Gross income and net income are two important numbers to know when it comes to understanding your financial status on a personal level or how your business is doing if you are a business owner. It can also impact your understanding of how to account for paying taxes. Because gross income is used to calculate net income, these terms are easy to confuse.
What is gross income?
Gross income is the total amount you earn (typically over the course of a year) before expenses. Think of gross income as the profit you’ve made from the services you provide—the sum of all your client billings before any deductions, taxes, or withholding.
How is annual gross income calculated?
If your client billings from the past year added up to $90,000 in revenue, that number is your annual gross income or total gross wages.
How your gross income affects your goals
Gross income is a helpful way to look at the revenue potential of your business and to assess how you are doing year over year. By looking at your various revenue streams, you can see which clients and which types of projects bring in the most income and the least income. This insight may influence where you choose to direct the majority of your time and effort, or determine the future goals you set for your business.
What is net income?
Net income is the profit your business earns after expenses and allowable deductions.
How is annual net income calculated?
To calculate net income, take your gross income and subtract all of your business expenses—marketing or advertising costs, travel or office expenses, tax payments, etc.—as well as any deductions you may be eligible for such as a home office space, retirement plan, or legal and professional fees. For example, if your business expenses for the year totaled $30,000, your annual net income would be $60,000 – ($90,000 – $30,000).
How your net income affects your goals
Net income can also help you understand the health of your business. For instance, if your gross income is significantly higher than your net income year after year, you may want to evaluate your expenses line-by-line to see what you can eliminate or reevaluate.
Why the difference is important
Knowing your net and gross income is an important part of managing your finances on a personal level and managing a successful business if you are a small business owner or self-employed. It can also help you make important decisions about income choices, such as when to raise your rates, whether or not certain expenses are necessary, and the types of income, projects and clients that you should be focusing on.
To learn how to calculate your income based on expenses and allowable deductions, try our calculator.
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