Offering credit sales to customers is a common practice among many enterprises. Credit sales are a type of sale in which the customer is allowed to purchase goods or services now and pay for them later.
This differs from cash sales, which are another common sale type. It's critical to understand the difference between the two, as well as the advantages and disadvantages of credit sales.
What are credit sales?
Credit sales are specific transactions whereby a customer pays for goods sold at a later date.
Payment terms are set before goods are exchanged, stipulating when the full payment is due and how it will be paid. It is not uncommon for a credit sale to include a down payment from the customer. They pay a percentage of the overall payment now, and then the rest is sent over at a later date.
When are credit sales typically used?
After seeing what are credit sales, the next obvious question is when might they be implemented?
Nowadays, businesses of all sizes may use credit sales as an alternative form of payment. Giving customers the ability to pay in instalments means they can space out payments and manage their cash flow better.
You will also see cash sales used for significantly large payments. When a sizable sum of money is owed for goods or services, it makes more sense to allow multiple repayments rather than demanding the payment in full.
Are credit sales the same as cash sales?
No. Credit sales refer to transactions where the buyer pays for things at a later date.
By contrast, cash sales refer to any transactions whereby the customer pays for items immediately. Money instantly appears and is transferred into your account, while credit sales refer to money owed.
Therefore, credit sales are considered short-term assets and will be labelled as such on your balance sheet. It is technically categorised as accounts receivable because you have assets that are not yet in your account.
How to calculate credit sales
It's imperative that you have a clear understanding of your company's finances. Calculating your credit sales is a smart way of doing this. It will show you how many credit sales you had during a specific period, which can be used to analyse and compare your sales strategies.
In this section, we will help you with two key elements:
- How to calculate credit sales
- How to calculate net credit sales
There are different ways of calculating credit sales. One of which is to take your initial accounts receivable and subtract it from your cash received, then add the ending accounts receivable.
The calculation looks like this:
Credit sales = cash received - initial accounts receivable + ending accounts receivable
An example of this could look like this:
You have an initial accounts receivable of $10,000 and an ending accounts receivable of $5,000. After looking at your financial records, you see your company earned $20,000 in cash. Using the calculation this would mean $20,000 - $10,000 + $5,000, which equals $15,000 in credit sales for that particular year.
Recording credit sales is an essential task as this assists you when you calculate net credit sales. They should be recorded on your balance sheet.
Calculating net credit sales
Firstly, what are net credit sales?
Net credit sales refer to the revenue made by your company through credit sales, less all sales returns and allowances. It takes into account any products bought via credit that were returned or any allowances given to customers who perhaps overpaid for products.
Calculating net credit sales is useful as it gives a better overview of how much money your company generated through credit sales during the average collection period.
The calculation for net credit sales is as follows:
Net credit sales = sales on credit - sales return - sales allowances
The advantages of credit sales
Companies may wonder why credit sales should be used at all. Theoretically, it makes more practical sense to receive money owed immediately when transactions take place.
Contrary to this belief, credit sales have numerous advantages that can help an enterprise uncover new customers and sales avenues:
Provide alternative payments for customers, drawing in new clients
Some leads may admire your goods/services but feel unable to commit to a one-time payment. Credit sales help you capture this particular audience by spreading their costs over a longer period. It attracts new customers by giving them new ways to pay.
Therefore, you can elicit more sales and help your company grow.
Encourage larger purchases from customers
Similarly, credit sales provide a more convenient way for customers to afford significant purchases. One credit sale can split payments up over months, making a large purchase more accessible for clients.
As a result, you can encourage customers to spend more money, which increases revenue and could help to expand profit margins.
Establish better customer service to gain new customers & retain old ones
Every organisation must focus on delivering good customer service whenever transactions occur. You want to drive as many new customers to your enterprise as possible while also retaining existing customers.
A credit sale can help you do both as it improves customer service. You're making payments more convenient, giving customers various choices so they can select a method that appeals to them the most. This can influence customers to continue returning - and it may also result in positive reviews from said customers.
Positive reviews are seen by potential leads, encouraging them to choose your company as they trust that you provide an excellent service.
The disadvantages of credit sales
Evidently, credit sales can be a positive way to boost businesses. At the same time, you must consider some potential drawbacks:
Increased accounts receivable & unpaid invoices
A successful credit sale is one that results in the full payment of goods before or at the agreed-upon date. Unfortunately, situations occur where customers don't pay their invoices on time.
This leaves you with a multitude of unpaid invoices, increasing your accounts receivable and damaging cash flow.
The potential loss of money owed
In extreme circumstances, a customer or client may go insolvent or file for bankruptcy before they pay what they owe. This leaves your company in the precarious situation of losing out on payments due with no way to recoup the losses, generating bad debt.
One customer that gives you bad debt isn't a major problem, but multiple can be catastrophic. You cannot recover thousands of dollars owed, which could potentially push your company over the edge and lead to bankruptcy.
Managing the risks associated with credit sales
The risks of credit sales may worry you, but it is possible to manage and control them.
In this section, we will explain some tactics and methods your company can use to reduce the risk of bad credit via credit sales.
Conduct background checks on all customers
Before extending credit to every customer who requests it, run background checks to see if they're able to pay their bills. The simplest way to do this is via credit checking services to get their credit score. Customers with a positive credit rating and a high score will be deemed creditworthy and showcase a strong history of making repayments to other vendors.
Request deposits
Requesting deposits from customers ensures you get a fraction of the money in cash at the very least. This reduces your losses if they can't make repayments, but it can also be used to dissuade unreliable customers from choosing a credit sale.
Consider requesting larger deposits from customers with worse credit scores. They are more likely to miss payments so it makes more sense to get a larger down payment to minimise losses.
Set clear credit terms
Credit terms stipulate what customers pay, how much they need to pay and when payments are due. You should also incorporate late payment fees and detail what customers will be charged if they don't meet the credit terms.
For instance, outline that, if payments are due each month and the payment date is missed, an interest fee will be added until the payment is made. It's an incentive for customers to make payments on time, which can reduce the average collection period for your company.
Review your credit control policies
Lastly, stay on top of your credit control policies. Ensure they are consistently updated with the latest regulations and best practices. This enables you to be more consistent with your credit decisions, maintaining healthy relationships with customers. As a result, you can protect your business from bad debt.
All of these tips are critical for companies of all sizes that use credit sales. They assist you in developing a sound credit policy to ensure the financial health of your organisation for years to come.
Key takeaways credit sales
We will conclude this guide with a brief summary of the main takeaways of credit sales:
- Credit sales are a type of payment allowing customers to pay in instalments rather than all in one go
- Credit sales can benefit your business by unlocking new opportunities to generate sales through new customer acquisition or customer retention
- Bad debt is one of the major drawbacks of credit sales, though it can be managed if you implement a good credit policy to ensure payments are made on time, all the time
- Calculating your credit sales helps you understand how much money is generated through this income stream while also letting you see how this compares to other payment forms
Take advantage of automation to streamline your credit sales
Credit sales can be a great way to increase cash flow and grow your business. However, it's important to understand how they work and the risks involved before offering them to your customers.
By being aware of the potential problems and taking steps to avoid them, you can reduce the risk of bad debt and keep your business healthy.
One of the best ways to manage your credit sales is to use an automated system.
Automation platforms like Chaser allow you to credit-check customers, automate invoicing and payment chasing, and keep control of receivables.
Automated credit control not only reduces your risk but also saves you time and money.
Book a demo with Chaser today to see how easy it is to manage your credit sales with our platform.
