How to explain in simple terms what is revenue and what is income
The distinction between income and revenue can – at a basic level – be explained very easily, with the help of a simple equation:
Revenue is the largest value in this equation. However, the costs of generating the income must be deducted from the income received, and only this action will give us the result in the form of income. This is best illustrated by an example:
Example 1
Company X, a small, one-person online store, generated revenue of PLN 14,000 in February 2020, selling books, board games and comic books. At the same time, however, the owner had to incur costs of PLN 6,000 (purchase of goods), PLN 2,500 (costs of renting warehouse space) and PLN 1,500 (shipping and packing of orders, transportation, accounting services and other fixed costs). This means that his income in February will be only PLN 4,000 – the owner of company X will still have to pay tax on this amount.
What is revenue?
The definition of revenue is relatively short: it’s anything that comes into a company or person’s account in connection with a business, property ownership, employment relationship or transaction.
In the case of a salaried job, the employee’s income will usually be a paycheck. The resulting income from owning real estate can be rental income in the event that the owner of the property has decided to rent it out. Revenue is also generated by transactions – for example, the sale of a used car.
Companies, on the other hand, must include in income receivables from the sale of goods and services resulting from previously issued invoices, VAT (which can later be deducted or refunded), compensation received, donations, as well as receivables resulting from the disposal of fixed assets, rights and other intangible assets.
What is income?
The simplest definition of income might go like this: income is the difference between revenue and the cost of generating it, i.e. the profit of a person or business. An important piece of information that should not be forgotten, especially if you run your own business, is that the amount of tax due and the obligation to pay it is based on the income earned, not the income.
This means that even if we have not yet received the amount due for the invoice issued, we must pay the resulting tax. Here’s an example.
Example 2
The aforementioned company X a month later, on March 25, 2020, won a contractor who placed a large order with the store, amounting to PLN 3,000. The ordering party did this on behalf of company Y, so he received an invoice from the online store with a payment term of fourteen days. In this situation, the owner of company X will count the aforementioned PLN 3,000 as income earned in March, and will also have to pay tax on it, even though he will probably receive the money for the completed order only in the second week of April.
Running a business can also lead to a situation where no income is generated in a whole month – but this does not mean that the business is not doing well. It might as well be a signal that the company is investing in growth. In short: income does not occur when revenue is less than the costs generated by the company.
Example 3
Mr. Maciej, the owner of company X, founded it several years ago. While he didn’t sell much merchandise in the first few months , he invested in computer equipment and equipment for the warehouse where he would store the purchased goods. In May 2017 – the first month of the company’s operation – it earned only PLN 2,000 and generated as much as PLN 9,000 in expenses. As a result, he did not pay a single zloty of income tax, since he did not earn any income de facto. Importantly, in June and July, Mr. Maciej received income of PLN 2,500 and PLN 4,500, respectively, which means that he did not have to pay income tax for those months either.
Deductible costs
As part of their business, business owners often incur expenses that help them grow their business. The costs incurred reduce their income and the resulting taxes.
However, contrary to popular belief, entrepreneurs cannot simply account for every one of their expenses in this way. In order for the expenses incurred to qualify as tax deductible, they must meet several conditions.
Deductible expenses are:
- incurred to increase the company’s revenues or to secure them;
- related to the operation of the business (must not have the characteristics of expenses of a personal nature);
- properly documented;
- not included in the list of expenses not recognized as tax-deductible (Article 23(1) of the PIT Law).
The aforementioned law contains a detailed catalog of expenses that cannot be considered a deductible expense. One of them is cost.
The cost of representation can be, for example, a gift for a business partner – so its purchase will not affect the income received (although we will be able to deduct the cost of VAT from it). However, in a situation where the gift is a company gadget bearing the logo of the company or a brand belonging to it, then we will include this type of expense in the category of advertising expenses, which we can treat as tax-deductible without obstacles.
Net income vs. gross income
While this might seem to be the end of the calculation, it is still necessary to separate net income from gross income. This demarcation is important for both entrepreneurs and full-time employees.
A business person earns income by subtracting deductible expenses from income. This is her gross income. Only after paying income tax (18- or 32-percent when settling under the general rules) can we talk about net income, i.e. actual earnings.
A full-time employee, on the other hand, should pay particular attention to job listings stating the gross salary. This amount usually does not tell applicants much, as the most important thing for them is the net amount, i.e. earnings “on hand”. However, it is worth being aware of another figure – this is the cost of the employer, who pays even more for each employee per month than the gross amount of his salary.
