What is Credit Sales?
Credit Sales refer to sales in which customer or purchaser is allowed to make payment at a later date instead of making payment at the time of purchase. In this type of sales, the customer is getting adequate time for making payment.
There are mainly three types of sales transactions are happening, which are as below:
- Cash Sales – Cash sales refer to sales in which customer is making payment at the time of purchase.
- Credit Sales – It refers to sales in which customer is making payment at a later date.
- Advance Payment Sales – Sales in which customer has to make payment before sales.
Terms Related to Credit Sales
- Credit Limit – Credit limit is the maximum amount up to which the company can sell his material to a particular customer as credit sales.
- Credit Period – Credit period refers no. of days under which the customer has to make payment to the seller or when payment will be due for credit sales.
A Credit Sales Journal Entry
Below is the journal entry for recording it in the books of account.
The following are credit sales journal entry examples of this concept to understand it better.
Walter is a dealer of mobile phones, and he is selling goods to Smith on 01.01.2018 of $ 5000 on credit, and his credit period is 30 days, which means Smith has to make the payment on or before 30.01.2018.
Below are the Journal entries in the books of Walter.
Sometimes the Company gives a cash discount or an early payment discount. Assume in the above example, Walter is giving a 10% discount if Smith makes the payment on or before 10.01.2018, and Smith makes his payment on 10.01.2018.
Below are the Journal entries in the books of Walter.
Assume in the above example, John is not able to make payment by 30.01.2018, and he got bankrupt, and Walter believes that now outstanding is unrecoverable, and it is bed debt now.
Below are the Journal entries in the books of Walter:
At the end of the financial year, Walter will pass entry for bed debt.
- Credit sales with good credit policies give competitive advantagesCompetitive AdvantagesCompetitive advantage refers to a benefit availed by a company that has remained successful in outdoing its competitors in the same industry by designing and implementing effective strategies in offering quality goods or services, quoting reasonable prices and maximizing the wealth of its stakeholders. to the organization.
- Such policies help newly set up organizations in increasing sales.
- It develops trust and relation between the customer and the company.
- It helps those customers who do not have enough cash to make payment at the time of purchases, and they can make payment after 15 days 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 can attract new customers.
- Here, 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 cash flow of the companyCash 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 will receive at a later stage.
- The company has to incur expenses 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.
- The company has to maintain separate books of accounts for accounts receivableAccounts ReceivableAccounts receivables refer to the amount due on the customers for the credit sales of the products or services made by the company to them. It appears as a current asset in the corporate balance sheet..
- There is a notional loss of interest during the credit period because money is getting 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 person or entity that owes money to the other party in a transaction. The receiver is referred to as the creditor, and the payment terms vary for each transaction based on the terms and conditions agreed upon by the parties. will show in assets side of the balance sheet under current assets if there is any outstanding as on 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..
Credit Sales is a type of sales in which companies are selling goods to the customer on credit on this basis of the credibility of customers. It gives time to the customer that they can make the payment after selling the purchased goods and do not require to invest their own money into a business. It helps small businesses, especially those who do not have enough capital; at the same, it helps big companies also because it attracts the customer.
In credit sales, there is always a risk of bad debt. It means if a customer is not able to make payment or fraud or not traceable, then in that situation, it is very difficult to get money and become bed debt. It increases the cost of capital also because customers giving payment after 15 days or 30 days depends on their credit terms. In such a scenario company’s capital gets blocked for these days, and there is a loss of interest. So it is a very good option for new companies as well as it is a costly affair.
This has been a guide to what is Credit Sales?. Here we discuss the most common examples of a journal entry of credit sales along with explanations, advantages, and disadvantages. You can learn more about accounting from the following articles –