Net vs Gross Income [Definition, Calculation, Examples]

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Gross income and net income are two key concepts in financial management. Even if someone else does your taxes or an employee manages the tracking of your business’ profit, understanding these two elements can help you do your own financial reports. This article addresses the net vs gross income difference and how to calculate both gross and net pay.

Net vs Gross Income

It’s a common misconception among inexperienced business owners that net income is the numbers you see in the bank account. The reality is a bit more complicated.

What Is Net Income?

Net income refers to the amount of money in your bank account after expenses and allowable deductions are taken out. For companies, net income is what’s left after taxes, the cost of goods, monthly wages, employee salary, retirement pay, and health insurance. In other words, businesses’ net income is the profit they’ve made.

How to Calculate Net Income

You must subtract such expenses as taxes and deductions from your gross income to calculate your net income, i.e., gross – expenses = net income. When calculating your net income, it’s essential to include other sources of income into the gross pay.

The net income is your discretionary income—money you have complete control over. So it’s imperative to base your spending habits and form a budget on your net income rather than your gross income.

Calculate Net Income for INDIVIDUALS
  1. To determine your current personal net income, take the total (gross) amount you’ve earned, including all taxable wages, interests, and dividends.
  2. Subtract income taxes and Medicare and Social Security taxes from the total amount.
  3. Your marital status also plays a role in your net income—subtract wage garnishments, for example, for child support as well.
Example:

If a person has only one source of income and earns an annual salary of $50,000, subtract their retirement plan contributions, FICA payments, and other taxes and deductions, and their net income might be around $40,000.

Calculate Net Income for BUSINESSES

All company income statements include the gross income vs net pay ratio. To calculate the net income, businesses subtract the total expenses from their sales revenue.

  1. The first step is to determine a company’s sales revenue, which is earned by selling its products. Then, subtract the cost of goods sold (COGS)—all the expenses around creating the product.
  2. Next, find the operating income by calculating the company’s operational expenses (rent, marketing, salaries for staff not included in the product’s creation) and subtract them from the established gross income.
  3. Determine the non-operating expenses (debt, lawsuit payments) and subtract them from the operating income.
  4. Finally, add the company’s non-operating income (activities unrelated to business operations, e.g., interest paid to the company) and subtract the taxes to get the net income.
Example:

The following example features ABYZ Candy Co.’s gross vs net pay ratio.

  • Revenue sales: $75,000
  • COGS: $39,500
  • Gross income: $35,500
  • Operating expenses: $12,500
  • Operating income: $23,000
  • Non-operating expense: $1,500
  • Non-operating income: $1,700
  • Taxes: $7,500

Calculating the net income for ABYZ Candy Co.:

  • 75,000 – 39,500 = 35,500
  • 35,500 – 12,500 = 23,000
  • 23,000 – 1,500 = 21,500
  • 21,500 + 1,700 = 23,200
  • 23,200 – 7,500 = $15,700 Net Income
DID YOU KNOW? The lifetime learning credit (LLC) is an excellent way to minimize your tax payments. Individuals are entitled to a maximum of $2,000 per return on the money they have spent to improve their education after finishing high school

What Is Gross Income?

Gross income refers to the total earnings of an individual or a company before taxes and deductions. By comparing gross pay vs your net pay, individuals can become more aware of their financial status.

Individual gross income includes the salary (and bonuses) you receive from an employer or clients, depending on if you’re working as a freelancer or standard employee. Gross income includes rental income, alimony, capital gains, and insurance payments. Such incomes are subjected only to partial taxation.

A bank account interest, inheritance from a relative or friend, dividends, and gambling winnings are additional sources of gross income that you should also include in your tax report. But according to federal government regulations, life insurance proceeds and workers’ compensation payments are non-taxable.

Learn how to calculate your gross income so that you can compare your personal or business gross vs net salary.

How to Calculate Gross Income

The following includes calculating gross income for individuals and businesses.

Calculate Gross Income for INDIVIDUALS

Individuals typically receive their salaries monthly, bi-weekly, or weekly.

  1. The gross pay an individual receives solely from their employment can be quickly calculated by taking the monthly earnings, for example, and multiplying them by 12.
  2. If the payment is based on an hourly wage, multiply the salary by the number of hours they worked to get the gross income.
Example: 

Consider the following example to calculate your gross income—leading to net income.

  • Full-time job: $80,000
  • Rental income: $50,000
  • Interest: $3,000
  • 80,000 + 50,000 + 3,000 = $133,000 Gross Income
Calculate Gross Income for BUSINESSES

To calculate the gross income, subtract the COGS from the revenue sales.

  1. Collect information on all sales statistics to obtain the number of your company’s earnings from the sale of services or products.
  2. When calculating the COGS, consider labor and supply spending and the cost of equipment and raw materials.
  3. So then, what is the net vs gross income ratio? Subtract the numbers to see.
Example:
  • Revenue Sales: $1,500,000
  • Labor spending: $150,000
  • Supply spending: $50,000
  • Cost of equipment: $300,000
  • Cost of raw materials: $10,000
  • 1,500,000 – (150,000 + 50,000 + 300,000+ 10,000) = $990,000 Gross Income
DID YOU KNOW? The AGI (Adjusted Gross Income) of the 2021 tax return was located on different lines from the preceding years. Taxpayers can now find the AGI on Line 11 on Form 1040, 1040-SR, and 1040NR.

The Importance of Knowing the Gross vs Net Income Comparison

Regardless of whether you’re a business owner, an employee, or a freelancer, distinguishing between gross income vs net income is vital for good financial health. The net and gross income results help businesses evaluate their performance on a corporate level. And on a personal level, individuals can consciously make smarter financial decisions by being aware of their earning status.

Key Takeaways

Net income is your discretionary income.
It’s imperative to base your spending habits and form a budget on your net income rather than your gross income.
Gross income refers to the total earnings of an individual or company before taxes and deductions.
Net income refers to the amount of money in your bank account after taxes and deductions.
Regardless of whether you’re a business owner, an employee, or a freelancer, distinguishing between gross income vs net income is crucial for good financial health.

Conclusion

Differentiating between net and gross income is crucial, especially during tax season. Confusing these two terms can bring serious consequences, such as being accused of tax evasion, resulting in financial penalties. Gross and net earnings are also valuable when planning your budget and establishing financial balance—essential for business owners and other professionals and wage workers.

FAQ

What does net income mean?

The net income meaning depends on your position in the workforce. In the corporate world, net income is the indicator of a company’s profitability. For wage employees, net income represents their post-tax earnings or take-home pay.

What is net income and gross income?

Gross income is the total amount of money that an individual or business makes before taxes, allowable deductions, and retirement contributions. The sum left after taxes and deductions is net income.

Why is net income lower than gross income?

Net income is always lower when comparing net vs gross income since the gross income makes up the number of your total earnings. In contrast, net income is the sum after taxes and deductions from your full payment.

Is monthly income net or gross?

Monthly income is gross income since it refers to the total earnings during a month before taxes and deductions.

ABOUT AUTHOR

I learned a lot about finance after working for a digital marketing company specializing in investing and trading stocks, forex, etc. After that, I got exposed to other verticals such as wealth management and personal finance, which further improved my understanding of the financial world.

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