What Is the Difference Between Net Revenue, Net Sales, Cost of Sales & Gross Margin?

by Cam Merritt, Demand Media

If you're new to business, or just unfamiliar with the accounting aspects of business, terms such as net sales, net revenue, cost of sales and gross margin may be confusing, even intimidating. But getting a grasp on these concepts is the first step toward evaluating your company's efficiency and profitability.

"Revenue" refers to the money a company earns in the normal course of business. If you own a clothing store, for example, then revenue is the money you get from customers who buy clothes. If you're a plumber, it's what you get for doing plumbing work. Simply put, it's what you earn by doing "what you do." In accounting, "sales" means the same thing as revenue -- and "sales" makes the concept even clearer. Every company is in business to sell something, either a product or service, and sales (or revenue) is the income from selling it. Your company income may get some income from other sources, but if it's not from your core business, it's not sales.

Net sales, or net revenue, is your total sales revenue, minus a few things: returns, sales allowances and sales discounts. Most people are familiar with returns. If you sell three items for $100 each, you can record $300 in revenue, but if a customer returns one of the items, you must account for $100 worth of returns, for net revenue of $200. Net sales allowances are rebates or credits to customers to compensate them for problems with an item without actually taking back the item as a return. Sales discounts are price reductions offered to customers who purchase on credit but pay off their balance quickly. For example, a company may give customers 90 days to pay, but if they pay within 14 days, they get a 2 percent discount.

"Cost of sales" refers to the direct costs involved in generating your net revenue. If you own a clothing store and you sell a jacket, it's typically the cost you paid for the jacket; if your employees work on commission, the commission would be part of the cost of sales. If you're a manufacturer, cost of sales includes the materials that go into your products, plus the direct labor needed to make them. For a service business, it may include direct labor, plus supplies and parts. Overhead and other costs that can't directly be attributed to a particular sale -- such as rent, phone bills, administrative salaries, wages for store employees that aren't tied to sales -- don't get counted in cost of sales. Cost of sales is often called "cost of revenue"; companies that sell merchandise use the term "cost of goods sold," commonly abbreviated as COGS.

Take your net sales and subtract your cost of sales. The result is your gross profit. Now divide that number by your net sales and you have what's known as your gross profit margin, or just gross margin. This figure tells you how much of each $1 of sales is left over for other things after accounting for the costs of the products and services you provided. Those "other things" include overhead costs, capital projects -- and, don't forget, profit for the owner. In general, higher margins are preferable. You can calculate gross margin not only for your whole company, but also for each product line, which is where this figure is especially valuable. Knowing the margins for individual products helps you decide which items to make or stock and how much to charge for them.

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