Updated July 7, 2023
Definition of Net Revenue
Net Revenue is the net collection from selling goods or providing services, i.e., from the entity’s business. It is calculated as gross revenue, fewer trade discounts, recoverable taxes, refunds, direct expenses, etc.; in a nutshell, net Revenue is gross Revenue less the cost of goods sold.
Explanation
Revenue is the gross sales from business or gross receipts from the profession. We calculate gross revenue by adding gross sales or collections with direct incomes, such as the sale of scrap, discounts received, etc. In contrast, we deduct the cost of goods sold, which includes the cost of goods purchased, directly attributable expenses, sales returns, etc., from gross revenue.
For example, the organization made gross sales of $ 5,000 during a period when the cost of purchase was $ 2,500. Also, expenses attributable were labor expenses amounting to $ 500, manufacturing expenses of $ 1,000, and other direct expenses amounting to $ 400. So, in this case, the net Revenue will be $ 5,000 – $ 2,500 – $ 500 – $ 1,000 – $ 400 = $ 600. i.e., it is derived by deducting the purchase cost and direct sales expenses. It is helpful to know the exact Revenue or collection in real terms so that the company can make future investments and plan for expansion or diversification.
The Formula for Net Revenue
The formula for net Revenue is as under:
Where,
- Gross Revenue is the sum of bills raised throughout the period.
- The cost of goods sold includes the cost of goods related to the sales, for example, purchase, and direct expenses related to purchasing.
- It shows whether the sales can generate income or it is showing a loss.
Examples of Net Revenue
Different examples are mentioned below:
Example #1
An Ltd made sales of $ 700,000, and the purchase cost of the goods sold was $ 500,000. During the period, the Sales return was $ 50,000, the purchase Return was $ 70,000, labor expenses were $ 5,000, and the Other Direct costs related to purchasing were $ 7000. Calculate the net Revenue.
Solution:
Effective Sales are calculated as
- Effective Sales = Gross Sales – Sales Return
- Effective Sales = $700,000 – $50,000
- Effective Sales = $650,000
Effective Purchases are calculated as
- Effective Purchases = Gross Purchase – Purchase Return
- Effective Purchases = $500,000 – $70,000
- Effective Purchases = $430,000
The cost of Goods Sold is calculated as
- Cost of Goods Sold = Effective Purchases + Labour Expenses + Other Direct Expenses
- Cost of Goods Sold = $430,000 + $5,000 + $7,000
- Cost of Goods Sold = $442,000
It is calculated as
- Net Revenue for the period = Gross Revenue During the Period – Cost of the Goods Sold During the Period
- Net Revenue = $650,000 – $442,000
- Net Revenue = $208,000
Example #2
MNP Ltd is a manufacturing company that supplies goods to wholesalers for resale products. Other details are as below:
|
Particulars |
Amount ($) |
| Sales | $800,000 |
| Cost of Raw Material | $400,000 |
| Direct labor cost | $100,000 |
| Direct manufacturing expenses | $50,000 |
Apart from this, due to fault in manufacturing, the sales of $ 100,000 were returned by the customers. Also, the organization had spent $ 200,000 on replacing a significant part of the machinery. Calculate the net Revenue.
Solution:
Effective Sales are calculated as
- Effective Sales = Sales – Sales Return
- Effective Sales = $800,000 – $100,000
- Effective Sales = $700,000
The cost of Goods Sold is calculated as
- Cost of Goods Sold = Cost of Raw Material + Direct Labour Cost + Manufacturing Expenses
- Cost of Goods Sold = $400,000 + $100,000 + $50,000
- Cost of Goods Sold = $550,000
It is calculated as
- Net Revenue = Gross Revenue/ Effective Sales – Cost of Goods Sold
- Net Revenue = $700,000 – $550,000
- Net Revenue = $150,000
The cost of Replacement of part of the machinery is the capital expenditure, and hence it won’t be added to the cost of goods sold.
Importance of Net Revenue
Some of the importance is stated as under:
- It helps to understand whether the organization can earn the operating income or it is making a net loss.
- It aids in establishing the actual net collection.
- It helps in getting loans and financial assistance from third parties.
- Its calculation helps to assess the better situations of the business.
- It guides the managers and decision-makers on whether to expand or diversify.
Advantages
Some of the advantages are as follows:
- It calculates the net realization of money after netting off the expenses.
- It helps the analyst rate the organization, i.e., higher net Revenue, ratings, and investments.
- Its determination facilitates effective decision-making, guiding whether Revenue can generate effective income.
- It also helps in getting finance from outside parties.
- It helps to keep the business.
- It increases the value and reputation of the company as it is Revenue in real terms.
Disadvantages
Some of the Disadvantages are as follows:
- It is calculated as gross sales less the cost of goods sold, which might be negative (mostly in the starting phase of business) and can de-motivate the investors to invest.
- It does not consider the indirect income as there might be chances that adding indirect income will generate the operating income.
Conclusion
It is calculated as gross Revenue less the cost of goods sold. At the same time, gross Revenue is the total of bills generated during the year or the number of sales or gross receipts shown in the income statement. Gross Revenue is shown as gross sales less recoverable taxes and sales returns, whereas net Revenue is gross revenue fewer purchases, and direct expenses related to purchases. It can be used as a base for borrowings from third parties, banks, and financial institutions and helps keep the organization’s business. However, at the same time, this can negatively affect the business. At the start of business, the organization may generate negative net revenues, but in the long run, it might be able to generate positive net Revenue.
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