Net revenue is a metric frequently used to determine a company’s profitability. It helps analysts understand the amount of money the business has earned after deducting the costs associated with running the company. In this article, we will answer the question, what is net revenue, and provide insight into how it is calculated and why it is so important for businesses.
Highlights & Key Takeaways
- Net revenue is a helpful metric for any business to determine their profitability.
- Net revenue is a KPI (key business indicator) that reflects the revenue earned after taking into account any discounts, refunds, or returns.
- Business analysts must track net revenue over time to identify trends and make informed decisions about the company's future strategy.
- While net revenue has its limitations, such as not accounting for operating expenses, it remains a crucial tool for businesses to assess their financial health and make strategic decisions.
What Is Net Revenue?
Net revenue shows how much money a company makes after deducting all the costs that went into making that money. Think of it as the amount of money a business gets from selling its products or services, minus all the costs that go into making those products or providing those services in the first place. This includes things like the cost of materials, taxes, and shipping fees. Basically, it's a good way to see how much money a business is actually making, instead of just how much it's bringing in.
Net revenue helps businesses keep tabs on their success. It's like a report card that shows how much money a company brings in from its regular operations. Companies use net revenue to see if they are making money and how they are managing their expenses. So, it's a handy tool to help businesses figure out how well they are doing.
What Is the Formula for Net Revenue?
Calculating net revenue is a relatively straightforward process. Here is the formula.
Net Revenue = Total Revenue - Cost of Goods Sold (COGS) - Other Direct Expenses
As you can see, the formula involves subtracting the total cost of goods sold (COGS) and other expenses that are directly related to generating revenue from the total revenue earned during a specific period.
Let’s look at an example. Consider a landscaping company that earned $100,000 during the spring season, with most of its work consisting of cleanup from the winter, planting shrubs, flowers, and trees, aerating and fertilizing the lawn, and performing irrigation system maintenance. During this same period of time, the landscaper paid $30,000 for the cost of goods sold, such as purchasing plants, soil, and the other items needed to fulfill their hired landscaping projects. The company also took on other expenses, such as renting new equipment and paying for transportation.
Here is how you would calculate their net revenue:
Net Revenue = $100,000 - $30,000 - $10,000
Net Revenue = $60,000
The landscaping company's net revenue for the spring season is $60,000.
How Is Net Revenue Used?
As mentioned, net revenue shows the amount of money a business has earned after deducting the costs associated with its operations. Here are ten ways that businesses use net revenue as a KPI.
- Measure profitability - Net revenue is a key metric used to measure a business's profitability.
- Track financial performance - Businesses use net revenue to track changes in their financial performance over time.
- Determine gross profit margin - Gross profit margin is the percentage of revenue a company keeps after deducting COGS.
- Calculate net profit margin - Net profit margin is the percentage of revenue a company retains after accounting for all expenses, including COGS, operating expenses, interest, and taxes.
- Determine pricing strategies - Net revenue helps businesses decide how to price their products or services. So in the example of our landscaping company, they can evaluate the profitability of each of their services to ensure the highest net revenue while remaining competitive in their niche.
- Evaluate sales performance - Setting sales targets helps you measure how effective your sales team is (should you have a sales team for your business). The comparison of net revenue to your sales targets can help you evaluate sales performance and see if any tweaks need to be made.
- Identify trends and patterns - Analyzing net revenue over time can help businesses identify trends and patterns that inform decision-making. For example, an alarming net revenue trend for our landscaper would be a consistent decline in that metric over a period of time, indicating that there has been a change in demand or more competition has entered their niche.
- Set financial goals - Businesses can use net revenue to set financial goals and track their progress toward achieving them.
- Make strategic decisions - Net revenue informs strategic decisions related to investments, expansions, and other growth opportunities. So for example, an increase in net revenue could signal to our landscaper that they can expand into more geographies.
- Assess financial health - Lenders, investors, and other stakeholders use net revenue to assess a company's financial health and creditworthiness. So, a lender might look at the landscaper’s net revenue to determine if they are a good credit risk for the financed purchase of a trencher, aerator, stump grinder, or new tractor.
Why Is Net Revenue Important?
Net revenue is a vital KPI for businesses because it represents the amount of money a company has earned after deducting the costs associated with its operations. By evaluating net revenue, businesses can gain insight into their profitability and sustainability and make informed decisions regarding pricing, expenses, and investments.
Net revenue is also a KPI that can be used to measure the success of a company's sales and marketing strategies and its overall financial health. Monitoring net revenue helps companies identify areas for improvement and optimize their operations to achieve long-term success.
How To Calculate Net Revenue
Calculating net revenue is a crucial financial metric for any business. It represents the amount of money a business earns after accounting for all the expenses related to generating its revenue.
As shared earlier, net revenue is calculated as follows:
Net Revenue = Total Revenue - Cost of Goods Sold (COGS) - Other Direct Expenses
Net Revenue Example Calculation # 1
Here are two more examples of how net revenue is calculated based on various businesses.
Let’s start with an example of a copywriter who writes landing page content and blogs for financial services businesses. Let’s say this copywriter earns $200,000 per year writing content. And let’s assume their business expenses were $15,000 for home office expenses, a new laptop, software to check for grammar and accuracy, etc.
Here’s how we can calculate that copywriter’s net revenue.
Net Revenue = Gross Revenue - Expenses
Net Revenue = $200,000 - $15,000
Net Revenue = $185,000
In the above example, the copywriter’s net revenue for the year is $185,000.
Net Revenue Example Calculation # 2
Let’s look at one more example, this time for a fictional high-end tennis shoe company. In this case, the business had $1,000,000 in revenue from their shoe sales and the following in expenses:
- COGS: $400,000
- Marketing and Advertising Expenses: $100,000
- General and Administrative Expenses: $150,000
- Research and Development Expenses: $50,000
So in this case, we can calculate the net revenue as follows:
Net Revenue = Gross Revenue - Expenses
Net Revenue = $1,000,000 - $400,000 - ($100,000 + $150,000 + $50,000)
Net Revenue = $300,000
The net revenue for our fictional high-end tennis shoe manufacturer would be $300,000, which represents the amount of money they earned after accounting for all their business expenses.
Interpreting Net Revenue
Let’s revisit the net revenue calculation for the landscaper referenced earlier in this article. In our example, the landscaping company's net revenue was $100,000, representing the amount of money it earned after accounting for all its business expenses. This figure is important because it gives the company insight into its profitability and long-term sustainability.
- A high net revenue indicates that the landscaper is earning a lot of money and has financial resources to invest in the business and help it grow.
- Low net revenue could indicate that the landscaper struggles to cover its costs. As a result, they may need to adjust their pricing or reduce their expenses.
- Tracking net revenue trends over time can help businesses identify their strengths and weaknesses, make informed decisions about pricing and expenses, and track their progress over time.
- If net revenue is continuously rising, it suggests that the company is growing and expanding.
- Consistently decreasing net revenue can indicate that the company is losing customers or facing increased competition. As a result, they will likely need to make some changes.
Advantages and Disadvantages of Using Net Revenue
Net revenue helps businesses understand the money they make after taking away all their expenses. It's a useful way to understand a company’s financial performance and whether or not it's making a profit. But net revenue is not perfect, and there are some things companies need to watch out for.
Advantages of Using Net Revenue
Here are three advantages to using net revenue as one of a company’s KPIs.
- Provides a clear glimpse of a company's profitability - Net revenue shows how much money a business earns after all its expenses. This gives them a good understanding of their profitability, which is important for making informed decisions about investments, future pricing strategies, and expenses.
- Helps businesses identify areas of improvement - Businesses need to evolve to stay ahead of their competition. By tracking net revenue over time, they can identify trends in their sales and expenses and pinpoint areas where they can improve.
- Comparability across different businesses - Since net revenue is calculated similarly for all businesses, it puts businesses on a more even playing field for measurement. This makes benchmarking performance and identifying industry-wide trends easier.
Disadvantages of Using Net Revenue
There are disadvantages, however, to using net revenue as the primary KPI to evaluate a business.
- Doesn't account for variations in profit margins - Net revenue does not consider variations in profit margins across different products or services. So, two businesses with the same net revenue could have dissimilar profit margins and profitability.
- May not reflect the true financial health of a business - Net revenue can be influenced by one-time events, such as the sale of an asset, the settlement of a lawsuit, major restructuring, etc., which can misconstrue a business's financial health. And though it is widely considered unethical, businesses may artificially manipulate their expenses to inflate their net revenue figures.
- Ignores non-financial factors - Net revenue only considers a business's financial performance. It doesn’t consider things like customer satisfaction, brand reputation, and employee morale which can play a critical role in a company’s success or failure. As such, focusing only on net revenue can create a narrow view of a business's performance.
Once again, let’s revisit the example of our landscaping company. Let's say the landscaper had $300,000 in net revenue for the year. This sounds great, especially for a small seasonal operation. But, if this was achieved by underpricing their services and not factoring in the true cost of their operations, the company might actually be running at a loss.
Additionally, net revenue does not consider non-operating income and expenses, such as investment or interest expenses. This can also lead to an incomplete picture of a business's financial health. For these reasons, businesses need to look at additional financial metrics such as gross profit margin, operating profit margin, and return on investment (ROI).
Net Revenue vs. Gross Revenue
Net revenue and gross revenue are both used by businesses to measure their financial performance. While these metrics relate to a company's revenue, there are important differences that businesses should be aware of.
What Is Gross Revenue?
Gross revenue, also commonly referred to as gross sales or total revenue, is the amount of money a business brings in from sales in a given period. This metric is also a critical KPI and reflects all sales or services rendered by the business, regardless of any discounts, returns, or allowances. Gross revenue provides businesses with a quick snapshot of their revenue performance.
What’s the Difference between Net Revenue and Gross Revenue?
The primary difference between net revenue and gross revenue is that net revenue is the revenue a company earns after deducting expenses, while gross revenue is the total revenue a company earns before any deductions are made. In other words, gross revenue is the total revenue a business generates from its sales or services. In contrast, net revenue is the revenue that remains after all the costs of producing and selling the goods or services are deducted.
Let’s revisit our landscaping company. The gross revenue would be the total revenue earned from all landscaping services provided, without any deductions for expenses. So if the company earned $500,000 in revenue from landscaping services in a given year, that would be its gross revenue. You’d get at their net revenue by subtracting all the expenses incurred such as labor costs for additional workers, equipment costs for a backhoe, and material costs. So if the total expenses incurred by the landscaping company in that year were $300,000, the net revenue would be $200,000.
- Is the revenue earned after subtracting all expenses related to generating the revenue.
- Shows the amount of money the business has earned from its operations.
- Is considered a more accurate measure of a company's profitability.
- Is the total revenue earned by the business without any deductions for expenses.
- Does not account for COGS or other expenses.
- Provides a quick snapshot of the overall revenue generated by the business.
When to Use Net Revenue vs. Gross Revenue
When a business wants to have a more accurate measure of its profitability after considering all the expenses related to generating its revenue, it's best to use net revenue. This metric helps analyze company profitability to make informed decisions about pricing, cost management, and overall financial performance.
It is more beneficial to use gross revenue when a business wants a quick and dirty snapshot of its overall revenue generated without considering any expenses or COGS. For this reason, gross revenue is often used to provide an overall idea of the size of a business's operations and revenue stream.
- Use net revenue for the landscaping company when evaluating profitability, efficiency, and sustainability and to understand the actual amount of money made after deducting expenses related to generating revenue
- Use gross revenue to understand overall sales performance and market share and to evaluate the total amount of money earned from sales without considering expenses
Gross vs. Net Revenue Ratios
While there is no specific financial ratio called the gross revenue ratio or net revenue ratio, there are several other ratios that can be used to analyze a company's financial performance. Some examples include:
- Gross profit margin ratio - Measures the amount of gross profit a company earns relative to its net sales revenue.
- Net profit margin ratio - Measures how much net income or profit is generated as a percentage of revenue.
- Operating profit margin ratio - Measures how much profit a company makes on a dollar of sales after paying for variable costs of production, such as wages and raw materials, but before paying interest or tax.
Net Revenue vs. Net Income
Understanding the difference between net revenue and net income is integral for any business owner or investor who wants to make informed financial decisions. While the two terms sound similar, they represent very different concepts.
What Is Net Income?
Net income is a financial metric that represents the amount of profit a company has earned over a specific period of time, such as a quarter or a fiscal year. It is calculated by subtracting all expenses for the company, including taxes and interest payments, from its total revenue. Net income is often used by investors and analysts to evaluate its financial health.
What’s the Difference between Net Revenue and Net Income?
Net revenue is the total amount of revenue a business earns from its operations after deducting returns, discounts, and allowances, while net income is the amount of revenue that remains after deducting all of the business's expenses, including COGS, operating expenses, and taxes.
Simply stated, net revenue measures a company's sales, while net income measures its profitability. Net income considers all of the costs of doing business, while net revenue only looks at the top line. Most analysts agree that net income provides a more accurate picture of a company's financial health than net revenue alone.
Let's use the same example of the landscaping company we've been working with:
- Net revenue: $500,000 (total revenue - COGS)
- Business expenses: $150,000
- Net income: $350,000 (net revenue - business expenses)
So, net revenue represents the total revenue the company earned after justifying the direct costs of producing its services. The net income considers all of the company's expenses, both direct and indirect, to determine its overall profitability.
- The total revenue earned by a business minus COGS, while net income is the revenue remaining after all expenses, including taxes, have been deducted.
- In the case of the landscaping company, net revenue would be the amount earned from landscaping services after subtracting COGS (i.e. materials, labor, and equipment costs).
- The revenue remaining after all expenses have been deducted, including operating costs, taxes, and other expenses.
- Provides a more comprehensive picture of a company's overall financial performance.
When to Use Net Revenue vs. Net Income
Net revenue is often used by analysts and business leaders to measure their company’s top-line performance. It is also a useful way to determine the company's ability to cover operating expenses. Conversely, net income is better to measure the bottom line performance, such as the amount of profit or loss after accounting for all expenses, including taxes and interest.
Net revenue can help the landscaper understand their overall sales performance and whether they are making more or less money. It can also be used to compare revenue from different quarters or periods of time.
Net income, on the other hand, provides a more detailed picture of the profitability and financial health and accounts for all expenses, including those related to sales, general and administrative costs, and taxes to determine the amount of profit or loss generated.
Comparing Net Revenue to Gross Revenue and Net Income
This chart provides definitions and calculations to help you understand the difference between net revenue, gross revenue, and net income.
|Net Revenue||Gross Revenue||Net Income|
|Definition||Total amount of revenue a company earns after deducting returns, discounts, and other costs||Total amount of revenue a company earns without any deductions.||Profit of a company after all expenses and taxes have been deducted from its total revenue.|
|Formula||Net Revenue = Total Revenue - Discounts - Returns - Allowances||Gross Revenue = (number of goods sold) x (the price of goods sold)||Net Income = Revenues - Expenses|
|What It Indicates||Revenue after deductions, reflects company’s operational efficiency||Total revenue before any deductions or expenses.||Profit after all expenses and taxes.|
$100,000 (total revenue) - $10,000 (business expenses) = $90,000 (net revenue)
Therefore, the net revenue for the landscaper would be $90,000.
|If the landscaper earned $500,000 in revenue over the course of the year and had $100,000 in expenses, their gross revenue would be $500,000.|
Assuming the landscaper has $150,000 in expenses:
Net Income = Gross Revenue - Expenses
Net Income = $300,000 - $150,000
Net Income = $150,000
|Also Known As||Net sales or revenue after deductions||Gross sales or total revenue||Bottom line, earnings, or profit after tax|
Net Revenue vs. Profit?
Net revenue and profit are two important financial metrics that businesses use to assess their financial health. Although they sound similar, they have different meanings. Net revenue is the total amount of revenue a company earns after accounting for any discounts, returns, or allowances. Conversely, profit is the amount of money left over after all expenses have been paid.
Using our landscaping company example:
- Net revenue would be the total revenue earned from landscaping services after accounting for any discounts, returns, or allowances
- Returns - When a customer returns a product
- Discounts - Sales or incentives made to influence a purchase
- Allowances - A credit or refund given to a customer
- Profit would be the amount of money left over after subtracting all expenses, including materials, labor, and overhead costs, from the total revenue.
What’s the difference between net revenue and net sales?
Accountants and financiers often use the terms net revenue and net sales interchangeably. But, there are some nuances to the two terms.
- Net sales refer to the total sales a company generates, minus any discounts, returns, and allowances.
- Net revenue refers to the revenue a company earns after deducting all the expenses related to earning that revenue, such as COGS, operating expenses, and taxes.
In the case of our landscaping company, if they generate $100,000 in sales but had to give $5,000 in discounts and received $2,000 in returns, their net sales would be $93,000. If their COGS is $30,000, operating expenses are $20,000, and taxes are $5,000, then their net revenue would be $45,000.
Here it is represented numerically:
Net Revenue = (Gross Sales - Cost of Goods Sold) - Operating Expenses - Taxes
Net Revenue = ($100,000 - $30,000) - $20,000 - $5,000
Net Revenue = $45,000
Therefore, the difference between net revenue and net sales is that net revenue accounts for all the expenses associated with generating revenue, while net sales only account for the sales revenue itself.
How does net revenue impact financing for a business?
Net revenue can have a significant impact on a business's ability to secure financing such as a small business loan. Lenders and investors often use net revenue as a key metric to determine a company's financial health and creditworthiness. A high net revenue indicates a healthy and profitable business, which may increase a lender's confidence in extending credit or an investor's willingness to provide funding. Conversely, a low net revenue may make it more difficult for a business to obtain financing or may result in less favorable loan terms or equity agreements.
Net revenue is a key metric used by businesses to measure their profitability. It is the revenue generated from sales after deducting all returns, discounts, and allowances. Net revenue provides a clearer picture of a company's financial performance as it reflects the actual revenue earned by the company. While it has its advantages and disadvantages, net revenue should be used in conjunction with other financial metrics to get a complete understanding of a business's financial health.