Net Earnings Explained: How to Calculate Net Earnings

A company's net earnings—also called net income, net profit, or bottom line—is the amount of income left over after subtracting all business expenses from its total revenue. In addition to the cost of goods sold (COGS), other expenses for net earnings include operating expenses, income taxes, interest expenses on loans and debt, depreciation of fixed assets, and SG&A (selling, general, and administrative expenses). For the net earnings calculation, total revenue includes the amount of money earned from product sales in addition to income from other places, such as investments.

Since net earnings takes into account all of a company's expenses and revenue, it's a metric that reflects a company's actual profitability during a particular accounting period. You'll typically find net earnings listed on the last line of a company's income statement, which is why it's informally called the "bottom line."

The terms net earnings, net income, and net profit are interchangeable. They all refer to a company's income left over after subtracting all business expenses from total revenue.

The net earnings calculation is an important metric for assessing a business’s overall financial health.

• Investments: Investors look at a company's net earnings when calculating whether it's worth investing in the company. A company with consistently high net earnings will assure investors that they're likely to see a return instead of a loss.
• Loans: Banks and lenders look at a company's net earnings to assess whether or not they should grant the company a business loan. Banks are more willing to give loans to a company with a higher net earnings because the company is more likely to pay the loan back.
• Revenue: Small business owners need to carefully track their net earnings to better understand their net profit margin and to determine how they can generate higher revenues.
• Losses: Some business owners expect to operate at a loss, especially in the early years of a business. Determining net earnings means that they can still have a precise idea of exactly how much of a net loss they are expecting and how long they expect to sustain losses.

To calculate the net earnings figure, subtract a given period’s total expenses from the total revenue in that same period, as seen in the following equation:

In this equation, revenue represents the total amount of money earned from product sales in addition to income from other places, including investments. Total expenses represents all expenses—cost of goods sold, operating expenses, income taxes, interest expenses on loans and debt, depreciation of fixed assets, and SG&A (selling, general, and administrative expenses).

Gross profit is a partial picture of a company's profitability, while net earnings is the complete picture. Gross profit does not take into account all of a company's income sources or their fixed expenses (such administrative expenses, rent, depreciation, amortization, and insurance), but it does show how efficiently a company operates based on the direct costs involved in producing its products. Net earnings takes into account all business expenses and revenue and gives an accurate measurement of whether a company is profiting or losing money.

In the United States, when it comes to federal income taxes paid to the IRS or state taxes paid to state agencies, taxable income tends to be based on some form of net earnings, rather than gross intake that doesn’t account for expenses. This can affect the amount owed in capital gains taxes, social security taxes, and more. Factors that can make one’s net income lower than one’s gross income include cost of living expenses, contributions to retirement accounts (such as an IRA), health insurance premiums, payments on student loan interest, and upkeep of rental property. Such expenses are documented on a tax return form and will affect what the government considers to be a person’s or business’s total taxable income for the year.

There are different metrics you can use to track your company's financial health and compose your company's financial statements:

1. 1. Gross profit: Gross profit is the amount of income left over after subtracting the cost of goods sold (COGS) from the total sales revenue. Gross profit indicates whether a company’s production process needs to be more or less cost-effective in comparison to its revenue.
2. 2. Net earnings: Calculate the net earnings (aka net income or net profit) by subtracting total expenses from total revenue to see exactly how much a company profits (a new profit) or loses (a net loss). A company's net earnings over time is a great indicator of how well or poorly its management team runs the company.
3. 3. Gross profit margin: A gross profit margin is the percentage of revenue generated that's greater than the COGS. To calculate this financial ratio, divide gross income by revenue and multiply the result by 100.
4. 4. Net profit margin: Net profit margin is the ratio of net profit to total revenue expressed as a percentage. To calculate the net profit margin, divide your net income by total revenue and multiply the answer by 100.
5. 5. Operating income: To calculate operating income or earnings before interest and taxes (EBIT), subtract operating expenses—which include overhead costs like rent, marketing, insurance, corporate salaries, and equipment—from gross profit. Investors find EBIT useful in determining a company's financial performance because it doesn't factor in items that are out of the management team's control.

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