Business, Politics, & Society

Gross Income vs. Net Income: Understanding the Difference Between Gross Income and Net Income and How Each Affects Your Business

Written by MasterClass

Last updated: Sep 25, 2019 • 3 min read

As a business owner, keeping track of your annual profits is incredibly important to projecting the overall health of your company. Two concepts that affect your overall profit are gross income and net income.

Gross and net income are very similar concepts, but understanding the difference between them is very important for both businesses and individuals.

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What Is Gross Income?

Gross income has different meanings when applied to businesses and individuals. Regardless of whether you are an individual or business, gross income appears on personal finance, corporate earnings, or income tax forms as an initial figure which then gets reduced by other operating expenses and deductions.

There is an important distinction between gross income for businesses and individuals:

  • Business. For businesses, gross income is sometimes used interchangeably with the term gross profit. Gross income takes the total revenue found on your company’s income statement and subtracts the cost of goods. Gross income does not, however, take into account other operating costs or business expenses outside of the pre-sale cost of goods sold. Gross income is the gross margin of profit factoring in simply sale revenue and production costs. Gross income is a way for businesses to track the amount of money they generate in profit before factoring in administrative expenses and tax money owed to the IRS.
  • Individuals. For individuals, gross income can be used interchangeably with gross pay (or sometimes gross earnings or gross wages). It’s much simpler for individuals to calculate their gross income than it is for businesses. For employees of a company, gross pay is simply the amount their employer pays them prior to any payroll deductions and tax withholding. Gross pay can be found as the amount listed on the employee’s paycheck above any and all taxes (including state tax, social security tax, and federal tax) and other deductions.

What Is Adjusted Gross Income?

Adjusted Gross Income or AGI is a measurement (dictated by state and federal income tax laws) that is used to come up with an individual’s taxable income and tax liability.

Some of the big deductions that affect AGI include deductions for social security payments, retirement plan contributions, medical expenses/medicare tax, health insurance premiums/healthcare savings account payments, etc.

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How Do You Calculate Net Income?

Just as with growth income, the process for calculating net income is slightly different for businesses and individuals:

  • Businesses. The first step of calculating net income is determining a business’s net revenue and then subtracting total expenses. To find the net income you’ll need to deduct any and all business expenses including, employee gross pay, administrative expenses, utility bills, etc. The net income formula is: Total amount of revenue-(cost of goods + expenses + depreciation + taxes). This formula will calculate your company’s net income and take stock of how much money your company has generated in profit for the year. Net income is a vitally important number for taking stock of a business’s overall viability and health. Small business owners need to carefully track their net earnings to keep track of the net profit margin and determine how they can generate higher revenues.
  • Individuals. For a wage earner, net income is simply their take-home pay after deducting all taxes, benefit payments, insurance, and any other miscellaneous deductions. Keeping track of your net pay requires that you keep tabs on your total income from income statements and track any and all tax deductions.

Net and gross income are similar concepts but individuals and business owners should be able to differentiate between the two. Mixing up gross income and net income can have financial consequences, like incorrect tax returns resulting in potential penalties or garnishments.

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