Do you have all of your accounts in order? If you aren’t accounting for the difference between gross revenue versus net revenue, you could end up in the red!
If you aren’t sure how to account for the difference, be sure to read on. Without a knowledge of the difference, you could end up in hot water. Accounting errors don’t just have the potential to cause small issues. Businesses who don’t have their books in order have the potential for catastrophic consequences.
Fortunately, we’re here to help! We’ll show you how to determine just how much net revenue, your business will take home. Don’t spend another day risking the health of your business!
Gross Revenue vs. Net Revenue: What’s the Difference?
Basic knowledge of accounting is a must for anyone who wishes to enter the business world. It is crucial that any entrepreneur knows how to compute the necessary figures. What we are referring to is the math needed to help you recognize whether your business investment is profitable and sustainable in the long run.
Many business owners are confused about what net revenue is all about. Some of this is because the term is often used interchangeably with net income or the profit earned by the business. To remove any confusion, we’ll begin by defining the word revenue. Revenue is your total sales.
So what’s the difference between gross revenue and net revenue? Quite a bit.
Gross revenue is the total amount of sales your business has made for a specific accounting period. This total hasn’t been subjected to any deductions yet. Your gross profit can give you a clear picture of your business’ ability to sell goods and services. This figure, however, can’t accurately depict your business’ ability to generate profit.
The resulting amount from the deductions of sales discounts and sales returns (also known as the cost of goods sold) is what we call net revenue. Businesses offer discounts to attract more customers and to facilitate the easy disposal of extra inventory on hand.
On the downside, businesses can also face sales returns at times because the customer is disappointed with the goods or services they have received.
One reason may be that the customer found defects with the products they bought or they are not satisfied enough with the services you provided. In this case, they may ask for a refund or return. These factors identify the gap between your gross revenue and net revenue.
What is a Good Sale?
It should be every business’ aim to lower the cost of goods sold and receive a higher net revenue, but that doesn’t mean that you won’t have to give discounts on your products and services.
After all, a good sale is a proven and effective way to generate higher sales. You can, however, reduce sales returns by ensuring that your products are of high quality. This will also help to ensure the satisfaction of your customers. After all, you need customers to build a highly reputable business brand.
Before we go on to tackling gross and net revenue in details, let us first identify the importance of making an income/loss statement. What does sales revenue have to do with it all? Why do we need to compute for it and what’s the formula of computing it?
Your income/loss statement is one of the important financial reports you’ll have to prepare for your business, alongside balance sheet, cash flow statements and profitability ratios. Income/loss statements provide you with a clear picture of your business investment.
Is it profitable or are you on the losing end?
Is Your Business Worthy of Investment?
There is constant competition among businesses. Because of this, entrepreneurs and business owners must strategize. This can help ensure that your business thrives in the industry and stands out from your competitors.
It is an alarming reality that even huge businesses face bankruptcy because of factors such as having their total sales revenue lower than their total expenses.
If a business is pouring out more money than what it is getting back in return and resources are not utilized or managed correctly, the owner’s equity is much lower compared to the business loans. These are the loans that are often already invested in the business. So, how would you know if your business is still worthy of investment?
Start by asking yourself, “is my business earning profits or not?”. Profits are one factor that makes your business investment worth more. Unless you’re running a charity, you should always expect something in return.
As is the accounting rule in computing your net income/loss, you’ll be deducting all the costs that your business incurs. This also includes taxes that your company pays. Taxes are yet another barrier to achieving higher net income; however, it is mandatory that you pay taxes properly or the government will not let you operate legally.
The Simple Math
The general formula for computing net income is all revenues minus all expenses. While expenses are usually broken down into subcategories, it doesn’t matter as every type of expenses must be accounted for.
There are two subcategories that you’ll need to account for: the gross sales revenue and net sales revenue. Before you can subtract the total from the revenue, you should first identify which sales revenue you should subtract them from.
If your business earned net income after the business cycle, then it is profitable and worthy of investment. However, it’s the other way around, then maybe it’s high time to find another investment opportunity.
Everyone in the business world passes through an infant stage where growth is at a prolonged phase. This should be in your first three to five years in the industry. However, your business efforts and investment should start to materialize soon after. Thus continuous growth should then be quickly realized after that stage.
Another thing you need to consider in your business is that the level of your assets should be more than your business liabilities. These accounts are computed in your balance sheet statement. This can also provide you a clear picture of the monetary amount you have invested in the business.
Your owner’s equity should be more than the number of loans you have invested in your business. Yes, it may be inevitable to need loans from outside sources for use as capital in your business but be cautious!
You must bear in mind that it should not level off your capital invested in the business. Otherwise, you are not the owner of your company at all — it is owned by your creditors. Your business should also be liquid as much as possible which means almost every asset that your business owns can be turned into cash almost immediately.
Ideally, business-minded people would say, the best computation you’ll need to know is you ROIT. This means that your business is profitable, stable, liquid and worthy of investment and your return on investment is high.
In Practice: Examples to Get You Started
Gross revenue enables businesses to determine the physical quantity of goods they sold. If your business sells services, this can also account for services rendered.
In other words, gross revenue is the actual amount of money that the customers pay your business; however, the calculated value of gross revenue doesn’t give you the whole financial picture. You’ll need to compute your expenses in ordered to create an estimate of your net income.
To make sure that you are properly accounting for the cost of goods sold be sure always to consult the GAAP (Generally Accepted Accounting Principles).
Here’s an example of how you should compute for your gross revenue:
You are selling serving utensils at $3.50 for a pair. However, if a customer buys three pairs (or six serving utensils), you’ll be willing to sell them three pairs for $10. If the next customer buys two pairs of serving utensils, you’ll expect them to pay you $7.
Now, your gross revenue will be the number of items sold times price per pair, so basically you’ll have five pairs of serving utensils sold, multiplied by their sale price; which totals $17.50.
To compute for the net revenue, you have to subtract the discount you gave for three pairs from the amount of your gross revenue. Three pairs of serving utensils sold separately would generate $10.50. However, if you sell three pairs for $10 you are discounting $.50 to your customer as part of your marketing strategy.
Your gross revenue of $17.50 minus $.50 equals $17 which is now your net revenue. Your net revenue is where your total expenses should be subtracted from and not your gross revenue.
How To Maximize Your Net Profit?
There are two main things that you’ll have to consider in maximizing your net profit. These two items are (1) increase your sales revenue and (2) lower your total expenses.
Your net revenue, as disclosed earlier, has a lot of importance or value to your business. This means more than just the figure of your gross revenue. What matters most is how you would strategize to have higher pitches of sales because the higher your sales, the higher your gross and net revenue will be.
Increasing your sales revenue will greatly depend on your marketing strategies. This means that the better and more effective your marketing strategies are, the higher your sales will be.
You can have promotions and use other marketing strategies to help boost your sales but make sure that the cost related to your marketing is still regulated. After all, this will also add to your expenses. Remember, expenses are exactly what you and your small business are aiming to lower down.
Keep in mind that cutting costs and expenses strategically can greatly help you earn higher net income. That said, you must make sure that while you are reducing your costs and other operational expenses, you are not sacrificing the quality of your product or services.
One great way you could minimize your business expenses is to buy inventories in bulk. This strategy will help you save on the price of stock and expenses incurred. You will also further minimize transportation-related costs too, as you will not be going back and forth of your business as often as you would do if you buy in a retail environment.
What are Your Business Expenses Costing You?
If you see a relatively small difference between your net revenue and total expenses, you may want to take a look at your company’s budget. Increasing sales alongside cutting costs can help you increase your profitability ratios.
This, in turn, can help you grow your business over time. Excess expenditures can spell the difference between a second location and struggling to get by. A practice known as “cooking the books” is another business no-no.
If you’re intentionally forecasting much higher profits than expected, you could be on the hook for fraud. For publicly traded companies, this can even spell jail time for the people responsible. One of the most famous examples of this might be the Enron fiasco. By projecting false numbers, Enron executives were able to mislead many of their shareholders intentionally.
If you’re a small business, it’s unlikely that your business is concerned with this issue. You aren’t likely a major publicly traded company…yet. However, let it serve as a warning to you. Accounting issues can cause significant problems down the road for you and your business. Be sure to forecast your net profits properly, so your business can have a long and healthy future.
Ready to Learn More?
If you’d like to learn more about some of the tips and tricks you’ll need to know about your business; you’ve come to the right place. You’re looking to grow your business or determine the difference between net and gross revenue, and we’ve got your back.
We’re here to help you grow your business and ensure that your budget comes out on track. Visit our resources section to learn more. Until next time, do what you love and prosper!