How Gross income differs from Net income, and why should you care?

In simplest terms gross income is what you have earned above your basic expenses – as a business or as an individual, while net income is what you are left with after your basic expenses plus those that are necessary. However, when it comes to the accounting processes, they are easier said than done. These terminologies are different in definition for a business than they are for an individual, but same in significance. Let’s go over both these types of income for businesses first, and then we will talk about them in personal or individual context.

The money you make by selling your goods or services is called revenue. The costs that you have incurred in producing those goods and services are called ‘Cost of Goods Sold’ or CoGS. The gross income, then, is the difference between these two amounts, and hopefully a positive and large one if you are to continue being a profitable business. To elaborate further, let’s say you sell shoes. The leather, laces, colors and other raw materials are part of your CoGS. The salaries of your employees producing the shoes, power bills and any machine fuels that have gone directly in producing those shows are also part of CoGS. The money you made from the sales receipts of shoes are your revenues. And CoGS subtracted from revenues is your gross income.

Remember how we only counted the direct manufacturing costs for CoGS. However, if you are running a business, these are not your only costs. There will be overheads like the salaries of the human resource department and the managerial departments. The electricity bills of lights, fans, air conditioners and so on for the rest of the factory as well as the sales outlets. Then there will be the interest payments on any loans you have borrowed. There will also be depreciation of the machinery you are using and so on. These are all necessary expenditures, just not those that can be directly translated into the value of the final shoes. Subtracting all these expenses – and any other such costs you may have – from the gross income gives you your net income.

Now when it comes to an individual, the most common gross income is the salary. In other words, it is the revenues generated from a person’s labor – physical or mental. If it is to be measured for an entrepreneur than the earnings from their shares in their business, or the final take home amount is the gross income.

Just as the net income for businesses takes into account the necessary expenses, the income tax an individual has to pay, plus any contributions they make into their pension fund or for paying back their credit card charges are the costs that once deducted from the gross income gives the net income for individuals.

It should be apparent from the definitions that both these measures give different evaluations of a business’s or a person’s strengths and weaknesses. For a company, a positive and high gross income will tell how much margin they are producing over their basic costs, or how much value they are adding to their raw materials. However, it is the net income that will tell the overall situation of the business. You can have a high gross income yet a negative net income, because your other expenses are out of control. In such a situation your gross income might still encourage you to invest further into expanding your operations while you may be better off by closing down some outlets and starting an e-commerce store.

Likewise, if the analysis has to be made from an individual’s perspective, you might be earning a handsome salary but the pension fund that you have invested in thinking of it as a sound investment is leaving you with just the amount that you can match your credit card bills. So while you may be getting anxious at your job, what you should be doing is managing your expenses.

Both gross and net incomes provide you with valuable information on how to run your business and how to manage your finances. One without the other will provide you incomplete information and may lead you to make ineffective money decisions. The bottom line is to identify the areas of improvements and gradually work towards better expense management, and better valuation and pricing of your company products, or personal services, as and when each of these are applicable. Calculating incomes might sound an easy task, but when subjected to accounting rules and regulations they can get fairly complicated. Therefore, another sound financial decision would be to let accounting experts take care of these calculations and interpretations for you. Outsourcing companies are there to help you achieve this in only fraction of the cost and virtually no risk of any legal or numerical mistakes. Take advantage of the service to make your life easier and business more profitable.