Net sales definition
/What is Net Sales?
Net sales is total revenue, less the cost of sales returns, allowances, and discounts. This is the primary sales figure reviewed by analysts when they examine the income statement of a business. The amount of total revenues reported by a company on its income statement is usually the net sales figure, which means that all forms of sales and related deductions are aggregated into a single line item. It is better to report gross sales in a separate line item than just net sales; there can be substantial deductions from gross sales that, if hidden, would prevent readers of the financial statements from seeing key information about the quality of sales transactions.
Presentation of Net Sales
The best reporting method for net sales is to initially report gross sales, followed by all types of discounts from sales, followed by a net sales figure. This level of presentation is useful for seeing if there have been any recent changes in sales deductions which may indicate problems with product quality, overly large marketing discounts, and so forth. If there are large discounts from sales, the reason for them should be disclosed in the accompanying notes to the financial statements. This level of detailed reporting may be employed for internally-generated financial statements, so that managers can take action to address any excessive discounts from gross sales.
If a company's income statement only has a single line item for revenues that is labeled "sales," it is usually assumed that the figure refers to net sales.
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Transactions Affecting Net Sales
There a number of transactions that can reduce the gross sales of a business, resulting in net sales. These transactions are most likely to arise for businesses that sell physical goods, and least likely for those that sell services. These transactions are clustered into the general categories of sales allowances, sales returns, and sales discounts, which are discussed below:
Sales allowances. A sales allowance is recorded when a customer complains about the condition of received goods, and negotiates for a reduced price. Since the seller has already booked the full amount of the sale, this reduction is recorded as a credit (reduction) of accounts receivable and a debit (increase) of the sales allowances account. The sales allowances account offsets and reduces gross sales. A sales allowance is relatively uncommon; in many cases, a business may not choose to record these transactions in a separate account. Instead, they are recorded in a sales returns and allowances account, which lumps together all sales allowance and sales return transactions (as described next).
Sales returns. A sales return is recorded whenever goods are returned by a customer. This is most common in a retailing environment, where retailers routinely allow returns within a certain number of days of the initial purchase. The accounting for a sales return is to credit (reduce) the accounts receivable or cash account by the amount paid back to the customer, while debiting (increasing) the sales returns account. The sales returns account offsets and reduces gross sales. In addition, the returned goods are returned to inventory or scrapped, depending on their condition.
Sales discounts. A sales discount is recorded when a customer takes an early payment discount when paying a bill to the seller. For example, if a seller offers a 2% discount if the customer pays within 10 days of the invoice date, then the 2% reduction in the amount paid is recorded in the sales discounts account. Recording these discounts is always done after the initial sale has been booked, since it is impossible to predict which customers will take the discount. The accounting for a sales discount is to credit (reduce) the accounts receivable account by the amount of the discount taken, while debiting (increasing) the sales discounts account. The sales discounts account offsets and reduces gross sales.
The accounting for these transactions is to record them in a sales allowances, sales returns, or sales discounts account. For presentation purposes, they offset gross sales to arrive at net sales.
Example of Net Sales
As an example of net sales, if a company has gross sales of $1,000,000, sales returns of $10,000, sales allowances of $5,000, and discounts of $15,000, then its net sales are calculated as follows:
$1,000,000 Gross sales - $10,000 Sales returns - $5,000 Sales Allowances - $15,000 Discounts
= $970,000 Net sales
Analysis of Net Sales
A good way to analyze net sales is to calculate the difference between a firm’s gross sales and net sales, and then compare this percentage to the reported results of competitors. If the business is reporting a larger percentage difference, it is likely that the organization is either being forced to offer higher discounts than competitors, or has to accept more product returns than the competition. Management would certainly be interested in such a result.