Gross Revenue Vs Net Revenue Accounting for Small Businesses
All earned income in your small business falls under gross revenue and net revenue, but treating them as the same could land your business in the red financially.
Gross vs net: Knowing the difference can give you an understanding of how well your business can generate revenue. The two also have income tax repercussions if handled incorrectly.
We take a look at the importance of recognizing and reporting revenue clearly according to these accounting categories.
Gross Vs Net Revenue Definition
The definition for gross revenue is the total amount of money that a company earns during a given accounting time frame. All the income that a company generates from the sale of goods and services falls under gross revenue.
On the other hand, net revenue refers to the resulting amount after the deductions of sales discounts and the cost of goods sold.
Simply put, gross revenue is the earnings of a company before deduction of expenses, while net revenue is the earnings after expenses have been subtracted.
Here’s a simple gross vs net revenue example: If a shoe store sells 100 pairs of shoes at the cost of $40 a pair, their gross revenue is $4,000 in that period. To calculate net revenue, the business will need to make deductions to account for the cost of goods and services (COGS), the cost of damaged goods, returned goods and discounts applied.
Differences between Gross and Net Revenue
When it comes to comparing gross revenue vs net revenue, the main difference is pretty clear from their definitions. However, that’s not where the differences stop.
For one, though gross revenue can give a clear picture of a business’s ability to sell goods and services, this figure cannot accurately depict the business’s ability to generate profit.
Since net revenue is calculated by considering COGS and allowances like discounts, it gives a better picture of the health of a company. However, it is not enough to understand the whole picture of a company’s financial health. For one, net revenue does not include expenses related to closing a sale.
Another difference of the gross revenue meaning is this all-inclusive sum, when accounting for revenue, needs no further adjustments made after the calculation of total sales. For net revenue, a company needs to consider possibilities such as returns. For example, a company selling electronic devices sees a higher rate of return due to the nature of the product. This company will most likely keep a certain amount of revenue as a provision to take care of the return, which is adjusted later depending on the actual return.
The Importance of Understanding the Difference
Knowing what is gross revenue and what is net revenue out of your company’s financials is an important part of managing a successful business as a small business owner. It can help you make important decisions about income choices, such as when to raise your rates, whether or not certain expenses are necessary, and the types of income, projects, and clients that you should be focusing on.
As a business, gross income can indicate the revenue generated year over year and give a perspective on how your business is doing. However, net income gives a clearer picture and could tell a slightly different story: Your gross income may be high, but when you factor in how much you are making after expenses, you might discover that your revenue is low. Even if a product is generating good sales and bringing in a lot of revenue, it still needs to be in-line with the expenses. Your net income will let you know if you need to reduce the COGS by making production more efficient.
Gross Revenue vs Net Revenue in Business Financing
If you’re thinking about getting a loan for business, pay close attention to your gross revenue. Banks not only look at a business’ debt service coverage ratio, they also review the company’s revenue stream from the core business. This is usually determined by gross revenue.
Increasing gross revenue is a sign of a strong product line and fair demand in the market, which shows the potential for an increase in sales and company growth with financing. This is especially important if you are seeking financing for company expansion like opening a new store location.
Keep in mind, it is also important to note that both gross and net revenue are not sufficient to understand the profitability of the company and lenders will take into account much more than these numbers.
Business accounting can seem complicated, especially if you’re trying to get your books in order to apply for financing. However, With L3 Funding, you don’t have to worry. When you choose to apply for merchant funding through us, you can simply fill out an application along with your business banking statements and we’ll take over the process from there. Talk to us to learn more!