What is Gross vs. Net Revenue?
Net Revenue (or “net sales”) refers to a company’s gross revenue after adjusting for returns by customers and any incentive discounts.
How to Calculate Net Revenue (Step-by-Step)
The starting line item on the income statement is revenue (i.e. the “top line”), which represents the total monetary value of goods and services sold in a specified period.
But more specifically, a company’s revenue on the income statement is typically presented as either:
- “Revenue, net”
- “Sales, net”
Just as a brief review of accrual accounting, the revenue recognition principle states that sales must be recognized once “earned” rather than after the customer’s cash payment is received.
Under accrual accounting policies, revenue is recognized once “earned”, i.e. the good or service has been delivered to the customer, and compensation is expected as part of the transaction.
Therefore, even if a company has yet to receive cash payment for goods or services already provided, the revenue is still recorded on the income statement with the unmet credit sale recorded as accounts receivable on the balance sheet.
In contrast, revenue is not recognized under cash basis accounting until the company has received the actual cash payments from the customer.
Under the reporting policies established under accrual accounting, revenue must be recognized in the period it was earned, whether or not cash was received.
Net Revenue Formula
Net revenue (or net sales) subtracts any returns from customers and any discounts from gross revenue.
If applicable to the scenario, another adjustment factor to gross revenue is allowances, which are closely related to discounts.
But discounts are discretionary decisions set by the company, while a reduction related to allowances is caused by an event such as a customer receiving a defective item or mistake, i.e. a compromise reached between the buyer and seller.
The formula for projecting revenue can be specific to the company, but the most common approach is the “price x quantity” method.
- Price: The price metric can represent the average selling price (ASP), average order value (AOV), and average revenue per account (ARPA) among various types.
- Quantity: The quantity metric, on the other hand, can represent the number of orders placed, gross merchandise volume (GMV), active user count, and more.
Upon projecting a company’s gross revenue, adjustments can be made to account for the fact that there are also returns and discounts – but in practice, the assumptions are often made implicitly (i.e. as a projected percentage of gross revenue) rather than projecting out returns and discounts individually.
Gross vs. Net Revenue: What is the Difference?
The distinction between net revenue and gross revenue is that the latter is not adjusted for customer returns (i.e. refunds) and discounts offered as an incentive for customers to purchase the products/services.
The gross revenue will therefore be greater than net revenue, assuming that there are returns and discounts to consider, i.e. both are downward adjustments to a company’s revenue.
Since net revenue takes into account returns and discounts, it is typically viewed as a more accurate measure of a company’s sales performance, as well as the quality of its offering mix, pricing strategy, and volume of repeat purchases from customers.
However, gross revenue can be more indicative as a “pure” growth metric.
Gross vs. Net Revenue Calculator – Excel Template
We’ll now move to a modeling exercise, which you can access by filling out the form below.
Gross vs. Net Revenue Calculation Example
Suppose a company had a total of 100k product orders in the past fiscal year.
If the average order value (AOV) of the company’s product line is $20.00, the company’s gross revenue is $2 million.
- Average Order Value (AOV) = $20.00 * 100,000 = $2 million
From our gross revenue amount, we must now deduct the returns from customers, as well as the discounts offered by the company.
We’ll assume that of all the orders placed, 5.0% of the total quantity was returned by customers.
- Returns (% of Quantity) = 5.0%
- Total Order Returns = 5,000 (5.0% * 100,000)
Moreover, a 10% discount was offered to certain customers, which 20% of the total orders used.
- Discount (% of AOV) = 10.0%
- Discounted Orders (% of Quantity) = 20%
Since we now have all the necessary assumptions, we can return to our net revenue build.
The dollar value adjustment for returns is $100,000, which we calculated by multiplying the number of returns by the average order value (AOV).
- Returns = 5,000 * $20.00 = $100,000
Next, the dollar value adjustment stemming from the discounts to customers is equal to the discount value multiplied by the number of orders placed with the discount.
- Discounts = (10.0% * $20.00) * (20.0% * 100,000) = $40,000
Using the figures we calculated, we can adjust the gross revenue amount by the returns and discounts to arrive at a net revenue of $1.86 million.
- Net Revenue = $2 million – $100k – $40k = $1.86 million