You're probably familiar with gross and net income as they apply to you as an individual taxpayer—but what about if you run your own business? How do you calculate and record your business' gross and net income, and what are they each used for?
As you'll soon find out, gross income and net income are both very important figures to your business in a variety of ways, so read on to get a crash course in both!
Income vs. Profit
One of the main differences between your business' gross and net income is that the first relates more closely to income, while the second has more to do with profit.
Gross income includes all of your company's income from the sale of goods and services throughout the fiscal year. (Learn all about setting your business' fiscal year.) Put another way, gross income (or gross margin) is the amount your business brings in from sales before any relevant expenses are deducted.
Deduction of expenses is key to net income, which is your gross income minus business expenses. Net income represents the profit earned by the business over the course of the year.
Calculating Gross and Net Income
As we saw above, to find your gross income for the year, you will be adding together all of your sales income. This includes payments made in cash, by check, debit, or by credit card. It also includes any interest earned, promissory notes, canceled debts, and dividends.
Calculating net income involves taking the gross income amount and subtracting your business expenses. These expenses include things like cost of goods sold (COGS), insurance, administrative fees, wages paid to employees, advertising expenses, vendor expenses, office supplies and equipment, and rent.
If net income ends up being a positive number, then your company may have capital gains to report come tax time. On the other hand, if net income turns out to be a negative number (i.e. expenses exceeded income), you may be reporting a deductible capital loss.
What to Do With Gross and Net Income
Now that you have these two figures, what do you do with them and how can they help you run your business?
Both gross and net income are recorded on your income statement. This financial statement is important not only in gaining a better understanding of your company's financial standing for your own purposes, but is also something that potential investors and lenders will look at to gauge your company's financial health.
As a small business owner, these figures are vital to seeing the bigger financial picture of your business and finding ways to keep expenses under control, so that your business can grow and thrive.
Questions for us? Get in touch anytime at firstname.lastname@example.org.