Gross vs Net Income – Importance, Differences And More

Gross vs net income is a topic that you must often have come across. Understanding the difference between the two is important for both business and individual or employee (from the tax point of view). Gross Income is the amount of money that a business makes by selling the product or service. For individuals or employees, it is the income without deducting the expenses. Net Income, on the other hand, is gross income – total expenses.

What is Gross Income?

Gross income is the income that a business earns over a period of time. Basically, it is the amount that a company makes on a product less direct expenses. Another term for this gross profit or the profit before other expenses are taken into account. Here, it is important to mention that one gets gross income by subtracting the Cost of Goods Sold (COGS) from Gross revenue. Gross Income = Gross Revenue – Cost of Goods Sold.

Cost of Goods Sold is the sum of all the expenses that a company incurs in producing the good. COGS include items such as Supply Costs, Raw materials, Packaging and shipping, Equipment and machinery, Direct Labor Cost.

For example, a business has sales of $100,000, Cost of goods sold of $50,000, Selling expenses of $10,000, Administrative expenses of $15,000, and Taxes of $5,000. In this case, Gross Profit is ($100,000 – $50,000) $50,000.

What is Net Income?

Net income is the profit that a business makes or the money that a business is left with after paying all the expenses. Business entities arrive at net income towards the end of the year by deducting operation expense from the gross profit. Net Income is usually a last item in the income statement, and thus, is popularly known as the bottom line.

To arrive at net income, we deduct other expenses from gross income. These other expenses include selling expenses, salaries, benefits for employees, travel expenses, advertising and marketing expenses and more.

Taking the same example as above, the net income will be ($500,000 – $10,000 – $15,000 – $5,000) $20,000.

Definition of Revenue under GAAP and IFRS

To achieve gross income, one needs revenue. Thus it is important to know what constitutes revenue under both GAAP and IFRS.

Revenue under GAAP – Para 78 of FASB concepts statement No.6, Elements of Financial Statements defines revenue as “inflows or other enhancements of assets of an entity or settlements of its liabilities (or a combination of both) from delivering or producing goods, rendering services, or other activities that constitute the entity’s ongoing major or central operations.”

Revenue under IFRS – Paragraph 74 of the IASB Framework states that revenue is an income that a company earns from regular business activities. Moreover, revenue can be in any form such as dividends, rent, interest, sales, fees, and royalties.

Paragraph 7 of IAS 18 defines revenue as the gross inflow of economic benefits from regular business activities. Further, the definition says these inflows result in an increase in equity as well.

Gross Income Vs Net Income

Why Gross and Net Income Are Important?

For a business, gross income signifies how well the company is performing on the revenue front. On the other hand, net income talks about an increase or decrease in the expense. If the expenses have risen while the gross income is constant, then net income would decline. Moreover, the calculation of gross and net income helps a company identify major expenses in a business. Knowing such expenses help companies manage their operations efficiently.

Understanding the difference between gross vs net income allows a company to track the income sources, how well the company is doing to earn that income and which items the company needs to focus on.

Also, studying net profit can help a business make a useful business decision. For instance, if sales are growing slowly, but the fixed cost is increasing relatively faster, then there will be a drop in the net profit. A business can address such an issue by increasing sales at a faster rate, and also making efforts to limit fixed costs.

Gross vs Net Income – Differences

Gross Income Net Income
Gross Income is COGS less net sales Net Income is gross income less operational expenses, interest, and taxes.
Gross Income tells the income of the company after direct costs Net Income talks about the amount that a firm can re-invest or use it pay a dividend to the shareholders
Gross Income does not rely on net income Net Income relies on the computation of gross income
The only expense deducted is COGS Both operational and non-operational cost is deducted
Gross Income is the immediate income that a company makes from the sale of goods Net Income includes income from operations and income from other sources
It is always more than the net income It is always less than the gross income

Gross vs Net Income for Employees

For individuals (mainly employees), gross vs net income is not as complicated as for the business entities. Gross income or gross pay is the total salary that the employer pays, i.e., before taxes and other deductions. A point to note is that gross income is not the amount that an employee takes back home, rather it is what the employee costs to the employer. So, net income for the employee is gross incomes less taxes and other deductions.

For instance, an employee has a gross income of $50000, taxes are $1000 while other employee benefits are $3000. In this case, net income is $50000 less $1000 less $3000 = $46000.

Final Words

Though gross and net income is different things, they are part of the same income statement. Both parameters play a crucial role in analyzing the performance of a company. One can use both gross and net income to calculate other vital metrics. Dividing gross income by total sales gives us a gross profit margin while dividing net income by total sales gives net profit margin.

Last updated on : April 6th, 2020
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