Gross vs Net Overview
Gross and net are two terms in finance and accounting lingo that often get confused and misused. Gross simply means the sum total of something. Net implies the result after deducting items. Because of the deductions, the net amount will always be smaller than the gross amount.
For this post we’ll use the two terms to evaluate gross income and net income.
Gross income and net income have different meanings depending on whether you are dealing with personal finances or the finances of a business. It is important to know the differences in both situations to properly evaluate the financial status of one or the other.
For your personal finances, gross income is the total income you earn, including salary, wages, pensions, alimony, interest, dividends, and rental income.
I remember coming out of college and being excited by what my earnings could be from the salary of my first full-time position. I would calculate how much I’d make every two weeks if my salary was $50k, $60k, or $70k per year.
The calculation I was using was for Gross Income.
I was soon brought down to reality after seeing the smaller size of my first paycheck. The amount that I was looking at in my direct deposit was the net income amount.
Net income is the amount you receive after deductions are taken out from gross income. It is also referred to as “take-home pay.” As the name implies, this amount is what you can take home and deposit into your bank once deductions have been taken out.
Examples of a few deductions include payroll taxes, health insurance premiums, contributions to retirement accounts, and union dues.
If an individual has a paycheck with a gross amount of $3000 and deductions of $900, their gross income would be $3,000 and net income would be $2,100
For a business, gross income is the residual amount after you subtract Cost of Goods Sold (COGS) from Revenues. This is how much a company makes on its products minus the expenses directly related to the creation of the products. It is also referred to as “gross profit.”
Gross Income for Business = Revenue – COGS
Net income, also referred to as “net profit”, is the residual amount of earnings leftover after subtracting operating expenses from gross income.
A business has total revenues of $1,000,000, costs of goods sold of $400,000, and other expenses of $300,000. In this scenario, gross income is $600,000 and net income is $300,000.
Why is Gross Income and Net Income Important?
The two can provide perspective on where you are at financially on an individual level and for your business. By understanding the amounts, you can make informed decisions on your financial goals, capabilities, and limitations.
They are also very important figures during tax season, as the gross income value is used to calculate Adjusted Gross Income (AGI).
Implications for Career
As a business student, you’ll be dealing between gross income and net income quite a bit in your coursework. Even with that exposure, you may forget the differences between gross and net. It is important to be able to distinguish the two.
When you are interviewing for a company, misuse of the two can hurt your credibility during conversation. When referring to income, you’ll want to be sure you are talking about the correct figure.
You’ll also want to know how to calculate both and give examples of what makes up gross income and what the deductions are that are taken out to arrive at net income. Review the examples above
As a professional, it is common for departments outside of finance and accounting to confuse Gross Income and Net Income. Wherever you are in the business, it’ll be able to know the difference between the terms to understand what is going on and to be able to have intelligent conversations with your team and management.
How to Interpret Gross Income and Net Income
Individuals will most commonly be presented with gross income figures. This is your annual salary, your hourly wage, and income from other areas. Before planning, you’ll need to understand that deductions will be taken out of that amount.
If you get a check for $1000, don’t buy a new iPad for $900. If your deductions on the $1000 is $300, your iPad will have detracted from your net worth by $200.
For a business owner, you’ll want to analyze your Gross Income and Net Income amounts to understand your strategy and plan.
Gross income is important to look at. Review the revenue side of it and your COGS. Either one may be too high or low and could be adjusted.
I’ll give you a personal example:
I dabbled in Amazon FBA, and sourced a product from China to sell online on Amazon.com. The cost per unit of my item was $3, and the price I was able to sell the unit at was $15. For one product, my revenue was $15 and COGS was $3. This gave me a gross profit of $12.
This was a healthy amount in my analysis. With that remaining $12, I was able to allow for sufficient advertising costs and fees Amazon took out for handling the logistics. All said and done, net income, or net profit, per product was $5.
If my cost of goods sold was higher (let’s say $10 per product), my gross profit would have been $5 and I would have been restricted with that amount to work with for advertising and other fees. In this scenario, I would break even and make no profit.
Or, if my cogs stayed the same at $3, but my revenue was $10, I would also break even and earn no profit.
So it is important to analyze your gross income with your revenue and COGS to decide on raising revenues or decreasing COGS
Furthermore, you can look at your gross income amount, net income, and analyze in a similar fashion as above. If your gross income is $10 and your net income is $1, your operating expenses may be too high. In this case, you can raise your gross profit or decrease your expenses to achieve a higher and healthier net income
How to Remember Gross Income vs Net Income
Gross > Net
Net comes after Gross on the Income Statement. N comes after G in the alphabet.
Related Terms and Ratios
- Gross Income = Gross Profit
- Net Income = Net Profit
- Gross profit margin = Gross Profit / Revenues
- Net profit margin = Net Profit / Revenues