Net Sales – Meaning And Explanation Of Net Sales

What is Net sales?

Net sales are the remaining sales that are left after subtracting the allowances, return, and sales discounts. A company reports its total revenue in the form of net sales on its income statement. In this way, the entire purchase made by the company and all deductions made from it are mentioned in a single line on the income statement. The net sales make the top-line revenues on the income statement.

Meaning of Net sales

Companies use income statements to analyze the operations expenses, total revenue generated by companies, and the growth of revenue in the particular financial year. An income statement is divided into three parts, such as capital costs, indirect costs, and direct costs. The net sales of a company are mentioned in the direct costs section of the income statement financial report.

Companies don’t completely expose their net sales externally. Several industries and companies don’t calculate net sales because of the different components required for the calculation of net sales. Net sale is calculated by subtracting discounts, allowances, and sales return from the gross revenue generated by the company. Different costs used for the calculation of net sales affect the total profit generated by a company and its gross profit margin. However, the prices of goods sold are not considered while calculating the net sales, which plays an essential role in the calculation of gross profit margin.

The costs of goods sold, administrative expenses, and other general expenses are not considered for the calculation of net profit but are analyzed with different effects on income statement margins. If a business has any pending allowances, returns, and discounts, then required adjustments are made to determine, and net sales are reported.

On an income statement, first the gross sales, then net sales, and lastly, the costs of goods are mentioned in the direct costs section. Otherwise, the net sale made by the company is indicated on the top line, followed by the cost of sales of the direct costs section of the income statement.

Different costs that affect the net sales

Gross sales are also known as total unadjusted sales made by a company. Companies that use accrual accounting book gross sales when a transaction takes place. A company that works on cash accounting is booked after it receives cash. Some companies don’t require any costs to calculate the net sales made by the company, whereas some companies use some costs for the calculation of net sales.

As I mentioned earlier, allowances, sales returns, and discounts are three main costs that affect the net sales of a company. All of these costs are expensed after the calculation of the net sales. All these costs are required to be mentioned in the annual financial report of the company so that proper financial analysis can be ensured.

Let us learn about all of these costs one by one.

1. Discounts

Providing discounts is one of the most popular strategies used by businesses to boost their sales. Companies that work on invoicing basis give rebates to their customers if they pay their bills early.

For example, a customer will receive a 1% discount off the total bill if he pays his bill within the first ten days of a 30-day invoice. This discounting method is termed as  1/10 net 30. No notations are retroactive; a customer gets the discount if a customer pays early.

Discounts are notated the same as that of allowances and sales returns. The discounts are debited as credit assets and liability. The gross revenue generated by the company is lowered by the total amount of discount provided by the company in financial reporting.

2. Allowances:

Allowances take place when a company decides to reduce an already book revenue. The allowances don’t take place as frequently as sales returns. A seller is required to provide a partial refund to the customers if a customer makes a complaint about the goods getting damaged during the transportation or wrong products sent. The notation as a sales return would be needed in such scenarios.

The seller would be required to debit it from the expense account and credit it to the asset account. This expense will become part of the income statement and will affect the value of revenue generated by the company negatively.

However, net sales allowances are different than write-offs. A write-off is an expense debit from the account, which simultaneously reduces asset inventory. Write-offs take place when goods are damaged or lost. The write-offs take place before the sale is made, not after.

3. Sales return:

Sales returns are a prevalent practice in retail businesses. That means the company allows its customers to return the products that they bought with a full refund only if they return it in a specified number of days. Return option might be liked by customers and help businesses to attract customers, but it makes the financial reporting complex.

Companies that support sales return should give refunds to customers in case their customers return the products that they bought. A sales return is considered as an expense.

The sales return expense is mentioned in the income statement as a net sales cost, which is deducted from the sales revenue.

Many times, a sales return is resold by the company. In such a case, the company is required to add additional notations to the account, such as the item is accounted as inventory until it is not resold.

What is the formula for the calculation of net sales?

The net sales of a company can be defined as the sum of the total sales made by the company minus its allowances, returns, and discounts.

Therefore, the net sales generated by a company can be calculated using the following formula.

Net sales = Gross Sales – Sales Returns – Sales discounts – Allowance

If the difference between net sales of a company and business’s gross is higher than the average of the industry, then it means that the company is offering high discounts or is facing hefty returns as compared to its competitors in the industry.

How to calculate Net sales revenue?

The income statement of an organization is a financial statement that reports how much income a company is making and where that income is spent. The net sales make a critical part of the income statement. It reveals how much revenue left after subtracting allowances, sales returns, and discounts from the gross sales.

Gross sales is an unadjusted income earned by your business in a financial year. The gross sales include all the credit cards, debit cards, cash, and trade credit sales before deducting any discounts, merchandise discounts, and allowances from it.

Let us understand the calculation of net sales with the help of an example.

Let us consider that a company has gross sales of $50,000. The company faces returns worth $1000, sales allowances of $2000, and provide discounts worth $2000. By putting these figures in the above formula, the net sales can be calculated as follows.

Net sales = Gross sales – sales return – sales discounts – allowances

Net sales = $ 50,000 – $1000 – $ 2000 – $ 2000 = $ 45,000

The $45,000 will be the net sales made by the company which will be mentioned on the income statement of the company.