When setting up a business plan for any length of time, understanding financial metrics is crucial. As business owners know that a small mistake can cost them a lot of money, they never neglect their financial operations.
Entrepreneurs are constantly trying to understand their sales operations and profit from the beginning. Net sales, the most reliable indicator of a company’s effectiveness, are among the sales operations.
This article will provide basic knowledge about net sales including definition, importance and calculation methods.
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What is net sales?
Net sales is the net sales after deducting sales discounts, sales allowances and sales returns. Net sales should be included on your income statement and should be used for all businesses that sell products.
You can report net sales as a business owner on your income statement. Include these deductions in the total sales or present gross Sales figures. List each allowance or deduction separately.
Because they directly impact your gross profit, it is important to accurately calculate allowances and deductions. Your deductions and allowances must not include the cost of goods purchased. This is subtracted from your net sales total.
What is the importance of net sales?
Comparative measures are often based on net sales. To address financial problems before they become costly, companies often compare their net and gross sales with others in the same industry.
Many returns can be resolved quickly without creating problems. Allowances are often due to transport problems. This may lead to a company reviewing its shipping methods and storage methods. To be more competitive in their industry, companies offering discounts might lower or increase their discount terms.
Investors also consider net sales figures when deciding whether to invest in a company. This is because it allows them to predict or determine the revenue that a company will receive from sales.
How to calculate net sales
You can use the following formula to calculate net sales:
Net Sales = Gross Sales (Total Revenue) – Sales Returns – Allowances – Discounts
We will analyze each component in detail to help you understand the formula.
Gross Sales
All sales, adjusted or not, of all products and services. No returns, allowances or discounts are included.
Sales Returns
Retailers love sales returns. These companies permit customers to return their item within a specified time period for a partial refund or full refund. This refund is taken out of gross sales to calculate gross sales.
Many sales returns are due to late shipping, defective items, improper product specifications, incorrect goods being sent, excessive quantities ordered or too many shipped.
Many businesses require that their buyers produce a sales authorization number before the receiving department accepts a returned item. Return authorization numbers (or RAs) allow sellers to track the return from its beginning to its ending. It allows companies to track customers’ returns, as well as the speed at which they are done, and whether or not they purchased the goods.
Allowances
Allowances are more common than returns, but they may be necessary if the business is able to reduce its revenue. A seller might offer a partial refund if a customer complains about damaged items or incorrect items being shipped.
To avoid losing customers or having them return the product, the discount is subtracted from gross sales to calculate net sales. These notations are required in this instance.
Regular accounting should include sales returns as well as allowances.
Get Discounts
Sales discounts, which are price reductions that a seller offers to a buyer in exchange for immediate or earlier payment, are included in the reporting of gross sales and net sales. The buyer must pay a lower amount than what was billed in such cases. This is a common approach for businesses when they are in dire need of cash.
You might invoice your buyer for $1,000 of products and offer them 2/10, net 30, payment terms. This means that your invoice must be paid in full within 30 days. However, if the buyer pays within 10 days they will get a 2% discount and you only need to pay $980 instead.
Example of net sales
Your company’s July 2020 total gross sales are $100,000. Sales returns for the same period are $3,000, sales allowances $4,000 and discounts are $5,000.
Although it is not difficult to calculate net sales you must measure each element correctly.
There are differences between gross and net sales
Gross sales is your total sales before discounts or amounts are applied, and net sales is the final result after these deductions have been made. What gross sales and net sales can tell you is more important than anything.
In fact, not every business uses gross sales to determine their bottom line. Gross sales are not an accurate indicator of the company’s health or sales process. You might find a significant understatement in a company’s sales numbers if you only consider gross sales, which is separate from the income statement.
Net sales are therefore the best option for investors, financial advisors, and accountants. It is essential to understand how well a company sells its products or services. You might overlook them and not be able to account for the different strategies or methods that your sales team uses.
A company’s quality product or service can be measured by the difference in net sales and gross. If your product returns are high you might want to investigate why. You might want to fix product defects or find a new supplier if your sales allowances are too high.
Gross sales and net sale are important metrics to understand, both in relation to one another and separately. You will likely need both numbers to assess whether your business should change the way it approaches sales or improve product quality.
There are differences between net sales and income
Net sales is the sales figure for a period. However, net income shows the income from net sales.
Net income is the income after subtracting all costs (production & administrative, selling & distribution), loss of assets, interest (long term debt), taxes, preference dividend, and losses on assets. Net sales are the main determinant of net income.
Net income can be held by companies in the form either retained earnings or distributed to equity shareholders as a dividend. You can calculate earnings per share by subtracting the total number shares from the net income. It is also the net increase in equity shareholder’s funds.
Below is a table that will help you see clearly the differences between net sales versus net income.
| Net sales | Net income | |
| Definition | The net sales of a company after deductions, returns, and discounts | Actual income earned by a company during a specific accounting period |
| Objective | To see the actual sales figures for a financial year | To assess the company’s operational efficiency |
| Financial statement position | In the first line, Income Statement | The Income Statement’s last line |
Use net sales only to a limited extent
Net sales is an important part of financial operations for almost all businesses. However, there are some limitations.
- This doesn’t necessarily have to be applied to every business that exists because there are many distinct elements used for calculation.
- Other components that are used in better analysis are not included in net sales, such as general expenses, cost of goods sold and administrative expenses.
The bottom line
Net sales are an essential factor in any business’ income statement. Every company must track and understand net sales. Net sales can be used by both managers and customers to assess how well the company’s products and services are selling.
This article provides all the information you need to calculate net sales in order to make informed business decisions.
