What are Credit Sales?

What are Credit Sales?

Credit sales are purchases made by customers for which payment is delayed. Delayed payments allow customers to generate cash with the purchased goods, which is then used to pay back the seller. Thus, a reasonable payment delay allows customers to make additional purchases. The use of credit sales is a key competitive tool in some industries, where longer payment terms can be used to attract additional customers.

Types of Sale Transactions

Basically, there are three types of sales transactions- cash sales, credit sales, and advance payment sales. The variation between these sales transactions simply lies in the timing of when cash is received.

Cash sales – Cash is collected when the sale is made, and the goods or services are delivered to the customer. Here the consideration for sale is settled in cash or cash equivalent by the buyer.

Credit sales – Here, the consideration is for sale is settled on a later date. The seller provides the credit period to pay the bill on the later date.

Sales against advance payments – Here, customer’s pay the seller in advance before the sale is made. Generally, the advance payment is a partial amount of full consideration and sometimes, it could be full consideration as well.

Credit sales and Credit Term

It is customary for credit sales to include credit terms. A credit term indicates payment due date for sales made on credit, possible discounts, and interest or late payment fees if any.

Let’s consider a credit term for a credit sale of 2/10, net 30.

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Here, net 30 refers to the maximum credit days in which the buyer needs to pay the bill.  2/10 implies that if the customer pays within 10 days, a 2% discount will be applied.

To make it easier, let’s consider another credit sale example.

Priya Enterprises sold goods worth Rs.10,000 /- Max Ltd. Priya Enterprises offered a credit term of 5/10, net 30.

If Max Ltd pays the amount owed (Rs.10000 /-) within 10 days, 5% discounted will be allowed. Therefore, the amount that Max Ltd would need to pay for his purchases would be Rs. 9,500. Else, they need to pay the complete amount of 10,000. 

Credit sales in accounting

It’s vital that credit sales are accurately recorded in your company books so that you stay on top of any money owed as well as any assets disposed of. How your sale is recorded will depend on the nature of the credit repayment as well as whether there is any interest payable or applicable discounts (such as an early-payment discount) to be applied. It will appear as a double entry in your bookkeeping, with debit and credit needing to be accounted for as well as receivables and revenue.

w to Manage Credit Sales efficiently?

Successful closure of credit sale is determined only when you convert your ‘sales into cash’. Till your sales are converted into your cash, you need to manage ‘how much you need to ‘receive?’ from whom? And when?

This is critical for business because the credit sales are nothing but the money which is yet to be enchased from your customers and it is referred to as accounts receivables.  

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Accounts receivables are one of the key sources of cash inflow, any inefficiency in managing accounts receivables will impact your business in several ways and potentially hamper the growth of the business.

Here are 4 Tips for increasing efficiency in managing bills receivable and reducing your order to cash cycle.

Bill-by-bill Receivable Management

Here, bill-by-bill refers to the tracking of each sales invoice and mapping with the subsequent receipts received from the customer. Thus, at any point, you can easily track the bills pending instead of just knowing only the overall outstanding of a customer

Ageing analysis

The longer an invoice sits as accounts receivable, will lead to cash flow issues and at some point in time it may turn into bad debt. Thus, it is important for you to be top of the ageing of each bill. This helps in identifying the bills which are pending from long-time and ones which require immediate action

Payment Performance and periodically following up

Payment Performance of customers’ is the average time the customers take to actually pay their bills irrespective of the outstanding balance on the statement date. This is also known as receivable turnover in days. This helps in identifying the customers with a poor track record and accordingly action.

Internal Credit Control Techniques

To ensure better credit management, you can define maximum Credit Limit based on the credibility, the volume of transactions, the capacity of repayment etc. for your customers. This will help business owners in overselling to a customer beyond the defined credit limit.

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While this sounds true, automating accounts receivables process using accounting software will be key for businesses. Accounting software helps in ease of managing the receivables, easy to track the pending invoices and real-time status of receivables and ageing of bills.

Find out How TallyPrime can help you recording credit sales and tracking complete accounts receivables

Advantages

  • Credit sales with good credit policies give competitive advantages to the organization.
  • Such policies help newly set up organizations in increasing sales.
  • It develops trust and relation between the customer and the company.
  • It helps those customers who do not have enough cash to make payment at the time of purchase, and can make payment after 15 or 30 days as per the credit term.
  • Longer credit days help attract new customers.

Disadvantages

  • There is always a risk of bad debt.
  • It affects the company’s cash flow because payment is received later.
  • The company has to incur expenses on the collection agency for regular follow up with customers for their outstanding amount.
  • The company has to maintain separate books of accounts for accounts receivable.
  • There is a notional loss of interest during the credit period because money is getting blocked.

Example

If January 1, 2019, Mr. C sold goods worth $1,000, and cash is not received but postponed to Feb.1, 2019. This will be termed credit sales.