Net Sales Revenue VS. Gross Sales Revenue

May 28, 2010 - PRLog -- Over the last 10 years, we have looked at financial formats from all financial model standpoints.  We contrasted the differences between many businesses the financial models, and one thing remains true. “You must use Net Sales Revenue not Gross Sales Revenue at the very top of your calculations.”

Bankers and accountants know about managing and handling revenue and costs, but few of the traditional financial service providers have a decent understanding of what the business principal is using (inside his/her four walls of their business).
Here are some of the differences in brief.

In summary, P&L statements
•   It tends to lump together all selling, general, and administrative expenses.
•   Has little or no breakout of individual category expenses for fulfillment, or other administrative costs.
•   It includes all sales from product as well as any other miscellaneous income fees in gross revenue.
•   It lumps together returns, cancellations, and other deductions and subtracts them from gross sales revenue.
•   It is produced at the end of each month, quarter, and year, and is seldom configured in connection with a strategically engineered pre-profit plan.
On the other hand, a company that wants a clearer P&L statement understanding.
•   It separates all expenses by applicable category such as returns, cancellations, cost of goods, fulfillment, advertising and promotion, and overhead (true general and administrative expenses).
•   Indicates gross product demand whenever possible, so they can forecast more accurately quantify returns, cancellations and bad debts.
•   Includes exact subcategory costs so that principals can build benchmark ratios such as cost to fulfill an order; variable cost of the product to hit the streets. Cost to get a new customer; lifetime value of a customer; and ratio of administrative costs to sales.
•   Are driven primarily for principals to measure business vital signs.

The detail allows business principals to measure every aspect of their businesses and to compare their results against standards for their industry segment or for businesses of a comparable type and size. Let's take a closer look at what makes Gross Sales Revenues different From Net Sales Revenue.

Gross is the whole, Net can’t be reduced any further
Let us examine each of the following cost segments in more detail to understand the rationale of why to use Net Sales Revenue vs. Gross Sales Revenue to calculate gross profits.

Gross sales:
One needs to capture total sales revenue and then measure and track returns, cancellations and bad debt. The income statement includes income from all sources in its gross sales or revenue. Returns, cancellations, bad debt, and any other top-line deductions are subtracted from gross sales to obtain Net Sales Revenue.

Returns:
Representing items being returned for credit or refund, this line is a deduction from gross sales. While hard goods have much lower returns, you must remember that while returns can occur throughout the sales cycle, they typically come in 30-60 days after sales are booked. If the product was returned you no longer are entitled to sales revenue.
Cancellations: Another reduction from gross sales, cancellations are typically credit-card- or check-related, or backorder-related. If customers write you bad checks or if their credit cards are wrong, maxed out, or fraudulent, you are unable to complete the sale.

Cancellations
are a reduction of gross sales and usually occur at the beginning of the order entry process. And not unlike returns, cancellations will vary widely by type of business.
Bad debt: An expense that reflects the amount of your company's accounts that is not collectible, that is the amount of your company's accounts that are "bad debts."

(Side Note)You Could Create…Allowance for bad debts. A "bad debt expense" account is an expense account of your company. A typical company makes an estimate as to how much it has in bad debts on a periodic (usually monthly) basis. Your best guess at how much of your accounts receivable will not be collectible. In other words, your best guess at how much of your accounts receivable will be "bad debts." An "allowance for the bad debts" account is kind of like a savings account for bad debts. Your company puts money into it on a periodic basis (usually monthly) as an expense of the company. When you decide that a particular account is not collectible, you tap the allowance for bad debts account to pay for the bad debt. Because you already made the allowance for bad debts, your profit and loss statement will not be out of whack in the particular month that you decide to "write-off" a particular account.

Net sales revenue:  
What is left from gross sales after deducting returns, cancellations, and bad debt, net sales is what you deposit in the bank (from which you will pay expenses). In all cases, net sales are the starting point (100%) from which all other costs are figured. Instead of just expensing these items listed above I hope you will now look at it differently and as a starting point of 100% rather than starting with gross sales.

Cost of goods:
Because the cost of goods is such a large cost center in the entire P&L, it becomes a key driver of economic success. Among the elements: cost of the product, which varies dramatically by type of company; freight to your warehouse (freight-in); and the cost of markdowns and remaindering of product at the end of a season.

Gross margin: What's left after the cost of goods is subtracted from net sales revenue not gross sales revenue. Margins are a critical economic driver of success. If you can improve the margin by 1%, that gain drops through to contribution to overhead and profit. Lose a point in the margin, and it (negatively) affects the bottom line. If you are a small business owner and would like an outside objective look at your business http://www.xsellence.com.

If you would like to have your business analyzed email us

John Lenzing, of Xsellence LLC, Michigan based, Small Business Consulting.

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