When it comes to understanding the potential of a new business, there are several metrics you can track to get an overall picture of a business’s financial success. Two of the most common figures to track are gross revenue and net revenue. Each measure your business’s potential in different ways, so it is important that owners know how to calculate and interpret each.
Read on to understand the difference between gross and net revenue, and the impact they have on financing.
Gross revenue 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 is often used to indicate your business’s ability to sell its products and make income, but note that it doesn’t consider expenses.
To calculate gross revenue for a product-based business, use the formula:
gross revenue = (number of goods sold) x (the price of goods sold)
For service-based companies, the formula is:
gross revenue = (number of customers) x (price of service)
Net revenue (or net sales) is defined as gross revenue minus returns and allowances, such as sale promotions and purchase discounts. It refers to the actual amount of money the company received at the end of a period.
To calculate net revenue for a given period, can use the formula:
net revenue = gross revenue – returns – allowances.
Returns refer to the monetary value of all returned items, and allowances is the total value of the discounts offered for the gross sales.
Gross Revenue vs. Net Revenue
Gross revenue measures a company’s total income from sales without returns or discounts. Net revenue refers to the total amount of money that the company collected after adjusting for returns and allowances.
Gross revenue is used to determine the ability to generate sales and test for a product-market fit. Higher gross revenue shows that consumers are interested in and willing to buy your product / service. As lack of product-market fit is a common reason new ventures fail, tracking gross revenue is especially important for start-up founders and small-business owners.
Net revenue is the actual money generated from sales during a period of time before taking costs into account. To calculate this, you’ll use net revenue as the starting point and subtract the relevant expenses.
The Impact of Gross and Net Revenue On Financing
When businesses first open, they often have higher expenses such as business loans, startup costs like equipment, and other operating expenses like marketing fees for your grand opening. Most companies operate at a loss when they first open, which is why investors examine both gross and net revenue.
Potential lenders and investors use these metrics to learn about your business model and company management. They observe gross revenue to verify your business model and product offering, then compare it with net revenue to gain more information about product quality and the effectiveness of your marketing and sales strategies.
Together, these numbers paint a picture of how customers react to your business and reveal its potential for growth and future sales. It helps lenders to evaluate risk and determine your ability to pay back a loan. If your revenue has been stagnant or declining, then the loan holds a higher level of risk.
These are just some factors that lenders look at, in addition to other income metrics like operating income, net profit margin, expenses, and so on. All of these values work in tandem to determine the health of your company’s financial situation.
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We have decades of experience consulting and securing funding for businesses, and our experts are ready to guide you through the process. Partner with Independence Business Consulting to find the best financing options for your business.