Net sales show the revenue your company makes after deductions such as discounts, returns, and allowances are subtracted from your total profits. They are different from gross sales, which represent total sales before any deductions during a certain period. Finding net sales will help you create an income statement, a valuable planning tool for anticipating your income and expenses.
Comparing net sales to gross sales, you can determine quality issues that may be present within your business. You can see how much product is being damaged or returned and adjust your operations accordingly. This difference also sheds a light on if the discounts you are offering are helping or harming your profits.
Types of deductions
As a small business owner, you encounter some transactions that work against your incoming money. Understanding these factors can help you pin down where losses are taking place. Here are three kinds of deductions that are subtracted from gross sales:
Discounts – Discounts allow a customer to deduct a percentage of their total invoice in exchange for paying that amount early or in cash. These offers will reduce your account receivables and bring payments to you faster.
Example: If you send a customer an invoice for $5,000, you could offer a 2 percent discount if they pay you within fifteen days. The discount would be a $100 deduction from your gross sales. Discounts may also be offered as special offers or coupons during holidays, annual events, or seasonal promotions. A discount deduction in net sales is the difference between the price of a good and the amount a customer paid for that good.
Returns – Customers return products for a number of reasons and, depending on your business’s return policy, they receive a cash refund or credit. If the good returned is undamaged, it may be resold to another customer. It is important to record both sales and the purchase return journal entry when calculating net sales if this occurs.
Example: Perhaps you run a home decorating store and a customer buys a lamp. Later, they change their mind and return it. If you are now selling that particular kind of lamp at a lower price, you will see a deduction from your gross sales even if it is resold.
Allowances – If a product has a small defect or was damaged before a sale, a customer may still be willing to buy it with a price reduction, or an allowance.
Example: Let’s say you own a clothing business and the shirt your customer wants to purchase has a hole in it. You offer 10 percent off the price to make the sale. The amount subtracted from the total is included in your deductions.
How to find net sales
It is important to carefully record both your company’s gross sales and deductions in order to find net sales. To calculate net sales, use the net sales equation.
Net Sales Formula
Gross Sales – Deductions = Net Sales
Discounts, returns, and allowances make up what is called a contra account. The items recorded in contra accounts are designed to offset the balance of another account. In net sales, the contra account (deductions) is designed to reduce gross sales. Contra accounts keep your accounting records clean by showing how your company arrived at the net sales figure on reports.
Using net sales numbers
Knowing your net sales is important for various reasons. You may find that your company acquires high deductions, and adjustments should be made to minimize money taken from gross sales. For example, setting higher quality control standards to reduce the risk of damaged products should lower your allowances and returns.
Net sales are needed for reporting in documents such as income statements and tax forms. Net sales are also the starting point to finding other important figures. Once calculated, you can deduct the cost of goods sold (COGS) from your net sales to find gross profits. Knowing your net sales means understanding your company’s true revenue.
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