Read TL;DR
- Net income is a key SaaS metric for assessing financial health and profitability. It measures a company's profit after all operating and non-operating expenses.
- Net income is driven by both internal factors like cost control, pricing, and operational efficiency, and external ones like tax rates, interest expenses, and economic conditions.
- How is net income calculated by subtracting the sum of all expenses (the cost of goods sold, operating expenses, other expenses, interest, and taxes) for a given period from the sum of all revenue (subscription revenue recognized and any one-time fees) for the same period.
SaaS companies have a lot of different metrics to help them understand their financial health. Net income is one of the most common metrics used to assess the financial health of a business and its growth potential through the lens of profitability. It also helps to prove the sustainability and scalability of your business model to investors.
Net income, also known as bottom line or net earnings, is the profit a company retains after subtracting all expenses, including the cost of goods sold (COGS), operating expenses, and other expenses, such as taxes and interest on any debts. Net income helps a company understand how much money the company has actually made during a specific period.
This article explains what net income means for SaaS companies and how it compares to other financial metrics. You'll also learn how it is calculated and how technology can help track and improve net income.
Table of Contents
What is net income in a SaaS business?
Recurring revenue gives SaaS businesses a steady stream of income, but cash flow can still be unpredictable due to churn, payment delays, and the timing of revenue recognition. Net income is a key metric showing a company's profit over a period, after all operating and non-operating costs are accounted for.
For SaaS companies, operating expenses include R&D, sales and marketing, customer support, and general administrative costs. Non-operating expenses include interest on debt, losses on investments, or other one-time charges. All of these are subtracted from the company's total revenue to arrive at net income. It helps assess whether the company is converting its recurring revenue into actual profit.
The net income of a SaaS business indicates its operational efficiency and overall viability, which is reflected in different ways on the company’s financial statements :
- Profit and loss (P&L) statement: Net income is shown at the bottom of the P&L statement (aka the income statement), which is why it’s often referred to as the company’s “bottom line.” By subtracting expenses for a given period from the revenue recognized for that period, net income provides a clear view of a company's ability to generate revenue, manage costs, and make profits.
- Cash flow statement: The net income from the P&L statement is the starting line item of the cash flow statement when prepared using the indirect method for cash flow reporting. Here, net income is adjusted for non-cash transactions such as depreciation and deferred taxes plus any changes in the balance sheet in the company’s assets and liabilities. This reveals how much cash the business is generating, which is important for maintaining operations and planning for growth.
- Balance sheet: The net income from the P&L is also added to the balance sheet in the section for shareholders' equity as retained earnings. Specifically, this is the part of net income that is reinvested in the business as opposed to being distributed to shareholders. So, the higher the net income, the more earnings the company can retain to grow the business.
Learn more about SaaS metrics here
Why net income matters in SaaS
Net income is a foundational metric in SaaS because it goes beyond growth to measure value creation and operational efficiency. Tracking it can reveal a lot about your business, such as:
- Financial health and stability: SaaS companies face high upfront costs for customer acquisition, service delivery, and product development. A positive net income, especially in the early stages of the company’s growth, indicates operational efficiency in spite of that reality, which bodes well for long-term financial stability.
- Whether your strategies are working: Tracking net income reveals if your revenue growth and cost management strategies are working.
- How attractive your company might be to investors: Investors focus on a number of different metrics to assess a company's ability to generate good returns. A strong net income reflects fiscal discipline and growth potential.
- Whether your growth is sustainable: Net income shows whether revenue covers scaling costs like marketing and R&D. A positive net income means the business can fund growth and innovation internally.
- Your performance compared to other companies: Benchmarking can be a powerful tool for strategic planning. By comparing your net income to other companies of similar size in your market, you can bring more objectivity into your planning and identify performance gaps that if improved, can accelerate growth. (Check out our article on the top benchmarking resources for B2B and SaaS businesses to get started.)
How to calculate net income for your SaaS business
You can use the following formula to calculate net income:
Start by adding your total revenue for the period, including other income like interest or investment gains. Then subtract your cost of goods sold (COGS), which covers the direct cost of delivering your software.
Note: This calculation should Include only recognized revenue.
In SaaS, revenue is often recognized over the life of a subscription as the service is delivered. Therefore, the timing and amount of revenue recognized each period has a direct impact on the net income for that period. How subscription revenue is recognized can vary depending on your pricing model, however, the basic revenue recognition principle–-revenue is only recognized when the service has been delivered—applies here.
Once you have the sum of your revenue and other income, you’ll deduct operating expenses like marketing, salaries, rent, and utilities, along with any other costs affecting your bottom line. After these deductions, you get the net income for the period.
Here are the different types of income and expenses that factor into each of the variables in the formula above:
- Revenue: One-time payments, such as onboarding or setup fees and recurring revenue that has been recognized from subscriptions.
- Other income: Foreign exchange (FX) gains and any income from investments.
- COGS: Direct service delivery costs like hosting fees, third-party tools, or customer support.
- Operating expenses: Salaries, R&D, marketing, administrative, and general overhead costs.
- Other expenses: Depreciation, amortization, and one-time charges.
- Interest expenses: Payments of business loans or lines of credit.
- Taxes: Income tax and other taxes applicable for the period.
Let's look at an example to calculate net income using the formula above. We'll assume that our example company recognized $1,000,000 in subscription revenue and implementation fees over the year and earned an additional $20,000 in other income. During the same period, it incurred $200,000 in cost of goods sold (COGS), $500,000 in operating expenses, $40,000 in depreciation and amortization, $30,000 in interest expenses, and paid $50,000 in taxes.
Using the formula, we can calculate the net income for the year:
So in our example, the company's net income for the year would be $200,000.
Net income vs. other SaaS metrics that offer insights to profitability
Net income reflects a company's profitability by accounting for all recognized revenue and expenses. However, SaaS businesses also use other metrics tailored to subscription models to better assess financial health and growth.
Here is how net income compares to other SaaS metrics and what they can tell you about profitability:
- Customer acquisition cost (CAC): CAC measures the efficiency of sales and marketing efforts by assessing the cost of acquiring a new customer. High CAC can reduce net income.
- Customer lifetime value (LTV) and LTV:CAC Ratio: LTV (aka CLTV) measures the expected revenue from a single customer over that customer’s relationship with the company. Comparing LTV to the net income that customer will produce for your business can help determine the customer’s net value. The LTV:CAC ratio offers a somewhat different way to look at profitability by comparing the costs incurred to acquire the customer to assess profitability. While both are useful ways to look at profitability, calculating your company’s unit economics will give you a more comprehensive view of the value each new customer brings to your business.
- Annual recurring revenue (ARR) and monthly recurring revenue (MRR): ARR and MRR are key SaaS metrics that track subscription revenue growth. Unlike net income, which reflects profitability, these metrics focus on recurring revenue. Consistent ARR and MRR growth leads to better profitability to the extent costs are controlled.
- Net profit margin and gross profit margin: The company’s net profit margin shows how it converts revenue into profit, while gross profit margin highlights revenue remaining after direct costs, such as hosting and software development. These two metrics provide deeper insights to profitability than net income alone.
Discover and track all the drivers of profitability in your business with Drivetrain
Net income helps SaaS companies assess their financial health, attract investors, and benchmark performance. Accurately tracking net income requires understanding revenue and how it is recognized in SaaS as well as expenses. It’s important to remember, though, that net income alone doesn’t tell the full story of a company’s profitability. You need to look at it within the context of other metrics to understand what it’s really telling you. And even still, you won’t have the complete picture of profitability. For that, you need to do a profitability analysis.
FP&A tools like Drivetrain make understanding your profitability easy with automated data collection and unified financial reporting that delivers real-time insights. Interactive dashboards and customizable reports allow you to track net income trends, compare net income with other key metrics, and drill down into your data to understand what’s really driving profitability in your business. And with its powerful multi-scenario planning capabilities, you can explore different strategies to improve it.
Learn more about how Drivetrain can help you fully understand and boost your profitability.
FAQs
Yes. Net income is a measure of profitability. It shows the profit a company keeps after deducting all expenses, taxes, and costs from recognized revenue.
Gross income is revenue minus the cost of goods sold (COGS), while net income is the amount after all expenses, taxes, and costs are deducted.
Net operating income reflects a company's profit from core operations before taxes and interest, while net income includes all expenses and recognized revenue for a more detailed view of profitability.
No. Net income, net operating income, and gross income reflect different stages of profitability and shouldn't be used interchangeably. Doing so can misrepresent the SaaS company's financial performance and lead to inaccurate analysis.
.svg)
