Net Sales

Net sales is the revenue a company earns from selling goods or services after subtracting sales returns, sales allowances and sales discounts from its gross sales. It represents the amount the business actually expects to keep from its sales, and it is normally the first line of a merchandising or manufacturing company's income statement, often labeled simply "net sales" or "revenue."

Because returns and discounts can be large in some industries, such as fashion retail and consumer products, net sales gives a more realistic picture of performance than gross sales. It is the basis for most margin and efficiency ratios, including gross margin, operating margin and asset turnover.

The formula is:

• $\text{Gross sales}$ is the total invoiced value of all sales in the period, before any deductions.
• $\text{Sales returns}$ is the value of goods customers send back for a refund or credit.
• $\text{Sales allowances}$ are price reductions given to customers who keep goods that are damaged, late or not as ordered.
• $\text{Sales discounts}$ are reductions given for early payment, such as 2 percent off for paying within 10 days.

Sales taxes collected from customers are not part of gross or net sales, because they are owed to the government.

A furniture wholesaler invoices $2,000,000 of sales during the year. Customers return goods worth $60,000, the company grants $15,000 of allowances for scratched items, and customers take $25,000 of early payment discounts. Net sales is $2,000,000 minus $60,000 minus $15,000 minus $25,000, or $1,900,000. If cost of goods sold is $1,140,000, gross profit is $760,000 and the gross margin is 40 percent of net sales.

Returns, allowances and discounts are recorded in contra-revenue accounts, which have debit balances that reduce sales. When a customer returns $2,000 of goods bought on credit, the wholesaler debits sales returns and allowances $2,000 and credits accounts receivable $2,000, usually issuing a credit memo. Under a perpetual inventory system, it also restores the goods to inventory and reduces cost of goods sold. Keeping these amounts in separate accounts, rather than reducing sales directly, lets management monitor return rates and discount usage.

Under ASC 606 and IFRS 15, the standards on revenue recognition, expected returns, rebates, volume discounts and early payment discounts are forms of variable consideration. A company must estimate them when it recognizes the sale and record revenue only for the amount it expects to be entitled to. For expected returns, it records a refund liability and an asset for the right to recover the goods. As a result, reported revenue under these standards is already close to a net sales figure, and many companies show a single revenue line with the deductions explained in the notes.

Analysts compare the gap between gross and net sales over time. A rising rate of returns or allowances may indicate quality problems, aggressive selling or a change in product mix. Heavy use of discounts and rebates near the end of a quarter can signal channel stuffing, in which a company pushes extra goods to distributors to inflate current revenue, only for them to be returned later. Net sales is also the denominator in ratios such as the accounts receivable turnover ratio and the asset turnover ratio. When comparing companies, readers should check whether shipping charges billed to customers, sales commissions or excise taxes are included in revenue, because practices differ between industries and between companies.