What is Net Pay?

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Explanation

The companies usually refer to the gross pay when they talk about salary. This is the amount of salary that a company incurs for its employees. Apart from gross pay, companies also incur expenses concerning employee benefit plans such as retirement plans, pension plans, insurance plans, etc., which also form part of employee benefit expenses for the company.

However, the employee doesn’t have the entire amount of gross pay. Therefore, certain deductions are made from the gross pay, and the resultant amount paid to the employee is known as net pay. These deductions can be on account of tax withheld and employee contributions to various employee benefit plans such as retirement plans, pension plans, etc.

How to Calculate?

It can be calculated using the following formula:

Net Pay = Gross Pay – Deductions

Thus, to calculate, you need to reduce the value of deductions from the gross pay. The companies usually mention the amounts of deductions it makes from the salary and bifurcation of the amounts.

Examples of Net Pay

Let us understand the calculation with the help of examples.

In this example, the deductions have been made from the employee’s salary on account of state tax, federal tax, contribution to the retirement plan, and contribution to the insurance plan. The total deductions amount to $720. It is calculated by reducing the value of deductions from the gross pay amounting to $4,000. The resultant net pay comes out to be $3,280.

Importance

The concept of net pay is important from the viewpoint of employees. Although their gross pay may be higher, the net pay will always be lower. Thus, employees are much more concerned with the net amount since it is the amount they will get as their paychecks.

The amounts deducted on account of employee benefit plans such as retirement and pension plans are not immediately received by the employees. The same is received after the conditions are met by the employees attached to such plans. Therefore, it becomes important as it immediately reflects the amount employees receive as paychecks.

Net Pay vs. Gross Pay

Advantages

It offers the following two advantages for the employees and employers:

  • For the employer, it represents the amount the business must pay to its employees. Therefore, it helps the company plan its cash flowsCash FlowsCash Flow is the amount of cash or cash equivalent generated & consumed by a Company over a given period. It proves to be a prerequisite for analyzing the business’s strength, profitability, & scope for betterment. read more and arrange the required funds.For the employees, it represents the value of funds they get as paychecks. They receive this amount in their bank accounts and can plan their spending based on the net pay they receive.

This has been a guide to what net pay is and its definition. Here we discuss calculating it along with examples, importance, and advantages. You may learn more about financing from the following articles –

  • Salary vs WagesGross Salary vs Net SalarySalary PayableGross Wages