Gross vs. Net Revenue for Small Businesses

Posted at 10:43h in Small Business Success by Kelly Hillock

Gross revenue is the total money that flows through a business’s accounts from the sale of goods and services. Net revenue is gross revenue minus these three items:

Allowances — Partial and minor returns to customers for things like defects or errors from the original sale. Getting a few dollars back on a refrigerator because of a dent in the side is one example.

Discounts — These aren’t promotional discounts like a 30% off sale but are discounts applied when customers meet payment terms like a 2% discount for payment within 10 days versus 30 days.

Returns — The total dollar amount from the original sale.

You’ll always report gross revenues on taxes and then subtract returns and allowances (schedule C for 1040 filers, form 1120 for corporations), but the IRS doesn’t have a separate net revenue reporting requirement.

For financial statements, public companies and a few private companies that fall under SEC regulations must report net revenues, but most small businesses don’t have to worry about this because they don’t disclose financial statements to the public.

The Generally Accepted Accounting Principles (GAAP) only say that you should remain consistent over the years with the way you report revenues. Examples of how businesses might track gross, net, or both include:

A car wash or gas station using gross revenue given that customers don’t return their products and rarely get discounts or allowances.

Clothing stores using net revenue, considering returns are normal, and a construction company using net revenue when they have payment terms with customers and regularly give allowances for finished jobs when things weren’t perfect.

Online travel sites using both where they report their gross sales value that includes the total dollars from all the hotel rooms, flights, etc. but their net revenue includes only the amount they keep as a commission or fee.

If you don’t want to report both on your financial statements, make sure to discuss this with your tax professional so you do what’s best for your business. With that said, because you’re already tracking returns and allowances for tax forms, the better option would be to include both gross and net revenues for a clear picture of your company’s finances.

Now that you understand the differences between net and gross revenue, here are the formulas to calculate them with tips to avoid common errors that can create issues when your cash flow is being evaluated, like when applying for a small business loan or seeking out investors.

What is Gross Revenue?

Gross revenue is the total value of all sales that touch a business’s financial accounts during an accounting period, which is usually a quarter or fiscal year. The formula for gross revenue is:

Gross Revenue = Sum of Sales (Quantity of Products * Sale Price per Product).

The sale price per product is the actual sales price to the customer after any promotional sale or markdown and not the sticker price. Imagine you own a shoe store and sell two different sneakers and one type of dress shoe, and you had the following sales last quarter:

Product	Sticker Price	Quantity	Markdown	Sale Price	Gross Revenue
Sneaker 1	$150	10	0%	$150	$1,500
Sneaker 1	$150	25	10%	$135	$3,375
Sneaker 2	$100	50	0%	$100	$5,000
Dress Shoe	$250	40	0%	$250	$10,000
Dress Shoe	$250	100	30%	$175	$17,500
TOTAL					$37,375

You would multiply each product quantity per sales price and then add up the line items for a total gross revenue of $37,375. That would be the top line of your income statement (also called the profit/loss statement) and you’d subtract all other expenses from it. But if your business has lots of returns or trade discounts, net revenue shows a clearer picture of your true top line.

What is Net Revenue?

Net revenue is a better reflection of your top line when there are significant activities related directly to sales and returns, and the formula is:

Net Revenue = Gross Revenue – Allowances – Discounts – Returns.

The discounts subtracted from net revenue are given based on payment terms with customers. Technology and other B2B sales will have terms like net-30 where a customer pays 30 days following the invoice date but can get a 2% (or similar slight discount) if they pay within 10 days. This does not include promotional sales or markdowns like you would find at a retail store or car dealer.

Sticking with the shoe store example from above, here’s how you calculate net revenue if the following happened:

5 full-price customers returned sneaker 1. This would make returns = $750 for the first line.

20 customers complained sneaker 2 was scuffed, so you gave them 40% of the list price back as an allowance. This makes allowances = $800 (20 * .40 * $100)

Product	Sticker Price	Quantity	Markdown	Sale Price	Gross Revenue	Returns	Allowances	Net Revenue
Sneaker 1	$150	10	0%	$150	$1,500	$750	0	$750
Sneaker 1	$150	25	10%	$135	$3,375	0	0	$3,300
Sneaker 2	$100	50	0%	$100	$5,000	0	$800	$4,200
Dress Shoe	$250	40	0%	$250	$10,000	0	0	$10,000
Dress Shoe	$250	100	30%	$175	$17,500	0	0	$17,500
TOTAL					$37,375			$35,825

You don’t have any discounts to subtract from gross revenue because your customers pay at the store and don’t get invoiced, so after subtracting returns and allowances from gross revenue, your net revenue is $35,825.

That’s 4.2% lower than gross revenue, and as your business grows, that 4.2% becomes a large amount of money. Using gross revenue would overstate your true top line and can lead you to spend more money on expenses than you actually should.

Avoiding Common Mistakes Around Gross and Net Revenue

Avoiding common mistakes around gross and net revenue is crucial because these mistakes scare off lenders and equity investors by making it appear you’re trying to manipulate financial statements. You could also get in trouble with the Securities and Exchange Commission if they think the mistake was on purpose and meant to mislead investors.

Both lenders and investors will quickly see the error and adjust for it, but they’ll be skeptical about your knowledge and reliability as a borrower or company owner and look for other places to invest their money.

Here are common errors, why they create a big issue, and how to clear up the confusion.

Common Mistake	Issue Caused	Clearing Up the Confusion
Subtract expenses like cost of goods sold (COGS) from gross revenue to get net revenue	This makes your top line growth rate artificially high and happens because of confusion over the “expenses” deducted from gross to get net revenue. Returns, discounts, and allowances aren’t “expenses,” they are adjustments to get net revenue from gross revenue.	Subtracting items from gross revenue to get net revenue meets the GAAP principle for transparency to accurately reflect the true nature of a business. Some people have confused the “adjustments” in the net revenue formula for “expenses” that should be subtracted from revenue on your income statement. COGS is a major expense defined in GAAP and is the first line subtracted from revenue on your income statement. The result of revenue minus COGS is your gross profit.
Confusing net revenue and net income	Mistakenly saying your net revenue number is your net income makes it look like you have a much more profitable company than is true. Making this mistake will cause lenders and investors to think you mislead them from the start.	This mistake also comes from the confusion between “adjustments” in the net revenue formula and “expenses” from the business. Net income is the amount remaining after subtracting all business expenses and taxes (if any) from revenue. Net income is also known as “the bottom line.” Net revenue is a “top line” calculated by adjusting gross revenue for allowances, discounts, and returns.
Promotional sales like “30% off sales” or “Buy 6 and get 1 free” decrease net revenue vs. gross revenue	This makes it look like you’re trying to inflate your top line revenue by counting money that would never hit your bank account in the first place.	Two interchangeable terms cause the confusion here: “Sales” can mean revenue or it can mean a product is on sale/marked down. “Discount” can mean the percent off from a markdown or it can mean the discount given for payment terms related to a revenue invoice. To clear up the confusion: Definite discounts given at the time of sale like 30% off shoes, $5,000 off MSRP, or similar promotions come out before counting revenue. Revenue is the actual sales price after the discount. Possible discounts like 2% off if you pay within 10 days or full price due in 30 days are subtracted from gross revenue to get net revenue.

Why Lenders and Investors Care About Gross and Net Revenue

Lenders and investors care about gross and net revenues because they help them evaluate the risk of you not being able to repay a small business loan (in the case of lenders) and the likelihood of your business making future profits (for investors).

When lenders and investors see a widening gap between gross and net revenue, it indicates a problem where you’ll have less money available to use in operations, make loan payments, or keep as profit. Reasons for this include:

Low-quality or defective products, causing more returns and leading to dissatisfied customers that buy less and less over time.

Lazy customer service where you’re too quick to placate customer complaints with money back instead of other solutions like store credit, for example.

By presenting both gross and net revenues on your financial statements, you’ll build trust with third parties who are looking to provide loans or invest their money in your business because you’re showing them a clear picture of your company’s operations and not making them dig for details. If you have a widening gap between gross and net revenues, this allows you to proactively explain your plan to address issues with increasing returns and allowances (for example) before the lender or investor finds out on their own.

Gross revenue is the total sales touching your financial accounts, and net revenue is gross revenue minus adjustments for returns and allowances. You’ll always report gross revenues on your tax forms, but presenting both gross and net revenues on financial statements helps you present a clear picture to lenders and investors and build trust when you need a loan or equity investments.

QuickBridge does not provide tax, legal or accounting advice. This material has been prepared for informational purposes only. You should consult your own tax, legal and accounting advisors.