Gross sales vs net sales

By Sean Stevenson – Latest Revision February 24th, 2021

What Are Gross Sales Vs Net Sales?

Gross sales are the total reported sales within a specific timeframe.  Often, these reports exist within a quarterly or annual basis.

Net sales are the gross sales minus certain deductions.  In total, there are three deductions that must be accounted for:

  • Sales discounts –  Any discount during the sales process that was used to secure a transaction from the customer.  For example, a salesperson may have used a 5% discount on a good or service to entice prospective customers.  This would mean that upon the receipt of cash, the discount would have to be applied and accounted for (subtracted from the total amount received).
  • Sales allowances –  Regardless of what is being offered, defects in goods or services result in a reduced price being paid by consumers.  This is meant to account for errors made during a production process.  Unfortunately, a purchased item or service can always be unknowingly compromised in terms of its quality.  Therefore, it is the responsibility of the seller to account for these sales allowances by offering affected consumers some reimbursement incentives to continue using the product or service in question.
  • Sales returns –  As its name implies, this is a total refund.  The entire amount paid for a good or service is reimbursed to an unsatisfied customer.  Most companies handle sales returns under a return merchandising authorization format.

Once each of these three deductions have been accounted for in their entirety, they are subtracted from the gross sales.  This formula produces the total net sales of a company over a specific period of time.

Example

Gross sales vs net sales

If a company fails to account for these deductions, then it would be impossible to separate the gross sales from the net sales.  

All three of these deductions are also known as contra accounts.  This means they are considered a debit balance, as opposed to a credit balance.  By design, they tend to offset a sales account.

Key Takeaways

  • The gross sales represent all sales that occur before any discounts, allowances, or returns, are calculated.
  • Net sales are typically an important metric for prospective investors to understand.  When compared to gross sales, the net sales can offer insight into the generation of realized (finalized) revenue. 
  • If gross sales are much higher than net sales, there may be a problem with product or service quality.

How Companies Present Gross Sales Vs Net Sales

Some companies choose to present their gross sales, deductions, and net sales on separate lines of their income statement.  However, it is more common to see gross sales and deductions combined together on a single line for easier reading.

Gross sales on its own is not an ideal metric for understanding overall profitability.  A company must list all inherent deductions within its pipeline, so that a more accurate comparison can be deduced.

Conversely, net sales shows the actual profits of a company.  When closely compared to the gross sales and deductions present on the income statement, investors can gain a better picture of a company’s operations.

A highly effective company will have high gross profits, with net profitability remaining high after all deductions are included.

Analysts closely track the trends of gross profitability, inherent deductions, and net profits. 

Example

 

(All Valuations In $U.S Millions)

TTM

6/8/20

TTM

6/3/19

Gross earnings from existing operations – before adjusted interest expenses and income taxation

 

3,201

 

3,848

+Operating lease interest*

70

61

-Income taxes

764

1,537

Net operating profit after taxes

2,507

2,372

 

 

 

Current portion of long-term debt and other borrowings

170

1,858

+Noncurrent portion of long-term debt

13,174

10,445

-Shareholder Equity

12,054

10,615

+Capitalized operating lease obligations *

1,339

1,187

-Cash and cash equivalents

2,156

2,122

-Net assets of discontinued operations

3

31

Invested capital

19,899

20,451

Average invested capital

20,175

20,894

 

 

 

After-tax return on invested capital

12.4%

11.4%

Note the gross sales and net sales.  Both align fairly well in this report.  This means that the company is operating effectively, and is likely well-managed.  Whether it is offering a good or service, this financial statement would indicate it has a fundamentally sound business model.  Prospective investors would typically seek metrics like these when looking for their next investment opportunity.

Understanding Gross Sales And Net Sales

It can be easy to assume that gross sales are virtually useless when compared to net sales.  However, this would be in error.

Gross sales are a uniquely useful tool for discerning a company’s value and overall revenue stream.  It reflect the total sales interest that an organization has managed to accumulate over a specified period of time.

If gross sales are continually growing, then a company is succeeding in generating interest from consumers.  This means that it likely has a promising product or service, even if it may be new (or flawed).

When comparing gross sales to net sales, it is important to focus on how closely the two trends align with each other.  This grants a key insight into how often a fully realized sale occurs, without any deductions or refunds needed.

Example

A retail store reports its gross sales for the year.  Fortunately, its net sales trend very well with its gross sales.  This means that most customers are satisfied with their purchase, and that there are few incidents that require any deductions.

Since the retail sales have been high, the gross profits reported are trending upwards from the previous annum.  This indicates a year over year potential for significant growth.

Gross sales vs net sales

Analysts tend to use trending graphs such as this to visualize the overall trend of both gross and net sales.  The plotting of lines to represent both gross and net sales can reveal unique trends over time.  It can also help display consumer spending habits, along with the seasonality of certain goods or services throughout a fiscal year.

Limitations of Gross Sales vs Net Sales

Both gross sales and net sales on their own are very limited metrics to draw from.  Without having one to reference the other, it is impossible to make accurate comparisons or predictions.

Moreover, there is no standardized way to report on income.  While many companies opt to file in a similar fashion -granting some commonality- there are still many accounting anomalies and outliers that go unattended.

Gross sales in particular can be far more deceptive than net sales.  Accounting malpractice can easily use the gross sales to exaggerate the total gross sales figure.  This discourages further investigation into the nature of fully realized sales, which account for all deductions to determine the net sales figure.

Gross sales is most useful and significant in the consumer retail industry.  This is due to the fact that retailers often compare themselves to other retailers.  The more gross sales a retailer enjoys, the more it tends to profit (as retail relies upon large volumes of distribution and sales in order to thrive).

Best Practice for Investing and Financial Research

Should you be exploring financial statements of any kind, it is always imperative to carefully observe the gross sales and their corresponding net sales.  In particular, be sure to also consider the deductions inherent in a given business model. 

By using these different metrics in tandem, you can gain a far greater understanding of the underlying operations and profitability of any given business model. 

Many companies tend to downplay the volatility involved in their sales practice.  There may be many deductions that they would sooner “gloss over.”  This is often done to make an investment appear far more attractive than it really is.

In the instance of a capital-intensive sector, such as manufacturing, there are often considerations that investors fail to make. 

The bottom line: always be certain you are looking at an investment opportunity from every angle possible.  Consider the sector it operates in, and how effectively the company is run based on its financials.

By carefully comparing gross sales, deductions, and finally net sales, you will be equipping yourself with prudent information.  This will allow you to make the best decision going forward.

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