Updated July 12, 2023
Definition of Net Credit Sales
Net credit sale refers to the part of the total revenue of the company which is generated by selling the goods on the credit basis to the customer and it is calculated by subtracting the total sales return out of credit sales and the sales allowances from the gross credit sales made by the company during the period.
Credit Sales is the part of sales that is done on a credit basis i.e. cash is not to be collected immediately from sales but is collected after a specified period of time as per the policy of the company. To increase the sales the organization gives credit facilities to its customers and it is given to the persons having good market standing i.e. ability to pay for the sales made or it is given to the known customers. Generally, for a large number of sales, a credit facility is given so that the customer gets a sufficient amount of the time to resale the goods and arrange the finance. Net credit sales are calculated as sales done on a credit basis less sales return on a credit basis and sales allowance.
Formula of Net Credit Sales
The formula for Credit Sales is as follows:
- Total Credit sales refer to the total turnover of the business of a given period which is made on account to the customer i.e., on a credit basis
- Total sales return refers to the value of goods returned by the customer out of the credit sales made during the period. This is subtracted from the total credit sales value in order to calculate the credit sales value.
- Total sales allowance refers to the reduction in the price of the item sold to the customer, which generally happens in case of any issue which arises with respect to the product sold like product damage, quality issues etc. This is deducted from the total credit sales value in order to calculate the credit sales value.
Examples of Net Credit Sales
Suppose a company named Tom Inc. has made the following transactions in the financial year ending on March 2020.
- Sales Revenue was $2,000,000
- Total credit sales out of total sales: $1,100,000
- Out of the total credit sales, goods sold worth $95,000 were returned by the customer
- Also, there was a fault in one of the products delivered to the customer, so a sales allowance of $5,000 was granted to that customer
Now we need to calculate, Net credit sales of the company from the above figures.
Calculation of Net Credit Sales
|Credit Sales Revenue
|Less: Sales return
|Less: Sales allowance
|Net Credit sales
Therefore, net credit sales of the company is $1,000,000 after considering the effect of sales return and sales allowances given to the customers.
Net Credit Sales on Income Statement
Credit sale is the part of the total revenue generated by the company for the period under the consideration so it is present in the income statement of the company and it is included in the value of total sales. In other words, total sales in the Income statement of the company also includes sales made by the company on credit. It is present in the same manner as total sales as they represent gross sales amount minus sales returns and sales allowances. However, some of the companies report cash sales and credit sales separately, so in that case, it will not be part of total sales and would be reflected separately in the income statement along with the cash sales.
Importance of Net Credit Sales
Importance of Credit Sales is described as under:
- It helps in increasing the revenue of the organizations so that the targets can be easily achieved.
- It helps to determine the amount which is recoverable from debtors and the risk involved in the amount which is due and not recovered so that the provision can be made.
- It is important in ratio analysis as it is useful in the calculation of the receivables turnover ratio.
- It helps to manage the liquidity position in the organization as debtors are considered liquid assets.
The advantages of Credit Sales are as under:
- Net credit provides the position of the net amount to be recovered i.e. after deducting the discounts and allowances.
- Credit sales are also helpful in managing the cash flow so that it is to be ensured that no liquidity crunches arrive.
- Credit sales can be easily converted into cash hence it is useful for maintaining the liquid ratios.
- Through the recording of credit sales, the tracking of customers becomes easy.
- It reflects a clear picture of the organization and helps in further decisions and actions that are required to be taken.
Disadvantages of Credit Sales are described as under:
- There might be problems in the collection of net credit sales because of default by the customers.
- The credit sales might increase the expenses as the collection expenses are to be levied.
- Credit sales increase the risk of bad debts as there is no guarantee that the customer will pay them back.
- Due to the risk involved in net credit sales, the risk of bad debts also increases.
Net credit sale is calculated as credit sales made to customers less sales return less the allowances if any. Net credit sales increase the liquidity as the debtors are considered the liquid asset. But business organizations try to make credit sales to the persons from whom there is no or less risk of being the default. As there is no guarantee of collection from customers there is risk involved in the credit sales as there are chances of bad debts and due to which organization may lose the income as well as it creates a negative impact on the investments.
This is a guide to Net Credit Sales. Here we also discuss the definition and net credit sales on the income statement along with advantages and disadvantages. You may also have a look at the following articles to learn more –