What Is Gross Income Minus Expenses?

The calculation of gross income minus expenses determines a business’s net income, which reveals its profitability. This formula is used for assessing the financial health of an enterprise and fulfilling tax obligations. The result of this subtraction shows whether a business is making money after its costs are accounted for and is a central figure on financial statements and tax returns.

Identifying Your Gross Income

A business’s gross income is the total revenue it generates from all sources before any expenses are taken out. For a company that sells products, this is often called gross profit and is calculated by taking total sales revenue and subtracting the cost of goods sold (COGS). COGS includes the direct costs of producing goods, such as raw materials and direct labor.

For service-based businesses, gross income is simply the total revenue received from providing those services. Other sources of income must also be included in the total business revenue. These can include interest earned from business bank accounts, income from rental properties owned by the business, or income from canceled debt. It is important to track all streams of revenue to ensure an accurate starting point.

Distinguishing between business and personal income is a fundamental step. Only income generated by the business should be included. For sole proprietors or single-member LLCs, where the legal distinction is less defined, this requires careful record-keeping. All income must be accounted for to establish an accurate gross income figure.

Identifying Deductible Business Expenses

Business expenses are the costs incurred in the course of running a business. For an expense to be deductible for tax purposes, the Internal Revenue Service (IRS) requires that it be both “ordinary” and “necessary.” An ordinary expense is one that is common in your industry, while a necessary expense is helpful and appropriate for your business.

Operating expenses are costs that are not directly tied to the production of goods or services but are necessary for the day-to-day functioning of the business. This category includes items like office rent, utilities, marketing and advertising costs, and salaries for administrative staff. Keeping detailed records of these expenditures is important for financial management and tax compliance.

Other common deductible expenses include the cost of office supplies, business-related travel, professional fees, and insurance premiums. For businesses with employees, payroll taxes and contributions to employee benefit programs are also deductible. Personal living expenses, political contributions, and capital expenses are not deductible in the year they are incurred.

Calculating Net Income

The process of calculating net income uses the formula: Gross Income – Total Deductible Expenses = Net Income. This final number, often referred to as the “bottom line,” represents the actual profit a business has made over a specific period. It is the most direct indicator of a company’s profitability.

To illustrate this, consider a freelance graphic designer operating as a sole proprietor. In a year, the designer generates $80,000 in revenue from client projects. This $80,000 is their gross income. Throughout the year, they incur various business expenses:

• $1,200 for design software subscriptions
• $600 for marketing materials
• $2,500 for subcontractor fees
• $500 for professional association dues
• $1,000 for home office expenses

The total of these deductible expenses is $5,800. The calculation would be $80,000 (Gross Income) – $5,800 (Total Expenses), which equals $74,200. This resulting figure is the designer’s net income for the year. This is the amount on which their income and self-employment taxes will be based.

The Role of Net Income in Business and Taxes

Net income is a primary measure of a business’s financial performance. It is the final profit figure shown on a company’s profit and loss (P&L) statement, providing a clear summary of how effectively a business is managing its revenues and expenses. Business owners and managers use this figure to make informed decisions about pricing, cost control, and growth strategies.

From a tax perspective, net income is the foundation for determining a business’s tax liability. For pass-through entities like sole proprietorships, partnerships, and S corporations, the net income is passed on to the owners’ personal tax returns to be taxed at their individual income tax rates. For a sole proprietor, this calculation is performed on IRS Form 1040, Schedule C, “Profit or Loss from Business.” The resulting net income is the amount subject to both income tax and self-employment taxes.