We will examine the profit and loss accounts with examples and the difference between gross salary and net salary.

Gross vs Net Income

Gross income is your total revenue less the Cost of Goods Sold (COGS); it is the top line of your income statement before any other costs are deducted. Net income, on the other hand, is your profit – what’s left after all those expenses are paid. Understanding the crucial difference between these two figures is essential for accurate budgeting, strategic pricing, and, ultimately, the long-term success of your business.

Gross Income Definition

The gross income for a business is the gross revenue generated before any general expenses or deductions are subtracted. The initial figure represents the raw earnings from the company’s core business operations. Consider it the “top line” of your income statement, the first number you see when assessing your business’s financial performance. For many businesses, gross income is calculated by subtracting the cost of goods sold (COGS) from total revenue. This calculation, resulting in gross profit, clearly shows how efficiently the business generates revenue from its products or services.

Gross income encompasses all the money a business brings in from its primary activities. This includes sales revenue from products or services and any other income directly related to the business’s operations. Gross income serves as a crucial starting point for understanding a business’s financial health, as it provides a snapshot of the company’s ability to generate revenue. By focusing on gross income, business owners can assess the effectiveness of their sales strategies and pricing policies and identify areas for potential improvement in their core operations.

What is Net Income

Net income represents a business’s final profit after all expenses are subtracted from total revenue. It’s the amount of money left after accounting for the cost of goods sold, operating expenses, interest, and taxes. Essentially, net income is the company’s “bottom line,” indicating its true profitability. Calculating net income involves taking gross income and deducting all business-related expenses.

These expenses include operating costs such as rent, utilities, general business expenses and salaries, which are subtracted to arrive at net income. Interest expenses, the costs of borrowing money, are also factored into the calculation. Finally, taxes are deducted, leaving the final net income figure. Net income is a critical metric for assessing a business’s financial health and profitability. Investors and creditors rely on net income to evaluate a company’s performance, and business owners use it to make informed decisions about investments and growth.

What is the difference between Gross and Net Income Examples?

Below, we look at examples of Gross and Net Income.

Gross Income Example

Imagine ABC Computers, a small business that sells computers and provides IT consultancy. In a given month, the business generated the following:

• Computer Sales: 15,000
• IT Consultancy Fees: 5,000

To calculate the gross revenue or sales, we add these two revenue streams:

• 15,000 (Computer Sales) + 5,000 (Consultancy Fees) = 20,000

Therefore, the revenue for that month is 20,000. This figure represents the total revenue earned before any expenses, such as purchasing the computers or any operational costs, are deducted.

Now, let us imagine that the cost of the computers sold was 8,000. In this case, the gross profit would be calculated as:

• 20,000 (Computer Sales) – 8,000 (Cost of Computers) = 12,000 Gross Income

This 12,000 figure is the gross profit that can be used to pay for overheads and other business expenses.

Net Income Example?

Let’s continue with the ABC Computer example above and calculate the net income. To do this, we need to introduce some operating expenses:

ABC Computers Expenses (Monthly):

• Rent: 1,000
• Utilities: 300
• Salaries 4,000
• Marketing/Advertising: 200
• Office Supplies: 100
• Taxes: 500

Recap of Gross Profit:

As previously calculated, the Gross profit was 12,000.

Calculating Net Income:

Now, we subtract the total expenses from the gross profit:

Total Expenses: 1,000 + 300 + 4,000 + 200 + 100 + 500 = 6,100

Net Income: 12,000 (Gross Profit) – 6,100 (Total Expenses) = 5,900

Therefore, ABC Computers’ net income is 5,900 actual profit after all expenses were paid.

Key points to remember:

• Net income is what’s left after all the bills are paid.
• It’s the figure that truly reflects the business’s financial health.
• This money can then be reinvested back into the company, or taken as profit by the owner.

It is essential to look at both figures as a business may have a high turnover and think it is performing well. Calculating the net income, including the expenses, may produce a different picture. An example is a business with an annual gross income of 250,000 that thinks it is doing well. When looking at the profit and loss account, there are expenses of 260,000, so the business has made a loss.

Using the same business, here is an example annual Income Statement:

In the example, the business would need to examine the figures and see if it can make any savings. It would also need to compare this profit and loss to the previous years to see the differences. It might be that turnover has dropped while other expenses have stayed the same, or expenses have increased.

Gross vs Net Income Wage Slips Explained

The difference between gross and net income is also essential for employees looking at their payslips. Each employee earns a gross pay or taxable income, but deductions are required for income tax, NI, Student loans and pensions. The figure that the employee receives is the net income.

Example Wages

An employee has an annual salary of £24,000; this is the taxable income. The monthly payslip may have the following:

The taxable income is Gross income minus pension minus personal allowance (12,750). From the taxable income, you then deduct income tax and national insurance. Your tax will depend on your salary, personal allowance and any other deductions.

To estimate your take-home pay, use a salary calculator. Entering your gross income will give you a good indication of deductions and net income.

P60s

A P60 is an annual statement employers provide to employees, summarising their pay and deductions for the tax year (April 6th to April 5th). It details the total gross income, the amount of income tax and National Insurance contributions deducted, and any other relevant financial information. The P60 also helps individuals verify that their tax deductions are accurate and provides a comprehensive overview of their annual earnings, making it an essential component of personal financial records.

Conclusion To Gross Income and Net Income

Gross income is the total money you make, and net income is what is left after expenses or deductions. For businesses, that means revenue versus profit/loss. For individuals, it’s the difference between your total pay and take-home pay on your payslip. Knowing the difference helps you understand your financial situation, whether you’re looking at a business’s bottom line or pay.

Return from the difference between Gross and Net Profit to Profit and Loss Statement.

The post What is the Difference Between Gross and Net Income? appeared first on Business Accounting Basics.

Although financial statements may seem a little complicated to understand at first, they will make your life as a business owner much easier because you will have a much better understanding of the numbers for your business.

Today, we will take a detailed look at what they are and how you can start using them for free to better understand your finances.

What is a Financial Statement UK?

In simple terms, a financial statement represents the financial position of a business or, in some cases, an individual using data structured to create a clear overview.

This data can be used to show the financial activity of a business to an outside party, such as investors, government agencies, or for tax purposes. Or it can also help the business owner make better and more informed decisions for the business.

Why Financial Statements are Important

Financial statements display the financial health of a business.

They provide a clear overview of what’s going on financially inside a business to both internal and external parties. For example, it can help investors understand whether a company is going to be able to repay a loan depending on whether it has the needed cash flow.

If there are many potential problems with a business, investors may choose not to invest in it.

A cash flow statement is one of the main types of financial statements, alongside a balance sheet and profit & loss forecast. They’re all extremely important, but we’re going to talk about these in detail a little later on.

Nowadays, investors require key financial statements before they will invest in a business as they show the company’s financial position.

If your business does not have the statements available, you might just run into a couple of issues, and you will definitely not be able to get any type of loan. If you haven’t started keeping your financial statements, we will talk you through some of our free templates later on. 

Types of Financial Statements

As already mentioned a little earlier on, the four main types of key financial statements are:

1. Balance Sheet
2. Cash flow statement
3. Profit and Loss or Income Statement
4. Statement of changes in Equity

In case you are wondering why the third type of financial statement has two names, it’s because, in the UK, we call it a profit & loss. However, in the USA, it is often called an Income Statement.

So, if you have ever heard of an Income Statement, it’s the same as a profit and loss forecast. Let’s take a look at what the different types are used for and how you can use our free templates.

1. Balance Sheet

The balance sheet is there to give yourself or outside parties a snapshot of the business’s assets, liabilities, and equity. Having a snapshot of the assets, liability, and equity is an excellent indication of how a company is performing, as well as the stability of a business.

Assets are made up of both fixed assets and current assets. Fixed assets have a longer life than current assets and tend to be used in the production of goods or services, while current assets are cash or cash equivalents that can be converted into cash within one year, such as stock, debtors, bank accounts and cash itself.

Liabilities are debts or obligations that must be paid. This could include loans, mortgages, credit card debt and any other money owed to a business or individual. They are split between long-term liabilities and current liabilities. Long-term liabilities are for expenses that will take longer than a year to pay back and current liabilities are for expenses that must be paid within the next 12 months.

It is important for a business to keep track of its liabilities so it knows how much it owes.

Shareholders’ equity is the difference between a company’s assets and liabilities.

It represents shareholders’ ownership of the company and their claim on its assets. Shareholders equity can include shares, retained earnings, and additional paid in capital.

To put it simply, shareholders equity is an account that measures how much shareholders have invested in a company minus any dividends or distributions they have received. It helps inform potential investors of a company’s value and is an important metric to consider when evaluating whether to invest in a business.

Keeping a balance sheet is essential, as it’s required to be submitted by all companies registered at Companies House.

If you would like to start keeping a balance sheet, we have a free balance sheet template that you can use. You can download the template in excel format for free and easily edit it to start keeping your balance sheet.

2. Cash flow Statement

The second type of financial statement is the cash flow statement or statement of cash flows.

The cash flow statement is an essential financial document for any business; it helps track the cash coming in and going out. It’s essential to understanding a business’s cash flow because it can tell you how much cash is available at any given time.

This information can be invaluable when planning or investing, as it will give you insight into a company’s cash situation. Further, cash flow statements help indicate trends over time, revealing which cash sources significantly contribute to a business’s health and growth.

Ultimately, a cash flow statement is an incredibly helpful tool that provides valuable insight into cash availability and helps companies make informed decisions regarding their finances.

We have a cash flow forecast template that you can download for free. Using this template, you can easily forecast the cash flow of your business, which will help you make better decisions in the future.

3. Profit & Loss

The profit & loss statement will show both the gross and net profit.

This is also a helpful financial statement for management decisions, as it helps you understand the exact numbers inside of your business. Often, you might think that you are making more profits than you are because you are selling your products at decent margins, but after taking into account your overheads, you are making a lot less.

The profit and loss account helps you identify if something like this is happening. If it is, you can then review your management decisions to improve them for the future.

You can download an excel profit and loss statement template for free.

This template will make it easy for you to calculate your:

• Total sales
• Cost of sales
• Gross profit
• Expenses
• Net Profit/Loss

Using these figures, you will be able to gain much better insight into the real numbers inside of your business.

4. Statement of Changes in Equity

Every business needs to keep track of changes in its equity statement over time in order to ensure they maintain the right amount of capital.

Equity changes occur due to changes in profits and losses, paying out dividends and other changes like investments. Considerations such as the timing of changes, events causing the changes and economic factors that may impact those changes must all be taken into account when developing an accurate equity statement.

Every business should reach out to a financial professional if they need help navigating changes related to their equity statement.

How to Produce a Statement of Financial Position

There are two ways to produce financial statements using a spreadsheet or accounting software.

The easiest way is to use the best accounting software that includes lots of reports. Accounting software helps to reduce mistakes and can save time.

HMRC are introducing Making Tax Digital, requiring all tax returns to be submitted by third-party software. VAT was introduced in 2019, and self-assessment is planned for 2026.

Frequently Asked Questions Around a Statement of Financial Position

Lastly, I just wanted to cover some frequently asked questions regarding what is a financial statement.

What is the Difference Between a Financial Statement and Bank Statement?

A financial statement provides you with a much clearer overview of how your business is doing compared to a bank statement.

Bank statements just have your transactions listed, which makes it incredibly hard to see how your business is doing. Investors will always require certain financial statements instead of bank statements for this reason.

Plus, if your company is registered at the Companies House, you are required to submit certain financial statements as part of the year end accounts. 

What is the difference between a Balance Sheet and Profit Loss Statement?

The balance sheet provides a snapshot of a business’s performance at one given moment. It provides insight into a company’s assets, liabilities, and equity. The profit and loss statement provides insight into how much profit (or losses) a company is making over a period of time, usually one year.

In simple terms, the balance sheet is more of a snapshot, while the profit & loss statement is more of a video over a longer period of time. 

When Should a Business Prepare Financial Statements?

There are a couple of times when a business should prepare financial statements. For example, the government may need access to a company’s reports for tax purposes. Usually, businesses will also prepare financial statements for their results at the end of the year, but this depends on the size of the business.

Another example of when a business might prepare financial statements is when looking for investors.

For further reading, check out our accounting basics section.

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