Knowing the difference between gross income and net income is essential for business owners to determine their financial state. Gross income refers to the total amount earned minus the cost of goods sold (COGS). On the other hand, net income refers to the total earned after subtracting all deductions or expenses. For example, say you have $40,000 of gross income. After deducting $15,000 of additional costs, such as taxes, overhead, and currency exchange rates, if applicable (if so, you should know where currency exchange rates are based on), the net income result is $25,000.
Gross income and net income also apply to individuals. It’s typical for wage earners to see both terms in their pay stubs. The gross income indicates the base salary, while the net income is the take-home amount after taxes and other deductions. Knowing this disparity can help people better regulate their spending and allocate their savings. So, you need to save money fast for a house, and you’re calculating the amount you need to save in your banking account each month, you’ll have to consider this based on your net income instead of your gross income for a more accurate computation.
What Is Gross Income?
In financial jargon, the term “gross” describes a total value without any deductions. So gross income refers to the amount a business or individual earns over a specific period (monthly, quarterly, or annually, etc.) without deductions. So, for example, if a company earns $100,000 but spends $60,000 on product production, its gross income is $40,000. That said, for businesses, gross income usually already takes out the cost of goods sold (COGS), which typically includes variable costs related to production such as labor, materials, shipping, and the like.
For wage earners, gross income usually indicates the base salary. So a base salary of $48,000 per year is that individual’s gross income.
How To Calculate Gross Income
To calculate the gross income of a business, use the formula:
Gross Income = Total Revenue – COGS
If calculating for an individual, consider the total earnings, unless you have production costs to factor in, as well.
What Is Net Income?
The term “net” refers to a value after deductions. Hence, net income represents the final amount a business or individual earns after removing expenses and allowable deductions from the total revenue or gross income. So if a company with $40,000 gross income has to pay $15,000 in taxes, overhead, and other expenses, then its net income is $25,000.
Net income signifies their final pay for wage earners, i.e., the amount received after taxes, deductions, etc. For example, someone who has a base salary of $48,000 per year may only take home $2,900 to $3,000 monthly.
That said, net income doesn’t just consider deductions but also any other profits a business or individual earns from other income-generating ventures, such as investments.
How To Calculate Net Income
Here’s a simple way to calculate net income:
Net Income = Total Revenue – Total Expenses
However, it’s better to break it down into general categories so that you can ensure that you have accounted for everything:
Net Income = Total Profit + Other Income – Total Expenses, including operation expenses, business payments, taxes, debts, etc.
Differentiating Gross And Net Income
Knowing the gross and net income of a business can help the owners evaluate its financial status, profitability, and how efficiently its finances are managed. It’s a great metric to use when determining business decisions, especially regarding labor, expenses, and production. Investors also often use this information to gauge the health and potential of a business, and whether it would be a good investment or one that’s better to avoid.
Calculating one’s own gross and net income can help individuals assess their financial situation. Knowing these numbers can help you know how to budget your income, and also understand what portion of your pay is currently going to taxes or other deductions.
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