A business has to make sales in order to pay for various business expenses.An increase in sales can help a company in improving its net profitability position.

It is quite possible that a company may be able to generate sales,but may not be able to generate adequate amount of profits on account of high business expenditures. Hence, increase in sales cannot be taken as a measure to judge a company’s ability to earn substantial amount of profits.

Net Sales

Sales is the largest source of revenue for a company.Without making sales, a company cannot survive for a long period of time. A company generally makes sales on cash and credit basis. Sales made on cash basis represents that part of total sales where cash is immediately received by the company.

In case of credit sales, cash is received after a certain period of time.Till money is received by the company, amount of credit sales is recorded as accounts receivables in the company’s balance sheet.

For Instance, a company has made sales of $ 50,000 to a customer. Out of this $ 50,000, goods worth $ 10,000 are sold on cash basis while goods worth $ 40,000 are sold on credit basis.

While cash sales will result in an increase in the company’s cash balance, credit sales of $ 40,000 will be reported as accounts receivables in the balance sheet. Net sales is arrived by adding cash and credit sales and deducting the amount of sales returns made by customers during the year.

For Instance,a company may have sold goods for an amount of $ 1, 00,000 during the year 2010. However,goods having a value of $ 10,000 were returned by some of its customers. In this case, company’s net sales will be $ 90,000 ($ 1, 00,000 -$ 10,000).

Net Income

Net income is calculated by deducting the total amount of expenses from the amount of gross profit. Gross profit is calculated by deducting cost of goods sold from net sales.

Net income is also known as net profit. A company earns net profit when the total amount of revenue exceeds total amount of expenses incurred by the company in a particular year.

For Instance, a company may earn total revenue of $ 2, 00,000 from sales and business investments.In case company’s total expenses for the year were $ 1, 75,000, company will report a net profit of $ 25,000 in its income statement.

In case, revenue from all the sources is less than the total amount of expenses, company will report net loss in its income statement. It is important to note that irrespective of the level of sales made by the company, net income provides the basis for management’s decision on reinvestment of business earnings or dividend distribution to shareholders.

Conclusion

It is correct to say that the amount of net sales is different from the amount of net income. While net sales forms the basis for calculation of net income, net income is the final figure used for measuring a company’s overall profitability position.

Net profit ratio (Net Profit/Net Sales * 100) is frequently used to measure the percentage of net profit with respect to sales made by the company. This ratio indicates the amount of sales that a company is able to convert into its final income.

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