What Is Net Income and How Does It Work?

Highlights:

• Net income for an individual describes your earnings after taxes, benefits and other payroll deductions, while gross income describes your total earnings before these deductions.
• Both your net and gross incomes are typically listed on your pay stubs. You can also calculate your net income using a simple formula.
• Corporate net income — one factor used in determining the health of a business — refers to the total value of the sale of goods and services minus expenses.

If you've ever tried to calculate how much money you actually earn, you already know that your salary only tells part of the story. To really understand your financial situation, you need to know a very important number — your net income.

What is net income?

Net income, or net pay, describes your earnings after taxes, benefits and other payroll deductions. These deductions may include income taxes, social security taxes, Medicare taxes, contributions to your 401(k) or other retirement accounts, health insurance premiums and more.

Net income is also sometimes referred to as your “take-home pay” because it's the amount of money you actually take home from your job.

Gross income, on the other hand, refers to your total earnings before payroll deductions. Gross income is equivalent to your annual salary or, if you're paid by the hour, your hourly wage multiplied by your total hours worked.

Why your net income matters and how to calculate it

Building a budget based on your gross income is a recipe for overspending since a chunk of that money is designated to cover taxes, health benefits, retirement contributions, etc. That's why your net income helps you build a more accurate picture of your financial situation.

Luckily, finding your net income isn't complicated. Both your net and gross incomes are typically listed on your pay stubs. You can also calculate your net income using a simple formula.

Just take your gross income and subtract the total amount of any deductions — which are typically itemized on your pay stub. To calculate your net income for a year, you can use the formula below to determine one month of pay and multiply the result by 12.

For example, say you're an employee with an annual salary of $90,000. Your monthly gross income is $7,500, but your pay stubs indicate that $1,600 is deducted each month for state, federal, Medicare, and Social Security taxes, as well as a monthly health insurance premium.

Subtract the payroll deductions from your gross income to find your monthly net income:

$7,500 - $1,600 = $5,900

Then, multiply this figure by 12 to find your annual net income:

$5,900 x 12 = $70,800

What is corporate net income and how do you calculate it?

You're already familiar with how to find your own net income, but what about a corporation's?

Corporate net income refers to the total value of the sale of goods and services minus expenses. Corporate net income is generally used to measure the profitability of a business. For companies that issue stock, it helps determine earnings per share, which is an important figure used to indicate business value.

Calculating the net income of a business begins with totaling all expenses involved in running the organization. This includes operating costs, costs of goods sold, depreciation and taxes, among other expenses. This information is typically listed in a company's financial statements. This amount is then subtracted from the company's total revenue.

For instance, imagine a company with a gross annual income of $2 million. This business runs up $1,380,000 in total expenses — $1 million in costs of goods sold, $350,000 in operating expenses, $20,000 in payments to creditors and $10,000 in taxes. To calculate net income, simply subtract these operating costs from the company's total income:

$2,000,000 - $1,380,000 = $620,000

Why is net income important for businesses?

Net income is indispensable for both owners and investors. If you're a business owner, your company's net income is a clear indicator of financial health. A successful company will generally have a high net income, while a falling company will have a low or even negative net income.

If you're an investor, you might use corporate net income to evaluate whether a company is likely to offer a return on potential investments. For a business that issues stock, net income determines its earnings per share and therefore measures how much profit is created for individual shareholders.

From individual households to corporate accounting departments, net income is a critical piece of information when it comes to financial management — be sure you know how to find yours.