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I’m sure your accountant has asked you before for your gross and net income when preparing your tax return, right?

But what exactly is gross income, and how does it differ from net income?

Continue reading for everything you need to know about gross income and how it applies to you.

What is gross income?

For individuals, your gross income is the total amount of earned income that you can find on your paycheque before any taxes and deductions are taken off.

It considers all sources of income from your wage, rental income, interest income and even dividend profits.

Businesses calculate gross income slightly differently. Their gross income is also called gross profit, the income they make from selling their product or service minus the actual cost of those products sold.

Related: These 11 U.S. States Are Reducing Individual Income Taxes | Entrepreneur

How is gross income calculated?

Now that you know what gross income is, how do you calculate it?

You may need to calculate your total gross income to acquire a loan from the bank to satisfy the lender.

Your potential landlord may require it to ensure you can afford the rent.

You may even be applying for a credit card, and they require your gross income amount before approving your application.

Continue reading for how both individuals and businesses can calculate their gross income.

Related: How to Calculate Gross Profit: Formula and Examples | Entrepreneur

Gross income calculation for individuals

As gross pay for individuals includes numerous forms of income from employment, rental income, interest income and dividend payments, this must be considered when calculating your gross income.

Example:

If Alex earns an annual income of $100,000 a year at his office job and he also earns $70,000 in rental income from real estate he owns, $10,000 from dividend profits and $5,000 in interest income on his savings account his calculation would be as follows:

Gross Income = $100,000 + $70,000 + $10,000 + $5,000 = $185,000

Gross income calculation for businesses

A business’s gross profit is on the income statement of the business.

It is the business’s annual gross margin before taking off any indirect expenses, interest and taxes.

This calculation represents the business income earned from selling goods or services after deducting any tax deductions regarding the direct costs that the business incurred.

Examples of direct costs can include:

• Employee labor costs.
• Equipment used in the production phase.
• The cost of supplies.
• The cost of the raw materials.
• Any required shipping costs.

Example:

If the total revenue of Brian’s Hardware Store totaled $1,300,000 and their expenses were as follows, what is their gross income?:

• Material cost: $150,000
• Supply cost: $60,000
• Equipment cost: $340,000
• Labor cost: $150,000
• Shipping cost: $100,000

To calculate the gross profit, revenue minus the cost of goods sold (COGS), of Brian’s Hardware Store, the calculation is as follows:

Gross Income = $1,300,000 (COGS) -$150,000 – $60,000 – $340,000 – $150,000 – $100,000 = $500,000

What is net income?

Another question your accountant may ask you is what your net income is.

Your net income is your gross income minus any taxes and deductions taken off by your employer.

Essentially, you can see your take-home pay on your pay stub on payday.

Net income represents your actual total earnings and is what you can use to give yourself an idea of the amount of money you can spend throughout the month.

It is also a good indicator of how much you might pay in taxes every year.

Related: What Exactly Is Your Income Statement Telling You? | Entrepreneur

How do I calculate my net income?

To calculate your net income, first, take your gross income and deduct the following expenses:

• Income taxes.
• Health insurance payments.
• Retirement account contributions.
• Social Security and Medicare taxes.
• Loan payments.
• Child support payments.
• Alimony payments.
• Wage garnishments.

Example:

If Susan’s annual salary is $150,000 a year as a lawyer, and she has the following expenses, what is her net income?:

• Income taxes: $8,000.
• Health insurance payments: $2,000.
• Retirement account contributions: $5,000.
• Loan payments: $10,000.

To calculate Susan’s net income, the calculation is as follows:

Net Income = $150,000 – $8,000 – $2,000 – $5,000 – $10,000 = $125,000

Related: How To Calculate Net Income: Here’s a Comprehensive Guide | Entrepreneur

What is taxable income?

You will use your gross income when you fill out your state and federal income tax papers.

Next, you can deduct any applicable deductions to determine how much you may owe.

Remember that your gross income is not the same as your taxable income.

This is because some sources of income are not counted as part of your gross income for tax purposes.

Some sources of income that are not taxable include:

• Life insurance payouts.
• Specific Social Security benefits.
• State or municipal bond interest.
• Certain inheritances or gifts.
• 401(k) contributions.
• Health savings account contributions.
• Educator expenses.

Your taxable income is also what may be used to determine what tax bracket you are in.

Related: Is it taxable income if a company reimburses an employee for health insurance premiums? | Entrepreneur

What isn’t considered taxable income?

While most sources of income are considered taxable, there are a few cases where income isn’t taxed.

Partnership income

Typically, a partnership is not considered to be a taxable entity.

The distributive share of partnership income, such as the gains, losses, deductions or credits, is usually based on the partnership agreement.

You must report these on your tax return regardless of whether they have been distributed.

Even though a partnership typically doesn’t pay tax, it is still required to file an information return.

S corporation income

Typically, an S corporation does not have to pay any tax on its income.

Instead, the income, losses, deductions and credits are passed through to the shareholders based on each of their pro rata shares.

Again, even though an S corporation normally doesn’t pay tax, it is still required to file a return.

Related: Tax Basics For Business Owners | Entrepreneur

What is adjusted gross income?

The IRS defines your adjusted gross income (AGI) as your gross income minus any applicable adjustments.

Your adjusted gross income will never be higher than your total gross income and can be lower.

Your accountant will use your adjusted gross income as the starting point for calculating your taxes for the year and helping to determine your eligibility for any tax credits and deductions to help lower your overall tax bill.

Related: What Is Adjusted Gross Income? Everything You Need To Know. | Entrepreneur

What are tax brackets?

There are several different tax brackets that you can fall under at income tax time.

Federal income tax rates are broken down into seven sections called tax brackets.

As your income increases, so does the tax rate that you will pay.

To figure out what your marginal tax rate is or what your highest federal tax bracket is, you may need to know the following:

1. Private equity buyers want proof of franchise model quality, specifically strong unit-level economics and positive franchisee validation

This means to get top dollar, it’s not enough to have a strong franchise value proposition for franchisees. You must track system metrics and show positive trends over time. Collect franchisee profit and loss statements from the beginning. Standardized point-of-sales systems can help collect unit-level performance information that buyers will want to see. Franchisee satisfaction surveys should be implemented. If franchisee feedback isn’t strong, move quickly to address issues and communication gaps.

Related: Thinking of Selling Your Franchise to a Private Equity Firm? Here Are 9 Ways to Build a Valuable Reputation

2. There must be additional evidence of brand momentum through new unit openings, same-store sales growth, significant open whitespace and other growth opportunities yet available

The operating model must be replicable, and there must be proof.For example, can you demonstrate that you open 100% of the units you sell? Are franchisees ramping to profitability within 18 months or fewer? That is much more valuable and important than selling a bunch of multi-unit licenses that never open. Do franchisees experience a solid cash-on-cash return? Buyers especially get excited when they see existing franchisees returning to buy new expansion units.

Private equity sponsors want to see strong growth potential within their own planned hold period. But they also want a terrific growth story for the next sponsor as well to command a good exit price. Franchise businesses can trade between private equity (PE) sponsors multiple times. Technically, this is called a “secondary buyout” (whether it’s the second PE-to-PE transaction or the tenth). I prefer to think of it as the PE Profit Ladder. At each step, new sponsors need to see a compelling long-term growth story for the business to command premium enterprise value.

3. If No. 1 and No. 2 are missing or weak and if the evidence doesn’t match the hype, PE quickly moves on

While you may be selling franchise licenses, that in and of itself doesn’t make your business attractive. It validates that you’re good at selling franchises, not that PE will find your company attractive. You may have even received (or paid for) flattering press coverage. Are you starting to believe your own press? Buyers may be calling you with effusive, “We’d love to talk about your business,” messages. After basking in the warmth of some positive market attention and getting these phone calls, the transition to engaging seriously with a seasoned PE buyer who assesses your business with a swift, clinical eye can feel like suddenly walking into a freezer. Where did the love go?

Related: Is This the Right Time to Sell your Franchise to a Private Equity Firm?

4. This is where your franchisee-franchisor relationship karma will finally catch up to you

Your franchisees have tremendous power over your sale outcome. If that idea strikes fear into your heart, you know where your work begins. Call it “turnabout is fair play,” “revenge of the franchisees” or whatever you like.

If you’re a franchisor, your ability to sell your company to private equity at a high price with great terms depends on the quality of your relationship with your franchisees, strong return on investment for franchisees and the quality of operators you attract to your system.I’ve seen this collapse of the hype-machine dawn on sellers far too late. PE’s brutally cool, fact-based assessment and the importance PE attaches to franchisee satisfaction, profitability and positive references about their franchise experiences can be jarring to some sellers. If you’re used to acting independently as a founder, it can feel like turning in your high school math test and getting it back with a bunch of red pen mark-ups. Whatever attention you are, or are not, currently investing to ensure strong franchisee profitability, the market will one day hold you accountable.

The demand for creative talent is perhaps stronger than ever. The World Economic Forum recently cited creative thinking as the second most important employee skill in 2023.

Likewise, a survey of business leaders conducted by Pew Research Center identified creativity as among the most frequently mentioned skills employees need to be successful.

Given such realities, many of today’s workers face unique pressures to standout from their peers and establish a name for themselves as the “creative” in their organization.

But such pressures are not unique to lower-level employees. Being seen as creative is also becoming increasingly associated with effective leadership. One IBM survey, which focused on 1,500 CEOs across 60 countries and 33 different industries, found that “creativity is now the most important leadership quality for success in business, outweighing even integrity and global thinking.”

In many ways, this makes intuitive sense. As business has become increasingly global and dynamic, members at all levels of the organizational hierarchy are expected to develop cutting-edge approaches to improving processes, procedures and practices they encounter in their role.