From individuals’ perspective, income is defined as money earned through working or the returns of their investments. From businesses’ perspective, it is what remains of a company’s revenue after expenses.
How does it work?
If you are an individual, the money you bring home at the end of the day is your income.
It’s quite simple to calculate your “income,” whether it comes from salary, investment gains, or business profits. However, “income” is a lot more complicated for enterprises. Businesses refer to the money that enters their bank accounts as “revenue.” They classify “income” in several ways (described below) to reflect how it has already been put to use, such as paying bills or taxes.
Individual income is divided into two categories by the Internal Revenue Service (IRS). Your wage income constitutes your active income. The term “unearned income” refers to passive income, such as royalties, investment income, or, if you’ve suddenly struck it rich, gaming profits. In most developed countries individuals need to pay taxes on their income.
Revenue VS Income
If the words “revenue” and “income” are used together, it’s most likely in a commercial context. As a result, when you refer to “income,” it will mean something quite different than when you discuss individual income.
The term “revenue” in this context refers to the total sum of money received from a company’s sales. The money still available after expenses are covered is referred to as “income.” Let’s stick to the different types of income to help you understand the difference.
Types of individual’s income
There are three of them: earned income, portfolio income, and passive income:
1. As the term suggests, earned income is money that you have worked for. This is labor converted into money, whether from pay or business ownership.
2. Earnings from investing activities are referred to as portfolio income. Dividends, interest, and capital gains (profit from selling securities or investments that have appreciated in value) all fall under this heading.
3. The IRS defines “passive income” as earnings from firms you possess a share in or from rental properties in which you “do not materially participate.”
Disposable and discretionary income
Your disposable income is the amount of money that is left over after paying income taxes, Social Security and Medicare taxes (FICA), and any pre-tax deductions for things like retirement and health insurance. But before you go on a spending binge, you still need to make your payments on time. This category of funds is used to pay for basics like housing, food, and other things.
If anything is left, it is your discretionary income. Discretionary income is for the enjoyable “extras” in life. This involves eating out, traveling, enjoying yourself, engaging in hobbies, and possibly investing.
Gross profit and net income: the difference
After the cost of products sold, profits are referred to as gross profits. Profits before taxes, depreciation, and interest are referred to as operating profits. When a business refers to “income,” it usually means net earnings, which are profits after taxes. All of these are listed on an organization’s income statement.
That’s a crucial distinction to make as net income occasionally falls well short of gross profit. Take ownership of a used car dealership that sells $1 million worth of used vehicles annually as an example. Your wholesale cost for the automobiles is $600,000. This indicates that you made a $400k gross profit.
Let’s say you have a jewelry store that sells $1.3 million worth of jewelry in a year. The jewelry itself will set you back $800,000. This means you have a gross profit of $500,000.
But running a jewelry store costs a lot of money, from saloon rentals to advertising costs. Based on this, it costs the business $200,000 in operating expenses.
This is an operating profit of $300,000. But you have $20,000 in interest expenses and also $20,000 in depreciation (expenses on capital assets) that are needed, bringing the total profit to $260,000. If your tax rate is 50%, that gives you only $130,000 in income per year.