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Some technical terms that you have to deal with throughout your life can be difficult to understand. Some of the more common terms that appear primarily in relation to taxes include gross income, adjusted gross income (AGI), and modified adjusted gross income (MAGI).

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Knowing the difference between gross income and adjusted gross income will help you better understand how your taxes and finances work. And, once you understand this, you’ll be in better shape to navigate it all.

What is adjusted gross income?

Your gross income, according to the Internal Revenue Service, consists of all of your income from all sources. Gross annual income includes obvious sources of income, such as your wages, bonuses, self-employment income, and passive income, which includes rental income, capital gains, interest, and dividends.

So what is AGI? Your AGI is your gross income minus any income adjustments you claim on your tax return.

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How to calculate AGI

You don’t need an adjusted gross income calculator to determine your AGI. It’s very simple – for example, if your gross income is $ 47,000 and you claim $ 2,000 in income adjustments, your AGI is $ 45,000.

You will not find your AGI on your W-2, but you can find it on line 37 of Form 1040. Learning how to calculate your adjusted gross income allows you to determine which tax bracket you are in and what your federal tax rate will be.

To verify: How to Avoid Paying Taxes Legally – and the 11 Craziest Ways You Did It

What is an income adjustment?

An income adjustment is a tax deduction that you can claim whether you are claiming the standard deduction or itemizing your deductions. Sometimes income adjustments are called “above-line deductions” because they reduce your gross income even if you don’t itemize.

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Expenses considered income adjustments include traditional IRA contributions, HSA contributions, interest on student loans, educator expenses, and any penalties you paid for early withdrawals from a CD. For example, if you made a deductible contribution of $ 1,500 to your traditional IRA and paid $ 500 in student loan interest, you would have $ 2,000 in income adjustments.

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What is modified adjusted gross income?

Different deductions and tax credits affect what the modified AGI means for everyone. For example, if you are calculating your MAGI to see if you are eligible to deduct your traditional IRA, you must first add back your IRA deduction, student loan interest, tuition fees, and several other adjustments to your income. However, if you are calculating your adjusted adjusted gross income to see if you qualify for the Lifetime Learning Credit, you do not have to add back the amounts you are claiming for IRA or interest deductions on them. student loans.

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Why are AGI and MAGI important?

The AGI and MAGI are important because many deductions and tax credits are only available if your AGI or MAGI falls below a certain number. Additionally, Social Security uses your adjusted gross income to help calculate how much of your Social Security benefits are taxable. Planning ahead can help you plan your expenses to get as much tax relief as possible and maximize your reimbursement.

This article is part of GOBankingRates’ “Economy Explained” series to help readers navigate the complexities of our financial system.

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Chris Jennings contributed to the writing of this article.

This article originally appeared on GOBankingRates.com: What is adjusted gross income and why does it matter?

• Gross income is the total income from the sales of goods and services during a given period.
• Net income is the profit that remains after deducting total expenses from gross income.
• Understanding the difference between the two is essential to understanding the financial health of your business.
• This article is for entrepreneurs who want to improve their accounting process and better understand the profitability of their business.

The net income of a business is its total profit over a period of time, while the gross income is simply the total of its sales over the same period. The difference between the net income and the gross income of a business is equal to the total of its expenses incurred during the period covered.

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Understanding the difference between net income and gross income is important because this is the only way small business owners understand how their business makes money, which affects budgeting and planning. Without distinguishing between net and gross, managers have no way of knowing whether their path to increased profitability involves increasing sales or reducing costs.

[Learn more about how accounting software can help you track your expenses and calculate your net income]

What is gross income?

Gross revenue is the amount a business realizes before it recognizes expenses, whether it’s the cost of goods sold directly attributable to a particular product or fixed expenses such as administrative staff salaries.

Essentially, a business’s gross income is equal to its total sales over a period of time.

Importance of gross income in the business

In managing their business finances, owners and managers need to periodically total their sales over different time periods, including weekly, monthly, quarterly, or annually. This allows managers to track the growth (or contraction) of their sales of various goods and services.

When business owners look at their income over different time periods, they should do so before deducting expenses. This is the only way they can track their sales over time, average sales size, and seasonality.

It is also important for managers to track employee sales quotas and productivity requirements to measure gross income. Gross income helps managers track a company’s sales volume, as opposed to profitability.

Example of gross income

Imagine a retail clothing store that sells $ 250,000 worth of clothing in a quarter. This $ 250,000, before expenses are deducted, is the store’s gross revenue for that quarter.

The gross income of a business is relatively simple. This is equal to the company’s total sales over a period of time. Gross income is extremely easy to report using any standard accounting software.

To remember : Gross revenue measures the total amount of revenue generated from sales during a given time period.

What is net income?

Net income is the amount of money a business earns over a period of time after accounting for all of its expenses incurred during that same period – it is profit as opposed to income. Without calculating net income, a business owner has no way of knowing if he has actually made or lost money over a period of time, no matter how much he has sold in property and in sales.

Importance of net income in the business

Net income is extremely important in measuring the profitability of a business; since it not only represents sales, but also costs incurred over the same period.

It is important for businesses to track net income in addition to gross income so that they can measure their profitability over time, as opposed to just their income (total sales). Determining net income also allows businesses to calculate their profit margin (net income as a percentage of gross income) – in other words, how much profit the business makes for every dollar of sales.

Most importantly, calculating net income helps managers and small business owners determine how to make their business more profitable and improve cash flow – by increasing sales or reducing expenses.

And – perhaps the MOST important – net income is an important metric for business owners to calculate and track because it is taxable.

Example of net income

Let’s continue with our example of the retail store with $ 250,000 in sales in a particular quarter. Now let’s say the items the store sold cost a total of $ 115,000 to buy (inventory cost). Let’s also say that the total cost of employee salaries during this period is $ 25,000, rent and utilities expenses were $ 15,000, and supplies and other miscellaneous expenses were $ 5. $ 000.

In this case, the store’s net income for that period would be $ 90,000 ($ 250,000 – $ 115,000 – $ 25,000 – $ 15,000 – $ 5,000). This is the amount of profit the store made in that quarter – the amount of money it made in that time period, minus all of its expenses.

This number is important at first glance because it tells store owners and managers how much money they made in the quarter, after spending. This is even more important when compared to net income from previous periods – the same quarter of the previous year, for example.

And net income is important because it allows store owners and managers to calculate their net profit margin. In this case, the store’s profit margin would equal $ 90,000 divided by $ 250,000, or 36%. This means that for every dollar in sales made by the store, it made a profit of 36 cents for the period.

To remember : Net income measures profitability, by deducting total expenses from gross income to show the profit made by a business during a given period.

When to use net income versus gross income

Measure profitability

Gross income is a good metric that business owners can use to measure their total sales and track over time. It’s also good for determining their market share, as well as the trends and seasonality of their sales if certain months, quarters, or days of the week are stronger than others, for example.

Gross income is also good for business owners to gauge the effectiveness of their sales staff and set quotas and goals. But that doesn’t tell managers or owners if they’ve actually made or lost money over a period of time.

Net income, on the other hand, is a much better number for tracking a company’s profitability, or how much money the business is making (or losing) over given time periods. Net income doesn’t tell owners or managers if their sales are increasing or decreasing, but it helps them identify ways to improve their business (for example, by increasing sales or reducing expenses).

Calculation of profit margin

Net income is also better for businesses to use in calculating their profit margin, which they can track over time to see if the business is getting more or less profitable for every dollar it sells.

Valuing a company

And, finally, net income is also better for valuing businesses, determining a business’s creditworthiness for obtaining a loan, and making investment or hiring decisions.