Gross Profit vs Net Income: What’s the Difference?

To illustrate the difference of gross and net income, as well as how they can be used in financial analysis, let’s look at Barb’s Gas Station. Barb owns one location and sells gas, as well as the typical snacks, sodas, and basic sundry items. At the end of the year, she needs to put together an income statement, the financial statement that includes gross and net income. For example, if a business sells a product for $100 and then $10 is taken as cost of goods sold and another $20 is taken as operating expenses, then they will have gross income of $100.

It includes costs for buying materials, labor to make products or services, and shipping costs. COGS or COS is deducted from the gross receipts of the business before calculating gross income. Deduct all operating expenses like salaries, utilities, rent, marketing expense, etc., from your gross profit. These are expenses that are directly tied to your business operation. Essentially, net income is your gross income minus taxes and other paycheck deductions.

Step 3: Subtract COGS from Total Revenues

Also known as a profit and loss (P & L) statement, an income statement is a financial report that details your revenue and expenses over a fixed period of time. However, accounting income is a key point in calculating the cash flow statement. From here, changes in cash due to operations, financing, and investing are added or subtracted to find the net change in cash in any given period. Net income is calculated by subtracting the cost of goods sold from gross revenue.

After considering all these elements, you will arrive at net income. This figure represents what is truly left over for the business after all costs have been deducted from revenues. When assessing profitability, net income offers definitive proof of whether a business makes more money than it spends. A positive net income indicates revenues that exceed expenses, signaling successful operations and potentially promising future growth. On the other hand, negative net income may provide an early warning sign for stability and liquidity. The higher your gross income, the higher your tax liability will be, depending on your marital status, deductions and other qualifying credits.

Tools for tracking gross and net sales

One such adjustment is contributions to traditional 401(k) retirement accounts. This reduces gross income and, therefore, the amount of taxes that are paid. Was the amount a little or a lot less than what you expected the total to be? That’s where people think, “Hey, how does the money promised differ so largely from what I received? Finance leaders use gross income to indicate sales growth and potential market share, while net income determines profitability. Decision makers use these figures to assess the company’s financial performance.

• Net income also includes any other types of income that a company earns, such as interest income from investments or income received from the sale of an asset.
• It summarizes all transactions, gains, or losses on the balance sheet and it is used to calculate the profit and loss before taxes.
• Typically, when you’re creating your monthly budget, you’ll use your net income since your after-tax pay is what you use to pay your bills.
• Gross sales provide an objective measurement of your company’s ability to generate revenue.

Net income, or net profit, is what a business has left after subtracting all of its expenses from revenue. Net income is commonly referred to as the bottom line, because it’s the last line of an income statement. The cost of goods sold includes only why is net income lower than gross income expenses directly tied to the production of a company’s goods or services, such as raw materials, shipping, and labor. It excludes other costs, such as office rent, utilities, and staff payroll, often referred to as overhead or indirect expenses.

Calculating Adjusted Gross Income (AGI)

The result would be higher labor costs and an erosion of gross profitability. However, using gross profit as an overall profitability metric would be incomplete since it doesn’t include all the other costs involved in running the company. As stated earlier, net income is the result of subtracting all expenses and costs from revenue while also adding income from other sources. Depending on the industry, a company could have multiple sources of income besides revenue and various types of expenses. Some of those income sources or costs could be listed as separate line items on the income statement. Understanding net versus gross income is important for your budget, taxes, loan applications, and more.