Gross vs. Net Income

What is the Difference Between Gross Income and Net Income?

The gross income, at the individual level, refers to the sum of all wages earned, salaries, non-core profits (e.g. dividends), interest payments, rental fees, and other forms of earnings before deductions or taxes.

Contrary to a common misconception, the gross income of an individual (or “gross pay”) is interchangeable with the term “gross revenue” since no deductions or expenses have been applied yet — barring unusual circumstances.

• Gross Income ➝ Gross Pay
• Net Income ➝ Net Pay (Take-Home)

The gross income, at the corporate level, is the difference between net revenue and the cost of goods sold (COGS) incurred to create a product or provide a particular service.

• Gross Income ➝ Gross Profit (or Gross Margin)
• Net Income ➝ Net Profit (or Net Earnings)

The two pieces of information necessary to calculate gross income and net income for companies are as follows:

• Net Revenue = Gross Revenue – Returns – Discounts – Sales Allowances
• Cost of Goods Sold (COGS) = Σ (Purchase of Inventory, Cost of Raw Materials, Cost of Direct Labor)

For a company, gross income—or “gross profit”—is the net revenue generated in a given period minus cost of goods sold (COGS).

Because the revenue of the company is not directly tied to operating expenses, the deduction is not applied to gross income. Likewise, non-operating costs like income taxes or interest payments are neglected.

The sources of income included in the gross pay of an individual include the following:

• Wages ➝ The payment to an employee compensated on a hourly, daily, or piecework basis for the labor or services provided.
• Salaries ➝ The compensation paid to employees for the services provided on behalf of the employer, per the employment contract.
• Bonuses ➝ The performance-contingent payment issued to employees.
• Rental Income ➝ The income earned from renting out a property to a tenant.
• Interest ➝ The income paid by a corporation (or borrower) at regular intervals to an investor.
• Dividends ➝ The periodic or one-time payments issued by a corporation to equity shareholders.

The tax rate applied to the various sources of income differs based on the surrounding circumstances.

For instance, the capital gains tax on short-term and long-term investments is a distinction with broad implications on taxes owed to the government.

Gross Pay vs. Net Pay: Taxable Income Example

Hypothetically, suppose an individual taxpayer generated $200k in 2024, the $200k reflects the total gross pay that the individual earned.

The $200k gross pay must be adjusted for fees, such as health insurance or retirement planning, such as a 401(k) contribution.

Once deducted, the residual income represents a form of taxable income, rather than flowing straight into the pocket of the individual, unfortunately.

The tax rate applied to the taxable income of the single taxpayer is based on the bracket in which the income falls under.

Note, the income taxes paid to the IRS are much more complicated than merely adjusting the taxable income by the coinciding tax rate; hence, our recommendation to consult with a certified accountant.

For instance, there are certain nuances to be aware of, such as the capital gains tax, where the holding period of the investment determines the appropriate tax rate.

^{2023 Tax Rate for Single Taxpayer (Source: IRS)}

Gross Income Formula

The gross income of an individual is calculated as the total earnings received from all income streams.

For purposes of filing taxes, the annual gross income is the most common variation of the gross income metric.

On the other hand, the gross income of a company is the net revenue generated across a given time frame subtracted by cost of goods sold (COGS).

On the subject of relative valuation, the gross profit of a publicly-traded company is often compared to that of its closest comparables operating in the same industry, or an adjacent sector (i.e. peer group).

But the gross profit must be standardized before any comparative analysis (“comps”) is practical — which is achieved by converting the profit metric into a profit margin.

The gross margin, or “gross profit margin” is equal to the gross profit divided by net revenue in the corresponding period.

Net Income Formula

The net income—also referred to as “net earnings”— is the funds remaining after all expenses, taxes, and deductions have been subtracted from an individual’s gross income.

In simple terms, net income is the “take-home” pay of an employee, i.e. the amount deposited into the bank account.

The net income metric, or “bottom line” on the income statement of a company, is not interchangeable with the net income of an individual taxpayer.

Why? For individuals, net income is the residual income left after all taxes, insurance payments, retirement or healthcare plan contributions, and other deductions have been subtracted from the gross income.

The net income of a company, however, is the profit remaining after all operating costs (i.e. COGS + Opex) and non-operating costs (e.g. interest, income taxes) have been deducted.

Because net income is inclusive of all cost and expenses, the metric is often perceived as the most comprehensive profit metric — albeit, there are several flaws with the net income metric that can distort the profit margin (e.g. net profit margin) and valuation multiple (e.g. P/E ratio) of a given company.

While net income is widely used in practice, the shortcomings of the metric—or more specifically, accrual accounting—reduce the practicality of the metric.

But one key takeaway here is that for both profit margins mentioned—the gross margin and net margin—any form of comparative analysis is useful only if the selected companies are comparable (i.e. industry, product or service, life-cycle, customer base, end markets served, etc.)

Note: Given a negative net income, the net margin of a company is not meaningful (NM).

Gross vs. Net Income: Income Statement Example

The gross income—more commonly recorded as “Gross Profit”—and net income are each measures of profitability under GAAP reporting standards.

Hence, the two profit metrics are recorded on the income statement (P&L), contrary to a non-GAAP measure like EBITDA, which is prohibited from being recognized on the financial statements filed with the SEC.

The income statement is one of the core financial statements that reflects the operating performance of a company in a given period.

Most often, the gross margin refers to the ratio between the gross profit and net revenue — however, there are exceptions, of course, such as Apple (AAPL).

The gross margin of Apple is calculated by deducting its cost of sales from its net sales in the coinciding period, whereas the net income (the “bottom line”) is the profit remaining after subtracting all costs and expenses, including income taxes.

^{Gross vs. Net Income Example (Source: AAPL 10-K)}

What is Adjusted Gross Income?

The adjusted gross income (AGI) is a metric used by the Internal Revenue Service (IRS) to determine an individual’s tax liability for a given year.

The AGI of an individual represents the total gross income earned for the year, subtracted by adjustments to income.

The common deductions to the adjusted gross income (AGI) are as follows:

• Contributions to Traditional IRAs and Retirement Accounts
• Student Loan Interest
• Self-Employment Taxes
• Health Insurance Premiums
• Health Savings Account (HSA) Contributions
• Qualified Business Expenses (Military, Performance Art, Fee-Basis Public Officials)

The formula to calculate the adjusted gross income (AGI) is as follows:

Gross vs. Net Income Calculator — Excel Template

We’ll now move on to a modeling exercise, which you can access by filling out the form below.

Excel Template | File Download Form

First Name *

Email *

Submit

By submitting this form, you consent to receive email from Wall Street Prep and agree to our terms of use and privacy policy.

Email provided

Your Download is Ready

Submitting...

1. Gross Income Calculation Example

Suppose we’re tasked with calculating the gross income of a company, given the following financial data.

Based on the income statement of our company, for fiscal year ending 2024, the gross income amounts to $60 million.

• Gross Income = $100 million — $40 million = $60 million

By dividing the gross income by revenue, the gross margin is 60%.

• Gross Margin (%) = $60 million ÷ $100 million = 60.0%

The 60% gross margin implies that for each dollar of revenue generated, the company retains $0.60 in gross profit.

2. Net Income Calculation Example

In the next section, we’ll calculate the net income of our company starting from gross income.

The operating expenses (OpEx) to deduct from gross profit are the SG&A and R&D expense, which results in operating income (EBIT).

The commonality in the deductions thus far is that each cost (or expense) is an operating cost, i.e. the operations of the company cannot continue without incurring the costs.

The EBIT, or operating income, of our company is $25 million (and 25% operating margin).

• EBIT = $60 million — $20 million — $15 million = $25 million
• Operating Margin (%) = $25 million ÷ $100 million = 25.0%

With that said, the company retains $0.25 per dollar of revenue generated.

From EBIT, the next step is to deduct non-operating costs, like interest.

• Pre-Tax Income (EBT) = $25 million — $5 million = $20 million

The final step is to deduct income taxes from our company’s pre-tax income (EBT), which comes out to $16 million (and 16% net margin).

• Net Income = $20 million — $4 million = $16 million
• Net Margin (%) = $16 million ÷ $100 million = 16.0%

3. Gross vs. Net Income Calculation Example

In closing, we’ll compare the gross income of our hypothetical company to its net income for fiscal year ending 2024.

The gross and net income—to reiterate from earlier—came out to $60 million and $16 million, respectively.

The 60% gross margin implies that for each dollar of revenue, $0.60 remains in gross profit.

On the other hand, the 16% net profit margin implies that for each dollar of revenue generated, $0.16 is left over.

The higher the gross margin, the higher the net profit margin — all else being equal.

Hence, companies strive to optimize their cost structure and pricing strategies to reduce their spending on direct costs, for the sake of improving their net income (and thus, earnings per share, “EPS”).

The earnings per share (EPS) is of particular importance to publicly-traded companies, because of the obligation to report earnings each quarter (SEC).