Financial advisers and accountants often throw around the terms “net” and “gross” when they’re talking about money. But what are gross and net income really?
In this post, we look at the difference between gross and net, and the impact these terms have on your wallet. Let’s do some jargon-busting.
The difference between gross and net: Terminology
The word “gross” means the sum total of lots of things added together. Gross income refers to all the earnings of an individual or business over a certain period of time (typically a year) before any deductions such as taxes.
In contrast, the word “net” means the amount of something (e.g. money) that is left once everything that should be subtracted has been subtracted. Net income refers to the earnings of an individual or business that remain once all relevant deductions have been made.
However, gross and net mean slightly different things depending on whether you’re talking about an individual wage-earner or a company.
Gross and net earnings for an individual
As an individual, your gross pay is your salary (before any deductions) plus any other sources of income you may have. Other sources of income that count towards your gross pay include:
- Earnings from freelance or self-employed work
- Income from shares (dividends)
- Rental income
- Income from selling belongings online
Your net pay, on the other hand, is your gross pay minus certain deductions. These deductions can include:
- Income tax
- National Insurance contributions
- Pension contributions
- Student loan repayments
As a wage-earner, your net pay is also called your “take-home pay”, as that’s the amount that arrives in your bank account.
Let’s look at a couple of examples of how you would work out your gross vs net earnings as an individual.
Tim works in an office and earns a salary of £45,000 per year. He has no other sources of income, so Tim’s gross pay is simply his £45,000 salary.
When Tim looks at his pay slip, he sees that his employer has made deductions for income tax, National Insurance, and pension contributions. The amount remaining is £32,500.
So Tim’s net pay is £32,500.
Claire works in an office and earns a salary of £35,000 per year. She has additional income from a rental property and she also recently sold some old clothes online. Claire’s gross pay is her salary of £35,000 + £12,000 rental income + £500 from selling the clothes.
So Claire’s gross pay is £47,500.
To find out her net pay, Claire must submit a tax return to HMRC, declaring all her sources of income. Claire’s employer makes deductions from her salary, but Claire also has to make some additional payments to HMRC, as a result of her extra income.
Therefore, Claire’s net pay is £34,000.
Gross and net profit for a business
For a business, gross income (also known as gross profit) is defined as the total sales revenues of the company minus the cost of goods sold. The “cost of goods” means expenses directly related to making the product, including:
- Equipment or machinery
- Raw materials
- Labour costs for manufacturing the product
A business’s net profit (or income) is the gross revenue minus other expenses, taxes, and interest.
Finding out a business’s gross and net profits can be useful in different ways. The gross profit will give you a good indication of how well the business is generating revenue. On the other hand, the net profit will show you how the business’s expenses are impacting their earnings.
Let’s take an example:
Jack owns a company that makes teapots. He works out the company’s gross profit by taking the sales revenues of £800,000 and subtracting cost of goods (including clay, paint, ovens, wages for teapot painters, etc.) of £200,000.
So the company’s gross profit is £600,000.
Jack then takes the gross profit of £600,000 and subtracts running costs (such as office rent, salesperson wages, computer maintenance), taxes, and interest. After these deductions, Jack is left with £200,000.
Therefore, the company’s net profit is £200,000.
If Jack had found that the amount of money deducted was greater than his gross profit, we would say that his company had a net loss.
Possible ways to improve company profit
In order to increase its net profit, companies can attempt a few tactics:
You can increase revenue by boosting sales, or increasing the value of your existing sales. You might want to try launching new products, or introducing your products to new markets. And increased revenue might come from existing customers if you can retain them better or encourage repeat business when it was once a simple one-off purchase.
You might want to reduce operational costs, such as cutting outlays on office supplies and software that your company isn’t using to its full capacity. Alternatively, you might focus on utilities and cut down on expenditure for power, gas, and water. Finally, check whether your insurance premiums are currently what you need, or whether they can be optimised or reduced.
Optimising the workforce:
While remaining sensitive to the human effects of this approach at all times, you might consider options like limiting overtime or consolidating tasks, projects, or campaigns. And you might be able to restructure internal teams or reshuffle hierarchies to make work more productive and efficient.
Gross vs net: Key takeaways
So, as an individual wage-earner, should you be focusing more on gross or net? Well, both figures can be helpful, depending on the situation.
Looking at your gross pay will allow you to compare better with other people in similar positions, so you can determine whether or not you’re receiving a fair wage.
In contrast, your net pay is what should be guiding your budget. That way, you can make sure that you’re only spending what’s actually coming into your bank account.
Want to find out more about the difference between gross and net? Check out these other blog posts:
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