Genome Blog/articles/ Gross salary meaning: differentiating between gross pay and net pay
Jun. 28, 2024
Gross salary meaning: differentiating between gross pay and net pay
Managing a business is not only about producing products and making a profit. Mutual respect and trust between employers and their staff are crucial to the company’s success.
That’s why a business owner and their salaried employees need to understand the concepts of gross salary (gross pay) and what it consists of. In this article, you will learn more about gross pay and how it differs from net pay.
What is a gross salary?
Also known as gross pay, gross salary is the term that describes the individual’s total earnings (based on hourly rate, monthly salary, etc.) before any expenses are deducted from them. The deductibles are taxes, health insurance premiums, post-tax deductions, etc.
To better understand the concept of gross pay, let’s break it down into components:
Base salary. It is the core of gross pay — the money a salaried employee earns for their work within set pay periods (monthly, weekly, based on hourly rate, etc.).
Overtime pay. An employee receives money as compensation for additional working hours based on the hourly pay rate.
Bonuses. Any additional payments that employees earn for exceeding performance expectations or based on the profitability of their work.
Allowances. These are housing, medical, conveyance, and other special allowances used by a company to cover various expenses an employee can face when performing various business tasks.
For instance, Bob is a tech engineer working for a small business. His basic salary is €7,000 per month (or approx. €40.41 hourly wage). He also has a monthly conveyance allowance of €500 as he travels to different locations every week. Bob also received a performance bonus of €1,000 this month. Thus, his gross pay is €8,500.
What is a net salary?
Net salary (aka net pay) refers to the amount of money an employee actually receives after all the deductions are taken out of gross pay during set pay periods. In other words, their take-home pay.
Again, to better understand this term, let’s list the primary deductibles a job can have:
Taxes, mainly income tax and other taxable income, are set by local government authorities.
Health insurance premiums, as in health insurance programs, are mandatory or optional for certain workplaces. In some cases, this also refers to unemployment insurance funds and other employee benefits packages.
Social security contributions to fund social insurance programs.
Payments to public pension systems to ensure employees have funds for retirement.
Payroll taxes or other deductions imposed by local governments. For example, Germany has solidarity surcharge taxes, which are used to fund development in former East Germany.
Let’s use Bob’s gross pay of €8,500 as an example. In his case, the deductions are: income tax of €1,200, health insurance of €340, and pension insurance of €800. The deductibles amount to €2,340. After subtracting these, Bob’s net pay is €6160.
There’s not much to compare when it comes to gross pay vs net pay. Essentially, a gross salary is a vital component used to determine the exact sum the employee will get paid after all the necessary deductions.
Points of comparison
Gross pay
Net pay
Definition
All the funds an employee earns before the deductibles.
All the funds an employee receives to use after the deductibles.
Components
The sum of a base salary, overtime pay, bonuses, and allowances.
Gross pay minus the deductibles: income tax / other taxes, health insurance, pension funds, etc.
All the money deducted from the gross pay impacts the actual money a salaried employee receives into their bank account.
Importance of understanding the difference
Knowing the difference between gross pay vs net pay is crucial for salaried employees, especially for those who just started their career or are looking for a new job and don’t quite understand all the intricacies of salary and income calculations.
Having a better understanding of how the deductibles can influence their final paycheck allows employees to:
Better budget and plan their future expenses;
Manage expenses more accurately;
Determine if they need a savings bank account.
At the same time, businesses need to provide clear and extensive information to staff about gross pay and net pay. Being transparent about these is not only a good company practice, but it also establishes a good business reputation in the market.
In turn, it allows building trust between the employer and the staff, which leads to better relations and productivity.
How to calculate gross income and gross salary
Let’s calculate gross pay using the following example: Mary is a sales manager working for a software company.
We begin from the base salary: Mary gets €4,000 paid monthly (or approx. €23.08 hourly wage);
Next is hotel allowance: the sales manager has to travel almost every week, so her company issues €500 a month to cover hotel expenses;
Transportation allowance is also included: again, Mary has to spend funds to travel, thus getting €250 for these expenses;
Overtime pay: This month, Mary had to work extra hours, earning €1,230 based on additional hours worked;
At the end of the month, Mary also earned a bonus of €1,000 for attracting prospective clients.
To calculate gross pay, we need to add up all these numbers: €4,000 + €500 + €250 + €1,230 + €1,000 = €6,980.
Note: to calculate the gross annual salary, you must add up all the gross pay income you receive over the year.
Before we explain how the gross income is calculated, let’s point out the difference between the gross income and gross pay, as these are not interchangeable.
Gross income refers to all sources of income a person/business earns, including not just wages but other earnings, such as freelance, rental income, capital gains, etc.
To calculate gross income, you need to determine the proper amount of gross pay first. It was already done in our previous example, so let’s proceed with it.
Mary’s gross pay for the month is €6,980;
She also has a second apartment she rents out, earning her €2,300 monthly;
Additionally, Mary has a savings bank account, which brings her €400 every month.
Thus, Mary’s gross income is €6,980 + €2,300 + €400 = €9,680.
Note: As in the case of the gross annual salary, to calculate the gross annual income, you must add up all your earnings, including wages and other sources of earnings.
How to calculate net salary
Here’s what the calculation for the net salary can look like, let’s start with taxes and deductibles:
Mary’s income tax is at 20%. We need to multiply the percentage by the gross pay to get the concrete sum. 20 x 6,980 = €1,396 in income tax;
The taxes linked to social security are at 6,2%. 6.2% x 6,980 = €432.76;
The health insurance payment for the month is €200;
The monthly retirement contributions tax is at 5% x 6,980 = €349.
The total amount of all taxes deducted for the month is €2,377.76. Thus, gross pay (€6,980) – all deductibles (€2,377.76) = the net pay of €4,602.24.
Common misconceptions about gross and net salary
The most common misconception is that gross and net salaries can be used interchangeably, which, as we explained, is impossible.
Another mistake can occur when a person calculates gross/net pay and doesn’t have the right time frames for a pay period. For instance, if a person counts this month’s salary but uses deductions from last month.
Tips for employees
You can do a couple of things to better understand and track gross and net pay at your job.
1. Be thorough with your paychecks. Your earnings will be easier to analyze if you break the paychecks down to the main metrics: gross salary, allowances, any bonuses, or overtime pay.
Identify your deductions separately, as they will influence how much you will get paid in a given period of time.
2. Get help if necessary. Use online salary calculators to estimate net pay based on your gross salary and location-specific tax rates.
3. Consult the HR. You can always ask for additional clarifications from the HR department if you feel that your deductions aren’t right or you want to change your insurance/retirement plan, etc.
4. Use a reliable financial institution. If you’re getting paid, you want to make sure all your income comes on time, the transactions are recorded, and your money is safe. For all this and more – try Genome!
Open a personal or business wallet within our EMI to receive salary, store funds in different currencies (EUR, USD, and GBP), and issue multiple cards to make purchases and pay bills. The onboarding is completely online – check the benefits for yourself!
Understanding the distinction between gross pay and net pay is essential for employees navigating their financial responsibilities, particularly those new to the workforce or exploring career transitions. Use the formulas provided to keep your gross and net salaries in check.
FAQs
What is the difference between gross and net salary?
Gross salary is the total earnings before any deductions, while net salary is the amount an employee gets paid after deductions such as taxes and other forms of contributions.
How do deductions affect my net salary?
Deductions reduce your gross salary because taxes and other contributions are subtracted from your earnings.
Can gross salary vary from month to month?
Yes, it can because your overtime, bonuses, commissions, and deductibles are not set in stone and can change.
Why is my net salary lower than my gross salary?
Because your net salary is the result of different deductibles (taxes, contributions, etc.) being subtracted from your gross pay.
How can I increase my net salary?
You can increase your net salary in a couple of ways. The most obvious way is to negotiate a higher salary. The second way is to analyze your deductibles and figure out if any of those can be reduced. For instance, if you can change your insurance plan to pay less for it, etc.
