As a small business owner, you need to know the terms “gross income” and “net income,” how they are different, how they are calculated, and how they work in business tax returns and financial statements.
What’s the Difference Between Gross Income and Net Income?
Gross income is the total income of a business (often just income from its operations) and net income is gross income minus expenses. But gross income is also the result after deducting some expenses directly related to the core products or services of the business. Here’s the formula to calculate it: Gross income = Sales - Returns and Allowances - Cost of Goods Sold (if any) or Cost of Sales if the company sells only services Within these definitions are some key elements you need to know.
Income From Operations
Gross income and net income for tax reporting purposes and financial statements are typically income and expenses from the business’s operations. This income is usually separated from income from other sources like investments.
Returns and Allowances
Returns are credits you give a customer for returning a product they purchased. Allowances are discounts or reductions in the selling price of a product. For tax reporting purposes, don’t include credit or cash refunds are not cash or credit refunds.
Cost of Goods Sold
Cost of goods sold (COGS) or Cost of Sales (COS) is the cost of products or services, respectively, that you’re selling. 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. These costs are separate from other costs of the business because they are directly related to sales. If your business isn’t selling products, you don’t have COGS.
How To Calculate Gross Income and Net Income
The calculations for gross income and net income (profit) are different in tax and accounting situations.
Income Statement Calculation
Each small business creates and uses an income statement (profit and loss statement) to show the income and expenses of the business for a period of time. The format and content may vary based on the needs of each business. Here’s a general, hypothetical income statement format for a year: In the Income section:
Other income and expenses (investment income and expenses, for example)Interest income expenses (for interest on borrowing for non-operation purposes)Income taxes
In this case, they might designate a new final number as net income.
Special Considerations
Specific expenses vary depending on the type of industry and business entity type. Depreciation is the cost of buying long-term assets (like business vehicles and equipment). This cost is spread out over several years. The current year’s cost is included in Schedule C and on the Income Statement. Loan principal payments are not tax deductible, but some businesses may include them on their income statement.
The Bottom Line
Gross income is the total income a business earns before expenses. It’s the income from sales of the business, after deducting sales returns and allowances (discounts). If your business sells products, calculate COGS and deduct it to reduce gross income. Net income, meanwhile, is the income of a business minus expenses. The net income of a business may be different for tax and accounting purposes because some expenses are tax deductible and others are not.
