When it comes to income, it may be a little difficult to understand the different parts that exist. Understanding income is an important part of understanding and organizing finances. Traditional income can be broken down into two categories: net income and gross income. The difference between gross income and net income is fairly simple to understand but varies when taking about individuals or businesses. Knowing and analyzing gross and net income can be an important financial tool especially for a business, and especially if an individual is a contractor/freelance worker.
The Difference between Gross and Net Income with Individuals
When it comes to gross and net income with a single person, the main difference between the two types of income is that, one factors in taxes and deduction while the other does not;
- Gross income for individuals is the income before any taxes or deductions are taken out.
- Net income for individuals is the income that a person gets to keep once all of those things are taken out.
So essentially gross pay is the amount that a person can look at on their paystub while net income is the amount that they receive on their paycheck.
At this point many may be wondering what those deductions and taxes that come out of a paycheck are. For most Americans the major taxes that come out of their gross income are state and federal taxes. Federal taxes are the same throughout the nation, while State taxes vary (some states do not even have this tax). Other deductions include garnishments and retirement plans.
The Difference between Gross and Net Income with Businesses
When it comes to businesses, the difference between gross and net income can be a little bit more complicated. This is because with businesses there are service or sales, and business expenses involved. Despite the difference net income and gross income carry similar meanings in both in out of the business world;
- Gross income for businesses is the amount of income earned from selling their good/services before, taxes or deductions are taken out.
- Net income for businesses is the amount of income that remains after all deductions and taxes taken out. Essentially this the profit or loss a business has made at any given period.
In the business world- gross and net income are also known as gross profits and net goods. When it comes to a business, gross and net income- usually- are calculated with data that is not closely related to each other. The deductions that most business have to deal with are work related expenses such as advertising or paying their employees. The taxes that businesses have to ranges from state to state.
How to calculate Net and Gross Income
Calculating gross and net income can be fairly simple;
- Let’s say a person makes $50,000 a year- This is Gross Income
- Their federal and state taxes totaled $10,000
- Their retirement fund totaled $5,000
- $50,000-$15,000=$35,000-This is their Net Income
For those who are traditional employees this work will be automatically done for them, however for those who are contract workers or do freelance work the calculations are up to them (they just have to figure out what their state and federal tax rates are for the year)- and saving for retirement is optional for these workers.
For businesses calculations follow the same general formula but have different expenses. Additionally, the bigger the business- naturally- the more complicated calculations may get.
Why is Important to Understand the Difference between Gross and Net Income?
For Individual Workers:
For an individual it is important to look at gross and net income because it can help a person better understand what they are making and where their money goes. For traditional workers/employees this may be done fairly simply- as it is broken down on a paystub.
However for contract worker things may not be so simple. If a person is a contract worker/freelance worker- and their employer is not taking out taxes out for them- it is up to the employer to take out or calculate how much money needs to be put aside for taxes.
So knowing what gross and net income for an individual can be helpful for budgeting, and for tax expenses- depending on the work that they do.
Examining gross and net income can be an important asset for businesses. Gross income can give a business a good idea of where most of their profits, and losses are coming from- on an annual basis. This can help a business set up improvements or changes for the following year. Knowing and analyzing both of these also show a business where they should be allocating their time, money and efforts.
The major difference between net and gross income is that gross income is the amount after necessary expenses such as taxes and deductions are taken out while net income is the amount left over after all those expenses have been taken out- the amount an individual gets to keep or the amount of profit/loss a business makes. Both of these types of income can be important for individuals who want to budget, or are contract workers. When it comes to businesses, gross and net income can help an organization improve the way they conduct business and increase their profits.