Gross vs Net Income for a Business: The P&L Waterfall
Every business P&L travels the same journey: from revenue at the top to net income at the bottom. Along the way it passes through gross profit, operating income, and pre-tax income - four different “income” concepts that matter for four different decisions. This guide walks every step with a $500k revenue example.
The P&L Waterfall: Revenue to Net Income
Revenue (Net Sales)
Total money received from customers
$500,000
100% of rev
Cost of Goods Sold (COGS)
Direct cost of delivering your product/service
-$200,000
40% of rev
Gross Profit
Also called gross income. Key margin: 60%
$300,000
60% of rev
Operating Expenses (SG&A, R&D)
Salaries not in COGS, rent, marketing, software
-$142,500
28.5% of rev
Operating Income (EBIT)
Earnings before interest and tax. Capital-structure neutral.
$157,500
31.5% of rev
Add back: D&A (for EBITDA)
Non-cash depreciation/amortization
+$7,500
EBITDA
Non-GAAP. Valuation benchmark.
$165,000
33% of rev
Interest Expense
Cost of business debt (if any)
-$8,000
1.6% of rev
Pre-Tax Income
Taxable business income (before entity-level adjustments)
$149,500
29.9% of rev
Income Tax
C-Corp: 21% federal flat rate; pass-through: owner's marginal rate
-$31,395
21% of rev
Net Income
The bottom line. Retained earnings or owner distribution.
$118,105
23.6% of rev
Example: $500k revenue consulting firm. *Restaurant COGS convention note: see the restaurant example for the prime cost convention.
Each Line Explained
Revenue (Net Sales)
Revenue is the total money received from customers, net of returns and allowances. For a cash-basis business, this is money collected. For an accrual-basis business, it is money earned regardless of whether it has been collected yet. For SaaS/subscription businesses, revenue is recognized per ASC 606 (ratably over the service period, not upfront). Gross revenue versus net revenue matters when returns are significant - a retailer might have $1.1M in gross sales but $1M in net revenue after a 10% return rate.
COGS (Cost of Goods Sold)
COGS is the direct cost of delivering your product or service. For a manufacturer: raw materials + direct labor + direct overhead. For a SaaS: hosting, customer success headcount, third-party API costs. For a service business: subcontractor fees, direct labor. For a pure consultancy with no subcontractors, COGS may be zero, producing a 100% gross margin. 'Cost of services' and 'cost of revenue' are synonymous labels in modern P&Ls.
Gross Profit (= Gross Income = Gross Margin when %)
Gross profit is revenue minus COGS. It is the first profitability indicator and measures how efficiently the core business delivers its product. Gross margin percentage = Gross Profit / Revenue. Industry benchmarks: SaaS 70-85%; consulting 50-75%; retail 25-40%; restaurant 30-40% (see note); manufacturing 20-40%. A declining gross margin while revenue grows is a red flag - it means cost of delivery is outpacing pricing.
Operating Expenses (OpEx / SG&A)
Operating expenses are all costs of running the business not included in COGS: salaries and wages not in COGS, rent and utilities, marketing and advertising, R&D (for tech companies), software subscriptions, insurance, professional fees, general and administrative costs. The line between COGS and OpEx matters for margin analysis: COGS scales with revenue; OpEx should not.
Operating Income (EBIT)
Operating income equals gross profit minus operating expenses. Also called EBIT (Earnings Before Interest and Tax) and 'Income from Operations' on many P&Ls. It measures operational performance independently of how the business is financed (debt vs equity) or where it is incorporated (tax differences). PE firms compare operating income across acquisition targets because it strips out capital structure.
EBITDA
EBITDA adds back depreciation and amortization to operating income. It approximates operating cash flow for capital-light businesses and is widely used in M&A valuation (EV/EBITDA multiples). For a SaaS with significant capitalized R&D, EBITDA can be 15-20% higher than operating income. Buffett's critique: 'Does management think the tooth fairy pays for capex?' For capex-heavy businesses (manufacturing, infrastructure), EBITDA meaningfully overstates sustainable earnings. For pure-software businesses with minimal capex, it is a reasonable proxy.
Net Income (Net Profit = The Bottom Line)
Net income is operating income minus interest expense minus income tax (plus or minus any non-operating items). For a C-Corp, income tax is calculated at the 21% flat federal rate (plus state corporate tax). For a pass-through entity (S-Corp, LLC, sole proprietor, partnership), there is no entity-level federal income tax - the owner pays personal income tax on their share of income. Net income feeds into retained earnings on the balance sheet. Note: net income is not cash flow. Receivables, inventory, and deferred revenue mean a profitable business can have negative operating cash flow.
How Entity Type Changes the Net Income You Keep
| Entity Type | Entity Tax Rate | Owner Pays |
|---|---|---|
| C-Corporation | 21% federal flat | Personal tax on dividends (qualified div rate: 0/15/20%) |
| S-Corporation | None | Personal income tax on distributed income; FICA on reasonable salary portion only |
| Single-member LLC | None (default disregard) | Schedule C: income tax + 15.3% SE tax on net earnings |
| Partnership / Multi-LLC | None | K-1 income taxed at personal rates; SE rules apply to general partners |
| Sole Proprietor | None | Schedule C: income tax + 15.3% SE tax on net earnings |
For a detailed comparison of LLC vs S-Corp net income after all taxes, see llcvsscorp.com. For C-Corp vs S-Corp at different income levels, see ccorpvsscorp.com.
Industry Margin Benchmarks
| Industry | Gross Margin | Operating Margin | Net Margin |
|---|---|---|---|
| SaaS (at scale) | 70-85% | 20-30% | 15-25% |
| Consulting / Services | 50-75% | 20-35% | 15-30% |
| Ecommerce / Retail | 25-45% | 5-15% | 2-8% |
| Restaurant | 30-40%* | 8-15% | 5-10% |
| Manufacturing | 20-40% | 8-15% | 5-12% |
| Healthcare | 35-60% | 8-15% | 3-10% |
| Construction | 15-25% | 5-10% | 3-8% |
| Software (pre-scale) | 60-80% | -20-5% | -25-5% |
| Finance / Insurance | 40-60% | 15-30% | 10-25% |
| Nonprofit | N/A | N/A | 0% (reinvested) |
Sources: CSIMarkets.com, Damodaran NYU Stern data. Ranges cover healthy operating businesses. Pre-scale startups and distressed companies fall outside these bands. *Restaurant gross margin per traditional accounting (labour in OpEx, not COGS); prime cost convention shown in business examples.
Calculate Your Business Net Income
Enter revenue and expenses. We return gross profit, operating income, EBITDA, pre-tax income, and net income with margin percentages.