A business owner who just checked their financial results might ask their accountant: “How much did we gross? What’s our net?”
Both are important questions, though they have very different answers. The most significant difference is gross income is almost always larger, because it doesn’t reflect the additional expenses that result in net income. Beyond that, net income is the most widely used measure of a business’s success, while gross income offers insight into the efficiency of a business’s operations.
Both are crucial for managing your business and understanding your income. Here’s more on how they compare and how to calculate them.
What is gross income?
Gross income, also called gross profit, is the money that remains after subtracting production and distribution expenses from revenue. These expenses are typically referred to as the cost of goods sold (COGS) or, in the case of non-manufacturing companies, the cost of sales.
Gross income appears on income statements, also called profit-and-loss statements. Sales or revenue, also known as the top line, is the first entry on an income statement. Below that is the line for the cost of goods sold, and below that is gross income.
The cost of goods sold includes only expenses directly tied to the production of a company’s goods or services, such as raw materials, shipping, and labor. It excludes other costs, such as office rent, utilities, and staff payroll, often referred to as overhead or indirect expenses.
Because gross income focuses on the costs directly associated with production, it serves as an indicator of productivity—a widget manufacturer can gauge its efficiency at making widgets, and an apparel retailer can see how well it sells its inventory, for example.
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How to calculate gross income
Calculate a business’s gross income using simple subtraction:
Revenue (or Sales) − Cost of Goods Sold (COGS) = Gross Income
Imagine a widget manufacturer with $50 million in annual sales and cost of goods sold of $25 million. Its annual gross income, therefore, is $25 million:
$50 million − $25 million = $25 million
A breakdown of the manufacturer’s cost of goods sold might look like this (in millions of dollars):
The gross margin is gross income divided by revenue. It’s expressed as a percentage, in this case, 50%. Businesses often analyze trends in their gross margins and compare them against their competition.
Businesses may want to be clear when referring to what they “grossed,” because this term may mean gross receipts, which is comparable to total sales or revenue, not gross income.
For an individual, gross income is wages and salary before any deductions, tax withholding, and pretax contributions to retirement or health care savings plans. Individual gross income also can include income from pensions, annuities, investment gains and dividends, and rental income.
Here’s how an individual might calculate annual gross income:
|Total compensation (salary plus bonus)||$125,000|
|Rental income (Florida condo)||$30,000|
|Interest income, bank, and brokerage||$1,200|
|Capital gains, sale of fund shares||$5,500|
Most individuals then use various adjustments and deductions, reducing the amount of income subject to taxation.
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What is net income?
Net income, or net profit, is what a business has left after subtracting all of its expenses from revenue. Net income is commonly referred to as the bottom line, because it’s the last line of an income statement.
Similar to gross income, a business’s net income can be expressed as a percentage of sales or revenue—the net profit margin. The higher the margin, the better.
Companies often make financial decisions based on the net income they generate, including expanding, hiring, borrowing, paying dividends, or making profit distributions to owners. Lenders and investors usually scrutinize a business’s net income when deciding to approve loans or offer equity capital.
How to calculate net income
Subtracting additional expenses from gross income leads to net. These other expenses include selling, general, and administrative (SG&A), commonly known as overhead; noncash expenses for the depreciation of assets; interest on debt; and income taxes.
Overhead—such as rent, utilities, payroll, marketing and advertising, and business insurance—isn’t directly tied to producing goods or services. These generally don’t change very much based on a company’s output and sometimes they’re referred to as fixed costs.
Calculating the hypothetical widget manufacturer’s net income might look like this:
|Cost of goods sold||-$25,000,000|
|Selling, general, and administrative expenses||-$13,000,000|
|Interest on $10 million loan (5% per annum)||-$500,00|
The widget company’s net income margin is 20%—$10 million of net income divided by $50 million of revenue.
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Gross income vs. net income
Gross income and net income are widely used profitability measures in business, and both are standard line items on a business’s income statement. Investors, lenders, and analysts look for growth in a business’s profitability to compare it to other companies.
But these two measures differ in important ways. Gross income highlights direct production costs, showing how cost efficient a business is in making goods or delivering services. It’s almost always higher than net income, which accounts for additional expenses and taxes. Net income, however, is the disposable income available after all expenses.
For individuals, gross pay and net amounts appear on pay stubs. It’s easy to tell the difference between the two. Net income, or take-home pay, is the amount left on a worker’s paycheck after the employer withholds income taxes and deductions for employee retirement contributions, along with mandatory Social Security and Medicare taxes (when applicable).
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