Think managing cash flow is just for accountants? Think again! For small business and franchise owners, understanding cash flow is essential to business success. Two crucial metrics in this process are gross income and net income.
In this blog, we’ll explore how both types of income affect cash flow management and why accurate calculations are essential for sustaining your business’s health.
Understanding Cash Flow Management
Cash flow management is the method of tracking how much money is coming into and going out of your business. It involves knowing your revenue and expenses as well as ensuring you have enough liquidity to cover your operational needs and investments.
Doing this effectively can mean the difference between success and failure.
About Gross Income
Gross income, sometimes called gross profit, is the total revenue from sales subtracted from the cost of goods sold (COGS). It represents a company’s ability to generate income from its primary operations before deducting other expenses like taxes, operating costs and overhead fees.
On an income statement, gross income is typically listed near the top.
Pro Tip! Gross income is also a term that can be found on your income tax return. There, gross income generally refers to the total income from all sources, but excludes certain non-taxable items.
Calculate gross income, by using this formula:
Gross income = Revenue – Cost of Goods Sold (COGS)
COGS includes expenses directly connected to production:
- Costs of raw materials
- Shipping charges
- Direct labor costs
- Manufacturing overhead directly related to production
For example, if a company generates $100,000 in sales revenue and incurs $30,000 in costs associated with producing its goods, the gross income would be:
[ $100,000 – $30,000 = $70,000 ]
Understanding gross income is critical because it highlights the efficiency and profitability of your primary operations. Wrong calculations can affect pricing, inventory management, and production processes.
About Net Income
Net income, often called the bottom line since it is the last line of an income statement, is the amount of profit left after all expenses have been deducted from gross income.
These expenses include:
- Selling, general and administrative (SG&A) expenses
- Rent
- Insurance
- Marketing
- Administrative pay
- Depreciation
- Amortization
- Interest expenses
- Income tax
- COGS
In order to calculate net income, this formula is used:
Net Income = Gross Income − Total Expenses
For instance, if the same company from the previous example has a gross income of $70,000 and total expenses of $50,000, the net income would be:
[ $70,000 – $50,000 = $20,000 ]
This figure provides a complete picture of your business’s financial health and profitability after all things considered.
A Recap…
Understanding and accurately calculating both gross and net income is necessary for effective cash flow management.
- Gross Income:
- Definition: Revenue minus the cost of goods sold (COGS).
- Importance: Shows how well your main business activities are doing.
- Use: Helps when setting pricing and determining profits.
- Net Income:
- Definition: Gross income minus total business expenses.
- Importance: Reflects your overall profitability after all costs are covered.
- Use: Important for evaluating performance and making business decisions.
Ceterus As Your Financial Reporting Solution
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View daily sales and cash reports, income statements, profit and loss statements, and peer benchmarking, ensuring you always stay informed about the financial health of your business.
Discover how Ceterus can help you better understand your business’s finances and tax requirements. Schedule a call today.
