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Gross & Net Income: Definition & Examples

Instructor: Dr. Douglas Hawks

Douglas has two master's degrees (MPA & MBA) and a PhD in Higher Education Administration.

On any income statement, you will see two different numbers reported as income - one called 'gross' and one called 'net.' In this lesson, we'll explain the difference between these two numbers.

Some Accounting Context for Income

Let's start with an important clarification: gross income IS NOT the total amount of money a business receives. Understanding that is essential to understanding the difference between gross and net income. It is a common misunderstanding, but one that you must completely erase from your mind to understand financial statements.

Okay, now that we are done with that, we can define a few important terms that will help us discuss the difference between gross and net income. The first is revenue. Revenue is the total amount of money a business collects for selling goods and services. In this context, we don't subtract anything from revenue. If it comes from selling something, it's revenue.

The next term is cost of goods sold, often abbreviated COGS. COGS is the direct cost, to the business, of the products or services it sells. The most simplistic example is a vending machine. If a drink costs you $1.50 but it cost the vendor $1.00, COGS is $1.00 and the vendors revenue on your purchase is $1.50. If the vendor sells services, such as haircuts, COGS is the cost of the direct labor for cutting your hair.

Defining Gross and Net Income

Now we can talk about gross and net income. Gross income is the revenue a business receives, minus COGS. If we go back to our vending machine example, the gross income on your purchase of a drink is $.50 ($1.50 - $1.00 = $.50).

Net income is the amount of income remaining after the other costs required to run the business are subtracted. Again, using our vending machine example, the vendor had to pay someone to restock the machine, electricity to keep the machine operating, maintenance on a vehicle to deliver the drinks, etc. These costs are totaled up and subtracted from gross income to calculate net income. Net income is synonymous with profit.

An Example: Barb's Gas Station

To illustrate the difference of gross and net income, as well as how they can be used in financial analysis, let's look at Barb's Gas Station. Barb owns one location and sells gas, as well as the typical snacks, sodas, and basic sundry items. At the end of the year, she needs to put together an income statement, the financial statement that includes gross and net income.

The first thing she does is total up ALL the revenue she has collected. She feels like it has been a good year for business, but is surprised when she sees her total revenue for the year was $4,650,000. She sure doesn't feel like a millionaire!

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