A business of any kind is run with the aim of making a profit. In order to make a profit, the firm must ensure that its income surpasses its expenses. There are many types of income that are recorded on a firm’s income statement in order to assess a firm’s performance at different levels. The article takes a closer look at two types of income: net income and gross income. The two are quite different to each other and are calculated differently. Gross income and net income are also used in various financial ratios in order to assess a firm’s financial position.
What is Net Income?
Net income is the amount of funds that are left over once all expenses incurred in the business are accounted for. The net income is derived after reducing all expenses from the gross income that appears earlier in the income statement. Expenses that are reduced in order to derive net income include salaries, electricity, rent, taxes, maintenance costs, fees, interest expenses, etc. The amount that is derived once all these are deducted is the funds that the company is left with as a profit. A company’s net income also represents the earnings per share of the company’s total shares; hence higher the net income, higher the shareholder’s earnings.
What is Gross Income?
Gross income is calculated by deducting the cost of goods sold from net sales (this is the number that you get once the returned goods have been reduced from the total good sold). The cost of goods sold is expenses that are directly related to the manufacture of the goods that are sold. In the event that a business is a service provider, then the cost of goods sold would become the cost of services rendered. Gross income is usually used to calculate important ratios such as the gross profit ratio which tells the business owners whether the sales price charged compensates for the costs of selling incurred.
Gross vs Net Income
Gross income and net income are both important values in an income statement even though they are quite different in how they are calculated. Of the two, net income is the most important because it gives an overall view of the amount of profit that is made and the shareholder value that is derived through business activity. On the other hand, gross income provides an overview of the total income derived from the sale of goods/services. If a firm has a higher gross profit and a low net income, this can be attributed to high expenses that need to be minimized. In the event that a firm has a low gross profit, either the firm is not charging the amount they should have for the goods/services they sell or costs incurred in manufacturing are too high.
Difference Between Gross and Net Income
Summary:
• Gross income and net income are both important values in an income statement even though they are quite different in how they are calculated.
• Net income is the amount of funds that are left over once all expenses incurred in the business are accounted for.
• Gross income is calculated by deducting the cost of goods sold from net sales (this is the number that you get once the returned goods have been reduced from the total good sold.