You may not be familiar with the significance of net pay and gross pay terms if you don't have an accounting or payroll background. But make no mistake, understanding these definitions is crucial for employers and employees.
As a hiring entity, you want to know exactly how much an employee costs your company. On the other hand, workers care more about the amount of money they are receiving in-hand.
At the end of this article, you will be better equipped to negotiate salaries, regardless of if you are looking for a new job or a new employee.
Let's dive in and learn more about:
Gross pay, or base salary, is the amount of money an employee receives before withholding payroll deductions and other mandatory taxes or voluntary payments. It is not the amount of cash you are paying your employees.
Gross pay, or the Cost to Company (CTC), refers to the salary package you list when advertising a new position within your company. This package includes basic pay, state income tax, social security, health and retirement contributions, and other annual bonuses.
The highest figure on the pay stub is the gross pay. It is usually at the top of the payslip. The taxes and deductions are listed below, and their values are deducted from this figure.
Gross Pay (Hourly) = Employee's Hourly Rate x Hours Worked.
Gross pay (Salary) = Annual salary / Number of pay periods.
Net pay, or take-home pay, refers to an employee's earnings after subtracting all deductions from their gross salary.
Net pay = Gross Pay - Deductions
Net pay is the amount of cash you deposit into your employee's bank account, which they can spend however they choose.
The net pay figure is typically listed on the bottom of the payslip and can be significantly less than the gross wage.
Gross pay is what you promote to attract employees, but, in the end, they are more interested in the net pay.
You can use two formulas to calculate gross wages, depending on the employment contractual payment method: salaried or hourly paid.
Usually, companies pay their salaried employees monthly. However, some companies may split their payroll schedules into different periods. Here are the steps to calculate the gross pay for your employees.
a. Determine the pay periods of your company
The first step to calculating your employees' gross pay is to determine the payment frequency in your company.
Payroll Schedule | Pay Periods |
Weekly | 52 |
Bi-weekly | 26 |
Semi-monthly | 24 |
Monthly | 12 |
Learn how many pay periods are in a year.
b. Divide the annual salary by the number of pay periods
After determining the gross payment recurrence, you must divide the annual salary by the number of periods from your company's payroll schedule.
Here is an example to calculate gross pay for a salaried employee earning $ 48,000 per year:
c. Add additional earnings
Sometimes, when your employees work overtime or finish a project earlier, you want to reward their efforts by paying them additional money.
For example, you want to pay a $200 bonus to the employee above, and the pay schedule is set monthly.
Gross pay in a month = ($48,000 / 12) + $200 (bonus) = $4,200 in a specific month
Some companies have hourly employees, meaning the employer pays them for the number of hours they work (in general, during a week) according to your time tracker.
To calculate an hourly employee's gross pay, you should multiply the hourly pay rate agreed upon while hiring by the number of hours worked by your employee.
Hourly employee gross pay = hourly pay rate x number of tracked hours
Here is an example of an hourly employee's gross pay formula in one week.
a. Multiply the hourly rate by the number of worked hours
Let's say your employee worked 35 hours a week, and your rate is $15 per hour.
Hourly rate x hours worked = Gross pay
$15 per hour x 35 worked hours = $525 per week
Related: How to calculate hours worked?
b. Add additional income, such as bonuses or overtime
Typically, overtime is 1.5 times the employee's hourly rate.
In our example, let's calculate gross pay for an employee who worked one hour overtime, and you want to reward the excellent work by paying a $40 bonus.
Total hourly pay + overtime + bonus = Gross pay
$525 + ($15 per hour x 1.5) + $40 = $587.5 per week
Calculating the gross pay is the easy part of the equation.
Determining net pay is a little more complex as you must consider all mandatory and optional deductions.
Determine gross pay
We showed you how to calculate gross pay in the previous chapter.
Let's continue with the example from above and determine net pay for a salaried employee earning $48,000 per year, paid monthly.
a. Establish and subtract the optional deductions (pre-tax)
The next step is to withhold pre-tax deductions from your employee's wage.
These are voluntary deductions that lower the employee's gross income. They include premium payments such as health benefits, retirement contributions, and/ or life insurance.
For example, your worker contributes $200 to life insurance and $300 to retirement each month.
$4.000 (monthly gross pay) - $200 (life insurance) - $300 (retirement) = $3.500 (taxable income)
b. Determine and subtract mandatory payroll taxes
The types and percentages of mandatory payroll deductions can vary depending on the law of the country where your company operates.
Here are the most common deductions subtracted from the taxable income across countries:
The key distinctions between gross pay vs. net pay are the deductions: