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Net sales is the total number of sales that a business makes minus the discounts, sales returns, and allowances. Net sales are different from gross sales because the latter does not take sales returns, allowances, and discounts into account. Net sales are part of the income statement and they ensure that an accurate figure is provided when analyzing the financial statement. You will typically see the gross sales mentioned first in the income statement. Then you will see deductions and discounts. After these expenses, you will see net sales. Net sales can be calculated annually or they can also be calculated quarterly depending on the business.
The net sales value must be regularly analyzed by you because it is an important metric. For example, if the difference between gross sales and net sales is big then it means your business is getting product returns or giving more discounts than others. You cannot calculate net sales accurately if you do not know the gross sales, returns, allowances, and discounts. This is why a software solution like TallyPrime is crucial for MSMEs to ensure every sale is recorded so it can be used to calculate net sales and other important values that the business can use.
The formula for net sales is as follows.
Net sales = Gross sales – Returns – Allowances – Discounts
Gross sales value refers to the total revenue that your business generates before discounts, returns, and allowances. The gross sales will include sales that have been made with a debit card, cash, credit card, and trade credit. Gross sales is calculated by multiplying the total units sold by the sale per unit price.
Returns or sales returns refers to the goods that have been returned by the customers in exchange for a refund for the goods. Generally, businesses are expected to make a full refund to their customers when customers make a return.
Allowances refers to the price reduction of goods that have been found to be defective or which have been damaged. For example, if a customer bought a product and found that the product isn’t in perfect condition, then the partial refund will be an allowance and will be accounted for in the net sales calculation.
Discounts are given by the business to customers if they meet a certain criterion. For example, if a customer makes the complete payment in one go then he will receive a discount of 5%. This will be the sales discount and this will be used when calculating the net sales.
Note that the sales value does not include the sales tax. This is because the seller is not earning the taxes and so it is not his revenue. Sales taxes are going to the local government and so it is their revenue and not the seller’s. Although the seller is collecting the taxes on behalf of the government, it is eventually the government that is receiving those taxes from sales. Generally, businesses will include it in the sales taxes payable. When the tax is paid to the government, you will see a reduction in the sales taxes payable.
You can better understand the formula for net sales with an example.
Let us say that a business had a total revenue of 90,000 in a month. The customers who paid within 15 days were given discounts of a total of $1000. Some products were damaged and so the allowance was $100 in total during the same period. The business also provided a full refund of $500 to the customers who returned products because the products didn’t meet their expectations. Based on this information, let us calculate the gross sales and the net sales.
The net sales will be computed with the formula net sales = gross sales – returns – allowances – discounts. The net sales would be $90,000 - $500 - $100 - $1000 = $88,400.
Net sales is important because it is more accurate in comparison to gross sales. It provides an insight into your business and how much you are earning. This gives you a glimpse of your business health as it highlights the costs that are incurred when making sales. This allows you to know if you are meeting your target sales and if you are actually making money rather than spending more on returns and discounts. It helps drive business decisions because you can make better decisions when you have computed net sales. Let us say your net sales value is lesser than expected, it shows that you need to change your marketing or make changes to the prices to make more sales to meet your target.
When business owners, investors, and others look at the gross sales of a business, they get a skewed figure of sales. This can be misleading when making key decisions and this is the reason why net sales are said to be more accurate. Imagine if a business owner gets to know that they are making several thousand in sales while in reality a lot of products are getting returned or losses are taking place due to damage and defective items. In reality, no matter how careful a business owner is, mistakes happen and so the net sales provide a realistic view of the sales.
When you know that products are being returned more than the industry standard or that products are being purchased only after discounts, it is time to rethink your strategies. In the case of discounts, you can provide them only when customers reach a specific threshold of having spent a certain amount so you have more sales. In the case of more returns, you can take a proper look at the most common reason behind returns and then rectify it so that it doesn’t happen as often anymore. You might need to speak to the manufacturing department to ensure the products are nothing short of perfect.
You can only get accurate results when you have reliable financial records. TallyPrime empowers you to stay on top of your finances by recording and organizing your financial reports. It is a business management solution for MSMEs that allows you to generate all financial statements so you know the financial position of your business. It allows you to manage cash flow, inventory, and payroll. It enables you to manage more than one business and store data of different branches for easy accounting from one place. It provides advanced security and banking features so you can do complex accounting with a single software package.
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