Your company’s sales represent amounts you are paid for selling a product or service. However, you may not receive full payment from the invoices you send to customers. Your total sales (gross sales) may be reduced by sales returns, allowances and discounts. You make these adjustments to calculate net sales. Businesses do not immediately receive all of their sales in cash.
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EditUnderstanding Sales
- Review the net sales formula. Sales represents the total units you sold, multiplied by the sale price per unit. The formula for net sales is (Gross sales) less (Sales returns, allowances and discounts). Net sales is important to the people who read and use your financial statements. Your gross sales are total sales before any adjustments.[1]
- The net sales total is the most precise figure for the sales that your firm generates.
- Sales generate revenue. Revenue is defined as the amount of money a business receives in a period. Most of the revenue generated by a business is from selling a product or service.[2]
- Your company can also generate revenue from non-sales activities, such as selling a building or a piece of machinery.
- Use the accrual method of accounting for your sales. The accrual method recognizes revenue when it is earned and expenses when they are incurred. Since sales generate revenue, you should post sales using the accrual method. [3]
- You can recognize revenue from sales when you send an invoice to the client, or when your physically deliver the product. Every company has a policy for recognizing sales revenue.
- This accounting method matches revenue with expenses. It is a better indicator of company profit than the cash method of accounting. The cash method recognizes revenue when cash is received. Expenses are posted when cash is paid.[4]
- Generally Accepted Accounting Principles (GAAP) requires most businesses to use the accrual method of accounting. All companies of any size need to conform with GAAP rules. Only a very small business with a single owner would use a different method than accrual accounting. Those small businesses may use the cash method.[5]
- Compute gross sales. Gross sales is the total amount of products and services sold during a period of time. You can think of gross sales as the total dollar amount of invoices that you sent to clients. Invoices are sent to request payment for a sale.[6]
EditDeducting Sales Returns, Allowances and Discounts
- Subtract sales returns. A sales return occurs when a customer returns merchandise to you. Typically, a sales return happens when the goods are defective or damaged. If you buy a pair of pants and notice that the stitching is coming apart, for example, you would expect to return the item for a full refund. Assume you have $50,000 in returns.[7]
- Account for sales allowances. A sales allowance is a reduction in price charged by the seller. The reduction could be due to a problem with the goods sold. For example, the quality of the items sold did not meet the seller’s standards. If there is a mistake in the number of items shipped, or an error in the sale price, the seller may post a sales allowance. Say that sales allowances total $40,000.[8]
- Post a sales discount. A sales discount is a reduction in the sale price, in exchange for an early payment from the buyer. In this case, the seller would prefer to collect cash early, even the cash received is less that the amount billed to the customer. Offering sales discounts can improve the company’s cash flow. Assume that sales discounts total $60,000.[9]
EditPosting New Sales to the Income Statement
- Calculate net sales. Assume that your gross sales total $1,000,000. You have $50,000 in sales returns, $40,000 in sales allowances and $60,000 in sales discounts. Your net sales would be ($1,000,000 - $50,000 - $40,000 - $60,000 = $850,000).
- Post net sales to the income statement. The income statement presents revenue less expenses equals net income (profit). This financial statement is created for a specific period of time, such as a month or year. Net sales should be added to other revenue in the income statement.[10]
- Analyze the income statement to make business decisions. You can compare the results in income statement to the amounts you budgeted for the period. This analysis can help you make informed business decisions to improve your company. If net sales were lower than budgeted, you may consider lowering your sales price to attract more customers.
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