Annual Net Income: Definition and Guide for Business Owners (2023) - Shopify (2024)

Your new ecommerce business just completed its first year of operations—congratulations! The first three quarters of the year were a downer, and your company lost money. Then, in the fourth quarter, sales soared while expenses didn’t increase, leaving you with a positive annual net income.

To start,Net income is your final profit—all sales or revenue minus all expenses, including taxes. Net income is often referred to as the bottom line because it’s at the bottom of a business’s income statement, accounting for all revenue and expenses. It’s also referred to as profit or earnings —or a net loss if expenses exceed revenue.

Table of Contents

  • What is annual net income?
  • How to use annual net income
  • How to calculate annual net income
  • How is annual net income used?
  • Annual net income FAQ

What is annual net income?

Annual net income is a measure of a company's profitability over a year. It's calculated by subtracting all of a company's expenses, including operating costs, interest payments, taxes, and depreciation, from its total revenue.

A business can base net income on the calendar year, or it can use a fiscal year with different start and end dates, say from July 1 to the following June 30. Another way of calculating annual net income is to use the past 12 months, which is called a trailing 12-month period.

Annual net income usually is reported in dollar figures or expressed in percentage terms, called the profit margin, which is net income divided by revenue.

How to use annual net income

Annual net income serves a number of purposes. For example, annual net income spanning several consecutive years can signal the long-term viability of the business and its financial health. Annual net income also functions as the most basic scorecard for a business’s management. Furthermore, the annual net income for a group of companies or industries is a key barometer of the US economy’s health.

Business owners review annual net income and profit margins to consider their operating efficiency, and to make decisions to expand, borrow, seek new investors, or distribute any profit to themselves. Net income also can be used in performance compensation plans to set gross annual salary, including bonuses, for a company’s senior executives.

How to calculate annual net income

Businesses use either cash accounting or accrual accounting for their income statements.

Cash accounting, sometimes known as cash basis accounting, records sales or revenue only when money is received and expenses only when they’re paid. Accrual accounting records sales when they’re earned, even if payment hasn’t been received. Likewise, expenses are recorded even if not yet paid.

Many small businesses with simple operations calculate net income using a single-step income statement, starting with revenue and then subtracting expenses and taxes. Typical expenses for a small business include rent or mortgage payments for office or production space, utilities, employee pay, and insurance and taxes.

Ecommerce small businesses selling products and services online incur other expenses for operating on the web. These include website development and web hosting costs, fees for third-party payment systems that handle customer transactions, backup for uninterrupted electric power, and cybersecurity software to prevent hacking and malware.

As small businesses grow, they sometimes switch to a multi-step income statement with more detail about revenue and expenses. Multi-step statements also show the progression from total revenue to annual net income, through intermediate steps called gross income and operating income.

A company that uses a multistep annual net income statement that might look like this:

Amount
Revenue$5,000,000
Cost of goods sold (COGS)
(cost of creating and delivering software)
-$3,500,000
Gross income$1,500,000
Selling, general, and administrative expenses (SG&A)
Rent-$200,000
Utilities-$40,000
Phone/computer/WiFi-$40,000
Cybersecurity-$10,000
Payroll-$150,000
Employee health insurance/health care premiums-$45,000
Marketing/advertising-$35,000
Office supplies-$20,000
Business insurance-$50,000
Transaction payment service-$10,000
Operating income$900,000
Interest on $3 million loan, 5% annual rate-$150,000
Taxes-$250,000
Net income$500,000


Based on this annual income statement, the business’s profit margin is 10%, or $500,000 of net annual income divided by $5 million of revenue.

How is annual net income used?

Once a business has completed its income statement, the company’s annual net income can be used in various ways, such as:

Distributions and dividends

Annual net income is the money available to the business owners. They can pay any net income to themselves as direct distributions, or as dividends if ownership is divided among shareholders.

Analysis and comparison

Business owners use the income statement to review sources of revenue and expenses during the year, and consider ways to cut expenses. Annual net income also is compared against past years: Did profit increase? Decrease? Or was it little changed? Net income also is used to compare performance with similar small businesses.

Planning and expansion

Changes in annual net income can help small business owners plan for the new year. They can reinvest some of the net income in the business to expand or add new products and services. Conversely, a decline can lead to scaling back growth and cost cuts.

Financing from lenders and investors

When a small business applies for a loan, business credit card, or line of credit, lenders examine net income, profit margins, and other financial statements to assess its ability to repay the debt. Outside investors also examine annual net income, especially growth trends, before they offer to buy a stake in a small business.

Tax filings

Small businesses use annual income statements to compute income taxes. Businesses operating as sole proprietorships, partnerships, or S corporations are not taxed. Any net income is passed through to the owners or partners, who pay federal taxes based on their individual tax brackets. These rates ranged from 10% to 37% as of 2023. State income taxes vary as well, ranging from 2.5% to 12%, although some states have no tax. Some municipalities also charge local taxes.

The tax rate for businesses organized as corporations is a flat 21% as of 2023, down from a top marginal rate of 35% before 2018.

Annual net income FAQ

How do you calculate annual net income?

Annual net income tallies all sources of annual revenue for a business, such as product or service sales, rental income, and investment income, then subtracts all expenses, including taxes, for a full year. The year may simply be a standard calendar year, a fiscal year, or the past 12 months of a business’s operation, called a trailing 12-month period.

How are net income and annual net income different?

A business may calculate its net income monthly, quarterly, or annually. The difference is that annual net income shows all revenue and expenses for a year—the full business cycle, including any seasonal fluctuations. A shorter period of net income accounting might miss some of the seasonal ups and downs in revenue and expenses, potentially giving a wrong impression of the business’s true financial condition.

What is the difference between gross income and annual net income?

Gross income is what’s left after a business subtracts production and distribution expenses from revenue. These expenses are typically referred to as the cost of goods sold (COGS), or cost of sales in the case of services businesses. Only costs directly tied to production of a company’s goods or services, such as raw materials and labor, go into calculating COGS. Net annual income is less than gross annual income because it accounts for other costs, such as office rent, utilities, and staff payroll, referred to as overhead, as well as any interest payments and income taxes.

Annual Net Income: Definition and Guide for Business Owners (2023) - Shopify (2024)
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