For profit-based companies and organizations, revenues are highly critical. These represent the income they make during an accounting period. However, some items may also adversely impact these revenues. According to accounting standards, companies must record and report these items separately. This process is crucial in calculating a company’s net sales, which goes on the income statement.
What is Net Sales?
When a company makes sales, it records the amount as revenues. These revenues contribute to a company’s gross sales. However, accounting standards require companies to report their net sales on the income statement. Through this, companies can give a more accurate and better representation of the operations involving their revenues.
Net sales is a company’s gross sales less its sales returns, allowances, and discounts. It represents the first item on the income statement. Usually, companies also provide a calculation of their net sales in the notes to the financial statements. However, the net sales figure may not be a part of every company’s financials. Some companies may not offer discounts, returns, or allowances at all. But for companies that do provide these, the net sales figure is crucial.
What are the components of Net Sales?
The most critical component of the net sales figure is gross sales. For most companies, this amount represents the total revenues generated during an accounting period. However, gross sales does not impact the net sales if the other critical components do not exist. An explanation of each of these components is as below.
Sales Returns
When companies sell physical products, they may also offer their customers the option to return them. Usually, they attach specific terms and conditions to these returns. Sales returns include any products received back from customers due to various reasons. For companies, these returns decrease the total revenues generated during an accounting period.
Sales Allowances
In some circumstances, companies may also offer their customers sale allowances. They are similar to discounts but differ from trade or cash discounts. Companies grant sales allowances after customers receive goods. Usually, it involves giving customers an incentive to reduce the possibility of sales returns. Companies often offer sales allowances to customers when their delivered products have issues.
Sales Discounts
Sales discounts are cash discounts provided to customers. With these discounts, companies do not reduce the price of the goods delivered. Instead, it entails decreasing the overall sum paid for those goods in case of early payment for credit sales. Therefore, sales discounts offer the customers an incentive to compensate the company before the credit term.
What is the formula for Net Sales?
The formula for net sales is straightforward after understanding its definition. As mentioned, it is a company’s gross sales after reducing returns, allowances, and discounts. Therefore, the net sales formula will be as follows.
Net Sales = Gross Sales – Sales Returns – Sales Allowances – Sales Discounts
As mentioned, companies usually present this formula in the notes to the financial statements. The net figure then goes into the income statement.
Example
A company, Green Co., made sales of $500,000 during an accounting period. However, some of its customers returned goods worth $50,000 during the period. Similarly, Green Co. offered sales allowances worth $30,000 to customers to avoid sales returns. Lastly, the company provided discounts of $20,000 during the period for early settlements. Therefore, Green Co.’s net sales will be as follows.
Net Sales = Gross Sales – Sales Returns – Sales Allowances – Sales Discounts
Net Sales = $500,000 – $50,000 – $30,000 – $20,000
Net Sales = $400,000
Conclusion
Net sales is a company’s gross sales minus sales returns, allowances, and discounts. This figure is a part of a company’s income statement. Similarly, companies may provide a breakup in the notes to the financial statements. Apart from the gross sales, three components are critical for calculating net sales. These include returns, allowances, and discounts.
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