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Business Finance Management
June 29, 2022
Earlier this month, we went over the basics of net profit vs gross profit (also known as net income and gross income) and how to calculate each number. Today we’ll take a deeper dive into why monitoring both matters to startups, how they can benefit your startup, and why knowing the difference matters.
Net income and gross income both portray essential information about a company’s financial standing. Clear, concise, and definite numbers allow founders to create or alter budgets, monitor cash flow, and plan for future growth.
Knowing the difference between the two, the subcategories beneath them, and how to calculate these numbers can get confusing if you’re unfamiliar with financial terms.
Below, we’ll take an in-depth look at net income, gross income and how to use these metrics to make important business decisions for your startup.
Gross income and net income work together to give founders well-rounded insight into a company’s current financial standing. We find both numbers by using revenue as the starting point, but both formulas vary in how expenses factor in and are important in different ways.. You’ll learn to focus a lot of attention on these numbers as your startup grows.
Net income refers to a company’s total profitability. Net income, also known as net profit or the bottom line, is calculated by subtracting every expense from the company’s total revenue. Expenses subtracted from a company’s revenue to calculate net income are:
Gross income is the company's total profit from sales after deducting product costs or COGS (cost of goods sold). This is the most significant difference between the gross income and net income formulas.
Deductions from COGS can include:
Revenue is the total amount of money that comes in from the sales of goods and services prior to any subtraction of expenses.
Net Income = Revenue - all expenses
Gross Income = Revenue - COGS
Gross income and net income are both found on your monthly profit and loss statements. Net income will always be at the bottom, hence the reference ‘the bottom line.’
For more about these formulas, check out our article here.
Investors look at a startup’s profitability over total revenue to evaluate whether or not they’ll see a return on their investment. Startups that retain revenue consistently over a long period often spread the wealth to shareholders through dividends. Or, founders put money back into the business. The point of investing is to see a return. If an investor sees your company is pulling in good revenue with a low burn rate they’ll often invest more when the time comes.
Cash flow problems can happen overnight. If you’re not inspecting your financial data, your expenses could outweigh total revenue or gross profit. Financial reports need to be precise and accurately updated to prevent surprises. Nobody wants to get caught treading water in the middle of an expansion or slump.
Gross income displays a transparent picture of a company’s operational success compared to the amount of money coming in. Once your product is on the market, your operating costs may fluctuate. Within a few months, your financial team needs to look at revenue compared to COGS. Operational costs should not outweigh total revenue.
Company sales are tracked via gross income when final numbers come in at the end of the month, quarter, or year. Accurate final amounts help founders and financial experts create a stable budget, whether it needs to be adjusted to combat negative closing balances or allocate money back into the company for growth.
Surveilling annual gross income makes it easier to estimate if your company needs to fundraise for extra runway if the economic climate shifts.
Net income is better suited for overall budget decisions when there are close calls with income vs cost of production. While you can make future business decisions based on net income, it is essential to remember that net income can change due to bad sales. Track net income consistently and track any patterns you notice to understand your sales better.
As stated above, net income is the best way for founders and investors to ascertain a company’s total profitability — where your company is losing money compared to how much money is coming in. You can then implement strategies to cut costs, adjust production, lower burn rate, or push more into sales for the following month or financial quarter.
You should periodically check total sales, whether monthly or quarterly, to ensure your numbers are going where you want them to. Compare sales to COGS regularly and have a plan to combat high costs and low sales.
Gross revenue is the total sales before subtracting any costs or expenses. Looking at total sales compared to net income is an accurate measure of COGS cost for the financial period. You can set goals to either lower or maintain the cost of production to keep revenue higher than the cost of COGS. Consistent revenue and cash flow management are what investors want to see, both new and current.
Profit margin is the measurement of sales percentage turned into profit. For example, your profit margin is ten percent if your company makes ten cents for every dollar of a sale. When sales decrease, your profit margin lessens. The benefit of accurate and up-to-date net income statements is that you can switch focus to sales to offset any lowered profit margin from a prior month.
The value of a company, or profitability, is a huge factor in getting business loans. High profitability shows proper money management, market impact, and credibility. While personal loans often require a high credit score for the best rates, business loans mostly depend on how much value the company has based on net income annually.
That isn’t to say credit score isn’t essential for business loans. However, a high score doesn’t guarantee a loan if your company’s profitability is consistently low with a high overhead. Dips in the market can poorly affect sales despite low production costs, but if you want a new business loan, you need to have accurate and up-to-date net income reports to heighten your company’s profitability.
Financial reporting and bookkeeping accuracy are what businesses need to grow and remain profitable. Net income and gross income work to provide finance teams with the numbers required to keep budgets tight, sales high, and increase revenue.
Traditional bookkeeping services take at least a month to get books closed out. During that time, your sales could take a nosedive, causing cash flow problems next month, or your overhead could soar due to a new product priced too low.
Up-to-date financial data provides a quicker, more accurate snapshot of your financial standing daily, weekly, monthly, and year.
At Zeni, your profit and loss statements are updated as transactions and sales happen. Our state-of-the-art, Ai-powered dashboard makes navigating all subcategories on your P&L sheet easy.