Net Income vs. Net Sales: Definitions and Differences
By Deepti Sharma
Updated July 26, 2022 | Published June 22, 2021
Updated July 26, 2022
Published June 22, 2021
Deepti Sharma is a freelance copywriter with experience writing for various platforms, on topics such as HR, finance and marketing. She has also been working with a couple of magazines as a freelance editor and proofreader.
Businesses maintain records of their financial activities in financial statements. An income statement contains revenue and expense details that allow professionals to calculate net income and net sales. If you’re a finance professional or create financial reports, it's important to understand what net sales and net income indicate to represent finances accurately.
In this article, we define net sales and net income, explain how to calculate them, provide examples, examine their importance and discuss the differences between them.
What is net sales?
Net sales is the total amount of money you earn from sales activities, subtracting any adjustments. This figure is your final revenue figure. Gross revenue is the total amount of money a company makes from selling products to customers. Adjustments, such as discounts and returns, affect the final amount. Adjustments include:
Returns: A return entails sending back an order to the vendor after delivery to the recipient within a predetermined time frame for a refund. Every order doesn’t qualify for a return or a full refund, as it depends on a set of terms and conditions.
Allowances: Allowances occur after a sale and are partial refunds in the form of price reductions or rebates offered as an alternative to returns.
Discounts: Discounts are price reductions on a product, usually represented as a percentage taken off the listed sale price.
What is net income?
Often called the bottom line since it appears at the bottom of an income statement, net income refers to all the money you have remaining after subtracting all costs and expenses from your gross income. Expenses may include the following:
Operating expenses: These are expenses a business incurs unrelated to the creation of a product. They often involve legal fees and rent.
Taxes: The government collects taxes from individuals and organizations to raise money for public services and infrastructure. Accountants deduct taxes from gross income to calculate net income.
Payroll: This is the process of paying salaries to a company's employees.
Interest on loans: Interest is the price one pays for borrowing money. Companies often resort to loans from financial institutions for various activities and pay a specific percentage of the loan amount on repayments as interest.
Depreciation on fixed assets: Depreciation is the periodic reduction of the recorded cost of a fixed asset. Fixed assets depreciating with time include furniture, office supplies and buildings.
Additional sources: Net income also factors in additional sources of income, such as gains from short-term investments and the sale of assets. All the other figures on an income statement, including net sales, calculate toward the net income.
How to calculate net sales
An income statement's net sales is the figure that remains after an accountant deducts sales discounts, refunds and allowances. The net sales formula is:
Net sales = gross sales - (returns + allowances + discounts)
Here are some steps you can take to calculate net sales effectively:
1. Calculate your gross revenue
Gross revenue is the whole amount of money a business earns without deducting the expenses for a specific period. Gross revenue doesn’t include the cost of goods sold and only considers the money earned from the sales.
2. Calculate your adjustments
There are three significant sales adjustments: returns, allowances and discounts. The sum of these three for the period for which they record the net sales is the adjustments.
3. Subtract your allowances from your gross revenue
Net sales is what remains after subtracting all returns, allowances and sales discounts from gross sales. If any of the above data is missing, the output might be incorrect and the figures won't match. Therefore, accumulating all of the necessary data ensures accurate calculations.
How to calculate your net income
To determine net income, start with gross income and deduct costs like interest payments and taxes. Here’s the formula:
Net income = (net sales + other income sources) - all expenses
Here are some steps you can take to calculate net income:
1. Calculate your net sales
Net sales is one of the most important sales parameters. It’s the result of gross revenue subtracting applicable sales returns, allowances and discounts.
2. Calculate additional sources of income
Analysts may use pretax income as a more accurate indicator of corporate profitability because these activities aren’t a part of a company's regular business operations. Add to that any income stemming from the sale of assets or earned interest.
3. Calculate your expenses
Expenses are the costs that a business incurs to make a profit. The depreciation of equipment, staff salaries and supplier payments are a few expenses. Operating and non-operating expenses comprise the two primary types of business expenses.
4. Add net sales and additional sources of income
Adding net sales and other sources of income results in gross income. It’s the revenue a company receives from the sale of goods or services before deducting taxes and other expenses.
5. Subtract your expenses from the gross income
The net income is gross income subtracting all other expenses and costs, as well as any other income and revenue sources that aren’t part of gross income. Some of the costs subtracted are taxes and operating expenses.
Related: How to Calculate Annual Growth Rate
Importance of net sales and net income
Net sales and net income are both important financial metrics. Net sales represent how much revenue a business has truly earned and maintained. Without considering cost adjustments for returns, allowances and discounts, an income statement would report higher earnings than are actually available. Knowing your net sales shows you exactly how much money stems from sales.
Net income considers net sales to calculate a figure representing a business' operational efficiency and profitability. A higher net income means the business is financially healthy, suggesting that its offerings and strategies are high-quality and effective. Inversely, a lower net income would indicate the need for improvements.
Net income vs. net sales
Though net sales and net income are both metrics used for determining the financial matters of a business, there are key differences between the two concepts, such as:
Placement on an income statement
Net sales and net income both appear on an income statement. Net sales is the first figure listed on the statement, while net income is the bottom figure. All figures on an income statement contribute toward net income, so net sales is a factor that accounts reflect as the bottom-line figure.
Every money-generating business can report a net income, but net sales may not apply to all businesses. This is due to the factors that comprise its calculation, such as price adjustments. Thus, businesses that offer returnable products, such as retailers, are the ones that report net sales.
The objective of net sales is to show how much money your products or services ultimately generate for your organization. It doesn't include income from other sources. For example, if you own a bookstore, your net sales are what you earn by selling books, stationery and other related materials from your stock.
Net income is a reflection of your business's overall financial health and factors in all sources of income. A high net income means your business is doing well and is financially healthy. Net income can also indicate the quality of your managerial skills. For example, a wide margin between net income and net sales shows you're making a profit despite lower revenue. This could stem from keeping expenses to a minimum, an indicator of effective financial management.
As metrics, net sales and net income are useful in different ways. Net sales can help identify areas within your business that need improvement. For example, if there's a growing difference between the figures for your gross sales and net sales, this may suggest customer dissatisfaction with the products you offer. The problem might be that a number of your goods sustain damage in shipment, which would signal the need to review and correct your shipping methods. Alternatively, the goods may be of low quality and might improve with production and quality control adjustments.
Net income is useful for determining profitability. This information can be helpful to various stakeholders. For investors, net income can help them decide whether to invest in a company, while other agencies can refer to net income to determine eligibility for loans. If you're a small business owner, net income can also show you whether you're getting a good return on your investments. If, for example, you initially invested $100,000 in your business and have a net income of $30,000, you're receiving a 30% return, which is substantial.
Examples of net sales and net income
Consider these examples to gain a better understanding of net sales and net income:
Deriving net sales after returns
A shoe store sold $10,000 worth of footwear and accessories this month. Several customers complained about the quality of their shoes and sought to return them. Three customers received full refunds for their returns, totaling $600. Seven other customers tried to return goods but didn't meet the criteria for returns, as their purchases showed signs of use. Wanting to retain their clientele, the store owner offered each of them a partial refund of 20% of the purchase price, totaling $350.
Gross sales for this month total $10,000, while total adjustments equal $950. Therefore, the net sales for this month are $9,050.
Deriving net sales after discounts
A stationery store has a one-day promotional event offering 50% off for teachers who present their school ID. 20 teachers purchased goods worth $300, 10 purchased goods worth $400 and five purchased goods worth $600. The gross sales from these purchases amount to $13,000. After applying the discount, the net sales equal $6,500.
Deriving net income after expenses
This year a shop that sells musical instruments reports net sales of $50,000. The store owner also provides private music lessons and channels that income to the shop. Total earnings from music lessons this year are $15,000. For expenses, there are the following:
Cost of goods sold: $10,000
Depreciation on assets: $8,000
The expenses total $38,000, while the earnings total $65,000. Earnings subtracted by expenses equal $27,000, representing the shop's net income.
Deriving net income after expenses
A company has gross sales of $600,000 in a fiscal year and has also sold two fixed assets and recovered $40,000 from these sales. Its expenses include the following:
$40,000 in employee wages
$50,000 in materials purchased
$5,000 for fixed assets purchased
$12,000 in depreciation of existing assets
$6,000 in taxes
The company's expenses total $113,000. It has net sales of $500,000 and an additional income of $40,000, totaling $540,000 as revenue. Subtracting expenses from total revenue equals a net income of $427,000 in 2021.
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