What is Net Revenue?
Net revenue is a company’s sales from which returns, discounts, and other items are subtracted. In accounting, Net refers to adjustments made to the original. Therefore, it can be calculated after adjusting gross revenue with the discounts, returned products, or other direct selling expenses.
Net revenue helps firms recognize their profit structure and also check how much money it is making after utilizing resources and making other operational expenditure. However, considering this revenue figure alone may not provide the accurate status of a business’s progress. Hence, other metrics must also be studied for a reliable assessment.
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Net Revenue Explained
Net revenue sales account for the sales revenue generated through daily operations. This is the amount that is obtained when expenses are deducted from the gross income. These expenses include marketing costs, office supplies, taxes, total cost of goods sold (COGS), employee wages and salaries, legal and administrative costs, rent and utilities, etc.
Though net revenue tries figuring out the actual revenue that the firm is left with after applicable deductions, it cannot be the sole metric for firms to depend on to assess its status and performance in the market.
In finance, no single metric can provide essential elements of investment. Net revenue alone cannot help a person decide where to put his money, 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. 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 think so too.
The question of why to calculate net revenue instead of revenue is the one we shall answer first. RevenueRevenueRevenue is the amount of money that a business can earn in its normal course of business by selling its goods and services. In the case of the federal government, it refers to the total amount of income generated from taxes, which remains unfiltered from any deductions. has all sorts of inclusions in it. Let us assume we own an electronics company that produces laptops, and during 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. However, using those numbers for financial calculations will mislead us into thinking that the revenue is more than what we got. So, we removed such discounts and also returned products.
The equation that helps calculate net revenue is mentioned below:
Net Revenue Formula = Gross Revenue – Directly Related Selling Expenses
Let us consider the following examples to understand the concept and net revenue calculation better:
Let us take the same example above and put some numbers to it. Let us assume our annual turnover last year was 1,000,000 USD. That originated from selling 2,000 laptops for 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 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% on 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 the 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 better, Buffet is one last triumph of traditional investing.
And he pays very close attention to “Profit Margins.” He can 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.
Profit Margins = Net Income/Net Sales.
Keep an eye on ‘net income.’ Every investor looks at multiple numbers and makes a decision. Because of how the financial world works, it is impossible to look at one number and take it as gospel for investing. 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., many companies started selling their products at a discount and boosting sales.
Now, everything is overstated. In such situations – Net Revenue is truer than the original numbers. A high number indicates that the company is doing well and vice versa.
Net Revenue vs Gross Revenue
While considering revenues generated, there are two categories of them that one comes across – gross and net revenue. Let us have a look at the differences between the two:
- Gross revenue is the total revenue generated from the sales, while net revenue is the revenue calculated after the expenses and liabilities are deducted. In short, the latter is the actual revenue figure that stays with the firm.
- Most of the time, investors are more bothered with gross revenue than with net revenue – because it shows one’s ability to conduct business and progress into a growth structure. On the contrary, the net revenue gives the figure that the firm retains after the liabilities or expenses are deducted.
- When selling 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, which parts have to be cut and which parts have to be grown, and to make a strategic decision on what to do for more profits.
This has been a guide to What net revenue is and its Definition. Here we discuss the formula to calculate Net Revenue, examples, advantages, and disadvantages. You can learn more about accounting from the following articles –