Written by Jay Fuchs @Jay_Fewks
Let’s imagine a world overrun
by pests.
In this reality, the most
in-demand product on the market is "The Battery Operated Light Up
Hooting Garden Owl Pest Deterrent" from Battery Operated
Light Up Hooting Garden Owl Pest Deterrent, LLC. Everyone wants one, and their
sales team is working hard to meet that demand.
At the end of the year, that
team’s sales are going to be reported on the company’s income statement. But,
what will that look like? What figures are going to be on that report? Well,
two of the most prominent ones are going to be gross sales and net sales.
They’ll tell Battery Operated
Light Up Hooting Garden Owl Pest Deterrent, LLC a lot about the state of their
sales efforts and product quality.
Here, we’ll take some time to
understand what gross and net sales are, what differentiates the two from one
another, and what they can show about the health of a business.
Gross Sales vs. Net Sales
Gross sales are the value of all of a business’s sales
transactions over a specified period of time without accounting for any
deductions. Net sales are a company’s gross sales minus three kinds of
deductions: allowances, discounts, and returns.
Allowances
When a customer pays for a
product with a minor but noticeable defect, they may get in touch with the
company they bought it from and request a retroactive discount. That discount
is known as an allowance.
If the company gives the buyer
that discount in order to avoid having them return the product altogether or
losing their loyalty, the difference between the original and discounted prices
is deducted from the gross sales figure when calculating net sales.
Let’s consider our
"Battery Operated Light Up Hooting Owl Pest Deterrent" example. If
you purchased one of these owls and found that only one of its terrifying laser
eyes was lighting up, you might consider returning it. However, you find it’s
still deterring a sufficient number of pests, and you don’t want to go through
the trouble of sending it back.
You could reach out to the good
people over at Battery Operated Light Up Hooting Owl Pest Deterrent, LLC and
tell them about your problem. In an effort to keep your business, they might
offer to give you some of your money back. You keep your defective owl robot —
they keep your business.
The price the company pays is
an allowance and that partial refund is reflected in the company’s net sales.
Discounts
Sales discounts — in the
context of reporting gross and net sales — are reductions in price a seller of
a good or service offers a buyer for immediate or early payment. Businesses
generally take this approach if they’re in urgent need of cash. For instance, a
company may offer a 2% discount to a buyer for paying off an invoice within ten
days of receiving it.
In the case of Battery Operated
Light Up Hooting Owl Pest Deterrent, LLC, the business may sell $100,000 worth
of its product to a retail outlet because people in the streets are clamoring
for more Battery Operated Light Up Hooting Owl Pest Deterrents. They give the
retailer an invoice to be paid off within 30 days.
However, in spite of its
product’s popularity, Battery Operated Light Up Hooting Owl Pest Deterrent LLC
needs that money as soon as possible. In this case, the company might offer the
retailer a 2% discount for paying off the invoice sooner.
The retail outlet would pay
$98,000, the owl company would get that money quickly, and that $2,000 discount
would be taken out of gross sales when calculating net sales.
Returns
A sales return occurs when a
buyer sends a product back to a seller for a partial or full refund. That
refund is deducted from gross sales when calculating net sales. Sales returns
generally occur for reasons like defects in goods ordered, late shipping,
incorrect items being shipped, incorrect product specifications, excessive
quantities ordered, or excessive quantities shipped.
Many sellers require a buyer to
produce a sales return authorization number before its receiving department will
accept a return. A return authorization number — or RA — allows sellers to
track a return from its outset to its end.
It also lets a company hold
customers accountable for the state of products they return, the pace at which
they do so, and whether they actually purchased the returned goods in the first
place.
Say the operations at the
Battery Operated Light Up Hooting Owl Pest Deterrent factory ground to a halt,
and the company wound up shipping one of its products to a buyer a month late.
By that point, the customer had grown frustrated with the number of pests in
their backyard and turned to a company that sold battery-operated, laser-eyed,
screeching hawk pest deterrents.
The buyer wound up being
perfectly happy with the product it bought in lieu of the one they originally
ordered. After receiving the Battery Operated Light Up Hooting Owl Pest
Deterrent in the mail, they decided they didn’t need it. If they promptly
returned it with a return authorization number issued by the company, they’d
likely get a refund.
That refund would constitute a
return, and that amount would be deducted from gross sales when calculating net
sales.
What Can Gross Sales and Net Sales Tell You
Gross sales isn’t a
particularly accurate metric when considering the health of a business or its
sales processes. If you only consider gross sales — separate from the rest of
an income statement — you might see a considerable overstatement of a company’s
sales figures.
Net sales is the best, most
accurate reflection of the efficacy of a company’s sales operations. Deductions
are important in understanding how well a business is selling its product or
service. If you don’t consider them, you might not account for different
strategies your sales team is employing or different ways they could be more
efficient.
The difference between gross
sales and net sales can also be a valuable indicator of the quality of a
company’s product or service. If the discrepancy between the two figures is
substantial or consistently growing, there may be issues or deficiencies with
the product, making for considerable amounts of returns or allowances.
Gross sales and net sales are
important metrics to understand — both in relation to and independently of one
another. If you’re trying to determine whether your business needs to change
how it approaches its sales efforts or improve its product quality, you’ll
likely need to consider both figures.
Originally
published Feb 20, 2020 8:00:00 AM, updated February 20 2020
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