What are Net Sales?
Please note that this article is intended for educational purposes only and should not be deemed to be or used as legal, employment, or health & safety advice. For guidance or advice specific to your business, consult with a qualified professional.
Net sales are one of the most important sales metrics to track. Your total sales revenue is subject to all kinds of deductions. When these are taken away, what’s left is your net sales for a given period. Accounting for net sales can make it easier to determine other financial health KPIs.
For instance, calculating your company’s net sales can help you to ascertain its gross profit margin. This can be calculated by deducting your cost of goods sold (COGS) from your net sales.
While COGS is not factored into net sales, you can calculate net sales by removing the value of deductions that are factored in. These include:
- the value of returned sales
- discounts provided to customers
- allowances such as partial refunds that are negotiated with your customers
Net sales may be used by outside analysts and investors to determine how the above costs differ between your company and your industry average.
Example of net sales
Let’s say you run a boutique clothing store. You made £5,000 in total sales last month – this is your gross sales revenue for the period. However, some of the items sold were discounted by 50% because they were left over from last season. This accounts for £500 of discounts. What’s more, several items were returned because they were either unwanted gifts or did not fit properly. These combine to make a further £400 in returns (a fairly industry-typical 8% of sales).
Finally, a customer complained that a £200 sweater that was ordered online was damaged in transit. You are unable to replace it, and the customer would prefer to keep it. As a goodwill gesture, you agree to give them a partial refund of 40%. A 40% allowance on a £200 sweater is £80.
To calculate the store’s net sales, we remove these three sets of deductions from the £5,000 total sales revenue.
- £500 in discounts + £400 in returns + £80 allowances makes £980 deductions
- £5,000 - £980 is £4,020
- Net sales for the month = £4,020
As we can see, net sales total a little over 80% of gross sales.
Net sales vs gross sales
As discussed above, a company’s gross sales are calculated by deducting cost of goods sold (COGS) from total sales revenue. Whereas net sales are calculated by deducting discounts, allowances and returns from gross sales. The proportion of net sales to gross sales may be of interest to internal and external stakeholders. If the margin between gross and net sales is particularly large, it may indicate that you have a higher than average rate of returns, or have been giving more discounts to customers than your competitors. This may raise potential concerns about your short-term profitability.
Frequently asked questions about net sales
Why is it important to calculate net sales?
Calculating net sales helps you to determine how much of your gross sales revenue is lost to returns, discounts and allowances. By measuring the ratio of gross to net income against your competitors, you can see how much potential revenue is lost to these costs.
Do I use net sales or gross sales when reporting to HMRC?
As a rule, any income your business receives should be declared as gross income when reporting to HMRC. Whether you receive it as gross or net income. However, when reporting sales, it is best to report net sales as your company has not received the income from returned or discounted items.
How can my company improve net sales?
If your net sales are substantially lower than your gross sales, there are steps you can take to improve net sales. Being less generous with your discounts, upselling, and finding other methods of building value for the customer before you offer a discount or allowance. These can still incentivise sales without the need to discount the cost of your goods.
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