It can be difficult to understand the difference between net sales and net income, but they are not the same. Both income statement accounts capture a look at the financial profitability of a company. However, net sales calculations provide a look at how a company generates revenue. In contrast, net income measures a company’s ability to generate profit. In other words, net sales is the amount in your cash register at the end of the day, while net income is the remainder of that cash after you’ve paid all the bills associated with your business.
When creating an income statement, net sales is your starting account. It includes all sales for the year, minus allowances, discounts and returns. Allowances, discounts and returns are contra-revenue accounts that reduce the overall recognized sales. Net sales can be analyzed to determine sales volume and sales growth. Net sales is also a component of net income.
Net income is the final calculation on the income statement. Starting with net sales, you deduct cost of goods sold, operational costs, interest expense and taxes to arrive at net income or loss. Net income is the residual value earned after paying all expenses made to generate and finance sales. At the end of the year, net income is moved to the balance sheet and recorded as a component of retained earnings.
Using Net Sales
Net sales is a vital component to a number of ratios and calculations useful for managers and users of financial information. For example, net sales divided by cost of goods sold will give you a company’s gross profit margin. The gross profit margin represents the portion of sales that exceeds direct costs of production. It is the starting point for calculating net income. Net sales is also trended and analyzed to determine the performance of the product being sold.
Using Net Income
Net income is used to determine earnings per share (EPS), which is the amount of income that would be dispersed to each share held in stock if a dividend was announced. Net sales divided by net income will give you net profit margin. Net profit margin is the percent of sales that generates profit in a given period. Net income is also used by managers in trending to determine profit growth or decline.