Every business owner must understand the difference between net income vs. net revenue, as these metrics shine a light on their business’s financial health and performance. Knowing the financial health of your business is important to plan for the future and understand any opportunities you can take advantage of. Plus, it’s often what lenders or investors look at when assessing the health of a business.
Let’s define net income and net revenue and learn why they’re important.
What Is Net Revenue?
The top line of every business’s income statement is its gross revenue, or how much money the company made before anything is taken out. Net revenue is how much of the gross revenue is left over after deducting costs and losses, and it’s used to pay for business operations or the cost of production.
To calculate your net revenue, subtract any sales discounts, allowances, returns, and commissions from your gross revenue.
Let’s say that you own a shoe store and you sold $100,000 worth of shoes — but you had to reduce prices by 30% to get customers to buy them. You’d have a net revenue of $70,000.
The difference between your gross revenue and your net revenue indicates how well your marketing and sales methods are working. In this case, the large discount might indicate that you initially priced the products too high.
What Is Net Income?
Net income is the bottom line on a business’s income statement. It is what is left of your revenue after you’ve covered your expenses.
To figure out your net income, subtract the cost of goods sold, operating expenses, interest and depreciation charges, taxes, and any miscellaneous expenses from your net revenue.
Small business owners can look at their net revenue vs. net income to see if their business is providing a good return on their money as well as paying them a decent salary. Let’s go back to the hypothetical shoe store. If your net revenue was $70,000 and you spent $25,000 running your business, your net income would be $45,000. And if you invested $150,000 in the store, your return on investment — your net profit divided by the amount of your investment — would be around 30%.
What is Net Profit Margin?
Business owners should track net income vs. net revenue to make sure their business is financially healthy.
Knowing your business’s net profit margin is an easy way to quickly understand your net profit and give insight into the business. A net profit margin is a financial ratio used to determine a business’s percentage of profit.
A net profit margin can be determined by dividing the net profit by the revenue.
Net profit ÷ Revenue = Net profit margin ratio
Net profit is calculated by subtracting all company expenses from its total revenue and creates a percentage, which is used to determine the ratio. For example, a 10% profit margin means for every $1 of revenue, the business earns $0.10 in net profit.
The net profit ratio is used to consider several factors, including a business’s ability to produce profit and how to increase or decrease expenses. It’s also considered to be a strong indicator of a company’s overall success and financial health – a higher net profit margin indicates a business can control its costs and provide its goods or services at a price higher than its costs. Of course, that’s the goal for all small businesses, but many industries struggle with high overhead costs or seasonal disruptions. Understanding this percentage gives insight into how a business may be able to lower its costs or increase its prices.
Net income, revenue, and profit margin are three factors every business owner should be aware of when running their business. Checking in with these factors frequently allows you to gain insight into how you can better understand opportunities to increase profits.
