What Is Gross Income For Business Owners? Everything You Need To Know
In this article, we explore what is gross income in business and outline everything you should understand as a new or existing business owner.
As a business owner, you must have a grasp of your financials and understand the difference between income and profits.
This article is no substitution for professional advice, but it will give you a fundamental understanding.
This simple equation illustrates what is gross income: Gross income = cash received from operations – the cost of goods sold.
Important: We always advise that for all financial matters, you seek professional advice from a professional.
What Is Gross Income?
Gross income (sometimes referred to as gross pay for individuals) refers to the total income an individual or a business makes before taxes and operating deductions.
Gross income does not only refer to wages, but all revenue made no matter the source.
Gross income is not to be confused with net profits or net income, both of which are calculated after taking deductions out. Gross income also differs from “revenue”; below, we expand on these definitions.
Gross income is calculated by adding up all the cash received from operations for a given period, minus any allowances given, unpaid expenses, and the cost of goods sold.
This is also sometimes referred to as gross profits or gross margins for businesses. However, this does not consider the cost of selling your products, such as admin, payroll, and taxes.
How Do I Calculate Gross Income?
Now that we have covered what is gross income, we can explore how it is calculated.
Gross income is calculated by subtracting revenue or net sales from a company’s cost of goods sold, as shown in the simple equation at the top of this article.
For example, if your company sold $3 million in items that cost $1,800,000 to create, your gross profit would be $1,200,000.
The income statement includes both gross profit and net profit.
Gross income margin is typically the first profitability ratio calculated by businesses. It measures how much sales income a company has left over after covering the cost of goods sold (COGS).
The method below may be used to calculate your company’s gross income margin percentage. The first set of numbers you will need to complete the calculation should be on your income statement.
Gross Income ÷ revenue (aka Net Sales) = Gross Income Margin %
A more significant gross income margin means you will have more money left over to pay operational costs, taxes, depreciation, and other charges.
It might also lead to better overall earnings for the company’s owners and stakeholders.
Why Is Gross Income Important?
Gross profit indicates how successfully a company controls its production costs, such as labour and materials, to earn money from the sale of its products and services.
A business may have a vast volume of sales and significant streams of revenue; however, if it does not have any gross income, then the business may not be financially viable.
It is also important to note that having a healthy gross income is not a guarantee of profit as other expenses will still need to be accounted for.
Important: We advise using reliable accounting software to help keep track of your finances and expenses. Check out our comparison guide of free accounting platforms.
What Is Business Revenue?
Revenue is the entire amount of money collected through sales during a period, such as a quarter.
It is sometimes known as net sales and includes discounts and deductions from returned or damaged products.
Net sales are commonly reported as a revenue number by businesses in the retail industry, for example. The total revenue is reduced by the value of products returned by consumers.
Revenue is frequently referred to as the “top line” statistic since it appears at the top of the income statement.
What Is Net Income?
Now that we understand what is gross income and revenue, we can expand on net income.
Net income is the profit earned from all elements of a businesses activities. As a result, net income is more inclusive than gross profit and can reveal the proper performance of the business.
A business could, for example, improve its gross profit while also mismanaging its debt by borrowing too much.
Despite strong sales and production efforts, the extra interest expenditure for repaying the debt might result in a drop in net income.
A businesses net profit should be understood and valued since it indicates the company’s performance. It is a considerably more critical statistic than revenue because.
This simple equation illustrates what net profit is: Net income = cash received from operations – (the cost of goods sold and all operating costs)
You may also use the net profit to determine how much money you have available to pay the owners and/or reinvest in the firm.
The net profit number is used by banks and other lending institutions to understand a business better and analyse the loan’s appropriateness.
The net earnings will offer them an idea of your ability to pay. If you are looking for investors or have shareholders, you will need to know your net profit.
This will help them have a better knowledge of your company and its performance. Investors may be confident that they will obtain a return if the net profit figure is solid and stable.
Although net profit is the most comprehensive measure of a company’s profit, it is not without flaws and can be deceptive.
For example, if a firm sold a building, the proceeds from the sale would boost net income for that period.
Now that you have a better understanding of what is gross income and how it is classified, we recommend you track your business finances and, if needed, seek further education from a professional.
If you need help with your bookkeeping, a good starting point is to use dedicated accounting software; you can check out our list of free accounting software here.