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November 01, 2022 November 01, 2022/ Steven Bragg
Credit sales are purchases made by customers for which payment is delayed. Delayed payments allow customers to generate cash with the purchased goods, which is then used to pay back the seller. Thus, a reasonable payment delay allows customers to make additional purchases. The use of credit sales is a key competitive tool in some industries, where longer payment terms can be used to attract additional customers.
A downside of credit sales is the risk of bad debt loss. Also, the seller must invest in a credit and collections department.
Terms Similar to Credit Sales
Credit sales are also known as sales made on account.
November 01, 2022/ Steven Bragg/
Credit Sales refer to sales in which the customer or purchaser is allowed to make payment later instead of at the purchase time. In this sale, the customer gets adequate time to make payment.
Credit sales are a type of sales in which companies sell goods to the customer on credit based on the credibility of customers. It gives the customer time to make the payment after selling the purchased goods and does not require them to invest their own money into a business. It helps small businesses, especially those that do not have enough capital. At the same, it helps big companies also because it attracts customers.
In credit sales, there is always a risk of bad debt. If a customer cannot make a payment, commits fraud, or is not traceable, it will be challenging to get money. It will become a bad debt in that situation. It can also increase the cost of capitalThe cost of capital formula calculates the weighted average costs of raising funds from the debt and equity holders and is the total of three separate calculations – weightage of debt multiplied by the cost of debt, weightage of preference shares multiplied by the cost of preference shares, and weightage of equity multiplied by the cost of equity.read more cost if customers pay after 15 days or 30 days, depending on their credit terms. In such a scenario, a company’s capital gets blocked, and interest is lost. So, it is an excellent yet costly option for new companies.
Below is the journal entry for recording credit sales in the books of account:
The following are credit sales journal entry examples to understand the concept better:
Example #1
Walter is a dealer of mobile phones, and he is selling goods to Smith on January 1, 2018, for $5,000 on credit; his credit period is 30 days, which means Smith has to make the payment on or before January 30, 2018.
Below are the journal entries in their books of Walter:
Example #2
Usually, a company gives a cash discount or an early payment discount. In the above example, Walter is offering a 10% discount if Smith makes the payment on or before January 10, 2018. Accordingly, Smith made his payment on January 10, 2018.
Below are the journal entries in their books of Walter.
Example #3
Let’s assume in the above example that Smith cannot make payment by January 30, 2018, as he has gone bankrupt. Now, Walter believes that the outstanding amount is unrecoverable and is bad debtBad debt expense is an expense recorded in financial statements when the amount receivable from debtors is unrecoverable owing to the debtors' inability to meet their financial obligations and can be calculated using the direct method of allowance/estimation method.read more now.
Below are the journal entries in their books of Walter:
Walter will pass entry for the bad debt at the end of the financial year:
Advantages
Disadvantages
- Credit Sales – It will show in the credit side of profit & loss a/c.
- Debtors – DebtorsA debtor is a borrower who is liable to pay a certain sum to a credit supplier such as a bank, credit card company or goods supplier. The borrower could be an individual like a home loan seeker or a corporate body borrowing funds for business expansion. read more will show on the assets side of the balance sheet under current assetsCurrent assets refer to those short-term assets which can be efficiently utilized for business operations, sold for immediate cash or liquidated within a year. It comprises inventory, cash, cash equivalents, marketable securities, accounts receivable, etc.read more if there is any outstanding on the balance sheet date.
- Cash Discount – Cash discount will show the debit side of profit & loss a/c.
- Bad Debt – Bad debt will show a debit side of profit & loss a/c, and the same amount will reduce from debtors in the balance sheetA balance sheet is one of the financial statements of a company that presents the shareholders' equity, liabilities, and assets of the company at a specific point in time. It is based on the accounting equation that states that the sum of the total liabilities and the owner's capital equals the total assets of the company.read more.
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