Sales are a component of revenue. Revenue encompasses several sources of income including sales. Other sources of revenue include interest, trust monies, royalties, and fees. In effect, revenue includes all sources of income, realized and unrealized. Sales are divided into two levels, gross sales are all sales at the regular price; net sales are gross sales less discounts or adjustments associated with that particular product(s). Just like the PBJ, sales are one ingredient of the revenue sandwich.
This article describes the difference between these two terms used in accounting. Although similar in nature, sales are more refined than revenue as the following sections describe both terms.
As a business grows, the financial reports convert the term ‘Sales’ to ‘Operating Revenues’. The word ‘Sales’ is a small business term whereas ‘Operating Revenues’ are for large operations especially publicly traded companies.
Sales are defined as the economic price paid by a customer for the product or service purchased. Although this seems simple in nature, it is more complicated than this. Sales in a financial statement refer to the primary source or main function of a business. If you are in the business of selling widgets, then the primary line in the revenue section of your financial income statement will reflect this information.
In a simple world, the customer comes along and buys the widget and hands you cash. The widget is perfect and therefore no issues as it relates to that sale. But we don’t live in the simple world, as business owners; we deal with lots of issues when it comes to selling widgets or any product.
At the end of the accounting cycle, all sales are accumulated in one ledger account. In addition, any returns are accumulated in another account on the books. The returns account should be classified as a revenue account and is generally an offset to sales. Returns are when a customer brings the widget back because it wasn’t the proper size or didn’t meet the expectations of the customer’s needs.
Another account in the revenue section used as an offset is an account labeled ‘Allowances’. This account is used to code customer discounts and some forms of customer appreciation transactions, such as Two for the Price of One or Buy-One-Get-One (BOGO) free programs. A common example of this is a tire dealer offering the 4th tire free when you buy 3.
An example of the presentation format for the Sales Section of the Revenue area of the Income Statement is as follows:
Gross Sales $ZZZ,ZZZ
Sub-Total Allowances & Returns Z,ZZZ
Net Sales $ZZZ,ZZZ
*Note that Allowances & Returns are subtracted from Sales to calculate Net Sales.
You may desire to separate out and record discounts in a separate account other than allowances. Allowances are generally used for customer appreciation or high volume customers as a marketing tool to maintain their continued patronage. ‘Discounts’ is a term used to identify those transactions that entice new customers to purchase or to determine the costs of ongoing advertising campaigns (e.g. coupons).
In addition, if you run a robust retail operation, you may create a separate offset account to reflect certain advertising or marketing campaigns. This allows you to accumulate the real cost of an advertising/marketing campaign.
Sales are an element of revenue. Revenue is broader in definition and encompasses more than the traditional customer purchase. Other forms of revenue include:
Service income – you may separate out the revenues for installation or services rendered that do not involve parts or widgets sold to customers.
- Fees – often small businesses charge fees for regular contact with customers. Examples include professional services that charge for copies made, travel and mileage reimbursements.
- Charges and Interest – as small businesses grow, accounts are developed with customers and sometimes the customers pay late and you assess a late charge and interest on the account.
- Royalties/Licensing – fees for use of rights or the name of your business
In general, these items are significantly less than the primary source of income for a business which is sales. They are listed after the primary section in the income statement. The following is an example of the traditional format for all encompassing Revenue section of a small business.
Gross Sales $ZZZ,ZZZ
Sub-Total Allowances & Returns Z,ZZZ
Net Sales $ZZZ,ZZZ
Maintenance Contracts $Z,ZZZ
Late Penalties & Interest ZZZ
Finance Interest ZZ
Sub-Total Fees Z,ZZZ
Total All Revenues $ZZZ,ZZZ
Notice the format of the revenue section. The small business owner has a clear picture of the various sources of his income. Sales; the most important element of the income section of the financial statement, is clearly stated. The adjustments associated with the primary function of his business are netted against total sales to illustrate ‘Net Sales’. The other sources of revenue are separated for a clear picture of all revenues.
An example of a small business using the above format would be a computer/technology based operation. They sell computers, peripherals, office equipment and other technology equipment. The primary source of income is the sale of equipment. They run coupon and advertising programs, offer discounts for early payment or prompt payment and have allowances for special customers. In addition, customers return the equipment because it just wasn’t right for their needs.
In addition to selling the equipment, they have a service department that goes out on calls to fix and install systems. In addition, the company sells maintenance contracts and charges late fees for slow payment. They earn interest on customer accounts and the bank pays some interest each month for the use of the money in their regular operating account. You can see how the above report conveys well the information to the owner of this business on how his business is performing.
Summary – Revenue and Sales
In summation, sales are considered the most important element of revenue and it is very important to identify total sales along with the offset issues that come with selling products. Other sources of revenue are separated from the traditional sales to determine total income for a business. As your business grows, continue to make updates to your financial statements to reflect the true nature of information you need to make decisions. Act on Knowledge.
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