Although gross income and net income are closely related, they are completely different terms. These terms often get confused since gross income is used to calculate net income.
They can be used to describe either an employee’s income (personal income) or a company’s income (business income). In the business world, calculating gross and net business income is more complicated than personal income.
Let’s examine what gross income and net income are and the differences between them.
Personal Gross Income
Gross income includes the salary an employee earns before any deductions are taken for taxes, health insurance, or social security. If we deduct these expenses, we will end up with the net income.
For example, let’s say an employee earns 2,000 dollars per month. Their taxes and insurance costs are 500 dollars, and these are deducted from their paycheck. Their net income is then 1,500 dollars per month.
However, gross income isn’t only calculated using your salary. Other sources of income are added such as rental income or interest earned from stocks or bonds.
So, if the employee above earns 300 dollars of interest per month, their gross income will be 2,300 dollars.
Your personal gross income can therefore include many resources other than your salary. These sources include interest from savings accounts, stocks, or bonds. Also, you can add the money you make from passive income sources such as child support, royalties or alimony.
When companies give a candidate a job offer, they often mention the gross salary in the offer letter or the contract. Banks typically use an individual’s gross income to determine the amount of mortgage or loan funds they qualify for.
Adjusted Gross Income
The Internal Revenue Service (IRS) uses adjusted gross income to determine how much tax you should pay. Adjusted gross income is the gross income after deducting certain items. These items can include moving expenses or interest on student loans.
There are some programs and mobile apps that can help you figure out your adjusted gross income. If you’re preparing your own taxes, you can use one of these and provide information via a questionnaire. After completing the questions, the app will calculate your adjusted gross income.
You should know that there are some items that shouldn’t be included in your gross income on your tax return. This is because certain items may be exempt from taxes. These might include interest from state bonds, inheritance, and money earned from selling your property.
If you are not sure what to include in your adjusted gross income, consider hiring a tax specialist to help you prepare your return.
Personal Net Income
Net income is the amount of money you earn after paying all your debts and taxes.
You can calculate your net income either on a monthly or an annual basis.
Your net income might actually be more important to you than gross income. This is because it tells you the exact amount you will have each month.
There are different tools to help calculate your net income, such as software and mobile apps. You can enter your net salary each month along with taxes and other deductions into the app. It will then calculate and track your net income.
If you want to calculate your net income, you can do it yourself quite easily. Start with defining your gross income. You should check your salary before any deductions; that constitutes your gross salary.
Next, make sure you add any other sources of income you have. Finally, subtract any taxes withheld or debts you have to pay monthly. Make sure that you deduct all your expenses and withholdings, including your retirement plan if you have one.
Although it’s very important to determine your net income, remember that you won’t use this in your tax return. Taxpayers should not enter net income amount on their 1040. This federal tax form instead requires the gross income and adjusted gross income.
Net income however is crucial for planning your monthly budget. You should know exactly how much money you have for your personal expenses. If you’re planning for a vacation or something special, you should know if you can afford it or not.
Gross Income in Business
In the business world, gross income refers to profit on the company’s balance sheet. Companies usually calculate their gross income by subtracting the cost of goods sold from the revenue earned. Businesses can also add other sources of income while calculating gross income.
If a company made income from bad debt recovery or interest, these can be added to the gross income.
When calculating a business’ gross income, it’s important to subtract the cost of goods sold. This means any expenses incurred in the production of goods or services. These may be the price of the raw materials, machines used, and wages for workers.
Assume a company generates two million dollars as annual revenue from selling notebooks. The cost of the products and labor for manufacturing these products was five hundred thousand dollars. In this case, the company’s gross income is one and a half million dollars.
In business, gross income is used to determine the gross margin. This is a tool used by a company’s management or investors to determine whether or not the company manages its resources effectively.
Gross margin is calculated by dividing gross income by the company’s total revenue. The higher the percentage of the gross margin, the greater the efficiency of the company.
On the other hand, a low gross margin percentage shows that the company isn’t efficient or competitive. It means that the cost of producing a product is higher than the selling price. It also shows that if the operations aren’t improved, the company could reach the stage of not making any profit.
If a company produces more than one product or provides multiple services, then gross income can be quite useful. It will help determine which channel generates more income and is more profitable to the company.
Net Income in Business
Net income is the last item on a company’s income statement. The term refers to the profit the company makes after deducting all expenses, taxes, and debts. Net income can also be referred to as net earnings or net profit.
The expenses that the company incurred to generate the revenue should be subtracted from gross income to calculate net income. These indirect operational expenses can include marketing, administrative costs, rent, and employees’ salaries.
Subtracting these expenses from gross income results in the operating income. This is also called EBIT (earnings before interests and taxes). Afterward, financial debt should be deducted. Finally, we subtract taxes to reach the net income.
This method of calculating net income in stages enables companies to track exactly which expenses consume the biggest portion of revenue.
Accountants and auditors have to be very careful while reviewing a company’s net income. This is because numbers can be manipulated. Accountants need to review all figures and calculations, and the staged calculation of net income makes this easier.
Net income is one of the most important metrics upon which a company is assessed. It ultimately determines whether a company is profitable or not.
If the net income is a high positive number, it means the company is profitable. Therefore, the company can pay dividends to investors or invest in expansion. If the number on the income statement is negative, the company is losing money and needs to improve its performance.
A company’s net income be tracked over time. If the income statement shows profit for one year, it doesn’t reveal much about the company’s long-term performance. However, if the statements show profit over five years, it means the company is successful in sustaining its profitability.
Benefits of a high net income
One of the benefits of sustaining a high net income is investment. If a company needs money to invest in expansion, it has the option of using its own net income. Unlike other financing options, such as loans, the business won’t have to pay interest.
Even if the business opts to take loans, a profitable company will have more external financial options. Banks will be willing to provide it with loans because it’s highly likely that the company will be able to repay.
A company’s value is related to net income. High net income over a number of years will yield a higher market value for a company. It also provides a benchmark to predict what the company’s future performance will be.
Summing It Up
Gross income and net income are very important concepts, both on the personal finance level and corporate level. Gross income is a necessary factor in calculating net income.
On the personal level, gross income is the amount of money a person makes from various resources. However, net income is the money that enters the person’s pocket after deducting all expenses and debts.
In the business world, gross income refers to revenue without the cost of goods sold. On the other hand, net income takes into account all kinds of expenses, debts, taxes, and interests.
In both personal and business contexts, understanding net and gross income reveals a great deal about the financial health of an individual or a company.