In order to create accurate sales forecasts to paint a picture of where your business is going and set realistic quotas for your sales team, you need to understand your total sales and revenue.
There are two main ways of keeping tabs on sales and each is important to grasp:
- Gross sales, which is the sum of all sales made with no deductions
- Net sales, which is gross sales with deductions (discounts, returns and allowances) included
In this post, you’ll learn about how gross and net sales are calculated, how gross sales vs. net sales are used in business and how salespeople can use them to identify potential issues or opportunities within their sales process.
Calculating your gross sales vs. net sales
As the sum of all sales made, the question of how to calculate gross sales is a straightforward one to answer. Simply multiply the number of units you’ve sold by the unit price. So, if you’ve sold 200 units in Q1 and the unit price is $40, your gross sales for that quarter equals $8,000.
How to calculate gross sales:
Gross sales = Number of units * Unit price/cost
Net sales is a little more complicated to calculate, as you need to know all of the deductions that have been applied to your sales.
How to calculate net sales:
Net sales = Gross sales – Deductions
There are three specific types of deductions you’ll need to consider when it comes to gross sales vs. net sales: discounts, returns and allowances.
In this context, sales discounts are different from the sales promotions, promotional discounts and seasonal offers consumers might be used to. Instead, these refer to early payment discounts which are offered to companies when they pay an invoice within a specified time frame.
For example, your company might send a customer an invoice for $10,000 to be paid within 30 days. However, you could offer a sales discount where they get 1% off if they pay within 10 days (this particular offer would be known as a 1/10 net 30 in discount terms). In that case, the customer would only pay $9,900, getting a $100 discount for early payment.
While the exact terms covering the timeframe and the discount offered will depend on the agreement your company has with the buyer, the general idea is to create a mutually beneficial outcome for both parties. The seller gets their invoices paid a little faster—allowing them to maintain a healthy cash flow—and the customer doesn’t have to pay full price.
In an ideal world, every sale would work out perfectly. Unfortunately, things don’t always go so smoothly in real life. For any number of reasons, from damaged goods to late deliveries, the customer may decide to send the product back and demand a refund.
When the order has been returned it’ll be checked and, once the purchase and reason for return are confirmed, the refund will be credited to the customer’s account. Regardless of whether the company is able to resell those items again or not, that refund amount would need to be deducted from the gross sales.
When there are minor issues with the delivered product but it is still usable, the seller and customer might agree to a compromise. Rather than the customer having to return the goods, the seller could propose a partial refund against the paid invoice. This discount would then be recorded as an allowance.
For example, imagine that your customer ordered $3,000 worth of your product, but they accidentally received the wrong color. While the product still functions correctly, the customer might reasonably complain that the delivered goods weren’t as described. To keep the customer happy, your company might offer a partial refund of $300 to make up for the mistake.
As an example, if your gross sales for Q1 were $8,000, but over the same period of time there were $700 in sales discounts—$200 in sales returns and $100 in sales allowances—these would need to be deducted from the total amount. This would give you a figure of $7,000 net sales vs. a gross sales figure of $8,000.
Where gross sales and net sales are used
These sales terms are most likely to be found on your financial statements, specifically as the top line on the company’s income statement (also known as a profit and loss statement).
A business might start by declaring their gross sales (commonly referred to as gross or total revenue), then listing the different sales deductions made as line items. Other companies skip the part of identifying what is gross sales and deductions and simply list the net sales. If the deductions aren’t included on the income statement, you will be able to find them in the company’s contra accounts.
Despite what your customers might promise, it’s impossible to know who will pay early and who won’t, nor can you know in advance whether or not there will be any returns or allowances. As all the deductions have to be made retroactively, you can only calculate your net sales at the end of the sales period.
Benefits of knowing your gross sales and net sales
Terms like gross sales and net sales are more commonly associated with companies selling physical goods (where deductions due to customer returns and allowances are more likely to occur). That said, all kinds of businesses can benefit from knowing how to find gross sales and net sales and how to compare the metrics to gain valuable insights.
Avoid misleading figures
While it can be tempting to rely on gross sales as a measure of performance (as it’s always going to be equal or higher than the net sales) it can be misleading. This begs the question: what are gross sales exactly and can they be trusted? A high gross sales figure might look impressive, but if you’ve had to refund most of those sales then it’s deceptive in nature.
To answer the question: Gross sales can be trusted, but should be approached with cautious optimism. Celebrate the wins, but be prepared for discounts and refunds need be.
Make better decisions
As net sales takes into account the costs directly arising from the sales process, more business owners use that figure to guide their decision-making process.
For example, a key part of sales forecasting involves setting a realistic budget. If you base your budget off gross sales only, you may plan to hire two new sales reps in the following quarter to manage a new account only to learn that the net sales figures are too low to support additional staff. This could seriously damage your plans and force you to reshuffle resources in a way that leads to decreased efficiency.
Run competitive analyses
As well as a general indication of a business’s financial health, net sales can also be used as a benchmark for comparison with other companies in the same industry. If your net sales figure is significantly and consistently lower than your competitors’ figures, it indicates there’s a problem and your company will need to investigate why.
On the flip side, if your net sales is consistently higher, it shows that you’re doing something right and you can confidently double down on your strengths.
Motivate your sales team
If you know your gross and net sales both company-wide, team-wide and individually, you can accurately measure and analyze performance. While gross and net sales may not be the most common key performance indicator (KPI) that you hold your reps accountable for, it’s arguably the most important.
Why? Because if your reps aren’t making money for your business, they’re not doing their job. For example, if you dig a bit deeper and analyze your top performing rep only to find out that most of their gross sales are cut in half when considering net, perhaps their deals aren’t as valuable as they seem.
Knowing this, you could bundle your set gross sales KPI with qualified leads and most likely to close KPIs. This forces your reps to focus on high-budget and high-quality deals in tandem, motivating them to prioritize big business and high-value business with the same forte.
Comparing gross sales and net sales to identify potential problems and opportunities
The greatest benefits come from knowing both and the differences between net sales vs. gross sales, and then seeing how they change in relation to each other over time. Here are two examples:
- If the gap between the gross and net sales is decreasing, that means the rate of deductions is also decreasing
- On the other hand, if the gap between the two is increasing, then you’ll have to do some detective work to diagnose the cause
If the sales discounts for early payment are increasing, this could be a good thing, as it means more of your customers are paying their bills promptly. If it’s too high and significantly affecting the final sales figure, however, it might be the case that your early payment terms are too generous. It would then be sensible for your company to re-evaluate those terms and see if they can be changed to remain competitive without negatively affecting cash flow.
If the sales discounts due to returns and/or allowances are increasing, there could be a number of causes, such as poor product quality or delivery issues. Usually there will be returns authorizations in place to record the reason for a return, allowing a company to identify any trends. If that’s the case, your company would have to see whether there were any opportunities to improve the manufacturing, quality control, delivery and other relevant processes.
For sales teams, the biggest concern would be if products were being returned because the delivered goods didn’t meet the buyer’s requirements. This could mean that your sales process is targeting the wrong people, in which case sales managers should consider reviewing their ideal customer profile and check that their teams are reaching out to the right people.
Alternatively, if more products are being returned because they’re not what the customer expected, you might be inadvertently misrepresenting the product. Are you giving customers all the information they need to make an informed decision? If not, it would be a good idea to review your sales playbook and ensure that all salespeople are sufficiently trained to accurately answer any questions a prospect raises.
While gross sales and net sales are terms that may be more familiar to accountants and investors, knowing what these mean can give you a strong indicator of business performance and help identify any potential issues before they become serious problems.
By understanding what is gross sales vs. net sales and tracking how the figures change over time, you can see what’s holding your sales back and review your processes to improve performance across the business, including your sales process.