What Is Net Revenue? Definition & Formula
Keeping an eye on your business finances is an important aspect of running your own business.
Whether it’s making sure that you’re sustainable in the long-term, or calculating how growth will affect your bottom line. It’s always smart to keep checking in with the financial health of your business.
Whenever you are looking at your financial statements, you want to make sure that the figures that you’re looking at are accurate. It's also important to make sure that they are a proper reflection of your business operations.
That’s where net revenue comes in. But what exactly is net revenue? We’ll take a closer look at the definition, and the formula you can use to figure out your own net revenue.
Here’s What We’ll Cover:
What Is Net Revenue?
Net revenue can be defined as a company’s sales revenue, minus discounts and returns.
Sometimes known as the ‘real top line’, net revenue reporting reflects total sales. But it shows the number that deducts your direct sales-related expenses.
What’s left after all of the expenses have been deducted is deemed as profit.
Expenses that would be deducted from your net revenue may include:
- Cost of Goods Sold (COGS)
- Cost of Sales
- Any other related expenses
These would all be accounted for in your income statement.
What Is the Formula for Net Revenue?
The formula business owners can use for calculating net revenue is very simple and straightforward:
Net Revenue = Gross Revenue-Directly Related Selling Expenses
Why Is Net Revenue Important?
Many businesses will use net revenue as their reporting base. This is to account for any returns and discounts early on in their income statement.
By doing this, they are making their actual revenue in the current period of time clear for potential investors or any financial auditors.
Net revenue is also important due to the fact that companies that pay commissions and fees must account for these costs. That's before overhead and profits are accounted for.
If this doesn’t happen, then they can misclassify commissions as indirect expenses instead.
What Is the Difference Between Gross Revenue and Net Revenue?
Businesses will tend to calculate their revenue and their net revenue. Both are important figures. But whilst revenue gives you an indication of how much money you are bringing in, net revenue is a more realistic view. This is because it shows how much money your business is actually making.
For example, let's say that you own a brick-and-mortar business selling furniture. To boost revenue, you decide to hold a 50% off sale and end up selling half of your inventory.
In your revenue statement, you would include the total amount of the pieces of furniture that were sold. This is because that is the selling price of the pieces. But using those figures for any financial calculations would mislead you. This is because it would lead you to think that the revenue is more than what you actually made.
So once you factor in the 50% discount, you’ll be able to get a far more accurate view of how much you actually made.
To put this into perspective numerically, let’s say that your annual turnover was $1,000,000. This was made from selling 2,000 wardrobes and beds at a price of $500 each. Of those 2,000 pieces of furniture, 200 of them were sold during a sale with a discount of 20%. Then 20 pieces in total were returned because of a manufacturing defect.
Now let’s assume that each piece of furniture costs $250 to manufacture. So the cost of goods sold, or COGS, is 250 x 2,000 which equals $500,000.
If you were to look at your revenue, you would see your profit as being $500,000. But in reality this is an overestimate of your actual profit numbers. You would have to factor in the returned 20 pieces plus the discounted 200 pieces. Then you would have to collectively minus the $50,000 of cash outflow that these deductions add up to.
So if we use these numbers, we can see that the net revenue gained was actually $450,000, compared to the original revenue of $500,000.
The Advantages of Using Net Revenue Over Gross Revenue
Investors tend to be more interested in a potential investment's gross revenue growth rather than their net revenue. This is because it shows your ability to conduct business and progress into a growth structure. It also shows the potential growth rate that can occur if they have the capital to expand.
However, net revenue is the number that truly matters when it comes to a businesses financial wellbeing. Studying net revenue can clearly show where in the business profits are high and where they are low. It can also show which parts are underperforming and potentially need to be cut, and which parts of the business should be grown.
Gross revenue can also be a misleading number for investors. It can be used to cheat people into investing into a company that is simply not worth the cost. This can be done by pointing out that the incoming revenue stream is high, but leaving out that the expenses are also very high.
This leads to narrow profit margins or even potentially negative net revenue.
Net revenue is one of the essential elements that you can use when considering the finances of your business.
It is not the only revenue metric that should be considered, but it is a useful one that accurately depicts the financial health of a company.
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