Income is any inflow of economic benefits. The term “Economic benefits” means any benefits that can be quantified in terms of money.
Businesses generate income through various means. Usually, income is generated through the sale of goods or services.
Income generated through a business’ main activity is also known as revenue. Businesses can also generate through activities apart from their main business activity.
These incomes may come in the form of incomes from investments or income from the sale of fixed assets, for example.
For employed individuals, income is generated mainly through the basic salary or wage they get from the organization they are working for. Their income may further be increased by some other benefits they may receive from their employer.
These benefits may be in the form of bonuses, overtime premiums, commissions, holiday pays, sick pays, golden handshakes, etc.
Income is a fairly straightforward concept for both businesses and individuals. However, for both individuals and businesses, there are two types of income that may be confusing.
These are gross income and net income. While they may sound similar and are closely related to each other, they are completely different in what they mean and how they are calculated.
Gross Income vs Net Income
Gross income generally means the full amount of income for an entity. For businesses, gross income means all the incomes from business activities, especially sales.
For individuals, on the other hand, it means all the incomes from the individual’s employer whether that is salaries, bonuses, overtime premiums, or anything else.
On the other hand, net income describes any income that is left after certain deductions from gross income. For businesses, net income is the figure that is calculated after subtracting all of the business’ expenses from its revenues.
For individuals, net income is the figure that is the amount they actually get paid. This figure is calculated after deducting different rates and taxes from the individual’s gross income.
For businesses, gross income is the amount they are generating from their business activities. This amount denotes the actual efforts of the business in generating income for the business.
Investors look at the gross income of the business to determine the total revenue the business is generating from its activities. However, this isn’t the only figure that investors consider when making a decision about a business.
When making a decision about investing in a business, investors also consider the net income of a business.
While the gross income tells the investors how much the business is generating from business activities, the net income tells investors about how much of the revenue generated is being converted into profits.
Since the net income is calculated after all of the expenses of the business are subtracted from its gross income, the net income also tells the investors about the control the business has over its expenses that are not part of their sales.
For individuals, gross income is the amount they have earned for their work. This includes all earnings that an individual is entitled to as stated above.
The gross income of an employed individual is generally pre-determined and agreed upon with the employer.
For example, before joining the organization, the employer and the individual will sign a contract detailing the salaries or wage rates, the overtime premium rates, any possible bonuses, etc.
In contrast, net income for individuals is the actual amount they get paid. Like net income for businesses, net income for individuals is also calculated after deducting some expenses from the gross income of the individual.
These deductions from salaries depend on different rules and regulations of the country the individual is working in or the country the payment is being made in.
For instance, taxes are deducted from the gross income of individuals based on different tax rates in different countries. Other examples of possible deductions include pension payments, unemployment benefit payments, child support payments, etc.
Gross Income
Gross income is any income that is earned over a specific period of time. For both businesses and individuals, gross income is calculated in different ways.
For businesses, gross income is also known as gross profits and requires some deductions to be made from the revenues of the business to be calculated. For individuals, gross income doesn’t need any deductions.
Businesses
For businesses, gross income is also known as gross profits. Gross profits, in business terms, is the residual amount after deducting all the expenses related to producing or purchasing a product.
These expenses may include but are not limited to, raw material purchase costs, factory costs, freight and forward expenses, utility expenses related to production, depreciation related to machinery or factory, etc.
For a service-based business, gross profit is calculated by subtracting any expenses that are directly related to the provision of the services.
For example, a consultancy will deduct the fee of the consultants from the revenue generated from clients to reach the gross profit.
The gross profit of a business can simply be traced in the Statement of Profit or Loss (also known as Income Statement) of a business. The gross profit is calculated using the following formula:
Gross Profit = Revenues – Cost of Sales/Goods Sold or Cost of Services Provided
The Cost of Sales also known as Cost of Goods Sold is all the expenses of a business that are directly related to the product sold that generated the revenue.
They do not include other costs such as administrative costs that do not directly add to the cost of a product. Furthermore, financial costs such as interest charges or marketing costs do not constitute the Cost of Sales as they do not relate to the cost of producing/purchasing a product.
Taxes are also not directly related to the cost of a product and therefore, not a part of the Cost of Sales. However, any sales tax that cannot be claimed on the purchases of raw materials is a part of the Cost of Sales as they are directly related to the product.
Individuals
Gross income for individuals is defined in their contracts. If an individual has a fixed salary, the fixed salary amount is their gross income.
If the individual has an hourly rate wage, the hourly rate multiplied with the total hours worked is their gross income.
Any overtime premium rate is also agreed upon in the contract or in the employer’s policy manuals. This can also be easily calculated using the guidelines for calculating overtime premiums and making a part of the gross income of individuals.
Furthermore, bonuses may also be pre-determined or can be given whenever the employer chooses to. Either way, bonuses are still included in the gross income of an individual.
Simply put, for an employed individual, any income the individual earns from the employer is their gross income for the period.
Individuals that are not employed may have other sources of income. For example, a local business owner may run a small store. For them, any income they generate before any deductions are their gross income.
Net Income
Net income is a term used to describe income after all deductions have been made from the gross income. Net income for businesses means deducting any remaining expenses that are not directly related to the production or purchase of the product.
For individuals, it means subtracting taxes, pension payments, and any other mandatory or voluntary payments from the gross salary.
Businesses
For businesses, the other term used for net income is net profit. Net profit is the residual amount after deducting all of the business’ expenses from the revenues of the business.
Net profits can also be defined as the residual amount after deducting expenses that are not directly related to the production or purchase of products from the gross profit of the business.
The net profit of a business, like its gross profit, can be simply traced from its income statement. The formula to calculate the net profit of a business can be written in 2 ways, as follows:
Net Profit = Revenue – Expenses (all business expenses)
Net Profit = Gross Profit – Other expenses (expenses that are not included as a cost of sales)
The expenses deducted from the revenues of a business are all the business expenses including all taxes.
If these expenses are being deducted from gross profit, they include expenses such as administrative expenses, marketing expenses, research expenses, selling expenses, financial expenses, and taxes.
These are expenses that are not directly attributable to the sales of any specific product.
Individuals
For individuals, net income is the amount they actually get paid. The net income for individuals is the amount after deducting different amounts from the gross income of the individual.
These deductions can be for amounts that are either mandatory or voluntary deductions. These amounts might differ according to each employer and country the individual is working in.
The main deduction from the gross incomes of individuals is taxes which are mandatory. Whether the individual is working for an employer or self-employed, they have to pay taxes and deduct these taxes from their gross incomes to reach their net income figure.
Other expenses may include pension payments, medical expenses or insurance, leave deductions, and other voluntary deductions.
Conclusion
Income is any earnings made by a business or individual. There are two terms that are related to income which are gross income and net income.
Gross income for businesses, also known as gross profit, is the income after deducting expenses directly related to the products being sold from the business’ revenue.
For individuals, gross income is the amount they have earned whether from their jobs or other sources.
Net income, for businesses, is the amount after deducting all the business’ expenses from its revenues. For individuals, it is the amount of payment they actually receive after deduction of any taxes or other amounts.
