What is Business Gross Income and How is it Calculated?
What is Gross Income for a Business?
The term "gross" in a financial sense means an initial amount before any deductions, expenses, or withholdings. In accounting and financial terms, you always go from gross to net.
Gross Business Income is an amount calculated on a business tax return. Gross business income is calculated as the total business sales less cost of goods sold. The method of calculation of gross business income may vary, depending on the tax return form for each type of business.
Gross income appears on the income statement (profit and loss statement) of a business as a starting figure for income for that period of time. Then the gross income is reduced by returns/allowances and other deductions to get net income or net earnings.
The different terms used on business tax returns for income are confusing, so let's look at them more in detail.
What Gross Business Income is NOT
It's not Personal Gross Income. Gross income for an individual is the amount on that person's paycheck before any withholding or deductions. Personal gross income from employment is calculated for hourly workers by multiplying the hours worked by the hourly rate (including overtime); for salaried workers, it's calculated by dividing the annual income by the number of pay periods.
It's not Adjusted Gross Income. AGI is a calculation on a personal tax return. It is personal gross income minus allowable deductions on page 1 of your Form 1040.
It's not Modified Adjusted Gross Income for an individual. This figure is used to determine whether you can contribute to an IRA or qualify for certain other benefits, including education tax benefits and some income tax credits.
It's not Gross Revenue or Sales of Your Business. Gross revenue or gross sales is the amount of money the business brings in through sales. Gross revenue is the most comprehensive income, and it is the first item in the calculation of gross income. Gross revenue may be reduced by discounts and returns.
It's is not gross profit. Gross profit is gross revenue or sales minus the cost of producing that revenue. Gross profit includes a calculation for the cost of goods sold, for businesses that sell products. Gross income includes income from other sources than sales.
It's not net income, sometimes called profits or earnings. Net income is calculated by subtracting all deductions, tax credits, and cost of goods sold from the gross income number.
Gross Income in Business Financial Analysis
Gross income is usually the result of the operations of a business. The "operations" are the day-to-day activities of what the business sells. Since you want to see the profit from your business operations, you want to keep gross income free of non-operations income like investment income.
Your business gross income is used in several calculations to determine the profitability and viability of your business.
One key financial ratio is gross profit margin. Joshua Kennon, Investing for Beginners Expert, says that gross profit margin is the "percentage of revenue /sales remaining after subtracting cost of goods sold." The calculation is gross profit (gross income) divided by total sales. This calculation results in a percentage; the higher the percentage the better.
For example, if gross profit (income) is $400,000 and sales are $1,000,000, the margin is 40%.That means your business sold $1 million in products and its cost of sales was $600,000.
The debt-to-income ratio is another financial ratio used for both individuals and businesses. For individuals, it's used to determine the affordability of a home. The debt-to-income ratio for a business serves a similar function and is used when considering how much debt a business can support. This ratio is the amount of debt divided by the gross income of the borrower. The lower the debt-to-income ratio, the better.
For example, if a small business has $500,000 in income and $230,000 in debts, it has a debt-to-income ratio of 230/500 or .46. That means that almost half of the business's income is going to pay off its debt.
How Gross Income is Calculated for Business Income Taxes
A calculation of gross income appears on the tax forms for all business types. We'll use Schedule C for small businesses as an example.
In Part 1 of Schedule C:
- Gross receipts or sales of the business is entered first.
- Then, returns and allowances are deducted.
- Then, Cost of goods sold i(COGS) s entered. Cost of goods sold is calculated on a separate schedule and the total is entered here. COGS is only applicable for businesses that sell products.
- Gross receipts minus returns and allowances and cost of goods sold equals gross profit.
- Then, income from other sources is entered. This might be income from dividends, tax credits, or refunds.
- So, gross receipts, minus cost of goods sold equals gross profit. Then other income is added to get to what the IRS calls "total income."
Where does "Other Income" enter the calculation of gross income? It comes after cost of goods sold and the calculation of gross profit. Other income includes interest income and income from the recovery of bad debts.