You may get advice as a small business owner to measure your incoming revenue and profits based on a number of criteria, such as net revenue, gross margin, and net income. But what’s the difference, and which is the best measurement for understanding the financial health of your business? All of these measurements are helpful if you understand what each one means and what they tell you about how your business operates.
What Is Net Revenue?
Your net revenue is the total amount of income you earn from business operations minus any adjustments, such as accounting for returns, refunds, and discounts. Say your company had a good month and sold 500 products at $100 a piece. Your revenue for the month would be $50,000. But what if customers returned 20 of those products? You subtract $2,000 ($20 x 100) from your total revenue to get a net revenue of $48,000. Now imagine you offer a price-matching deal to stay competitive with other businesses. Five customers come in with a competitor’s ad showing a price of $80, so you refund them $20 each. Net revenue is revenue minus adjustments, so you also subtract the $100 ($20 x 5) to get a net revenue of $47,900. It’s helpful to keep an eye on net revenue because it gives you a more complete picture of how much money you’re taking in then revenue alone.
What Is Gross Margin?
Gross margin digs a little deeper into how much money you’ve earned by deducting the cost of goods sold (COGS), so you calculate it by taking total revenue and subtracting COGS. The COGS includes the materials, labor, and overhead you assign to the products you sell. If you’re making pricing and manufacturing decisions, net gross is a useful metric, as it focuses only on what goes into the actual product.
What Is Net Income?
Your net income is your income after all eligible business expenses. Net income goes even further than net gross margin because you deduct all other expenses, including overhead and taxes. So, the formula for net income is simply total revenue minus total expenses. People often refer to net income as “the bottom line,” as it is the last line item on an income statement. This figure indicates whether your business is profitable. For example, company A has a sales revenue of $1 million and high expenses, so it has a net income of only $10,000. Your company has a sales revenue of $100,000 with low expenses, so you have a net income of $50,000. Even though company A has a higher revenue, your company’s more profitable.
In Canada, if you have a small business or are a self-employed professional, you report your net income on Form T2125 at tax time. If you have a small businesses, net income is your business income (the revenue for selling products or services) minus your deductible expenses. If you’re self-employed, your net income is your professional income (the money you make for providing professional services) minus your deductible expenses.
Net Revenue vs. Gross Margin vs. Net Income
Your management department may make decisions on whether to continue selling a product based on the gross margin of the good. Although net revenue and gross margin are useful internal figures, external parties care most about net income. Because net income incorporates all expenses, it’s the only figure that truly encompasses all operations of a business and is helpful for providing an overall picture of your financial health.
Net revenue and gross margin are particularly helpful internally, as they help you make business operating decisions. If there’s a significant difference between revenue and net revenue, you may want to look into what’s eating into your earnings. Are your discounts too generous? Could a large number of returns indicate that there is a production problem that is impacting product quality? Analyzing net revenue can help you identify these opportunities for improvement. Similarly, gross margin can help you make decisions about setting prices and managing costs. If you have a slim gross margin, you might consider seeking a cheaper supplier, cut costs by streamlining production, or raise prices to increase revenue.
Ultimately, all three figures are important to know because they reflect different positions of a company. Net revenue only looks at money you earn, gross margin only looks at product or service activity, and net income looks at everything. These figures also help you measure your company’s financial health when you factor them into profitability ratios, which are measurement tools that give you even further insight to aid your decision making.
Tracking these three figures gives you useful information that help you make the best possible decisions for your company. Using an accounting system, such as QuickBooks Online, you can generate a Profit and Loss statement automatically. Learn how today.