Net purchases are total sales minus purchase discounts, returns, and allowances. This figure is reported at the top of the income statement to provide insight into sales revenue and whether a company is falsely increasing sales. Low net purchases can indicate significant discounts, and sales allowances should be infrequent. Companies track net purchases to ensure discounts, returns, or allowances do not significantly impede overall sales.
Net purchases represent total sales minus purchase discounts, returns, and allowances. Companies report this figure at the top of the income statement for each accounting period. Purchase discounts include any amounts taken from the original purchase price of an asset, such as a 10% discount on large orders. Returns can be any items that a buyer sends back to the company due to overordering or permitted returns for dated merchandise. Allowances include one-time specials for broken items or mis-shipped goods.
Companies separate financial sales information in this way so that internal and external stakeholders have a better understanding of sales revenue. Net purchases data also provides insight into whether a company is falsely increasing sales. For example, a company may send out several large orders to buyers. A portion of these orders may return when buyers acknowledge errors. Comparing total sales with high returns should give stakeholders the opportunity to discover these errors.
When a business has low net purchases, it can indicate that the business is offering significant discounts to move merchandise. This is often the case in tough economic times when shoppers settle for fewer purchases. Discounts are also more frequent at certain times of the year. For example, near or after the holidays and the end of the weather seasons are popular times for discounts. Businesses can quickly move merchandise at higher discounts in order to avoid product obsolescence.
Another reason for bigger discounts and low net purchases includes small discounts that cause shoppers to pay their bills quickly. An example is payment terms such as “1/10 Net 30”. In this scenario, buyers receive a 1% discount if they pay their invoice within 10 days of receipt. Otherwise, the full invoice is due within 30 days of receipt. The discount will go against total purchases and will result in lower net purchases as the discount increases.
Sales allowances can have a negative impact on businesses and should be infrequent. Even so, when they do happen, companies are often at fault. If a business ships goods improperly, it must replace them. Product damaged in shipping which is refundable by shippers will be compensated by company payments.
Most businesses will track their net purchases. This allows the company’s management team to ensure that discounts, returns or allowances do not significantly impede overall sales. Businesses often expect higher discounts during the previously stated periods; large discounts or returns in other periods may require further revision. As discounts and returns will reduce sales, profits will also decrease. A reduction in profits can lead to a reduction in capital invested in the business and minor operational improvements.
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