Understanding the potential of a new business is essential for founders and investors — and there are several metrics you can use to get a better picture of a business’s financial potential.
Two of the most common figures to track are gross revenue and net revenue. While they may sound similar, they measure your business’s potential in different ways, and it’s crucial that you know how to calculate and interpret each.
Gross revenue definition
Gross revenue (also known as total revenue or gross income) is the total amount of money generated by the sale of goods or services over a period of time, such as a quarter or a year. It’s often used to indicate your business’s ability to sell its products and make income, but it doesn’t consider expenses.
Gross revenue formula
You can use the formula gross revenue = (number of goods sold) x (the price of goods sold) to calculate gross revenue for a product-based business. For service-based companies, the formula is gross revenue = (number of customers) x (price of service).
Gross revenue examples
For example, say you have a company that sells water bottles for $30 each. In one quarter, you sold 60k water bottles, so your gross revenue for the quarter would be:
Gross revenue = (number of goods sold) x (price of goods sold)
Gross revenue = 60k x $30 = $1.8m
The formula works similarly for service businesses, but you calculate revenue using the number of customers instead of products sold.
If you have a SaaS company that sells a monthly subscription at $50 and you have 10k customers, your monthly gross revenue is:
Gross revenue = (number of customers) x (price of service)
Gross revenue = 10k x $50 = $500k
Net revenue definition
Net revenue (or net sales) is defined by the US Securities and Commission Office (SEC) as gross revenue minus returns and allowances, such as sale promotions and purchase discounts. In effect, net revenue refers to the actual amount of money the company received at the end of the period.
Companies that pay commissions often use net revenue when calculating payments to their sales team.
Net revenue formula
To calculate net revenue for a given period, you can use the formula net revenue = gross revenue - returns - allowances.
Returns refers to the monetary value of all returned items, and allowances equals the total value of the discounts offered for the gross sales.
Net revenue examples
Say you’re a retailer who sells shoes for $100 a pair. In one quarter, you sold 12k pairs of shoes and have a total of 200 pairs returned.
Your gross revenue would be your price times the total number of shoes sold, or $1.2m. From there, you can calculate net revenue by subtracting the value of the returned shoes.
Net revenue = gross revenue - returns - allowances
Net revenue = ($100 x 12k) - ($100 x 200) - 0
Net revenue = $1.2m - $20k - 0 = $1.18m
Discounts also affect net revenue. Say the same store ran a 30% discount the next quarter to increase its sales volume.
You sold a total of 15k shoes that quarter, but 3k of them were discounted. Additionally, 200 full-price shoes were returned, and 100 discounted shoes were returned.
To calculate your net revenue, start by finding gross sales.
Gross revenue = units sold x unit price
Gross revenue = 15k x $100 = $1.5m
Then, calculate the value of your returns:
Returns = ($100 x 200) + ($70 x 100)
Returns = $20k + $7k = $27k
Finally, calculate the amount of money that you won’t earn from the allowances. In this case, that refers to the $30 discount, which applies to the 3k shoes you sold on sale.
Allowances = $30 x 3k = $90k
When you put it all together, you get:
Net revenue = gross revenue - returns - allowances
Net revenue = $1.5m - $27k - $90k = $1.383m
When you compare the two quarters, you can see that you earned $200k more by offering a discount, even if it meant lower prices and more returns.
Difference between gross revenue and net revenue
Gross revenue measures a company’s total income from sales without returns or discounts. Net revenue, however, refers to the total amount of money that the company collected after adjusting for returns and allowances.
Interpreting gross revenue
Gross revenue is often used to determine your ability to generate sales from your core business and see if you have a product-market fit. Higher gross revenue signals that consumers are interested in and willing to buy your product (or service).
According to research, 34% of startups fail due to a lack of product-market fit, making it the most common reason new ventures close shop. So, tracking and understanding gross revenue is especially important for early-stage founders and small-business owners.
Interpreting net revenue
Net revenue is the actual money that you generated from sales during a period of time before taking costs into account. It’s often used as the metric for determining commissions. This way, you’re not paying commissions for items that have been returned.
If you want to calculate operating income or gross profit, you’ll use net revenue as the starting point and subtract the relevant expenses.
How gross revenue and net revenue impact financing
Potential lenders and investors use both types of revenue to learn about your business model and company management.
Gross revenue serves as an indicator of your ability to sell a product. When you can show an increasing trend in gross revenue, that’s a good sign to investors that you’ve found product-market fit.
In contrast, net revenue reveals how much of your gross revenue remains after accounting returns, refunds, and discounts.
When your net revenue is close to your gross revenue, it may suggest that customers like your product enough to keep it. It also says that you don’t have to rely on steep discounts to move products.
Investors may look at gross revenue to verify your business model and product offering. However, they can compare it with net revenue to get more information about product quality and the effectiveness of your marketing and sales strategies.
For instance, a company implements aggressive sales tactics and discounts to sell more products. By doing so, it was able to increase sales volume and gross revenue numbers.
However, upon looking at net revenue, investors realize that the number of product returns also skyrocketed because people felt pressured to buy products they didn’t really want. On top of that, the price discounts were extremely high.
Here’s a case where gross revenue may be trending upward, but net revenue may be decreasing. This signals to investors that while there may be potential product-market fit, the management decisions have lowered the company’s income.
In this scenario, a potential investor may decide not to invest even though the company’s gross revenue was increasing.
While price discounting can be an effective way to bring in new customers and expand your target market, you should be aware of the effect it has on your business’s income. Comparing gross revenue with net revenue can help you maintain the balance between aggressive growth tactics and business strategies that are viable in the long run.
Additional income metrics
While your business’s gross revenue and net revenue metrics are important, they don’t tell the whole story of the company’s financial health.
Neither of these metrics accounts for your business expenses or the cost of goods sold (COGS). Accounting for these costs is essential for understanding your company’s profitability.
That’s why there are other income metrics, such as:
- Operating income: Calculated as net revenue minus cost of goods sold and operating expenses.
- Net income (also called net earnings or net profit): Calculated as net revenue minus cost of goods sold, operating expenses, taxes, and interest.
- Net profit margin: Calculated as the percentage of net profit divided by net revenue.
On the income statement, you start with gross revenue (your top line) and continue to refine it by subtracting returns, allowances, and various business expenses to get to net income, which is known as your bottom line.
However, none of these values alone are enough to tell you if your business is healthy or not. Instead, they work together to paint a picture of your company’s financial situation.