Net purchases is the total cost of goods bought for resale during an accounting period, after subtracting purchase returns, purchase allowances and purchase discounts. It is used mainly by merchandising businesses, such as retailers and wholesalers, that use a periodic inventory system, in which purchases are recorded in a separate account rather than directly in inventory. Net purchases is a key step in calculating cost of goods sold.
Textbooks differ on whether freight-in is included. In many presentations, net purchases excludes freight, and adding freight-in to net purchases gives the cost of goods purchased. Other presentations fold freight-in into net purchases. Either way, transport costs to bring goods in are part of their cost, while shipping costs to customers are selling expenses.
How net purchases is calculated
The standard formula is:
- is the invoice cost of all merchandise bought during the period, on credit or for cash.
- are reductions for goods sent back to suppliers, or price reductions granted for damaged or incorrect goods kept by the buyer.
- are reductions taken for paying suppliers early under credit terms such as 2/10, net 30.
Trade discounts, which are reductions from a supplier's list price, are not recorded separately; purchases are simply recorded at the net invoice price.
Worked example
A sporting goods store records the following for the year:
| Item | Amount |
|---|---|
| Purchases | $150,000 |
| Less purchase returns and allowances | ($4,000) |
| Less purchase discounts | ($2,200) |
| Net purchases | $143,800 |
| Add freight-in | $3,500 |
| Cost of goods purchased | $147,300 |
If beginning inventory was $36,000, cost of goods available for sale is $36,000 plus $147,300, or $183,300. If the year-end count values remaining stock at $41,000, cost of goods sold is $142,300.
Recording the components
Under the periodic system, each element has its own account. A credit purchase debits purchases and credits accounts payable. A return debits accounts payable and credits purchase returns and allowances, a contra account, usually supported by a debit memorandum sent to the supplier. When the store pays a $10,000 invoice within the discount period on 2/10, net 30 terms, it debits accounts payable $10,000, credits cash $9,800, and credits purchase discounts $200. At the end of the period these accounts are closed, and the net figure flows into the cost of goods sold calculation.
Under a perpetual system, returns and discounts are credited directly to inventory, so the business does not usually report a separate net purchases figure, though it can be derived from the records. Some companies record purchases at the net amount expected after the early payment discount, which shows any discount missed as a separate finance cost.
Why net purchases matters
Net purchases shows how much a business actually spent on stock, which is useful for analyzing supplier terms, buying patterns and gross margin. A high level of returns may point to quality problems with suppliers or poor ordering, while a low level of discounts taken may mean the business is missing cheap savings: skipping a 2 percent discount for paying 20 days early is equivalent to borrowing at an annual rate of more than 36 percent. Comparing net purchases with sales also shows whether inventory is being built up or run down, which affects cash flow and working capital.