If you are a small business owner, then you may want to pay close attention to this. Because this guide will show you exactly how to grow your revenue with net credit sales. If you are planning to grow and expand our business, net credit sales might be able to play a role.
It’s hard to make a business financially sustainable (especially when starting out). But there are always options available to help you grow your business to a point of financial stability such as net credit sales. Here, we’ll explain what net credit sales are, what the advantages and disadvantages are, and go over the best practices for implementing net credit sales.
By the time you have finished reading through this, you will have a good understanding of how net credit sales work. If you are serious about growing your business, keep reading. Let’s start by defining what net credit sales are:
What are Net Credit Sales?
Net credit sales are defined as revenue that is generated by a business that allows customers to purchase your products or services on credit. It also can be used for situations like sales returns and allowances. Sales that are made with cash transferred from the customer to the business do not constitute a net credit sale.
However, if your business has a loose credit policy, net credit sales are likely to go unpaid. This is generally caused by businesses liberally giving customers a large amount of credit (even those with poor payment histories), resulting in unpaid invoices.
As mentioned, there are situations like sales returns and sales allowances which are forms of net credit sales. Let’s define both of these terms:
- Sales returns: An example of a sales return would be to award some kind of credit to your customer. This can occur in situations when a customer’s shipment or service went wrong during the transaction.
- Sales allowance: In the event of an issue with the sales transaction, an allowance can be issued by the business to the customer. One common practice of this is selling the item or service to a customer at a reduced price.
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Advantages and Disadvantages of Net Credit Sales
While there are significant advantages to net credit sales, it’s also important to be aware of the disadvantages as well. Let’s take a look at each of them starting with the advantages first:
Brings in larger orders from every customer: Since your customers will not need to pay up-front for the products and services they purchase from you, they will be able to place larger orders. This greatly increases your average order size while giving yet another reason for your customers to purchase from you.
Decreases friction in the buying process: Your customers no longer need to pay for their purchases up front. So, this gives your sales team a huge selling point to push customers to try your products or services. Since they can pay for the product after they receive it, new customers can easily try your products and services. It also increases customer loyalty as they see the trust you put in them by offering net credit sales.
Improves order frequency from customers: With net credit sales, not only does it increase the frequency of orders because it adds an additional convenience for your customers, but also consistently reminds them of your services as they pay for their product. This keeps your business in the front of their mind anytime they need the products or services you offer.
Increases overall customer loyalty: When you offer your customers net credit sales, you’re trusting them to pay for their products or services after they receive it. They will recognize this trust you place in them and will become more inclined to trust your business as well. This increases your overall customer loyalty and gives your customers something to talk about in regards to your business when talking with their peers.
Potential bad debt: The last thing a business needs is bad debt. And it can cause a business to financially collapse and make it impossible to recover. The higher the debt, the more financial strain is placed on the business.
More expenses: Net credit sales can cost you money in order to track the credit of each client. There can also be additional expenses due to repair costs of a product that was previously shipped but returned to the original shipper due to severe damage or the like. However, these costs can occur whether you use net credit sales or not. It just becomes easier for the customer to return the product since they have yet to pay for it.
Recurring delays: Depending on the customer, businesses can experience delays in collection. Some will pay on time every time while others will likely hold off on payments or even forget about them altogether.
Should Your Company Offer Credit Sales to Your Business Customers?
While offering credit to customers will speed up the spending process, it does place businesses at a competitive advantage since some of their competitors may not offer credit at all. However, it’s a risky balancing act. If you believe that your business customers have financial stability, then you can offer credit sales to customers with minimal risks.
Keep in mind though, there may be those who will abuse the policy or forget about making payments. The money from this kind of credit may be hard to retrieve. If it is no longer financially sustainable to offer credit sales, then you’ll need to discontinue the practice.
Best Practices to Offer Credit Sales to Small Businesses
There are some best practices to consider when offering credit sales to small businesses. Here’s what they are:
Draw up an effective credit policy: A credit policy that has boundaries and is ironclad should be followed. It can only take a matter of time between when the debt should be collected by the business and when it goes to collections. It should give customers enough time to make payments in a timely manner.
Don’t make the policy too strict or lax: Too strict of a credit policy will turn away customers. Too lax of policy will lead to abuse of the policy by customers. So you’ll want to find a happy medium. You want a credit policy to be fair for customers so they don’t feel rushed to make payments. They may not have the financial means to make frequent payments. So make sure that you and your customers agree on a payment plan that is a win-win for both parties.
Always follow up: Your business needs the money to operate. So it’s always a good idea to follow up on delinquent payments if a customer has missed one. You can’t be too lax about skipped payments. Consider doing regular follow-ups (every two weeks, every month, etc.) for all outstanding payments.
Utilize software solutions: Processing net credit sales can be difficult and time consuming. However, there are now plenty of software services built exactly for these purposes. These solutions can automate the application process to give real-time approval to your customers with customized credit limits and terms based on the customer risk. You can also use these solutions to track and monitor your customers’ payment status. Finally, implementing a software solution allows you to offer various methods for digital payments and even flexible payment plans to ensure a simple customer experience.
How to Record a Credit Sale on a Balance Sheet
In case a credit sale is made, you’ll need to record it on a balance sheet. It should be done as follows: Add it as an increase to accounts receivable while it should be a deduction from inventory. This way, it will be counted as an item that was bought and sold (even if the money itself has yet to be received).
How to Record a Credit Sales Payment
A credit sales payment or net credit revenue can be recorded on a balance sheet. It can be constituted as a payment received or any similar labeling on the balance sheet. These are typically recorded as a debit for accounts receivable and a credit in the sales revenue section.
How to Calculate Net Credit Sales Formula
The formula for Net Credit Sales is as follows:
Net Credit Sales = Sales on Credit - Sales Returns - Sales Allowances
Another formula to consider is the sum of starting and ending accounts receivable divided by two. Sum of accounts receivable can be dependent upon the time frame such as monthly or quarterly totals.
The Bottom Line
Small businesses can benefit from net credit sales. However, they need to establish the best practices in order to stay financially afloat. You cannot afford to have many customers leave the store with a lot in their hands and nothing to pay for. At some point, you’ll want to make sure that your customers pay up or deal with collections (while you clean up your financial situation from the outstanding debts owed).
Find a happy medium that will help you keep your money intact without having to bleed so much cash due to people relying on credit. The more you pay attention to the amount in account receivables that needs to be collected and settled, the better off you’ll be.
When implemented correctly, net credit sales gives your business a huge opportunity for growth allowing you to secure new customers and clients easily as they do not need to pay anything up front.