Gross Sales vs. Net Sales: Key Differences and How They Are Used
While a surface-level review of monthly sales figures can make you feel like you’re on top of the world, don’t get excited quite yet. Contrary to popular misconceptions, gross sales can’t provide comprehensive insight into the overall health of your business. In this blog post you will learn more about the difference between gross sales and net sales and why both indicators are critical for evaluating your business success.
4 min read
Nov 29, 2021
What are gross sales?
Gross sales are the total number of all sales transactions your company makes during a certain period without any adjustments and deductions. In other words, gross sales are the raw money amount of sold goods and services, before applying any corrections.
Gross sales have a very simple formula - they are calculated as units sold multiplied by the market price per unit.
Companies typically use gross sales to compare year-to-year figures and analyze trends. While useful for these pursuits, understanding the complete financial health of your company can be better achieved using net sales. Let’s figure out what they are, how are they different from gross sales, why they are so vital and how to find net sales.
What are net sales?
Net sales are the total number of sales (gross sales) after subtracting adjustments. In other words, they are the result of gross sales minus the following three deductions: sales returns, allowances for damaged goods, and discounts (see these items explained below). The main point of calculating net sales is that gross sales never can tell you the whole story as these three deductions can dramatically reduce the overall amount of sales.
How to calculate net sales?
To find net sales you need to consider four key components: gross sales, sales returns, allowances, discounts
- Sales discounts: these are rewards for customers, such as seasonal discounts or bulk purchase discounts so the buyer has to pay an amount lower than the billed amount. Therefore, such discounts should be reduced from gross sales.
- Sales returns: these are money refunds granted to customers if they return unwanted goods to the company. The amount of gross sales should be reduced by the amount of these refunds as well.
- Allowances: these are price reductions due to goods damages. In such cases companies reduce the market price and sell goods at a lower price, so the difference between these prices is reduced from gross sales.
Needless to say, net sales are almost always lower than gross sales. Analyzing these three deductions that create the difference between gross sales and net sales can be of great interest for businesses looking to identify the source of financial issues and revenue gaps. For example, If the difference between number of net and gross sales is steadily increasing, it can indicate problems with products’ quality that lead to unusuallylarge sales returns and allowances. Let’s dive deeper into why it is important to consider both gross and net sales when you evaluate your business, and what insights each metric can reveal to you.
What can gross and net sales tell you?
Both numbers are important and both net sales and gross sales matter. Gross sales can be a particularly important metric in many industries, including the retail sector as they show the total amount of sales generated by your business over a particular period. Gross sales also help to evaluate the overall business size and annual growth. As you can see, analyzing gross sales is more valuable for gaining insight into the growth of a company rather than its profitability. Moreover, gross sales often are considered when developingpricing strategies to ensure a competitive market price.
Gross sales is also an extremely important metric for startups: they reflect the amount of money they make against the product costs they’ve incurred. High gross sales are important for propelling startups to their break-even point, and eventually profitability.
The volume of net sales on the other hand better reflects your business turnover and overall financial health. This makes net sales much more relevant for strategizing and decision-making compared to gross sales.
For example, by calculating and comparing net sales for the previous and current quarters, companies can analyze how discounts influenced their sales.
In our simple example, we can see that a doubling discounts dramatically affected companies’ net sales. Of course, the opposite is also possible. If the number and frequency of discounts or goods returns become extremely high, it can negatively influence business performance.
That is why It is important to build gross and net sales lines together on analytical charts to determine trends and changes over a specific period. If your business is growing, both numbers should increase. But if gross sales begin to outpace net sales, it could be a sign to start searching for growth bottlenecks and developing new strategies.
A few strategies to consider include:
- Exploring ways to decrease costs
- Reducing the frequency of sales discounts
- Improving product quality to decrease returns
One of the most critical points for developing any successful business is to maintain a keen understanding of the business’s financial situation. Thus, entrepreneurs interested in structured and steady long-term growth should never ignore neither gross sales nor net sales numbers. Gross sales are critical to evaluate annual growth and particularly useful for companies operating in industries related to retail. Calculating net sales on the other hand provides strong insight not only into your business’sfinancial health but also areas in need of improvements like sales and marketing strategies or quality of sales.
Understanding these metrics is crucial for every business owner or entrepreneur interested in increasing revenue and consistent business growth.