Net Credit SalesDefined along with Formula & How to Calculate

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How to Calculate Net Sales?

Net Sales are part of an Income Statement account that most users and the management monitor regularly to gauge the company’s economic status.

Net Profit is the difference between the Total Revenue and Total Expenses. 

Profit and Loss Statement or Income Statement measures the financial performance of the company.

The common line items in the Income Statement are Net Sales (Sales – Sales Returns, Allowances, or discounts), Cost of Goods Sold/Cost of Sales, Gross Margin, Selling and Administrative Expenses, and Net Profit. 

This article will help you understand what Net Sales are and will also guide you on how to compute Net Sales. 

What are Net Sales?

net credit sales

Net Sales is the amount of total sales less any sales returns and allowances or trade discounts.

Net sales make up the initial portion of the Income Statement. 

Sales returns can be a company policy allowing customers to return the sold item in case of product deficiencies or a wrong quantity of orders delivered.

Most of the time, retail stores allow returns of purchased items. 

A trade discount is an agreement between a manufacturer and a buyer. Such discounts are subtracted from gross sales to arrive at net sales.

The trade discount amount is subtracted from the standard to arrive at the actual price which essentially is the amount that the buyers pay. 

The recording of sales depends on the accounting method used by companies.

How to Calculate Net Sales

Net Sales is one of the line items included in the Income Statement where expense accounts are also recorded.

Such expenses are categorized according to their characteristics which include direct, indirect, and capital expenses. 

The section where Net Sales are recorded also includes direct expenses to compute the Gross Margin.

The concept of net sales does not always apply to all types of industries.

Some do not follow the method of Net Sales calculation. 

To arrive at the Net Sales, the following are subtracted from it: sales returns, sales allowances, and trade discounts.  

Sales Returns

Sales Returns refer to the return of the sold items to the seller affecting a decrease in sales amount.

Some of the reasons for customers to return items are excess quantity, wrong items shipped, defective goods, or mistaken product specifications.

There is only a specified period in which the goods can be returned, usually within only a few days.

The company may recognize the returned goods as sales returns or deduct the sales return from sales revenue directly.

Sales returns affect two accounts – a decrease in cash or accounts receivable (credit) and an increase in Sales Returns (debit). 

Sales Allowances

net credit sales

Sales Allowances are recognized when the price of the goods sold to the customer is below the standard price because of inferior product quality or wrong product specifications.

This is recognized when the customers are sent a bill but before they make a payment. 

The entry to record a sales allowance is by debiting the Sales Returns and Allowances account and crediting the asset account.

This entry reduces the Gross Revenue by the amount recorded against the allowance. 

This should not be confused with write-offs because the latter is recorded as an expense that reduces the asset value and is done before any sale is made. 

Trade Discounts

Discount is a strategy to encourage customers to pay earlier than the agreed payment period.

The payment term depends on the agreement of both parties.

An example of a discount term is 3/10 net of 20.

This means that a 3% discount will be given to the customer if the payment is made within ten (10) days of the given 20-day invoice period. 

Discounts should only be provided when the customer pays early.

Companies that aim to mobilize collections offer discounts to customers.

Such collections are used for purposes such as payment for business-related expenses, or to decrease the accounts receivable of the company.

A sales discount also decreases the gross revenue for the period.

The table below shows an example of Gross Sales and the related deductions. 

Net Sales = Gross Sales – Sales Returns – Sales Allowances – Discount

Net Sales = $4,000,000 – $30,000 – $25,000 – $15,000

Net Sales = $3,930,000

Gross Sales vs Net Sales

No.BasisGross Sales

Net Sales

1DefinitionGross sales are the aggregate amount of all sale transactions recognizable in one accounting period. Sales returns, allowances, and even trade discounts are not deducted yet from gross sales.Net sales are the Total Sales less any recognized sales return, allowances, or trade discounts.
2FormulaGross Sales is the total amount calculated from the total number of units sold multiplied by the selling price per unit. Net sales are the difference between the total sales less any sales returns, allowances, or trade discounts.
3PurposeGross sale is a gauge to measure how quickly the company is able to generate sales.Net Sales capture how much of the output has inferior quality, or how much discount was provided to customers.
4Decision-Makinggross sales do not give an accurate measurement of the financial condition of the company.Net sales are a more accurate measurement of how well the company’s business operations are.
5Value or amountGross sales have a higher value than net sales.Net sales are less than gross sales but they can sometimes be equal too.
6DependencyCalculation of gross sales is possible even without the net sales account.To arrive at Net Sales, Gross sales must be recognized first.
7Reporting in Income StatementThe recognition of Gross Sales is only in the Notes to Financial Statement.Net Sales are a vital account in the Income Statement.

How to Calculate Net Sales Revenue

Sales revenue is the total amount of generated revenue through a company’s business operations.

But there are times when customers do not pay them in full.

As such, a risk of reduction to the total sales may happen.

The adjustments can be sales returns, allowances, or trade discounts. 

The computation of Net Sales will require the following steps:

  1. Examine the Net Sales Formula

    Net Sales will always be the difference between the Gross Sales and related deductions such as returns, allowances, and discounts. Investors, owners, and other interested users often monitor the company’s net sales.

    Net Sales is the accurate measure of the sales generated by the company for an accounting period. A company generates revenue through the sale of goods or services. But there are other ways to generate sales, like selling non-current assets. 

  2. Use the Accrual Method of Accounting

    The preferred accounting method used by companies is the accrual method because such a method recognizes revenue when earned and expenses when incurred. Also, such an accounting method recognizes the matching principle that revenues be recorded in the same accounting period that its related expenses are incurred. 

    The accrual method gives a more accurate recording of revenues and expenses than the cash method. When goods are delivered and the invoice is issued, sales can also be recognized regardless of the receipt of payment. 

  3. Calculate the Gross Sales

    Gross Sales are the aggregate amount generated from the sale of goods or services. In an accrual method of accounting, the recognition of sales happens when the billing invoices are sent to the customers and the product or service is delivered.

  4. Subtract the Sales Returns, Allowances, and Discount

    Sales returns are a deduction from Gross Sales due to products’ inferior quality or if a wrong item was delivered. The accounting effect of these transactions is a decrease in cash or accounts receivable account and an increase in sales returns account.

    After deducting sales returns, the company must recognize any allowances if any. These are granted to customers due to an incorrect number of items shipped or the wrong price amount which leads to a decrease in gross sales. And the last allowable deduction is the trade discounts, if applicable. 

  5. Record Net Sales 

    After deducting the sales returns, allowances, and discounts, the remaining amount is the Net Sales. Such an amount is the recognizable amount to be recorded in the Income Statement. The format in the Income Statement is typically Gross Sales items, then allowances and discounts items, and lastly the Net Sales.

Gross Margin

Gross Margin is the difference between the Net Sales and the Cost of Goods Sold.

It is the remaining amount after deducting all the direct costs of the production of goods. 

Gross Margin is the amount before the deduction of other business-related expenses such as selling, administrative, and interest expenses if any. A higher gross margin corresponds to a higher capital earning rate. 

The formula to compute the Gross Margin is as follows:

Gross Margin = Net Sales – COGS

Where:

Net Sales = Gross Sales – Sales Returns, Allowances, Discounts. 

COGS = the components of cost of goods sold are direct material, direct labor, manufacturing overhead, etc. 

One of the salient indicators that a company’s financial status is healthy is the gross margin. It has a major effect on the gross profit retention of the business operation. 

For Example, the company retains $.30 for every sale generated and has a 25% gross margin every quarter.

The dollar amount retained can be used in settling the company’s debts and other expenses. 

Net Credit Sales Formula

Credit means an amount that is to be paid or received some time in the future.

Net Credit Sales are sales generated in selling goods or services to be paid in the specified credit period.

There is no involvement of cash in this kind of transaction. Net Credit Sales also follow the concept of sales returns, allowances, or discounts.

Net Credit Sales is part of a different financial analysis calculation like the Accounts Receivable Turnover Ratio, Day Sales Outstanding, etc.  

Net Income vs. Net Sales

 Net Sales

Net Income

DefinitionTo arrive at the Net Sales, some amounts need to be deducted like the sales returns, allowances, etc.Net Income is the amount calculated after deducting the cost of goods sold and operating expenses.
FormulaNet Sales is the difference between Gross Sales less Sales Returns, Allowances, and Discounts.Net income is the difference between Net Sales less COGS, Operating, and other related expenses.
Representation In Income StatementNet Sales is a line item  in the first part of the Income Statement.Net Profit is a line item at the bottom of the Income Statement.
DependencyNet sales are independent of net income.Net profit is dependent on net sales.
PurposeNet Sales recognizes the total sales activity of the company.Net income measures the profitability of the company. 

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