Definition of Net Credit Sales
Net credit sales refer to the total sales revenue that businesses produce after deducting sales returns and sales allowances from the credit sales.
As a business owner, you need to keep your sales payments active to avail the outstanding revenue flow. However, please note that cash sales are not applicable everywhere. Sale on credit or buy on credit is another option you can opt for to increase sales volume.
That’s why understanding net credit sales is a necessary part of any business owner’s toolkit. The process involves sales for which the customer pays later. In simple terms, it means customers are not paying on an immediate basis; instead, they pay the total amount with credits.
In the following sections, you’ll explore the real answer to what net credit sales are, their formula, and calculation. We’ll also show how to utilize the net sales on credit for better business.
📌 Key Takeaways
- Net credit sales represent total sales that are made on credit, minus any returns and allowances.
- It doesn’t include cash transactions.
- The primary use of net credit sales is to calculate key metrics, such as accounts receivable turnover.
- Higher net credit sales can lead to cash flow delays.
- Net sales on credit are most commonly useful in business-to-business (B2B) sales.
💡Have You Heard?
In the USA, the total outstanding consumer credit reached approximately $5.05 trillion in the first quarter of 2024.
What Are Net Credit Sales?
Net credit sales refer to the total revenue generated from the sales made on credit. Returns, discounts, or allowances are excepted from it. According to this, sales returns reduce the total credit sales and allowances.
It involves deferred payment, which affects the company’s financial health. Net sales on credit play a valuable role in financial reporting by providing a more accurate financial analysis and reliable forecasting. The data is also useful for evaluating the effectiveness of credit arrangements.
One of the most confusing moments is that people often associate net credit sales with sales made on credit cards. However, there is no such correlation that exists. It includes payments made on credit rather than cash.
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Net Credit Sales Formula
Calculating net credit sales involves using a specific formula. It’s a straightforward formula that calculates the deduction of sales returns, sales allowances, or discounts from gross credit sales. Thus, the formula looks like:
Net Credit Sales = Gross Credit Sales – Sales Returns – Sales Allowances – Discounts
Here,
Gross Credit Sales – It represents the total value of the sales made on credit before any deductions.
Sales Returns – The value of goods returned by the customers.
Sales Allowances – This covers the lowering of the selling price due to damaged goods.
Discounts – The discount amount offered to the customer for bulk purchases.
💡A Gem to Read:
How to Calculate Net Credit Sales? Step-By-Step Guide
It doesn’t require a complex strategy to follow when calculating net credit sales. As mentioned and explained in the above section, we now apply the same formula to net credit sales.
Net credit sales = All sales on credit – Sales returns – Sales allowances – Discounts
Before we determine the net credit sales, we need to calculate the correct values of total sales on credit, sales returns, and sales allowances. Here are the steps:
Step 1: Find the Total Credit Sales
This is the total amount of all sales made on credit. To determine credit sales, you can subtract the cash sales from the total sales/ gross sales. The other method involves directly tracking sales made on credit through the issuance of invoices.
Step 2: Identify the Sales Return
Determine how many sales were returned by the customer’s side. The primary reason for returning the product is the customer’s high dissatisfaction. Companies can monitor the number of returned sales and take relevant steps to address the issue.
Step 3: Identify Sales Allowances
Sales allowances refer to price reductions. Determine sales allowances or the adjustments made to the credit customer. The adjustment refers to a reduction in the original selling price of the product or service. The cost reduction is due to defects, incorrect items, and customer dissatisfaction.
Step 4: Applying Formula
Net Credit Sales = Total Credit Sales – Sales Returns – Sales Allowances
Input all the values in the formula, and you’ll get the output of the net sales you made on credits. Thus, in this way, you can find out how many sales your business has on credit.
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Net Credit Sales Example
We now understand the net credit sales through a practical scenario of the company. Suppose a company, StarWorld Pvt Ltd, sells home appliances with total credit sales of $200,000.
Out of them, some customers return the products due to manufacturing defects, which total a cost of around $10,000. The company offers sales allowances (discount) of $5,000. Thus, the company will calculate the net credit sales as follows:
Net Credit Sales = Total Credit Sales – Sales Returns – Sales Allowances – Discounts
= $2,00,000 – $10,000 – $5,000
= $1,85,000
Cash Sales vs Sales on Credit
Cash sales and sales on credit are two important metrics of the business. Cash sales include an immediate payment for the transaction. Sales on credit typically involve selling goods or services to customers on terms that allow them to pay over a specified period of time. Let’s have a clear, tabular form to examine the difference between cash sales and sales on credit.
| Cash Sales | Sales on Credit |
|---|---|
| Customer makes payment immediately at the time of purchase. | The customer is allowed to make the payment later on. |
| Cash, debit card, or payment apps are the major modes of payment. | The mode of payment includes credit card, invoice & terms of agreement. |
| Do not include customer tracking | It includes customer tracking |
| Sales volume is limited | It increases the sales volume |
| Record keeping is simple | Record keeping is complex |
How to Find Credit Sales on the Balance Sheet?
Where to find net credit sales on financial statements? Where are net credit sales mentioned on the financial statements? This question is common among professionals’ minds.
One can find the net credit sales on the balance sheet in the “short-term assets” section. It is because the customer will make the credit payment in a few weeks or months. The record of credit sales is typically under accounts receivable.
The profit and loss statement’s total sales revenue section accounts for credit sales. It also impacts the equity reports and cash flow statement.
Moreover, credit sales also appear on the cash flow statement by revising the net income.
What Are the Merits and Demerits of Net Credit Sales?
Understanding the net sales on credit is a highly valuable thing. Here, we look into some merits and demerits it offers:
Merits
-
- Net credit sales help build customer confidence because they allow for flexible credit terms. It also contributes to repeat business.
- Professionals can achieve accurate financial projections with the help of net credit sales.
- It is useful for financial analysis by calculating key ratios, such as Days Sales Outstanding and Accounts Receivable Turnover.
- Businesses can expand their market base while incorporating competitive credit policies.
- Monitoring the net sales on credit is helpful for financial stability.
Demerits
-
- Net credit sales result in irregular cash flow & liquidity issues due to deferred payment.
- Offering credits can open the doors for untrustworthy customers.
- Managing receivables requires additional resources for bookkeeping, resulting in increased administrative tasks.
- Keeps the money stuck, leading to mismanagement for daily operations
How to Use Net Credit Sales to the Benefit of Your Business?
Follow the tips below to use the net credit sales to benefit the business:
Analyse the Receivables Collection Efficiency
It reflects a company’s ability to recover outstanding customer payments in a timely manner. It is calculated by dividing the number by net credit sales and then multiplying it by the number of days in the year. The company is inefficient at converting sales on credit to cash in hand, particularly when the average collection period is longer.
Calculating Accounts Receivable Turnover Ratio
The accounts receivable turnover ratio refers to the output of dividing the net credit sales by the average accounts receivable. This indicates the business’s ability to collect money from customers who owe it.
Company’s Selling Practices
Use the net credit sales to examine your selling practices. One can review the sales returns to understand whether our sales returns are under control or not. A large volume of returns is a clear indication of quality issues, which helps keep customers satisfied.
💡Bonus Tips: Net Sales vs Gross Sales
What is the Accounts Receivable Turnover Ratio?
The accounts receivable turnover ratio is a financial metric that measures a company’s effectiveness in collecting payments from its customers in accordance with the terms of credit.
Accounts Receivable Turnover Ratio = Net Credit Sales/ Average Accounts Receivable
Here,
Net Credit Sales – Total credit sales – Sales returns – Sales Allowances – Discounts
Average Accounts Receivable:
(Opening Receivables + Closing Receivables) ÷ 2
The higher the accounts receivable turnover ratio, the more effectively the company collects payments. Business professionals can use this ratio to assess the effectiveness of their credit policy and liquidity.
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How Does Moon Invoice Ease the Net Credit Sales Process?
Moon Invoice is helpful in creating digital invoices and categorizing them as credit invoices. While enabling users to create credit notes digitally, it simplifies the credit sales calculation process.
It streamlines the recording of sales returns and allowances. Users can generate an accurate report within a minute. Furthermore, professionals can easily track sales, returns, and allowances, which helps automate the calculation of net credit sales. Business professionals can easily track their outstanding invoices and accept payments.
With the incorporation of automation, the tool removes the manual concept. This provides a clear picture of net credit sales data.
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Closing Statement
Understanding net credit sales is a key indicator in analysing a company’s performance. It provides clarity over sales performance, cash flow status, and customer credit management. This further helps predict future sales and budget forecasts. To determine the actual credit-based income of the business, calculating net credit sales is the most effective solution. It helps businesses to enhance cash flow management.
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FAQs
Is net credit sales the same as COGS?
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Jayanti Katariya is the founder & CEO of Moon Invoice, with over a decade of experience in developing SaaS products and the fintech industry. He holds a degree in engineering. Since 2011, Jayanti's expertise has helped thousands of businesses, from small startups to large enterprises, streamline invoicing, estimation, and accounting operations. His vision is to deliver top-tier financial solutions globally, ensuring efficient financial management for all business owners.
