When starting out as a business owner, understanding gross income (also called gross profit) is crucial for tracking your profits and filing your business taxes. To put it simply, gross income is the amount your company has earned, minus the cost of goods sold (COGS).
However, your gross income is only one of several metrics you need to keep track of. You also need to be able to work out your net income, operating profit, and profit margins. We’ll explain what these metrics are and how to calculate them in this article.
How to Calculate Gross Income
To calculate your company’s gross income, you start by adding up all the revenue your business has earned: total sales, plus any other income such as dividends, rental income, and canceled debt.
Then, subtract your direct costs, also called the cost of goods sold. To determine direct costs, add up the cost of raw materials (or items for resale), freight and storage, production and direct labor costs. Note that direct costs don’t include taxes, interest on debts, or operating expenses like rent, insurance, or marketing. Direct costs are simply the cost of making the product itself.
Your revenue minus your direct costs is your gross income. So, for a company that had $350,000 in revenue and $50,000 in direct costs, the gross income would be $300,000 ($350,000-$50,000).
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Reporting Gross Income on Tax Returns
In addition to tracking your gross income for your own records, you’ll need to report it on your tax returns. If you own a sole proprietorship or single-member LLC, which are both taxed as disregarded entities by default, you’ll report gross business income on your individual tax return. Partnerships report gross income on the partners’ individual tax returns and on IRS Form 1065, U.S. Return of Partnership Income. C-corporations note gross income on their Form 1120 tax returns, while businesses that elect s-corp status include it on Form 1120-S.
You’ll also need to know your gross income when preparing financial statements for investors or creditors.
What is my company’s gross profit margin?
The term profit margin means the percentage of revenue left over once you subtract costs. In the case of the gross profit margin, it’s the percentage of revenue left after subtracting the cost of goods sold. Your gross profit margin shows you, by percentage, how much the cost of making the product cuts into your profits, which can help you estimate future growth and let you know if you need to cut costs or raise prices.
You can calculate your gross profit margin by dividing your gross income by your revenue, and then multiplying the result by 100. So, in our example above, the company with $350,000 in revenue and $300,000 in gross income would have a hefty gross profit margin of more than 85% (300,000 ÷ 350,000 = 0.857, 0.857 × 100 = 85.7).
What’s the difference between gross income and operating profit?
Operating profit (sometimes called earnings before interest and taxes or EBIT) is the amount left over after subtracting operating expenses from gross profit. Operating expenses include rent, equipment, marketing, salaries, insurance, and other overhead costs. EBIT is useful for measuring a company’s performance outside of external factors the management team has no control over, making it appealing to investors.
What’s the difference between gross income and net income?
While gross income is revenue minus the cost of goods sold, net income is revenue minus your total expenses. In addition to the cost of goods sold and operating expenses, your total expenses will include taxes and interest on debts—in short, anything that subtracts from your company’s bottom line. After subtracting total expenses from revenue, the result is your company’s net profit or loss.
Your net profit margin can be calculated by dividing net income by total revenue, and multiplying by 100. For example, if your total revenue is 500,000 and your total expenses add up to $300,000, your net profit would be $200,000 and the net profit margin would be 40% ($200,000 ÷ $500,000 = 0.4, 0.4 × 100 = 40).