Gross vs. Net Income: How Are They Different?

Do you know the difference between “gross income” and “net income”? For starters, while they both have a similar baseline,  gross income refers to the “big” amount of money on your income statements while net income is the “small” one. 

Thinking about it this way makes it easy to understand, but if you’re serious about managing your money, there’s more to learn. In today’s article, we’ll be taking a deep dive into gross income and net income. Also, we’ll discuss the relationship between income and budget and how you can manage your expenses more effectively!

Understanding gross income

Gross income is the total amount of money you earn before any deductions or taxes are taken out. Gross income can be comprised of active income, passive income, or both. Active income is the money you receive in exchange for your work. This type of income is commonly earned in the form of wages, salaries, tips, and commissions. Passive income, on the other hand, is obtained with little or no effort and includes rental income, alimony, interest, and dividends. 

If you’re a full-time employee with no additional streams of income such as a side project or job, your gross income will be solely made up of your salary, and any additional tips or commissions. 

Here’s an example:

Tessa is a sales representative for a cosmetics brand, her salary is $40,000 per year, and she also gets a yearly bonus of $3000. As a result, her gross income is a combination of a fixed salary and a bonus, which equals to $43,000.

If you’re a freelancer or independent contractor, your gross income is calculated by combining all the work you have completed for your clients over the course of 12 months. It’s noted that the payments you receive from each project are different due to a project’s sizing and complexity.

And if you’re an hourly worker, your annual gross income would be your hourly rate multiplied by the number of hours you work every year. For example, if your hourly rate is $8, and you have completed 1500 work hours, your gross income would be $12,000. 

Passive income is generated without requiring a person to be physically present to make money. Instead of trading your time and labor for money, by making an initial investment,  you can make a living passively. Rental income, interest, and dividends are passive income sources that can bring in a steady profit.

Understanding net income

Net income is the remaining money after deductions and taxes have been subtracted. That is the money that you put into your pocket on payday. It’s the amount you’d get if you cashed your check, or if you use direct deposit, it’s the amount deposited in your bank account.

Not everyone’s obligation is to pay taxes, but if you’re earning a certain amount, you’ll have to file taxes. However, not all sources of income will be taxed. It’s important to know what is taxable and what is not. 

According to IRS, these income sources are counted as taxable income:

  • Wages, salaries, tips, and other taxable employee pay
  • Union strike benefits
  • Long-term disability benefits received prior to minimum retirement age
  • Net self-employment or freelance earnings under certain circumstances
  • Jury duty fees you earned
  • Security deposits and rental property income
  • Awards, prizes, gambling, lottery and contest winnings
  • Back pay from labor discrimination lawsuits
  • Unemployment benefits
  • Capital gains (there’s an exception for the selling of a property that’s your primary residence)
  • Severance pay from a previous job
  • Alimony from an ex-spouse
  • Interest or dividends from investments
  • Royalties and license payments
  • Canceled debts (but there are key exceptions for those declaring bankruptcy)

Types of income that are not taxed include:

  • Workers’ compensation benefits
  • Child support payments
  • Life insurance proceeds unless the policy was turned over to you for a price
  • Disability benefits (if you contributed to the premiums from your salary)
  • Social Security benefits (depending on your filing status and other income)
  • Capital gains on the sale of your primary home (up to certain thresholds)
  • Money received as a gift or other inherited assets (the exception here is, if you’ve earned money as a result of that gift, you owe taxes on those earnings)
  • Canceled debts intended as a gift to you
  • Scholarships or fellowship grants
  • Foster care payments
  • Federal income tax refund
  • Money rolled over from one retirement account to another via trustee-to-trustee transfer

How does your income affect your budget?

A budget is a spending plan that allocates personal income towards expenses, savings, and debt repayment. This tool allows you to stay in control of your spending and not get into debt. When it comes to budgeting, it’s important to know what number to use: gross income or net income. As net income is the actual amount you have, it should be used as a base to create a budget rather than gross income. 

Once you know how much you take home every month, start tracking how much you’re spending. Start with your fixed costs, such as your rent, and any regular monthly costs that are usually about the same amount, such as utility bills. Next, gather all the bills for variable expenses such as groceries, personal care expenses, entertainment, etc. Be careful with your variable expenses because it fluctuates month to month. Play it safe by making sure there’s always a limit for these expenses. 

It’s important to keep track of your bills in order to ensure you’re staying on budget, but  eventually, these piles of bills can take up a lot of space. It can also be frustrating and time consuming to extract data from each bill to add to your monthly spending report. But don’t worry, we have the perfect solution for you —an expense tracker app!  

Shoeboxed is an expense tracker app that stores all your bills on the cloud and allows you to easily compile them into a report. All you have to do is scan your bills, organize them the way you want, and you’re good to go. Shoeboxed will make your expenses tracking and management a breeze!

The bottom line 

Some people often confuse gross and net income, which can be detrimental when doing taxes and budgeting. Therefore, having a solid grasp of gross and net income is vital to ensure you meet your financial goals. 

5 Tips to Control Your Business’ Expenses

“You have to spend money to make money”, that’s undeniable. Before a business can gain profit, it must first invest in designing your office space, equipment, etc. Unless you’re a fully remote business otherwise, you also have to spend money to rent an office and hire employees. There are budgets for marketing and sales campaigns too. 

Expenses are a necessary part of any business. But if you don’t control your expenses, chances are you’re likely to run out of funds. Worst case scenario, your company is deep in debt. That’s why it’s always important to have some plans in place to control your expenses. 

Do you know what exactly business expenses are and how to control them? If you have to think about it for more than a minute, it seems like you don’t really have a good grasp on it. No worries. We’re here to give you insight into business expenses and tips to control expenses better. 

What are business expenses?

Business expenses are costs required to run a business. It could be anything from the money you pay to rent an office to the funds for your employees’ training courses. Knowing types of expenses allows you to classify your expenses into the right group and manage them better. 

Typically, these expenses are categorized into three groups: fixed, variable, and periodic expenses. Fixed expenses are costs that remain constant for a period of time, such as rental, employee salaries, or interest charges. Variable expenses, on the other hand, are costs that fluctuate over a period depending on the situation. Examples of variable expenses are raw material and direct labor costs. Periodic expenses incur less frequently than fixed or variable expenses. They’re payments for some special occasions such as education fees or travel expenses. 

5 tips to control your expenses better

1. Make plans and stick to the budget

Doing business is like a running marathon, not sprinting. Aim for long-term progress, and don’t expect sudden good luck to carry you through. You need to understand your company’s mission and vision, evaluate where your business is now and where you want to take it in the future. 

A thought-out road map is essential to forecast expenses and allows you to stay within budget. For example, if you want to expand your business to other countries in the next year, you’ll need a plan with clear goals and budgeted expenses. 

2. Manage fixed expenses

Fixed expenses are costs that remain constant throughout a particular period. The reason why these expenses stay unchanged is that they are not directly associated with manufacturing or the business’s performance. As a result, fixed expenses are considered to be indirect costs. 

To determine the fixed costs, think of the expenses you have to pay whether or not your company operates. For example, due to the outbreak of the Covid-19, many companies are being forced to shut down their operation temporarily. Though there are no operating activities, businesses still have to pay for fixed costs such as rent and interest charges. It’s important for business owners to understand the incurred expenses to manage and control them effectively. 

Fixed costs are more controllable than variable costs. As a result, managing those expenses is less stressful and you can be more flexible if anything happens. Because fixed costs such as rent are established by contract agreements, if the landlord wants to charge higher rents in the future, they will have to notify you in advance. You’ll be aware of this change quite some time before it happens, thus coming up with different plans to deal with it. 

3. Manage variable expenses

Variable expenses are costs that fluctuate from month to month. The payments you make in a given month could be different from your earlier bills or ones you’ll make in the future. Managing variable costs is no easy game for business owners. Therefore they have to understand the dynamics of these costs to stay competitive. 

Variable expenses are costs that are associated directly with business activities. These costs are also known as manufacturing costs. They include raw materials, inventory, and direct labor costs. 

Manufacturing costs rise either when the production goes up or costs of material rise. If manufacturing expenses and production volume go hand in hand and increase simultaneously, the business is more likely to witness a profit. On the other hand, if manufacturing expenses climb as a result of surged material costs, they are sure to hurt the business’s profitability. 

To control variable expenses better, make sure you have at least three to five vendors for a particular material. It’s a poor bet to rely only on one supplier. Imagine if your sole supplier goes out of business suddenly, and you have no other suppliers to turn to; that’s horrible. 

Also, once you have several suppliers, review them regularly. It’s standard practice to make an annual or semi-annual review of all your key vendors. It allows you to track which vendors are doing more business with you or who offer you the best price. 

4. Manage periodic expenses

As its name suggests, this type of expense doesn’t occur monthly or annually like fixed or variable expenses. You’ll be surprised to know that these expenses are not associated with operating activities or manufacturing activities. However, there are some occasions that you’ll need these expenses, so you have to be aware of this and make a budget for them.

Periodic expenses include education expenses, networking expenses, travel expenses, etc. Is it necessary for your marketing team to update their knowledge and technical skills? Absolutely! A collection of skillful marketers will develop and execute strategies more effectively, which maximizes profits for the company. It sounds like a good idea to invest in a training course for your team. Or do you want to expand your contacts to gain more opportunities for your business? Then you have to go to a conference or a seminar and network. It’s the company’s responsibility to pay for such expenses like this. 

5. Track expenses 

Tracking expenses allows you to control them better. When an expense occurs, bookkeepers keep the receipt and record it into the account book. By doing so, bookkeepers can calculate how much a business spends in a month and create a report on spending habits. 

A business generates hundreds of documents per month including receipts, invoices, proposals, etc. It’s a labor-intensive task to categorize and record those documents manually. 

Gone are the days when bookkeepers had to do everything manually. In this technological era, bookkeepers use software to manage their work more efficiently and cut away many tedious tasks. Shoeboxed is a cloud-based software that helps businesses turn their massive paper receipts into digital data. You can get your receipts scanned, stored, and organized by your mobile app. It’s simple to install and easy to use. Start using Shoeboxed today!

The bottom line

Expenses are a necessary part of any business. They can make or break your business’s profitability. That’s why expense control is so important to every business. For those who’re looking for tips to manage their expenses better, following the advice you read in this article will be just what you need.

10 Reasons Why Bookkeeping Is Important To All Businesses

The main purpose of bookkeeping is to track the financial activities of a business. Alongside the growth of the business, bookkeeping becomes more complex with why the introduction of tax, assets, loans, and investments. Bookkeeping allows businesses to keep an up-to-date record of their revenue and expenses, the amount owed by the business, investors, and customers, and so much more. 

Obvious, detailed, and thorough bookkeeping is crucial for businesses of all sizes. This article will give you a detailed answer to the question “Why is bookkeeping important to all businesses?”

10 reasons why bookkeeping is important to all businesses

1. Optimizes your budget 

Bookkeeping is vital to any business because it makes budgeting so much easier. Bookkeeping helps you organize your income and expenses properly,  and makes it simple to review your financial resources and costs. A clear budget in turn creates a clear financial plan for your business. Then you can plan for future expenses and the anticipated resources needed to cover those expenses. 

See more: 9 Basic Types Of Bookkeeping That Every Bookkeeper Should Know.

2. Simplifies tax planning

Every business has to file their taxes at the end of the tax year. And for many accountants, tax season means scouring their desks to find missing paperwork. If this sounds familiar to you, then you may need to consider setting up a bookkeeping system. With an efficient bookkeeping process, you will have your financial information ready for tax season and your accountants will no longer need to spend hours on the tax filing process. Bookkeeping is important for your personal tax return as well. For business owners, a large part of their income comes from their business. To know their total annual income, they need to know what their business earned first. Having detailed balance sheets over time helps you predict your annual profits more accurately. 

3. Supports decision-making

The best decisions are informed decisions, and to make an informed decision, you need to have access to all available information. Bookkeeping tracks and compiles all of the information needed to support your financial decisions. 

An inaccurate understanding of your financial status and key performance indicators can lead you to make some erroneous decisions that could jeopardize your business. For example, in the short term, if you don’t understand your cash inflows and outflows correctly, you may experience overdrafts, late fees, and difficulty in making your payroll timely. In the long-term, if you don’t know your sales profitability, you may miss many opportunities to invest in the more profitable lines of your business, which leads to lower earnings. The same thing can happen to non-profit organizations. If you don’t know the true cost of your programs, you may make bad decisions on which programs to invest more resources in. Business owners can prevent these types of situations by maintaining accurate books and records. This will simultaneously optimize business operations as well. 

4. Tracks profit and growth

Bookkeeping provides financial information about your company through financial statements. Financial statements, including balance sheets, income statements, and cash flow statements provide information for a set period. For example, you can see if your business is profitable or not from the income statement. Together, all these statements take a snapshot of your business, allowing you to see how well the business has performed. 

Bookkeeping also helps to track business growth. Over time, you will collect months and years of data. You can use this data to observe trends and better understand your business progress and compare results across periods. By keeping regular financial records, you can map out your business goals more accurately and achieve steady growth. 

5. Manages and improves cash flow

Bookkeeping allows business owners to take control of their business’ finances. It draws a clear picture of how you spend money. As a business owner, you need to ensure that your customers’ invoices are paid on time. You can track when your customers and vendors pay their invoices through the routine records of revenues, expenses, liabilities, and receivables. You can also notice if you are paying your bills on time to avoid penalties. 

So, how does bookkeeping improve your cash flow? Bookkeeping provides information regarding your outstanding invoices, such as customer or vendor names, amounts, issued dates, and due dates. Business owners can use this information to implement better cash flow policies, such as shortening payment deadlines or adjusting the time of payment for vendor invoices. By doing so, you can increase the average amount of cash you have on hand at any given time. 

6. Greater focus on strategy

Disorganized books can weigh heavily on a business owner’s mind. Your bookkeeping should not be keeping you up all night. When your books are completed and in order, you can rest easy knowing that your company’s financial information is review-ready. You will then find your mind at ease and more focused on other elements of the business, such as planning and strategy. 

Tactical and strategic planning are at the core of business operations. As you are always thinking of growing and developing your business, bookkeeping will bring you closer to your short and long-term goals. You can use the information provided by bookkeeping to track the results of your strategy and adjust your goals accordingly. 

7. Maintains organized records

As your company’s financial records are important to a number of stakeholders – investors, lenders, customers, employees, etc, providing the information requested by these parties is vital to your ongoing operation. In this case, being organized is a skill that every business owner should be able to find information at any time. If you cannot provide records to the IRS, your business can face penalties and fees. If you don’t provide records that investors and lenders requested, it could result in the stoppage of cash flow and so on. Being disorganized with your books can compromise or even terminate your relationships with these parties. 

Furthermore, the last-minute stress of finding a crucial piece of paperwork can lead to missed deadlines and other errors. Businesses of any size can’t afford to make mistakes, and regular bookkeeping can help with that. By keeping an eye on your bookkeeping frequently, instead of leaving it to the last second, you will be able to maintain organized records and save a lot of time finding the information you desperately need. 

8. Meets law requirements

The law requires businesses to keep their financial records separate from the owner’s personal expenses. Failing to do this can lead to the termination of your business. 

Accurate financial records are essential to filing your tax return properly, and can also minimize the chance of being audited and/or incurring tax penalties. Businesses with bad bookkeeping practices tend to file late and may lack the proper documentation to support their filings. This can land you in deep trouble with the IRS. If you are audited and cannot support your income and deductions, the result can cost your organization a lot. 

9. Data analysis 

Bookkeeping matters because it helps with business analysis. Bookkeeping is a management tool used to analyze business performance. 

One of the most useful products of bookkeeping is the financial statement. Business owners should generate the financial statement regularly to know which lines of business are working or not working. Financial statements allow business owners to focus on their business’s strengths and improve on its weaknesses. 

Bookkeeping reveals the previous financial performance of your business. In order to make future plans, you need a good understanding of your situation. Bookkeeping will give you a clear picture of what does work and what does not. 

10. Makes it easier to report to investors

Investors and shareholders want to know the financial performance of your business so that they can determine the value of their investment. Let financial statements do the work. The combination of the balance sheet, income statement, and cash flow statement presents the value of the business. 

As stated above, the main product of bookkeeping is financial statements. Bookkeeping provides investors with up-to-date and accessible information. Then, investors will be able to make better, well-informed decisions, which is the ultimate purpose of bookkeeping. Bookkeeping is not only vital for current investors but future investors, too. Potential investors are more likely to invest in your business when you have organized information. Speaking of which, if you were an investor, would you invest in a company that did not have accessible and organized financial records? 

Final thoughts 

So now you have the answer to the question “Why is bookkeeping important?” It saves your money, time, and energy and helps you manage your business’s finances better. You can streamline the process even further by implementing a paperless bookkeeping system using Shoeboxed. Shoeboxed helps you clear your desks and turn your data into actionable information. Let us scan and organize your receipts, extract key data, create expense reports, and manage them in standard categorizations. Business owners no longer have to worry about keeping so many receipts, documents, and other accounting paperwork. Just leave it to experts. Contact us today and get ready to see how bookkeeping benefits your business. 

If you have any other reasons why bookkeeping is important to businesses, let us know in the comments!