The Difference Between Net and Gross Income for Small Businesses
Whether your small business prepares an income statement once a year or once a quarter, you need to know the difference between your net and gross income. While both of these are critical when considering your small business taxes and the true health of your business, they are very different statistics.
Understand the differences
So what is the difference between net and gross income? Gross income is any and all income your business receives. This would include all cash, check, credit card, dividends, rental income, and canceled debts. Have you routed any money to a third party? Be sure to count that as part of your income as well.
Net income, on the other hand, is gross income minus any business expenses. Business expenses can include the cost of goods sold, advertising, rent, utilities, or wages. Depending on your line of work, a business expense can be anything that is common or accepted in your industry, or something that is specifically helpful or appropriate in your trade or business.
Some other common business expenses include:
- Auto expenses
- Entertaining clients
- Trade shows, conventions, and seminars
- Professional associations
- Local business taxes and fees
In short, gross income is your total revenue. Net income is gross income minus expenses. To increase your net income, keep an eye out for government programs that provide additional tax benefits.
Why gross income and net income matter to your small business
Both gross and net incomes are critical not only for dealing with the IRS, but for understanding your business. Gross income shows how much money is coming into your business and the total amount earned, so you can see all your revenue streams and know how your business is making money. It also helps answer whether there's opportunity in your industry or business model.
Net income helps the IRS determine your business taxes and also gives you an idea of your business's health. A business could bring in a million dollars a year, but if it suffers from high overhead, expenses could lead it into debt, rather than profits.
It can take time to calculate your net income when you're busy running a small business. But knowing that number will help ensure you understand what's really happening in your organization.
Calculating net income also gives businesses the opportunity to review both revenue and costs line-by-line. Are there areas and opportunities to grow? What are the biggest costs?
With a strong understanding of your net income, you can begin to test general assumptions about your business and make decisions based on your unique data. You may decide it's time to raise prices, or cut certain expenses. It varies depending on business and industry, but in general, strategy should at least come from knowing the basics.
No matter your industry, understanding gross and net income is critical. If you don't know your numbers, be sure to set aside some time to find them out. The health of your business may depend on it.