What is Net Credit Sales?
Net Credit Sales refers to the revenue that gets generated by a company when it sells its goods or services to its customers on credit, less all the sales returns, as well as sales allowances.
Net Credit Sales Formula
- Sales Returns – It refers to the credit that gets issued to a customer, due to any problem which is usually caused by shipment or service provided to that particular customer
- Sales Allowances – It generally refers to the reduction in price that gets charged to a customer which is usually due to a problem with the sale transaction which does not involve the goods or the service being delivered
John and co happened to sell goods worth $50000, of which they happened to collect cash worth $25000. They also accepted a sales return from a customer who received faulty goods worth $2000 and granted a sales allowance of $500 for another customer. Calculate the total net credit sales for John and Co.
- = 22500
Hence if one were to consider the sales allowance and also the sales returns, the final net credit sales would finally stand to $22500.
- Provides Break-up: Net credit sales would tend to provide a perfect picture through a break up of values between sales returns and also sales allowances thereby helping the firm to understand the true picture of the amount that can be realized during any particular period
- Monitor Receivables: By keeping a watch on the total net credit sales of any company, it helps the management to closely monitor the total receivables that it expects to receive. An increase in the same would stand to create liquidity problems for the company and thus help the management to be cautious in this regard
- Preservation of Ratios: By helping a company understand the total receivables it has in hand after considering any addition of net credit sales, it helps the company to gauge the liquidity ratios that it currently has, which are usually cash and quick ratios. If it happens to find out that the ratios are depleting, it stands as a red signal for the company. Hence it facilitates the maintenance of ratios as desired by the company, and any deviation or discrepancy will help the management take corrective action in this regard
- Facilitates the Creation of Ledger: A company can tend to create a receivable account in the name of every customer and thereby track the associated amount with each customer that it is linked to. This action facilitates necessary segregation through the creation of ledger books thus prompting the company to take the required collective action against the required customer from whom the amount stands as overdue
- Goes into Ratio Analysis: It forms an essential part of having to calculate ratios such as receivables turnover ratios, as the net credit sales, which is the credit sales after deducting the sales returns from customers, goes on to be the numerator which is then divided by the receivables to arrive at the receivables turnover ratio
Given below are some of the disadvantages-
- Delay in Collection: There may be times when certain addition of additional debt through net credit sales may create collection problems for a firm. The 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. may not give the necessary amount in time thereby affecting the liquidity of a company, and this is certainly not a good sign for the company
- Additional Expenses: The amount being forfeited due to sales returns given for a default in service terms or a faulty product tends to be unnecessary expenses for the firm, and the same could have been possibly avoided if there were necessary scrutiny and due diligence in place
- Creation of Bad Debts: As indicated earlier, if the receivables are not collected in time, it may lead to the creation of certain bad debts, which may be an additional burden and expense for the company. There may be a requirement of certain provisions that have to be set up in place to tackle the issues which cause liquidity concerns for the management.
Net credit sales, being the total of credit sales that is arrived at after considering the impact and deducting sales returns and also the sales allowances, form an important part of ratio analysis as it becomes a part of numerator facilitating the calculation of receivables turnover ratio. Moreover, it helps the management in having to gauge and measure the total receivables it is owed and thereby keep a check on the same so that there is no pressure of additional liquidity crunch created owing to such measures.
However, if the net credit sales are unchecked, it may accumulate into a phenomenal amount of receivables. It may then become a significant burden to the company as it may create problems 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., and certain provisions may be required for such bad debts, which are again unnecessary expenses for the company. The debtorsDebtorsDebtors refer to the party to whom the goods are supplied or sold on credit by another party and the former owes money to the latter, whereas, a creditor is a party that supplies the product or services to another party on credit and has to receive the money from the latter. may not pay on time, and this may go on to have a huge toll on the company.
It may no doubt facilitate break up and provide a greater understanding of information by providing ratio analysis and also by serving as a pre-check to help the management plan out its working capital managementWorking Capital ManagementWorking Capital Management refers to the management of the capital that the company requires for financing its daily business operations. It is important for the company in order to maximize its operational efficiency, manage its short term liabilities and assets properly, avoiding the underutilization of the resources and avoiding the overtrading, etc.. Hence it becomes imperative and necessary for the company to have an excellent method of checks and balances in place so that the attention towards managing liquidity by having a good look at receivables does not go unattended at.
This article has been a guide to what is net credit sales and its definition. Here we discuss the formula to calculate net credit sales along with an example, advantages, and disadvantages. You can learn more from the following articles –