Entrepreneurs are, by default, the “men/women of action.”
You would prefer rolling up your sleeves and figuring out things yourself than attending some theory-focused lecture delivered in an uninspiring manner on a lazy afternoon, wouldn’t you?
However, things you would learn directly from your accounting textbooks have their places. Take the net sales formula, for instance. Knowing how to calculate net sales help you assess your business’s financial health and predict future catastrophes lurking in the shadows.
If you are already using it to create your financial reports, that’s great.
But if you didn’t have an accounting major in school, then this article is for you. It covers what net sales is, what financial insights you can gain using the net sales formula, and in which scenarios you should ditch the net sales formula and use something else instead.
Simply put, “net sales” is what remains after you deduct all sales allowances, returns, and discounts from your gross sales figure.
Here is an example:
Your company made $200k in gross sales in a quarter. But you also returned $20k worth of orders, granted $8500 worth of discounts and $5500 worth of sales allowance in the same quarter. In that case, your net sales will be $200000- ( $20000+$8500+$5500) = $166K
So, if you transform the net sales into a formula, it would look like this:
net sales = Gross Sales - ( Returns+ allowance+discounts)
For the sake of clarity, here are some explanations of the components of net sales formulas:
Gross Sales: This is the revenue a business earns from all the sales. Since expenses like discounts, allowances, and returns are not adjusted, the Gross Sales number is often inflated.
Ideally, you want to look at this number weekly, monthly, quarterly, and annually. Your gross Sales should cover all the sales where payments were made via cash, credit card payments, debit card, bank transfer, and even Paypal transactions.
Returns: Sometimes, customers will return your product and ask for refunds no matter what. The reason can be faulty products, poor customer service, misleading advertisements, and even customers changing their decisions.
The amount of revenue you spend on return orders will be taken into account while calculating net sales.
Allowance: This represents the amount of your product’s price reduction because of any damage, defects, or anything else except discounts. For example, the customer found a part of your product slightly damaged, but instead of returning it, he demanded a 30% price reduction. This 30% of the sale will go to the allowance expenses bucket.
Discounts: Discounts are the reduction in prices to incentivize your sales. There are multiple situations where you want to offer discounts. If your customers buy in bulk, for example, a sales discount can be applied. You can also offer discounts on seasonal and stock clearance sales.
Nonetheless, when you sell some of your products at a discount, you have to deduct the discounted amount from the Gross Sales.
The previous section covers how to calculate net sales. But why do you even use it?
Well, this metric can help you understand at what rate your net revenue is growing, how effective your discount strategy is and if there are any concerning issues with other areas of your business operation.
Let’s shed some light on the most significant benefits of using the net sales metric.
Assess the financial health of your business:
By comparing net sales of different quarters and months, you can tell whether your business is profitable enough.
For example, you can pull net sales data for two quarters and figure out the growth trajectory of your business. Since your cash flow is directly linked to your sales, the net sales metric can predict future cash flow.
Another way to use this metric is to compare your net sales and return values with the industry average. If your numbers are below-average, then something needs your immediate attention.
Insights on discount strategies and pricing strategies:
One of the components of the net sales formula is discounts. So by taking a look at your net sales, you can gain more insights into your pricing strategies.
- Does your net sales revenue increase after introducing a certain bulk/seasonal discount?
- Do your discounts yield diminishing returns after a certain mark?
- Do certain seasonal discounts lead to more ROI?
Optimizing your discounts, however, isn’t the only way to improve your pricing. To maximize your net sales, you might try different pricing models like monthly recurring pricing, value-based pricing and tier-based pricing.
Also, net sales might compel you to take a closer look at your audience segments. Some segments just spend more or have high CLV. You want to identify and then double down on them to increase your revenue.
Improved business decision:
The net sales metric also foreshadows any issues related to other business operations. For example, if you see a steady decline in quarterly net sales numbers because of the surge in return requests, that could indicate some issues with your customer service, product, or logistics.
Alternatively, if your return requests increase ( and net sales numbers decrease) after the launch of any major advertisement campaign, then you might have failed to communicate your offering to the right audience.
Long story short, the net sales metric can draw your attention to many issues brewing underneath.
So far, we have explained what net sales is and why you should use it. Now let’s take an example for better understanding.
XYZ is a small company that sells graphic t-shirts online. In the first quarter of 2022, the company made $500k in sales. However, Xyz had to return orders worth $35k. They also adjusted the price for various orders close to $9k. For discounts, XYZ lost $12k.
So the net sales is,
$500k-( $35k+$9k+$12k) = $464k
Please note net sales isn’t your Net profit. The net sales formula just takes into account of sales-related expenses. To find your net profit, you need to deduct the cost of goods sold( COGS) and other expenses like overhead, transport, and labor costs.
What would happen if the XYZ owners want to know how well their new eco-friendly clothes perform?
Simple, just tailor the entire calculation for the said product. Find the total sales of eco-friendly clothes, the number of return requests, and revenue lost due to the discounts offered on eco-friendly clothes.
In the same way, you can find net sales for a specific branch or location.
The Net sales metric focuses on your business's sales performance and reveals many things. However, this is not a magic metric that answers all of your questions.
For starters, net sales doesn’t take into account COGS. The cost of goods sold can have a huge effect on your business profitability and net profit numbers.
Also, it doesn’t cover Customer Acquisition Cost ( CAC). You might be making a lot of sales and getting very few return requests, but if the CAC is abnormally high, it can affect the cash flow.
Last but not least, most tiny businesses and mom-and-pop stores don’t need quarterly net sales to figure out they have a problem with their product or service. So when you see the number of return requests is abnormally high, you should spring into action.
Net sales is a high-level metric that can reveal a lot about your business’s profitability and cash flow. To find your net sales number, you need to calculate all the sales, returns, and discounts accurately.
It can be challenging, especially if you follow a monthly recurring payment model or have a bunch of outstanding invoices.
Fincent can be of great assistance here. Once you connect your Fincent account to your bank, your expenses get uploaded to the system, and the system keeps track of every transaction. When required, you can see your net sales numbers on the dashboard with a few clicks.
Long story short, Fincent makes calculating net sales and making sound decisions really easy.
Feel free to book a demo here.