Contents
- What is Gross Income?
- Calculation of Gross Income
- Gross Income vs Net Income
- Why Gross Income is Important
What is Gross Income?
Gross income is the total amount of money an entity earns before any deductions or taxes are taken out. It includes all sources of income. For instance:
- Revenue from Sales of Goods and Services: This is the primary source of income for most entities, representing the income earned from the sale of products or services before any costs or expenses related to those sales are deducted.
- Interest Income: This includes income earned from interest on investments, savings accounts, and other financial instruments where the entity has invested its money.
- Dividend Income: Income received from dividends on shares of stock held in other entities.
- Rental Income: For entities that own property and lease it out, the income received from tenants would be included in gross income.
- Other Operating Revenues: This can include income from royalties, fees, and other revenue sources directly related to the entity primary operations.
Its important to note that while these are common components of gross income, the specific inclusions can vary depending on the nature of the entity
Essentially, Gross income is the full sum of revenue before any expenses are subtracted. Gross income is important because its used as a starting point for calculating taxable income and can also determine eligibility for financial services such as loans and credit cards.
According to AASB 101 Presentation of Financial Statements, the financial performance of a entity, including revenue and expenses, is presented in the income statement, indirectly contributing to the calculation of gross income.
Calculation of Gross Income
The formula for determining gross income involves subtracting the Cost of Goods Sold (COGS) from the entity gross revenue. Gross revenue represents the total sales generated by the entity before any deductions, while COGS includes the direct costs associated with producing or purchasing the goods sold.
The formula is as follows:
Gross Income = Gross Revenue – COGS
Example:
If an entity generates $300,000 in total sales during a specific period and incurs $150,000 as the cost of producing the goods sold, the gross income is calculated as follows:
Gross Revenue – COGS = Gross Income
$300,000 – $150,000 = $150,000
Therefore, the entitys gross income for that period amounts to $150,000. This figure provides valuable insights into the entity’s profitability and operational performance, serving as a basis for informed decision making and strategic planning.
As per AASB 102 Inventories, the standard outlines how to determine cost and its subsequent recognition as an expense, which includes writing down inventories to net realisable value. The standard specifies that inventories should be measured at the lower of cost and net realisable value, directly influencing the calculation of the cost of goods sold (COGS) and, consequently, the gross profit.
Gross Income vs Net Income
Understanding the disparity between gross and net income holds significant importance for both personal finance management and running a successful entity, especially if it is a small entity.
It empowers individuals and entities to make informed decisions regarding their finances, including income choices, expense management, and strategic planning.
Perspective and Decision Making
Gross income represents the total revenue generated before any deductions or expenses. For entities, it offers insights into sales effectiveness, revenue trends, and seasonal variations. However, it doesnt reflect the actual profitability of the entity.
On the other hand, net income provides a clearer picture by factoring in expenses. It reveals how much money the entity is truly earning or losing over a specific period. While it may not indicate sales performance, a lower than expected net income prompts actions such as expense reduction and cost saving measures.
Entity Insights and Actionable Steps
For entities, tracking gross income helps in understanding revenue patterns and assessing overall sales performance. Meanwhile, focusing on net income enables entities to gauge profitability accurately and take necessary steps to improve financial health, such as optimising expenses and adjusting pricing strategies.
Personal Financial Management
On a personal level, knowing the difference between gross and net income aids in budgeting and financial planning. While gross income provides a baseline for earnings, net income reflects the actual disposable income available after taxes and deductions. This understanding facilitates informed decisions regarding spending, savings, and investment allocations.
Why Gross Income is Important
Gross income holds significant importance across various financial aspects, particularly in tax assessments, credit evaluations, and financial strategising.
Revenue Generation and Cost Management
Gross income helps in assessing the effectiveness of the entitys revenue generation and cost management. By examining gross income alongside the Cost of Goods Sold (COGS), an entity can gain insights into its operational efficiency and profitability.
In accordance with AASB 15 Revenue from Contracts with Customers, revenue is recognised when a entity transfers control of goods or services to a customer at an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services.
AASB 15 provides a five step model to apply in determining when to recognise revenue, and at what amount, thereby impacting the calculation of gross profit.
If there are consistent fluctuations or declines in gross income, investigating the relationship between gross revenue and COGS can reveal potential areas of concern. For example, a significant decrease in gross revenue or a notable increase in COGS could indicate operational inefficiencies or shifts in market dynamics that require attention.
Tax Assessment
In tax calculations, gross income acts as a fundamental measure. It marks the starting point for determining an entity tax obligations, indicating the tax bracket it falls into. This figure plays a critical role in computing deductions and credits, which can lessen the overall tax burden.
A higher gross income usually correlates with higher tax liabilities, especially considering different tax treatments for various income types like capital gains.
Credit and Loans
Lenders closely examine an entity’s gross income when assessing creditworthiness for loans. It serves as a key indicator of repayment capability. A higher gross income often results in more favourable loan terms such as lower interest rates and extended repayment periods.
Conversely, a lower gross income might lead to shorter loan terms with higher monthly payments. Additionally, lenders consider the debt to income (DTI) ratio, derived from the gross income, to gauge financial health and ability to manage debt.
Financial Planning
Gross income plays a crucial role in effective financial planning. It provides the foundation for precise budgeting and financial decision making. Understanding gross income enables entities to assess their earning potential accurately, facilitating the analysis of financial status, setting savings targets, managing debts, and preparing for future financial commitments.
Knowledge of gross income is essential for making informed decisions regarding job opportunities, salary negotiations, and pursuing additional income streams or higher paying roles.
This article is general information only and does not provide advice to address your personal circumstances. To make an informed decision you should contact an appropriately qualified professional.