Do you offer discounts in your business? If so, understand how discounts help—or hurt—your small business’s net revenue.
What is net revenue?
Net revenue is the money you earn from sales after subtracting your direct expenses. Direct expenses include deductions (e.g., discounts, returns, and allowances) and cost of goods sold.
Net revenue is different from gross revenue. Your gross revenue equals your total sales.
Net Revenue = Total Sales (Gross Revenue) – Direct Selling Expenses
Net revenue is the top line of your business’s income statement. Net revenue does not include indirect expenses, such as taxes, utilities, and rent.
Net revenue and discounts
You might decide to sell an item for a discounted price. You can discount items by holding a sale, printing coupons, or posting social media promotions.
The difference between your selling price and the discounted price is a direct expense. You deduct the difference from your total sales.
For example, imagine that you own a pizza shop. Last month, you sold 600 pizzas for $15 each. To find your gross revenue, multiply the number of goods sold by the price per good:
600 pizzas X $15 = $9,000.
Then, you look at your net revenue. Last month, you offered coupons that took $1 off a pizza. If 200 people used the coupon, you have $200 in discount expenses.
When you calculate your net revenue, you subtract the amount you discounted ($200) from your gross revenue:
$9,000 – $200 = $8,800.
Discounts decrease your net revenue.
So, why do businesses offer discounts? The effects of offering discounts could help you earn more money. Discounts may attract more customers. More sales can increase your revenue.
Benefits of offering discounts
Discounts could increase traffic in your business. The more traffic your business has, the more likely it is to make sales. One way to draw in customers is to offer incentives. Offering a discount as an incentive may attract more people to your business.
Discounts can help you sell old inventory. Let’s say you own a sporting goods store. As basketball season approaches, you need space for basketball equipment. The previous sports season left you with unsold football equipment. The equipment takes up needed space. Discounts may help you sell the old inventory (football equipment) faster.
Discounts can potentially earn you quick cash. Increased sales from discounts could help you when funds are low. Discounts offer a temporary rise in revenue if you sell a large volume of goods.
Disadvantages of offering discounts
Discounts could devalue your business. If you offer a lot of discounts consistently, you may need to lower other expenses. You could end up choosing to use low-quality materials or let valuable employees go. The quality of your products may suffer from those decisions.
Discounts could lower your profit margin. Your profit margin measures how well you use your incoming funds to pay for expenses. When you sell an item for less than your asking price, your profit margin decreases. The lower your profit margin, the less profitable your business is.
You might attract low-spending customers. Some customers who enjoy discounts may become repeat customers. However, other customers only buy items at a discounted price. These customers are often one-time buyers and do not contribute to your business’s growth.
Tips for offering discounts
Though discounts decrease your net revenue, discounts can potentially encourage higher sales. Most likely, offering a few discounts will not damage your net revenue. Discounts become dangerous in excess.
Here are some tips for offering discounts:
- Bundle products – Discounts for buying multiple items may encourage larger purchases. For example, if a customer buys three chairs, they may be willing to buy a fourth for half price.
- Time discounts carefully – Allow discounts when cash is usually low. If you sell swimwear, you might offer a discount during colder months to generate more sales in your slow season.
- Be prepared – You will need enough products on hand to meet increased sales. You will also want to prepare your small business budget for increased expenses if your sales end up low.
- Learn how to start a loyalty program – Loyalty programs reward repeat customers. For example, you might keep a point system for your customers. When they have earned a certain number of points, you can offer them a discount.
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This article has been updated from its original publication date of November 17, 2015.This is not intended as legal advice; for more information, please click here.