If you’ve ever applied for a credit card, paid taxes, or run a business, you might have heard of gross and net income. While these are common terms, their meanings may vary depending on the situation. It’s important to understand the difference so you can effectively manage your finances.
December 10, 2020 in Learn
Net income is the amount of money left over after deductions are taken from an individual or business income that is earned. These deductions may include taxes, operating expenses, withholdings, and other qualified benefits.
Gross income is the total amount of money that is earned. Compared with net income, gross income is always the bigger number. It’s the amount you get before deducting taxes, expenses, and other relevant costs. Context is important because gross income could mean something different for an individual than for a business.
If you work for a company, your annual gross income is the total amount your employer pays you before taxes, Canada Pension Plan contributions, Employment Insurance premiums, and other deductions.
A business’s gross income can also be referred to as its gross profit. Gross income for businesses is calculated by deducting the cost of goods from the revenue earned. Some examples of costs that are deducted at this stage could include machinery, raw materials, packaging, and shipping.
Your net income is calculated by subtracting taxes and deductions from your gross income. You could be subject to additional deductions, such as health and dental insurance premiums or union dues, if applicable.
Net income for businesses is calculated by deducting the total amount of expenses from the total amount of revenue. These expenses could include, but are not limited to, taxes, operational expenses, employee salaries and benefits, travel, and marketing and advertising costs. The amount of money leftover is the business’s profit.
Some credit card issuers could ask for your annual income on their application form.
Your debt-to-income (DTI) ratio (which is used by some lenders and creditors to understand how much more you can repay in debt given your income) typically use your gross income.
Understanding the difference between gross and net income can clarify how much money you bring home at the end of the day. In a business context, knowing your net income can help you assess how your business performs from year to year and how profitable it is. This information can help you more accurately manage finances and taxes, reevaluate your goals, and assess what is required to meet them. When applying for a credit card or loan, it is important to know your debt-to-income ratio to assess how easily you can pay off your debts with the actual amount of money in your bank account.