Master Your Finances: Understand Your Total Income

If you take control over your finances by tracking your income you will be able to plan for your expenses, savings, investments and more. Understanding how much money you have coming it and how to calculate your net income is a vital step in the process to mastering your finances.

Net Income is distinct from gross income. Gross income is the total amount you earn in a year, or income before taxes and other necessary expenses are deducted from the total. Net Income is your income after tax and necessary expenses are deducted from the total.

If you are a freelancer, then chances are your taxes are not withheld from your income. It is also likely that as a freelancer your income varies from month to month by a significant amount, so this guide will help you get a near approximation of your gross income. 

By Jasmin Sethi

Step by Step Process:

    • Calculate your total gross income for the year, including all sources: salary, wages, bonuses, overtime, etc. 

    • If your income does not vary from month to month, then your gross income should be easy to calculate.

    • If there are still many months remaining in the year, and your income varies month to month, then figure out what the range of your monthly income is for this year or,

    • If possible, take the total income for the previous year and divide it by 12 and see if the average lines up with the range. The average of your total income from the previous year or the range of the past 12 months should be good indicators for the months not yet recorded for the current year, assuming no substantial changes in pay.

    • If your pay has increased or decreased recently then do your best to come up with a monthly range to predict the rest of the year. 

      • For example, if you have only received two months at a higher pay scale, then pick a value within the range between the maximum and minimum that seems most plausible as an average for the rest of the year. You may have some months that are higher or lower than normal, so do you best to determine what number would be most reasonable in your circumstances. A simple average with only two values may end up being too high or too low depending on how irregular the base values in the calculation you use are.

    • Once you have your gross income for the year you can calculate your net income. Your net income is your gross income with necessary expenses and taxes deducted from the total. If you do not know your tax bracket or how much you will owe, then for now just subtract 25% from your gross income as an estimate.

    • Sum up the total taxes paid throughout the year, including federal, state, and local taxes.

    • If you do not know your tax bracket or how much you will owe then we encourage you consulting an accountant or financial advisor. 

    • If you wish to make quick calculations and do not know the taxes you will owe, then for now just assume 25% of your income for your taxes. 

    • Total mandatory deductions such as health insurance premiums and other automatic deductions such as rent, utilities, and any other insurance premiums. 

    • Exclude your savings from this deduction, such as automatic 401(k) or IRA contributions.

  • Calculate your functional net income by subtracting taxes and necessary deductions from your gross income.

Click the button below to download the worksheet, designed to help you calculate your gross and net incomes.

Key Takeaways

If you follow the above steps then you will gain an understanding of how much money you actually have available to spend throughout the year. It is important not to be fooled by your gross income as it can trick you into believing you have more leeway than you actually do. Without understanding your net income you cannot begin planning properly for your monthly expenses.