Understanding how net sales works is especially important when calculating your business’s revenue and determining your overall net earnings, also known as the bottom line. Knowing how to calculate net sales is one of the first steps to creating an accurate income statement for your business.
Definition and Examples of Net Sales
Net sales may sometimes be simply referred to as “sales” on financial statements, and it may also be referred to as “net revenue.” Although sales and revenue are often used interchangeably, there is a slight difference in their meanings. Sales generally refers to the money earned from purchases by consumers, whereas revenue generally includes all income made by a business, including other sources besides its sales. Net sales is the amount of sales calculated after sales returns, discounts, and allowances are deducted from gross sales. For example, if a business determines it has sold a certain amount of products, these deductions must be accounted for in terms of those goods to get an accurate representation of the numbers. This provides insight to understand the amount to which the business has profited and can actually be calculated in a business’s overall finances. Because net sales depends on several components, it is important to record data accurately, typically in a ledger, so that net sales can be calculated accurately.
How Net Sales Works
Net sales is typically included on a financial document known as the income statement. An income statement is essentially a summary of the amount of income and expenses generated within a specified time period. The net sales of a company is listed at or near the top line of an income statement and, depending on its layout, may be included in the revenue section. To calculate net sales, a simple formula can be used: Net Sales = Gross Sales - Sales Returns - Discounts - Allowances For example, if your business sold a total of $50,000 worth of merchandise, but you haven’t accounted for returns, discounts, or allowances, then your gross sales would be $50,000. This amount would be placed at the very top of the income statement. This simply means you sold $50,000 worth of products but it doesn’t necessarily mean your business has all that income from the sales because other deductions have not yet been considered. From your gross sales calculations, you can subtract the amounts for sales returns, discounts, and allowances. Let’s say you find the sum of these three to equal to $5,000—then your net sales would equal $45,000, as the table below illustrates. $45,000 = $50,000 - $2,000 - $2,000 - $1,000
Types of Deductions that Affect Net Sales
The amount of net sales that is calculated on an income statement is affected by different types of deductions, as noted in the formula:
Sales returnsDiscountsSales allowances
Sales Returns
Sales returns include any returns of products purchased by consumers. For example, if a customer buys something from a retail store but later decides to bring the product back to the store for a refund, it is a return. The amount of that refund would be included under returns when placed on an income statement, and is deducted from gross sales to calculate net sales.
Discounts
Discounts are another type of deduction. When a discount is applied, the price of the product is reduced, usually by a percentage of the original price. Discounts also are deducted from gross sales to calculate net sales. There can be many different types of discounts, including seasonal discounts, which are applied at certain times of the year when demand decreases, cash discounts, and quantity discounts for bulk buying.
Sales Allowances
Like discounts, sales allowances are also deducted from a product’s original price; however, an allowance is deducted for a specific reason on a particular product. Discounts are generally available for every customer, but allowances are mostly applied to issues with the products or their orders. For example, if a product has a defect or damage, an allowance may be provided because that particular product is not up to the standard of other similar products ordered.
