One of the biggest mistakes we see being made by new CPG branded product producers is they simply follow the net sales calculation formulas designed for accounting. This formula seems plausible and to the inexperienced, it may even seem complete. But it’s far from complete and even a little dangerous.
How to Calculate Net Sales Revenue
The business books and schools will tell you how to calculate net sales revenue. They say it’s a simple formula where you just subtract returns, allowances, and discounts from your gross sales revenue. How to calculate net credit sales is the same only now you subtract returns, allowances, and discounts from your gross sales on credit.
That may be true for a set of books but is deceptively missing the very thing that puts most businesses out of business, The Cost of Sales! Not the cost of goods, but the cost of sales. We believe that in order to really discover what is true net sales, you have to take into consideration the cost of actually making the sale. This cost may vary from market to market based on compliance, shipping, representation, customer support, merchandising, marketing, and other factors.
If, for instance, you have to fly across the country to not only make the initial sale but return monthly to monitor your distributer and retailers, that’s a cost of sales. If you have to stay in a hotel, rent a car, take someone to lunch and pick up the tab, that’s a cost of sales.
In fact, we think the cost of sales is so important to any expansion strategy that we recommend our clients hire a cost accountant to help them predict all these costs before they venture out into a new territory. By studying the true cost of sales, you can better understand the most financially feasible expansion strategy.
The key to success for most businesses is to achieve a positive cash flow before they run out of runway. In other words, they must eventually pay all their bills with their sales. Net revenue won’t do that because the formula is too simple. If the cost of sales gets thrown in to general overhead, how does the general overhead get paid? Again, through sales.
Net Sales Formula
Why look at a net sales formula that doesn’t clearly show the cost of sales in a specific territory, or to a specific buyer? You may see a net sales revenue that looks great – until you factor what it cost you to make those sales! You may be looking at a loss disguised as a net positive sale revenue.
But what if you could choose to sell in territories that had a lower cost of sales to start with? Then you would have a greater chance of achieving a positive cash flow sooner. Then you would have a better chance of building a war chest to take on those territories with higher costs of sales …later! Voila! A sales expansion strategy based on the true cost of sales!
Most accountants will take all these costs and spread them out throughout the books in different categories and call it “overhead.” By doing that, you can seriously underestimate your true net sales and make huge strategic mistakes during the expansion process. Most businesses fail during expansion because they did not take into consideration the cost of sales.
What is net sales?
So, the next time you think about how to calculate net sales revenue, remember, you must also calculate the money that it costs you to make the sale. Those costs not only erode your net sale revenue, but they figure prominently in your expansion strategy. What is net sales? Its gross revenue minus ALL costs!