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They are two words that often cause confusion. Both gross and net refer to income received, but there are significant differences between them.
While gross income is the total amount a company pays an employee, net income is the amount this individual actually sees in their bank account.
So, what is the difference between gross and net income, and how can they influence your salary negotiations, budgeting, and longer-term financial plans?
Here, we cover everything you need to know about gross vs. net pay.
Key Takeaways
- Gross pay is the total amount a business will pay its employees before taxes, benefits, and other payroll deductions.
- Net pay is the amount an employee receives in their bank account after all the various deductions have been made.
- Deductions can include government taxes, pension contributions, and student loan repayments.
- Gross and net pay, along with the various deductions, should be clearly listed on your monthly payslip.
- Budgeting, salary negotiations, and financial planning are three key reasons why it’s important to know the difference between gross and net.
What Is Gross Pay & How to Calculate It?
An important part of our gross pay vs. net pay analysis is understanding the definitions of each term. So, what is gross income?
This is what employees earn from their work before taxes, benefits, and other payroll deductions are taken into account.
It’s often the overall figure that a would-be employer would use when discussing the compensation packages for a potential employee.
How to Calculate Gross Pay
A worker can calculate their expected gross pay by multiplying the average amount earned in one hour by the number of hours worked each week. This will give them their weekly gross pay.
This figure can then be multiplied by the number of weeks they will be working. For example, if they are given four weeks of holiday each year, then their weekly pay will be multiplied by 48.
Obviously, this can also be done in reverse.
If they start with an annual figure of, say, $40,000 gross pay for the year, this can be divided by 12 to get the average monthly pay of $3,333.
The annual figure can also be divided by 48 to give a weekly amount of $833, if the employee is getting four weeks of annual leave.
How to Calculate Gross Income
It’s a similar calculation when it comes to businesses working out their gross income. This can be established by the following formula:
What Is Net Pay & How to Calculate It?
This is often referred to as ‘take-home pay’ as it is the actual figure that a person sees in their bank account after the monthly salary has been paid.
Net pay is the total amount employees actually receive in their bank accounts after deductions from their gross pay.
Net pay is the money that is actually available for them to spend, whether that’s on bills, such as food and the mortgage, or on hobbies and socializing.
How to Calculate Net Pay
It’s obviously important for an employee to know exactly how much they can expect to receive from the gross amount they have earned.
One option is to use a paycheck calculator to find out how much money you’ll be left with after the various taxes and benefits have been deducted.
There are plenty of free resources, such as this one from ADP, although it’s worth bearing in mind that a gross vs. net calculator is only meant to be used as a general guide.
What Affects Net Pay
A number of factors will influence net pay. Principally, these will include taxes and other contributions that are made.
The nature of these will obviously depend on where a person lives. While many deductions are similar across the world, they will vary in terms of their name and rate.
For example, in the UK, an employee may find that their net income figure results from deductions such as National Insurance and pension contributions. In the US, some common additional deductions that can affect net pay are Federal income tax withholdings, state income tax withholdings, social security, Medicare taxes, and payroll taxes.
Common Deductions From Gross Pay Include:
- Government income taxes
- National insurance deductions
- Student loan repayments
- Pension contributions
All of these will be detailed on their monthly pay slip so it’s important to check this on a regular basis to ensure no mistakes have been made.
Payslips: What Do They Show?
Businesses must give their employees a payslip that usually shows a number of important facts, for example:
- Pay before deductions (gross wages)
- Any deductions to pay, such as tax
- Pay after deductions taken
- The number of hours worked
- National Insurance number
- The employee’s tax code
- Total amounts of pay and deductions in the current year
How to Calculate Net Income
The annual net income figure is also important for businesses as it illustrates how profitable they are once all the various deductions are taken into account.
So, how is it calculated? This is the formula you can use when you’re looking at the net vs. gross income situation and working out your profit.
You can also work out the net profit margin, which is a percentage that shows how much profit a company makes relative to its revenue.
This is the formula:
This can show how well (or poorly) a company is performing. Starling Bank stated:
“This depends on what sort of business you are in, but 10% would be fairly normal. If the business owner is taking a low salary then you should be aiming for much higher than this figure.”
As an aside, there is a clear difference when it comes to net profit vs. gross profit.
Basically, gross profit is how much the company has made after some costs are taken out. Net profit, meanwhile, illustrates how much it has made with all the costs deducted.
Key Differences Between Gross vs. Net Pay
Here, we examine the major differences and similarities between gross and net pay.
| Gross Pay | Net Pay |
|---|---|
| In salary terms, it’s the total amount you receive before taxes, benefits, and other deductions have been made. | This is how much an employee will actually see in their bank accounts after taxes, benefits, and other deductions. |
| It’s often quoted as the headline figure when people are discussing what salary is on offer for a particular job. | It’s the realistic figure that’s needed for people to work out their personal budgets and negotiate salary increases with their bosses. |
| Details of the gross pay will be included on a worker’s monthly payslip. | The net income received by a worker will also appear on their monthly payslip. |
Why Understanding Both Is Important
It’s very important to know the differences between gross vs. net income, as this can have significant consequences for your finances.
The salary being paid is one of the most important factors in whether or not you accept a new job. If you base your decision on the gross figure, the net figure may not be enough.
Establishing the likely net income figure will also help you to evaluate possible salary increases and negotiate with your boss.
Understanding the net income figure will also enable you to make financial planning decisions, such as whether to take on debt or increase your monthly savings.
Gross Pay vs. Net Pay in Different Scenarios
There are many different groups for whom it is essential to know whether the rate they have agreed is in gross or net terms.
Full-time employees, for example, may be delighted with how much their boss is planning to pay them without realizing the net figure they end up with will be significantly lower.
Similarly, freelancers and contractors will need to be very clear on whether the rate offered is on gross or net terms.
Small business owners will also need to be wary of the distinction, albeit from a different perspective.
They will have to make it clear to prospective employees whether the salary they have promised them is on gross or net terms.
If they tell them it’s take-home pay when they actually mean gross, they could end up having to pay them more than expected.
The Bottom Line
There is plenty of confusion about gross vs. net pay, but it’s very important to know the differences; otherwise, you could be in financial trouble.
For example, if you base your budget on the gross figure, then you’ll be left with a significant shortfall every month. In some cases, you may not have enough to cover your bills.
Basically, gross pay is the figure you earn before taxes and other deductions, whereas net pay is what you’ll see in your bank account. Therefore, negotiate with your employer wisely.
