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.

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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.

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.

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Originally published Feb 20, 2020 8:00:00 AM, updated February 20 2020

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