What is Gross Income?
Gross income refers to the total income earned by an individual on a paycheck before taxes and other deductions. It comprises all incomes received by an individual from all sources such as rental income, interest income, and dividends. For example, if the revenue earned by an individual for rendering consultancy services amounts to $300,000, the figure represents the gross income earned by that individual.
Gross income is sometimes referred to as gross profit when preparing financial statements for companies, and it equals the revenues from the sale of goods or services less the cost of goods sold. The revenue sources may comprise income from selling goods and services, intellectual properties, income from rental property, capital gains from investments, etc. The gross profit is a line item in the profit and loss statement.
How to Calculate Gross Income
The gross income of an individual is required by lenders when deciding whether or not to advance credit facilities to an individual. The same applies to landlords when determining whether a potential tenant will be able to pay the rent on time. It is also the starting point when calculating the taxes due to the government.
Gross Income for an Individual
The gross income for an individual is the amount of money earned before any deductions and taxes. An individual employed on a full-time basis has the annual salary before tax as the gross income. However, a full-time employee may still have other sources of income apart from the annual salary, and the additional sources of income should be considered when calculating the gross income.
For example, any dividends on stocks held by an individual should be factored into the gross income. Other incomes that should be considered include income from rental property and interest income from investments and savings.
Assume that John earns an annual income of $100,000 from his financial management consultancy work. John also earns $70,000 in rental income from his real estate properties, $10,000 in dividends from shares he owns at Company XYZ, and $5,000 in interest income from his savings account. John’s gross income can be calculated as follows:
Gross Income = 100,000 + 70,000 + 10,000 + 5,000 = $185,000
Gross Income for a Business
Gross income is an item in the income statement of a business, and it is the company’s profit for the year before deducting any expenses and taxes. It represents the revenue that a company earned from selling its goods or services after subtracting the direct costs incurred in producing the goods being sold.
Direct costs can include expenses such as labor costs, equipment used in the production process, supply costs, cost of raw materials and costs of shipping. Taxes are not deducted since they are not directly related to the production and sale of the product.
The formula for calculating the gross income of a business is as follows:
Gross Income = Gross Revenue – Cost of Goods Sold
Assume that the gross revenue of ABC, a paint manufacturing company, totaled $1,300,000 and the expenses were as follows:
- Cost of raw materials: $150,000
- Supply costs: $60,000
- Cost of equipment: $340,000
- Labor costs: $150,000
- Packaging and shipping: $100,000
The gross income is calculated as follows:
Gross Income = (1,300,000) – (150,000 + 60,000 + 340,000 + 150,000 + 100,000)
= (1,300,000) – (800,000) = $500,000
Gross Income vs. Net Income
Gross income and net income are two different concepts that vary in meaning, and they are important in understanding the health of a business or individual account.
Gross income is the sum of all incomes received from providing services to clients, before any deductions, taxes, and other expenses. It helps businesses assess their revenue potential and compare the performance of the business over the years.
On the other hand, net income is the profit attributable to a business or individual after deducting all the allowable deductions and expenses. For a company, net income is calculated from the gross income, by deducting all the business expenses such as taxes due, advertising costs, and interest expenses plus any eligible deductions like professional and legal fees.
For an individual, net income is the income earned after deducting state and federal taxes, social security taxes, health insurance, etc. If the net income is a positive value, it is a profit, but if it is negative, it shows that the business made a loss.
If the difference between gross profit and net income is significantly high, it shows that the business incurs a lot of expenses that need to be reviewed. In such a situation, the business should review its expenses to eliminate the unnecessary expenses or cut down on expenses that eat too much into the profits.
CFI is the official provider of the global Financial Modeling & Valuation Analyst (FMVA)™ certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional resources below will be useful: