What are Net Sales?

Net sales is like the ice cream left in the bowl after a bit of it melts…

Suppose you’re treating yourself to a bowl of ice cream on a summer afternoon. The ice cream starts melting in the sun before you have a chance to finish it all. The total amount of ice cream you put in the bowl is like gross sales. The ice cream you get to eat before it melts is like your net sales. It’s a company’s total sales after accounting for the cash it missed out on.

Net sales is the total value of a company’s sales after accounting for certain costs, including:

• Discounts: If a consumer buys an item that’s on sale or purchases an item with a coupon, they may get the item at a discount. When that happens, the seller doesn’t get the full value of the item.
• Returns: A return occurs when a customer buys an item, then later returns it to the store for a refund.
• Allowance: An allowance is when a customer buys an item that is damaged, and the seller offers a price reduction to account for the damage.

To calculate net sales, a company first has to know its gross sales, which is the value of all the items it sold over a particular time period. Once the company knows its gross sales, it can subtract discounts, returns, and allowances in that same period to figure out its net sales. The net sales is the actual amount of revenue a seller brought in for transactions during the specified time.

A company’s revenue is all the money it generates over an accounting period. Revenue and net sales both describe income for a company, but there are some important differences. For example, a company could have revenue that is not a result of its net sales. Revenue is a broad term that includes all of a company’s income, while net sales accounts only for the income a company generates through the sale of its goods or services.

Think of a flower bouquet company that owns a retail building on Main Street. The shop generates revenue through the sale of floral arrangements and other gifts. These transactions make up the shop’s net sales on its income statement. But let’s say the flower shop makes money in other ways, too. For example, maybe the retail building is pretty big, and so the flower shop owner rents out some of the space to another business or individual. The rental income would count toward the flower company’s revenue. The company might also have some of its cash assets in investments, and receive revenue as a return on those investments. Both the rent and the investment returns would appear on the company’s income statement, even though they aren’t a part of the company’s sales.

A company’s gross sales is the value of all its sales before accounting for certain reductions, like damaged goods, coupons, and discounts, or returned items. Think of gross sales as one piece of a puzzle — It doesn’t give you an accurate picture of a company’s real revenue. Because the gross sales figure doesn’t account for costs like discounts and returned items, it doesn’t tell you the actual amount of money the company brought in in a given time period. So let’s say you buy a sweater for $100, but you use a 25% off coupon. The sweater only costs you $75, but the company’s gross sales amount for that transaction would be $100.

Meanwhile, net sales gives a more accurate picture of how much money a company actually made, because it does factor in costs like discounts from coupons and other sales allowances. For that sweater you bought with the coupon, the company would record a net sale of $75. If you were to later go back to the store and return the sweater for a full refund, then the net sales value of that transaction becomes $0. The gross sales figure for that sweater would still be $100. A company records its net sales in its profit and loss statements (aka its income statement).

A company’s gross profit is the amount of money it made as profit from the sale of its goods and services. To determine gross profit, a company would subtract the cost of goods sold (meaning how much it costs to produce each item) from its net sales. The formula looks like this:

Gross Profit = Net Sales - Cost of Goods Sold

Gross profit gives a more accurate picture than net sales because it also shows the profit margin a company gets for each product.

Suppose a bicycle manufacturer was selling bikes for $200 each. They sell 50 bikes per month, which gives them $10,000 in net sales. Now, what if the company had to invest $195 (say, for parts, materials, labor) to produce each bike? The total gross profit is $5 for each bike, and $250 for the 50 bikes in a month. Gross profit helps provide a snapshot of how efficiently a company is producing its products.

A company’s net income (aka net profit) is the result of subtracting all its expenses from all of its revenue. While net sales accounts for the revenue a business brings in from the sale of its goods or services (minus discounts, returns, etc.), there are a number of important factors that it doesn’t account for. For example, net sales doesn’t consider the cost of goods sold or any other operating expenses. That’s where net income can be helpful.

To determine its net income, a company starts with its net sales and subtracts the cost of goods sold, which shows the company its gross profit. After the company determines its gross profit, it can add any revenue it made through means other than sales to calculate its overall revenue.

Once a company knows its revenue, it still needs to subtract other expenses, like operating costs (not including the cost of goods sold, which is already factored into gross profit) to get a more accurate view of how much money it actually made. Other expenses might include rent or a mortgage, utilities, insurance, employee wages, and taxes. Once the company has totaled up its expenses, it would subtract the amount from its total revenue to figure out its net income (net profit).

The formula looks like this:

Net Income (aka Net Profit) = ((Net Sales - Cost of Goods Sold) + Other Revenue) - Other Expenses

Or, in short:

Net Income (aka Net Profit) = Revenue - Expenses

To calculate net sales, you’d start with gross sales (meaning the total value of the goods or services that a company sold during a particular period) then minus any discounts, returns, and allowances. It’s the actual amount of sales revenue the company brought in from those items.

To properly determine net sales, a company has to subtract any sales discounts, returns, and allowances from its gross sales number. The net sales formula looks like this:

Net Sales = Gross Sales - Discounts - Returns - Allowances

Most states in the United States (45 plus the District of Columbia) impose a sales tax on the purchase of retail goods. Sellers typically calculate and collect sales tax at the time of purchase. However, a company’s total net sales figure doesn’t include the amount of sales tax that it collected on those sales transactions.

Companies find their net sales by taking their gross sales and subtracting discounts, returns, and other allowances. Gross sales refers to the overall value of a company’s sales transactions over a particular time period. Companies don’t usually include sales tax in their gross sales, but if they do, they’d subtract those when determining their net sales.

Sales tax isn’t included as part of the revenue for a company — It’s revenue for the government.

A company typically records its net sales figure on its income statement (aka profit and loss statement), which summarizes all revenue and expenses over a particular period. The company records net sales as part of its revenue (the figure might appear as net sales or just as sales). Over a given accounting period, companies track their total gross sales numbers. At the same time, the company maintains records about sales returns, allowances, or discounts, if they apply. Tracking this information allows companies to get a more complete picture about the value of the items they sold, and the actual amount of money they made.