Credit Sales Meaning
Credit Sales refer to sales in which the customer or purchaser is allowed to make payment later instead of at the purchase time. In this sale, the customer gets adequate time to make payment.
Terms Related to Credit Sales
- Credit Limit – The credit limit is the maximum amount the company can sell its material to a particular customer as credit sales.
- Credit Period – Credit periodCredit PeriodCredit period refers to the duration of time that a seller gives the buyer to pay off the amount of the product that he or she purchased from the seller. It consists of three components - credit analysis, credit/sales terms and collection policy. refers to days under which the customer has to make payment to the seller or when payment will be due for credit sales.
Table of contents
- Credit sales mean sales in which the customer or purchaser can make payment later rather than at the purchase time. In this sale, the customer has sufficient time to make the payment.
- Credit limit and credit period are the terms related to credit sales.
- In these sales, there is always a bad debt risk. If a customer cannot pay, do fraud, or is untraceable, it may be challenging to obtain money. As a result, it will become a bad debt and increase the cost of capital if customers pay after 15 days or 30 days, based on the credit terms.
Credit Sales Explained
Credit sales are a type of sales in which companies sell goods to the customer on credit based on the credibility of customers. It gives the customer time to make the payment after selling the purchased goods and does not require them to invest their own money into a business. It helps small businesses, especially those that do not have enough capital. At the same, it helps big companies also because it attracts customers.
In credit sales, there is always a risk of bad debt. If a customer cannot make a payment, commits fraud, or is not traceable, it will be challenging to get money. It will become a bad debt in that situation. It can also increase the cost of capitalCost Of CapitalThe cost of capital formula calculates the weighted average costs of raising funds from the debt and equity holders and is the total of three separate calculations – weightage of debt multiplied by the cost of debt, weightage of preference shares multiplied by the cost of preference shares, and weightage of equity multiplied by the cost of equity. cost if customers pay after 15 days or 30 days, depending on their credit terms. In such a scenario, a company’s capital gets blocked, and interest is lost. So, it is an excellent yet costly option for new companies.
Below is the journal entry for recording credit sales in the books of account:
Examples of Credit Sales
The following are credit sales journal entry examples to understand the concept better:
Walter is a dealer of mobile phones, and he is selling goods to Smith on January 1, 2018, for $5,000 on credit; his credit period is 30 days, which means Smith has to make the payment on or before January 30, 2018.
Below are the journal entries in their books of Walter:
Usually, a company gives a cash discount or an early payment discount. In the above example, Walter is offering a 10% discount if Smith makes the payment on or before January 10, 2018. Accordingly, Smith made his payment on January 10, 2018.
Below are the journal entries in their books of Walter.
Let’s assume in the above example that Smith cannot make payment by January 30, 2018, as he has gone bankrupt. Now, Walter believes that the outstanding amount is unrecoverable and is bad debtBad DebtBad debt expense is an expense recorded in financial statements when the amount receivable from debtors is unrecoverable owing to the debtors' inability to meet their financial obligations and can be calculated using the direct method of allowance/estimation method. now.
Below are the journal entries in their books of Walter:
Walter will pass entry for the bad debt at the end of the financial year:
- Credit sales with good credit policies give competitive advantagesCompetitive AdvantagesCompetitive advantage refers to an advantage availed by a company that has remained successful in outdoing its competitors belonging to the same industry by designing and implementing effective strategies that allow the same in offering quality goods or services, quoting reasonable prices to its customers, maximizing the wealth of its stakeholders and so on and as a result of which the company can make more profits, build a positive brand reputation, make more sales, maximize return on assets, etc. to the organization.
- Such policies help newly set up organizations in increasing sales.
- It develops trust and relationships between the customer and the company.
- It helps those customers who do not have enough cash to make payment at the time of purchase and can make payment after 15 or 30 days as per the credit term.Credit Term.Credit Terms are the payment terms and conditions established by the lending party in exchange for the credit benefit. Examples include credit extended by suppliers to buyers of products with terms such as 3/15, net 60, which essentially implies that although the amount is due in 60 days, the customer can avail a 3% discount if they pay within 15 days..
- Longer credit days help attract new customers.
- There is always a risk of bad debtBad DebtBad Debts can be described as unforeseen loss incurred by a business organization on account of non-fulfillment of agreed terms and conditions on account of sale of goods or services or repayment of any loan or other obligation..
- It affects the company’s cash flowCash Flow Of The CompanyCash Flow is the amount of cash or cash equivalent generated & consumed by a Company over a given period. It proves to be a prerequisite for analyzing the business’s strength, profitability, & scope for betterment. because payment is received later.
- The company must incur expensesExpensesAn expense is a cost incurred in completing any transaction by an organization, leading to either revenue generation creation of the asset, change in liability, or raising capital. on the collection agencyCollection AgencyA collection agency refers to a firm engaged in the recovery of the default loans or dues from the borrowers on behalf of the lenders or creditors. A loan provider or creditor outsources its debt-collection function to such a third party to reduce bad debts. for regular follow-up with customers for their outstanding amounts.
- The company has to maintain separate books of accounts for accounts receivableAccounts ReceivableAccounts receivables is the money owed to a business by clients for which the business has given services or delivered a product but has not yet collected payment. They are categorized as current assets on the balance sheet as the payments expected within a year. .
- There is a notional loss of interest during the credit period because money is blocked.
How to Show Credit Sales in the P&L and Balance Sheet of Seller?
- Credit Sales – It will show in the credit side of profit & loss a/c.
- Debtors – DebtorsDebtorsA debtor is a borrower who is liable to pay a certain sum to a credit supplier such as a bank, credit card company or goods supplier. The borrower could be an individual like a home loan seeker or a corporate body borrowing funds for business expansion. will show on the assets side of the balance sheet under current assetsCurrent AssetsCurrent assets refer to those short-term assets which can be efficiently utilized for business operations, sold for immediate cash or liquidated within a year. It comprises inventory, cash, cash equivalents, marketable securities, accounts receivable, etc. if there is any outstanding on the balance sheet date.
- Cash Discount – Cash discount will show the debit side of profit & loss a/c.
- Bad Debt – Bad debt will show a debit side of profit & loss a/c, and the same amount will reduce from debtors in the balance sheetBalance SheetA balance sheet is one of the financial statements of a company that presents the shareholders' equity, liabilities, and assets of the company at a specific point in time. It is based on the accounting equation that states that the sum of the total liabilities and the owner's capital equals the total assets of the company..
Frequently Asked Questions (FAQs)
Credit sales are recorded on the company’s income statement and the balance sheet. On the income statement, one must register the sale as a rise in sales revenue, cost of goods sold, and expenses.
The percentage of credit sales method determines the uncollectible debts by predicting the probability of not collecting delinquent accounts. It estimates the expenses such as bad debt or uncollectible costs depending on the net credit sales percentage.
For calculating credit sales, one must analyze the cash received. After obtaining the figures, they must know credit sales by reducing total sales by the total money received.
Accounts Receivable (AR) shows the business credit sales which still need to be collected from the customers. In comparison, Credit sales are also known as sales made on the account.
It has been a guide to what credit sales are and their meaning. Here we explain how to record credit sales in the Balance Sheet along with examples, advantages, and disadvantages. You can learn more about accounting from the following articles –