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Credit Sales

Customer purchases to be paid at a later date

What are Credit Sales?

Credit sales refer to a sale in which the amount owed will be paid at a later date. In other words, credit sales are purchases made by customers who do not make a payment at the time of purchase.

 

Credit Sales

 

Types of Sales Transactions

There are three main types of sales transaction: cash sales, credit sales, and advance payment sales. The difference between these sales transactions simply lies in the timing of when cash is received.

1. Cash sales: Cash is collected when the sale is made, and the goods or services are delivered to the customer.

2. Credit sales: Customers are given a period of time after the sale is made to pay the company.

3. Advance payment sales: Customers pay the company before the sale is made.

 

Types of Sales

 

Credit Terms and Credit Sales

It is common for credit sales to include credit terms. Credit terms are terms that indicate when payment is due for sales that are made on credit.

For example, the credit terms for credit sales may be 2/10, net 30. It means that the amount is due in 30 days (net 30). However, if the customer pays within 10 days, a 2% discount will be applied.

Assume Company A sold $10,000 worth of goods to Michael. Company A offers credit terms 5/10, net 30. If Michael pays the amount owed ($10,000) within 10 days, he would be able to enjoy a 5% discount. Therefore, the amount that Michael would need to pay for his purchases if he paid within 10 days would be $9,500.

 

How to Record a Credit Sale

On January 1, 2018, Company A sold computers and laptops to John on credit. The amount owed is $10,000, due on January 31, 2018. On January 30, 2018, John made the full payment of $10,000 for the computers and laptops.

 

The journal entries would be as follows:

Date Account Title Debit Credit
January 1, 2018 Accounts Receivable $10,000
     Sales $10,000
To record the sale of goods to John on credit

 

Date Account Title Debit Credit
January 30, 2018 Cash $10,000
     Accounts Receivable $10,000
To record the full payment made by John for purchases on January 1, 2018

 

How to Record a Credit Sale with Credit Terms

Consider the same example above. Company A selling goods to John on credit for $10,000, due on January 31, 2018. However, let us consider the effect of the credit terms 2/10 net 30 on this purchase.

 

The journal entries would be as follows:

Date Account Title Debit Credit
January 1, 2018 Accounts Receivable $10,000
     Sales $10,000
To record the sale of goods to John on credit

 

John decides to take advantage of the credit terms and thus pays on January 5, 2018:

Date Account Title Debit Credit
January 5, 2018 Cash $9,800
Cash Discount    $200
     Accounts Receivable $10,000
To record the sale of goods to John on credit with the credit discount

 

John paid his invoice four days (January 5) after purchasing the goods on credit. Therefore, he would be able to enjoy a 2% discount on his credit purchase ($10,000 x 2% = $200).

 

Advantages and Disadvantages of Credit Sales

As previously mentioned, credit sales are sales where the customer is given an extended period to pay. There are several advantages and disadvantages for a company to offer credit sales to customers.

 

Advantages

  • Credit sales can be used to easily acquire new customers. Longer credit sales terms can attract new customers to purchase from the company.
  • Customers are sometimes without enough cash on hand. Offering credit sales gives customers the flexibility to pay for purchases at a later date.

 

Disadvantages

  • Customers can potentially go bankrupt. If customers go bankrupt, the credit sales may be unrecoverable and must be written off.
  • Costs of collection may decrease revenue. If a customer misses the payment or refuses to pay, the company would incur collection costs to try and recover the payment.

 

More Reading

CFI is the official provider of the online Financial Analyst Certification Program in financial modeling and valuation.  To develop your career in corporate finance, these additional resources will be helpful:

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