The difference between gross and net income
/Gross vs. Net Income for a Business
The concepts of gross and net income have different meanings, depending on whether a business or a wage earner is being discussed. For a company, gross income equates to gross margin, which is sales minus the cost of goods sold. Thus, gross income is the amount that a business earns from the sale of goods or services, before selling, administrative, tax, and other expenses have been deducted. For a company, net income is the residual amount of earnings after all expenses have been deducted from sales. In short, gross income is an intermediate earnings figure before all expenses are included, and net income is the final amount of profit or loss after all expenses are included. For example, a business has sales of $1,000,000, cost of goods sold of $600,000, and selling expenses of $250,000. Its gross income is $400,000 and its net income is $150,000.
The main flaw in the use of gross and net income for a business is that the gross income figure is more likely to be closely related to the results of operations, while net income can include a variety of non-operational expenses, gains, and/or losses. Thus, the two calculations are based on different sets of information, and so are used in different types of analyses. The disadvantage of using either one of them is that they do not necessarily equate to the cash flows generated by a business, which could be substantially different.
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The Interpretation of Financial Statements
Gross vs. Net Income for a Wage Earner
For a wage earner, gross income is the amount of salary or wages paid to the individual by an employer, before any deductions are taken. In this context, net income is the residual amount of earnings after all deductions have been taken from gross pay, such as payroll taxes, garnishments, and retirement plan contributions. For example, a person earns wages of $1,000, and $300 in deductions are taken from his paycheck. His gross income is $1,000 and his net income is $700. A person’s net income figure is more important than his or her gross income, since net income reveals the amount of cash available for expenditures.
Similar Terms
Gross income and net income are also known as gross profit and net profit.