Credit sales are a great way to entice more customers to buy from your business, enabling them to buy now and settle payments later. Knowing how to do it right helps you boost sales and prevent your company from taking significant financial hits.
In this article, you’ll learn how to define and calculate credit sales, how credit sales work, when to use them and ways to mitigate and prevent common risks.
Credit sales definition: credit sales allow customers to purchase goods or services on credit. You (the creditor) let your customer (the debtor) pay later, agreeing on the payment date at the time of purchase.
Typical sales credit payment terms range from 30 to 90 days but can be longer. The terms must be in writing and agreed upon by both parties, and a contract must confirm the details.
Other names for credit sales include sales on account, credit transaction, buy now, pay later (BNPL) and sales on credit, all meaning the customer pays for the product after acquiring it.
By offering flexible credit, you increase your chances of making a sale by appealing to new customers across a broader range of financial situations. It allows customers who are struggling with cash flow problems or tight budgets to buy from you without a significant upfront cost.
Studies show that customers value flexible payments. 41% of adults in the US have used “buy now, pay later” services in the past 12 months, and another 22% say they haven’t yet but could in the future.
How people use ‘Buy Now, Pay Later’ in the US
What about accrued revenue?
Accrued revenue is the revenue a company earns by delivering goods or services before invoicing or receiving payment. Similar to the credit sales meaning, you recognize this revenue before receiving cash.
However, there are some key differences between credit sales and accrued revenue:
Accrued revenue | Credit sales |
You record accrued revenue when you earn it but haven’t issued an invoice. | You record credit sales when you sell goods or services and issue an invoice for payment at a later date. |
You record accrued revenue in an accrued revenue account, which is a subset of accounts receivable. | You record credit sales directly in accounts receivable. |
Say that a consulting firm completes $5,000 worth of services.
With accrued revenue, the firm records the revenue as soon as they deliver the service and before sending an invoice. With a credit sale, the firm records revenue at the time of sale and sends an invoice simultaneously.
Next, you’ll learn the formula for working out your business’s net credit sales.
How to calculate net credit sales
Calculating net credit sales helps you analyze actual earnings from credit transactions and assess your financial health by closely monitoring your cash flow.
Net credit sales are the total revenue of credit sales after deducting:
Sales returns. Funds you reimburse customers if they change their minds and return your product or service. Say you sell an item for $100 on credit, and the customer decides to return it. You cancel the $100 receivable and deduct it from the total credit sales.
Sales allowances. You reduce the selling price when customers report defects, damage or dissatisfaction. For example, if a product has minor damage but the customer chooses to keep it, you offer a 10% allowance. You send them a 10% refund and deduct this amount from your total credit sales.
Sales discounts. You lower the price upfront to encourage customers to pay early or buy during a promotional period. For instance, you offer customers a 2% price reduction if they pay the invoice within 10 days, subtracting the 2% from the total credit sales.
How do you find net credit sales? You can do so using the net credit sales formula:
Net credit sales = total credit sales − (returns + allowances + discounts)
Say that a company has the following sales and deductions:
Total credit sales – $100,000
Returns – $5,000
Allowances – $2,000
Discounts – $3,000
Here’s how the above formula applies to these figures:
$100,000 − ($5,000 + $2,000 + $3,000) = $90,000
The company’s net credit sales amount to $90,000.
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How to record credit sales on your income statement
You record a credit sale as a journal entry on your income statement by:
Debiting the account receivables entry
Crediting the sales revenue account
The process, known as double-entry bookkeeping, involves recording both debit and credit transactions. You record credit sales this way because:
The customer owes money to the business. To represent the money you expect to receive in the future, you increase your accounts receivable ledger.
You recognize revenue at the point of sale. You record the sale income because the customer already has your product or service. This is known as accrual accounting, meaning you record revenue when you earn it, regardless of when you receive payment.
Here’s an example of how credit sales appear on an income statement:
By debiting the receivables account and crediting sales revenue, you record:
The increase in assets (what the customer owes)
The increase in revenue (the value of sale)
By doing so, you balance your accounts to get a more accurate picture of your financial health. If the sides don’t balance, it signals an error somewhere along the way.
Recording transactions in at least two accounts also shows where your money comes from and where it’s going. As a result, you can quickly assess your company’s financial position, identify trends and spot potential issues early.
Note: Double-entry bookkeeping also ensures compliance with financial laws and regulations, such as those set by the Financial Accounting Standards Board (FASB) and the Generally Accepted Accounting Principles (GAAP). Visit these websites for a full breakdown of the regulations.
What about your balance sheet?
Credit sales appear in the short-term assets section of your balance sheet, under accounts receivable (similar to the income statement).
Here’s an example of how that looks:
Current assets | Amount |
Cash and cash equivalents | $50,000 |
Inventory | $30,000 |
Accounts receivable | $75,000 |
Prepaid expenses | $5,000 |
Total current assets | $160,000 |
Accounts receivable ($75,000) represent outstanding credit sales in the above format.
Note: Credit sales also appear in the “total sales revenue” section of a profit and loss statement, a report that summarizes your income and expenses over a certain period. They also appear on cash flow statements by adjusting the net income to recognize revenue as you earn it.
How to use the percentage of credit sales method
The percentage of credit sales method estimates bad debt expenses based on credit sales.
Bad debt refers to amounts your business is unlikely to collect because the customer can’t or won’t pay.
Also known as the income statement approach, the percentage of credit sales method helps businesses assess previous sales (or industry benchmarks) to make informed projections for the future.
For example, if you have $100,000 in credit sales and estimate that 5% is uncollectible, you can record a bad debt expense of $5,000 (5% of $100,000). Knowing this, you can make informed decisions about your future business activity, such as:
Adjusting your budget to account for potential losses
Limiting expenditures in areas that may impact cash flow
Setting reserves aside to cover business costs
Follow these three steps to use the percentage of credit sales method:
1. Determine the percentage
Review historical data to calculate the percentage of credit sales that typically result in bad debts over a certain period.
For example, if you analyze past sales and find that 3% of credit sales usually result in uncollectible amounts, use this percentage to estimate future bad debt expenses (which the final step explains).
2. Identify total credit sales
Calculate the total credit sales for the period under consideration – usually monthly, quarterly or annually.
Say that you’re predicting bad debt for the previous month. The total amount of credit sales was $100,000, so this is your base figure.
3. Calculate bad debt
To calculate your bad debt, multiply the total credit sales by your estimated percentage of bad debts. Here’s the formula:
Bad debt expense = total credit sales x percentage of bad debts
Using the figures from the previous steps, here’s how it works:
$100,000 x 0.03 = $3,000 of bad debt
You now have a fairly accurate idea of how much bad debt to expect from last month’s credit sales. With this insight, you can plan for potential losses and adjust your financial forecasts accordingly.
When to use credit sales
Credit sales provide benefits for businesses and customers alike. People buy products or services without a high upfront cost, and companies secure more sales through flexible payment options.
Read through the following benefits to determine when to use credit sales for your business (there are also drawbacks to consider, which this article covers in more detail later).
Note: While this list of benefits can be a helpful guide, it’s not exhaustive. You might want to do additional research to determine if credit sales are the right option for your business.
To boost your sales volume
Credit terms make products or services more accessible to customers without immediate funds. As a result, you increase the likelihood of securing sales from a broader customer base.
Say you approach a new lead about your services, and they’re keen to move forward. However, they’re coming to the end of their financial year.
There’s little room in the budget to pay for your services, so they take advantage of your 90-day payment option. You secure the sale, and the customer can access your service. It’s a win-win for both parties.
Customers may also feel more confident making larger purchases, knowing they can spread the cost over time by purchasing more items or upgrading to a more expensive product or service.
For instance, an electronics retailer may see higher sales of its more advanced laptops when offering a 90-day interest-free payment plan. As a result, the business achieves a higher average sales transaction value (or average order value).
To gain a competitive advantage
Offering credit terms sets your business apart from competitors accepting only upfront payments. This flexibility is essential for potential customers working with a strict budget or poor cash flow.
According to Statista, “Buy Now, Pay Later” is a major draw for consumers for the following reasons:
Imagine two companies that offer the same service for the same price. The only difference is their payment terms:
One provides a 60-day payment plan with no interest
The other requires immediate payment for its service
Faced with these two options, which one do you think your typical customer would choose?
Note: Consider your product and demographic when offering credit sales. Credit sales are more critical if you sell pricier items to younger demographics (like smartphones to students). If you sell a high-end product (like vintage watches) to an older and wealthier target consumer, you might not need flexible payment options to secure sales.
To increase customer retention
Credit sales can boost customer retention in addition to attracting new buyers. If your competitors require upfront payment but you offer flexible payment terms, your existing customers have less reason to look elsewhere.
Providing flexible payments also shows you trust your customer’s ability to pay. You create a sense of mutual respect, which leads to stronger, longer-lasting customer relationships.
Credit options also help buyers manage their cash flow more effectively, enhancing their purchasing experience.
Customers who have a good buying experience are more likely to return. PwC research shows that 54% of business executives prioritize the buyer experience as a critical strategy for building customer loyalty.
To enhance market penetration
Credit sales can help you establish a strong presence when entering a new market.
Imagine a software company launching into a new industry, such as healthcare. To differentiate itself from competitors and appeal to potential clients, it offers the best credit terms on the market.
For example, the company offers a subscription model in which healthcare organizations pay for the software in quarterly installments – while industry leaders require upfront payment. The company stands out in the market for its unique credit terms.
To increase flexibility in closing deals
Offering credit terms can help address price objections, making it easier to close deals with hesitant customers.
Consider a lead uncertain about committing to a $30,000 contract because of cash flow concerns. Your sales team offers a credit sale as an alternative, meaning the final payment date is 90 days.
Your service immediately becomes more accessible and addresses the client’s concerns about cash flow. As a result, you secure the contract. The credit sale eliminates the risk of losing the deal.
Disadvantages of credit sales: what are the risks?
Credit sales are a powerful tool for building customer loyalty and boosting sales, but they require careful management to minimize the risk of bad debts and maintain healthy cash flow.
Let’s walk through the challenges of credit sales and some strategies to mitigate them.
Developing debt
Businesses risk falling into debt if customers fail to settle invoices.
Say you agree to a 30-day credit policy with multiple customers who delay payment by several months. As a result, you go into debt. You’re unable to pay suppliers and employees on time. With each month that passes, your debt incurs interest and late payment fees. On top of this, your credit rating takes a hit.
To stay afloat, you must secure loans (if your credit rating doesn’t get in the way) or reduce operations.
How to minimize the risk of debt:
Clearly define credit terms. Specify payment deadlines, interest rates for overdue accounts and any additional conditions upfront with every customer. Put it in a sales contract, make sure it’s legally binding and get all relevant parties to sign it to protect your business if payment fails.
Offer sales incentives for early payment. Encourage timely payments by offering discounts or other incentives for customers who settle invoices ahead of schedule. For example, give a 2% discount on the total invoice amount if a customer pays within 10 days. These incentives motivate customers to pay early, reducing the risk of delayed payments.
Strengthen your collection process with CRM technology. Use a customer relationship management (CRM) system like Pipedrive to automate reminders, track payment statuses and flag overdue accounts for immediate follow-up. Doing so reduces the administrative burden and ensures that you regularly remind customers about upcoming deadlines.
Perform credit assessments. Use credit-scoring tools or request financial statements to conduct a thorough credit assessment and evaluate the customer’s economic stability. This will reduce the likelihood of extending credit to high-risk customers.
Note: You’ll need to allocate funds and resources to perform credit checks. Pricing may vary depending on the credit check provider and the level of detail in the report.
Impacting cash flow
Credit sales reduce the company’s cash availability for day-to-day operations. Businesses rely on timely customer payments to maintain liquidity. They risk missing out on opportunities (like supplier discounts) if cash flow is impacted by overdue credit purchases.
How to alleviate the impact on cash flow:
Balance the types of sales. Encourage a mix of credit and cash sales to ensure a steady cash flow while still offering customers credit. For example, you might provide full payment options first instead of opening with credit terms. You can then refer to credit terms if the customer is apprehensive about paying in full.
Negotiate extended payment periods with suppliers. Ask to renegotiate payment terms with your suppliers to relieve pressure if customer payments are late. If you offer 30-day payment terms to your customers, you might ask for 60-day payment terms with your supplier.
Build a reserve fund during periods of strong cash flow. Set aside a portion of profits during strong cash flow periods to create a reserve fund. Use these funds as a buffer when customers fail to make a payment.
Budget for delays in your financial planning. Account for payment delays in your cash flow projections and budgeting to prepare for cash shortages. For example, use the percentage of credit sales method to predict how many customers won’t pay invoices and adjust budgets accordingly.
Increasing administrative work
Offering credit sales can lead to higher administrative work. These tasks often demand time and effort you could otherwise spend on revenue-generating activities, like nurturing high-quality leads.
Here are some additional administrative tasks that credit sales require:
Creating and updating payment terms
Monitoring payment deadlines
Issuing payment reminders
Performing credit assessments
The right tools, including Pipedrive, help you automate routine admin jobs and monitor progress – so you can focus on customer and business growth.
How to reduce additional administrative work:
Use technology to manage repetitive accounting tasks. Implement accounting software like QuickBooks or Xero to automate invoicing, track payments and centralize customer records. With repetitive tasks under control, you can focus more on crucial work areas, like generating leads.
Automate payment reminders. Set up automatic reminders for due payments to notify customers of upcoming deadlines and reduce the need for manual follow-ups. For example, use Pipedrive’s email automation to schedule reminders at specific intervals (using the Delay step).
Standardize your credit processes. Establish consistent procedures for credit sales to ensure all team members follow the same protocols. Creating a uniform process allows your team to work more effectively and spend less time on each transaction.
Create real-time revenue reports. Generating financial reports makes tracking upcoming payments and monitoring cash flow easy. In Pipedrive, for example, the Insights feature lets you create reports to track scheduled payment revenue and dashboards to view insights at a glance.
Use payment gateways. Integrate secure payment gateways like Stripe into your CRM to fast-track secure payment collection and processing. You’ll spend less time manually processing customer payments and more time building leads and closing deals.
Final thoughts
Credit sales are a powerful tool for boosting sales, increasing customer retention and expanding your market presence. While there are some risks, you can minimize them with proper preparation, planning and technology – reaping benefits like winning more deals.
Pipedrive reduces the administrative burden of managing credit sales. You can integrate accounting systems directly into the CRM to centralize all your financial activity, automate payment reminders and track customer payments.
Sign up for a free 14-day trial to see how Pipedrive can support your business’s sales efforts.
