Social Security, 401(k) income, interest, dividends, capital gains, and more.
For example, if you earn a salary of $100,000 from your job and have no other sources of income, that would be your gross income. Net income in a personal context is typically used to refer to after-tax or take-home income after all taxes and other deductions are subtracted. It's also important to mention that taxable income is a different concept and is more of a legal definition of the portion of your income that is subject to the federal income tax.
Example of calculating gross versus net income
For a more thorough example, let's say that you own a business with net 2024 sales of $5 million, it costs $2 million to produce the products you sell, and your equipment depreciates at a rate of $250,000 every year. This gives you a gross annual income of $2.75 million.
We'll say that you have the following expenses:
- $1 million in wages, benefits, rent, and other SG&A expenses.
- $250,000 in research and development (R&D) costs.
After subtracting these, we see you have an operating income of $1.5 million.
We'll also say that your business has a substantial amount of money in the bank and earned $500,000 in interest income for the year, and that you have no debt. You paid $800,000 in federal income taxes and $200,000 in state income taxes. After adding the interest income, you have $2 million, and after paying your taxes, you have a net income of $1 million.
