What is Net Revenue?
Net revenue is the sales of a company from which returns, discounts, and other items are subtracted from. In accounting, Net refers to adjustments made to the original and therefore, it can be calculated after adjusting gross revenue with the discounts, returned products or any other direct selling expenses.
Net Revenue Formula = Gross Revenue – Directly Related Selling Expenses
Why Calculate Net Revenue?
The question of why to calculate net revenue instead of revenue is the one we shall answer first. Revenue has all sorts of inclusions in it. Let us assume we own an electronics company that produces laptops, and during the Black Friday, we offer huge discounts on our laptops. Now, in our revenue, we include the total amount – because that is the selling price of the laptop. But using those numbers for financial calculations will mislead us into thinking that the revenue is more than what we got. So, we remove such discounts and also returned products.
Let us take the same example as above and put some numbers to it. Let us assume our annual turnover last year is 1,000,000 USD. That originated from selling 2,000 laptops at a price of 500 USD each. Now, of those 2000 laptops, 200 of them were sold during Black Friday at a discount of 20%. And then, 20 laptops in total were returned because of faulty parts. Since we have the part of the revenue, let us put some numbers on the cost too. Let us assume that each laptop costs us 250 USD to make. So, the Cost of Goods SoldCost Of Goods SoldThe cost of goods sold (COGS) is the cumulative total of direct costs incurred for the goods or services sold, including direct expenses like raw material, direct labour cost and other direct costs. However, it excludes all the indirect expenses incurred by the company. (COGS) is 250*2000, which is 500,000 USD.
If we use the above numbers for financial analysis, our profits will be 500,000 USD. Now, let us look into why this overstates the actual profit numbers. To be true, we haven’t got 1,000,000 USD in total. People returned 20 laptops, which is 10,000, and we have given a discount of 20% of 200 laptops – That comes out to 40,000 USD. SO, in total, we have 50,000 USD under discount schemes.
If we use these numbers, we can see that our profit numbers are different when we calculate net revenue and gross revenue.
Let us take an example of Warren Buffet. In an era where quantitative hedge funds make billions of calculations a second to invest, and companies build straight-lined optical fibers from Chicago to New York to get data faster and invest better, Buffet is one last triumph of traditional investing.
And he pays very close attention to “Profit Margins”. He is able to tear through the financial industry’s witchcraft by looking at Profit Margins. How does he calculate them? That is where we will use Net Revenue.
Keep an eye on ‘net income.’ Because of the way the financial world works, it is impossible to look at one number and take it as gospel for investing. Every investor looks at multiple numbers and makes a decision. When people started looking at gross profitGross ProfitGross Profit shows the earnings of the business entity from its core business activity i.e. the profit of the company that is arrived after deducting all the direct expenses like raw material cost, labor cost, etc. from the direct income generated from the sale of its goods and services., lots of companies started selling their products at a discount and boost sales numbers.
Now, everything is overstated. In such situations – Net Revenue is truer to the original numbers. A high number indicates that the company is doing well and vice versa.
Importance and Advantages of using Net Revenue Over Gross Revenue
Most of the time, the investors are more bothered with gross revenue than with net revenue – because it shows your ability to conduct business and progress into growth structure. If we are looking at a sale in a new location, it makes more sense to use gross revenue – because it shows us the potential growth rate at the new locations.
However, net revenue is the number that matters for all the financial aspects. To see where the profits are high and where they are low, to see which parts have to be cut and which parts have to be grown and to take a strategic decision on what to do for more profits – it is the one to look forward to.
Another more important factor is that it is used to calculate net profit – which is a far more important metric in investing. No other metric matches the ability to portray the success or failure of one’s business, like net profit and net revenue is used to calculate net profit. The net profit helps in business to get a loan, to call out for investors, to analyze if a company is better than competitors are not, and to see if our business is going right.
As we already spoke, gross revenue can be used in mysterious ways to cheat the people into investing in a company that is not worth the cost. A simple net revenue will solve all those troubles.
Net revenue alone cannot help a person in deciding where to put his money or what to do with his business and how to enhance his business. But it does provide an important metric to help in making a decision. In finance, no single metric can provide essential elements of investment.
There will never be a single metric that will help in entire decision making. Net revenue is a metric that, in augmentation with profits and other basic financial metrics, will help in investing in a company. It is not just the author of this article that thinks so, Warrant Buffet and his guru Benjamin Graham thinks so too.
This has been a guide to What is Net Revenue and its Definition. Here we discuss the formula to calculate Net Revenue along with examples, advantages, and disadvantages. You can learn more about accounting from the following articles –