As a business owner, you are responsible for the livelihood of those employed. Thus, it is a must for you to know the difference between gross pay and net pay. Two terms are present in every paycheck, yet they are often mixed up. The lack of clarity confuses many employers, and as a result, they mix up the compensation they pay with the sum employees take home.

In this article, we will put the confusion to rest once and for all and explain the difference between net pay and gross pay and how to calculate them.

Gross Pay Explained

Gross pay is the agreed compensation, as per the contract, that the employee earns. No deductions apply to the sum, including benefits and taxes. The term defines an employee’s hourly wage or salary pre-cuts and includes wages like bonuses, reimbursements, overtime pay, and commissions.

Say you have an employee who earns $25/hour and works, as per the contract, 40 hours a week. Their gross pay would be $1000/week. However, that’s not the only way to calculate gross pay. The method remains the same, yet the pay period changes. Let’s dig deeper to better understand how to calculate gross pay.

How To Calculate Gross Pay?

There are two ways to calculate gross pay: one for hourly workers and the other for salaried employees. The former is the one described above.

For hourly workers, you need to multiply the hourly wage by the hours worked in a defined pay period and add compensations like overtime pay, bonuses, commissions, etc. The period could be weekly, biweekly, monthly, or as per the contract.

For salaried employees, you must divide the yearly salary into a defined number of pay periods. For those paid monthly, the count would be 12, 24 for 15-day, 52 for weekly, and 26 for biweekly. Remember, the gross salary includes all other compensation you owe the employee.

Net Pay Explained

Net pay is always less than gross pay. It is the post-deduction sum the employees take home, and for the same reason, it is also called take-home pay. Some deductions include income tax, payroll tax, health insurance premiums, unpaid leaves, retirement account contributions, garnishments, etc.

As an employer, it is essential to learn how to deduct these deductions correctly, as most are obligations on your end. Failure to take the required sum from salaried or hourly wage employees’ gross pay would imbalance your finances and require you to either contact the employee or pay the difference from business accounts.

Luckily, calculating net pay is not as tricky as people think. Once you know all about the deductions and the percentage required, the math comes down to simple subtraction.

How To Calculate Net Pay?

Knowing the difference between gross pay and net pay is a must to correctly calculate the latter, as you must begin with gross pay. In simple words, you must first calculate gross pay. Once done, name and subtract deductions from the total sum.

Following are some deductions and tax obligations you must deduct before wiring the pay forward:

– 401(k) or retirement contributions

– Health insurance premiums

– W-4 withholdings + federal, state, and local income taxes

– Wage attachments or garnishments (court-ordered)

– Unpaid leaves.

– Payroll (FICA) tax

A Way Forward

So, now you know the difference between gross and net pay, but the job is still incomplete. Remember, you need time and up-to-date knowledge of tax laws and other deductions to calculate net pay right, and for business owners, the former is the most-prized commodity and the latter is not common knowledge.

That’s why it is best to delegate payroll to experts who live to differentiate net pay from gross pay and ensure your employees get what they deserve and you deduct what you must. Remember, an error in either could lead to an imbalance in finances and employee dissatisfaction.

Fortunately, you can turn to Monily to resolve all such woes. The platform helps small and medium-sized business owners streamline payroll and shipshape their finances.

See Also: What Is Cash Disbursements Journal In Accounting?

Wrap Up

Knowing the difference between net pay and gross pay is not enough. The definition is easy, yet routine implementation is where it gets tricky. So, the best way forward is to know the difference yet delegate the work to finance experts who know tax laws by heart and can help your business stay afloat.

Wajiha Danish

Wajiha Danish is a Chartered Professional Accountant (CPA, CGA) and the Director at Monily Finance and Accounting LLC. With over 20 years of experience in accounting, financial reporting, audit, and finance operations, she has held senior roles across multinational, energy-sector finance teams, and public accounting. Wajiha is proficient in both US GAAP and IFRS, enabling her to support businesses with complex reporting and compliance requirements.