Credit sales are transactions where a business delivers goods or completes a service and lets the customer pay later rather than collecting at the point of sale. The seller books the revenue right away and holds a legally enforceable right to collect, which sits on the balance sheet as an account receivable until the customer pays. That timing gap drives everything else: the journal entries, the risk of nonpayment, the tax treatment when a debt goes bad, and the collection tools available if the invoice goes unpaid.
The arrangement is often called trade credit. One business extends short-term financing to another, usually at zero interest for the agreed payment window, which commonly runs 10 to 60 days depending on the industry. A cash sale increases Cash and Sales Revenue at the same moment. A credit sale increases Accounts Receivable and Sales Revenue, and Cash stays flat until the customer actually pays. The practical consequence matters: a business can show strong profits on paper while struggling to cover payroll because its earnings are locked up in receivables.
Accounts Receivable (A/R) is distinct from a note receivable, which usually involves a signed promissory note and interest. Most routine business credit sales flow through A/R without a formal note.
How to Record a Credit Sale
Every credit sale produces two sides of a journal entry under double-entry accounting. The seller debits Accounts Receivable and credits Sales Revenue for the invoice amount. A $5,000 credit sale creates a $5,000 debit to A/R and a $5,000 credit to Sales Revenue. From an accounting standpoint, the sale is complete.
This follows the accrual basis required under U.S. Generally Accepted Accounting Principles. Revenue is recognized when earned, not when the cash arrives. Under the current revenue recognition standard (ASC 606), “earned” means the seller has satisfied its performance obligation by transferring control of the goods or services to the buyer. For a standard product shipment, that usually happens at delivery.
A/R is classified as a current asset because companies expect to convert it to cash within one year or the normal operating cycle. That feeds directly into liquidity metrics, and a healthy-looking quick ratio can mask trouble if a large share of current assets is tied up in slow-paying receivables.
Collecting the Full Amount
When the customer pays the invoice in full with no discount, the entry is simple: debit Cash and credit Accounts Receivable for the same amount. Revenue does not change. The payment converts one asset into another.
When the Customer Takes an Early-Payment Discount
If the customer pays within the discount window, the seller collects less than the invoice amount. Under the gross method, the seller records three entries: a debit to Cash for the amount actually received, a debit to Sales Discounts for the discount given, and a credit to Accounts Receivable for the full invoice amount. Sales Discounts is a contra-revenue account that reduces gross sales on the income statement to arrive at net sales.
On a $1,000 invoice with 2/10 Net 30 terms paid on day 8, the entry is a $980 debit to Cash, a $20 debit to Sales Discounts, and a $1,000 credit to A/R. The receivable clears, and net revenue reflects what the seller actually collected.
When the Customer Returns Goods
Returns and price adjustments on credit sales reduce the outstanding receivable. The seller debits Sales Returns and Allowances (another contra-revenue account) and credits Accounts Receivable. Smaller businesses sometimes debit Sales Revenue directly, but using the contra-account gives better visibility into how much revenue is being lost to returns.
What Payment Terms Like Net 30 and 2/10 Net 30 Mean
The invoice spells out when payment is due. “Net 30” means the full amount is owed within 30 days of the invoice date. Net 60 and Net 90 appear in industries where buyers need longer to resell or use what they purchased.
Some sellers offer a discount for fast payment. “2/10 Net 30” means the buyer can take 2% off the invoice total by paying within 10 days; miss that window and the full amount is due by day 30. Variations like 1/10 Net 30 or 3/10 Net 60 follow the same structure: discount percentage, discount window, outer deadline.
Passing up the discount is surprisingly expensive from the buyer’s side. Paying an extra 2% to hold the money for 20 more days works out to an annualized cost of roughly 36% to 37%. Unless the buyer’s cost of borrowing exceeds that, taking the early-payment discount is almost always the better move.
Estimating Bad Debts
Not every customer pays. GAAP requires businesses to estimate those losses upfront rather than waiting until a specific invoice goes bad, matching the cost of uncollectible accounts to the same period as the sale that produced them.
The standard approach is the allowance method. The seller estimates future losses and records a debit to Bad Debt Expense (an operating expense) and a credit to the Allowance for Doubtful Accounts (AFDA). AFDA is a contra-asset that reduces gross A/R on the balance sheet. The difference between gross A/R and AFDA is the net realizable value: what the company actually expects to collect.
Since 2023, all U.S. companies, including private businesses and smaller reporting companies, must use the Current Expected Credit Losses (CECL) model under ASC 326. CECL requires companies to estimate the total expected losses over the life of each receivable at the time the sale is booked, using forward-looking information rather than waiting for a specific trigger event.
When a specific account is finally deemed uncollectible, the seller writes it off by debiting AFDA and crediting Accounts Receivable. Gross A/R and the allowance both drop by the same amount, so net realizable value is unchanged. The loss was already baked into the earlier estimate.
The alternative, called the direct write-off method, waits until a specific customer defaults and then records Bad Debt Expense at that point. GAAP prohibits this approach for any business with material credit sales because the expense lands in a different period than the sale. It is really only acceptable for very small operations where uncollectible amounts are trivial.
Vetting Customers Before Extending Credit
Estimating bad debts after the fact is required, but screening customers beforehand is the cheaper discipline. Most B2B credit decisions start with a credit application that requests trade references, bank information, and permission to pull a commercial credit report.
The PAYDEX score from Dun & Bradstreet is the most widely used commercial credit metric. Scores run from 1 to 100, with higher numbers indicating lower risk. A score of 80 to 100 means the business pays on time or early. Scores of 50 to 79 suggest moderate risk, with payments averaging up to 30 days beyond terms. Anything below 50 signals high risk, with payments routinely 60 to 120-plus days late. The score is dollar-weighted, so a large invoice paid late drags the number down more than a small one.
Vendors commonly use these scores to set credit limits and payment terms. A customer with a PAYDEX of 90 might get Net 60 terms and a $50,000 credit line, while a customer at 55 might be limited to Net 30 with a $5,000 cap, or required to prepay. The upfront cost of a credit check is small compared to chasing bad debts later.
Tracking Collection Performance
The accounts receivable turnover ratio measures how well a credit sales operation is working. Divide net credit sales by average accounts receivable for the period. A company with $1.2 million in annual credit sales and an average A/R balance of $100,000 has a turnover ratio of 12, meaning it collects its receivables roughly once a month.
A high ratio points to efficient collection and creditworthy customers. A low ratio suggests credit is being extended too liberally, collection is too slow, or both. A gradually declining turnover ratio is often the first sign that a credit policy needs tightening, well before individual accounts start defaulting.
Days sales outstanding (DSO) flips the ratio into calendar days. Divide 365 by the turnover ratio to get the average days to collect a receivable. In the example above, that is about 30 days. If your standard terms are Net 30 and your DSO is creeping past 45, customers as a group are paying late even if no single account is in formal collections.
Collecting Past-Due Credit Sales
When an invoice goes unpaid past its due date, sellers typically start with reminder notices and phone calls. If the customer still does not pay, the seller can charge late fees, but only if the original invoice or contract disclosed them. Late-fee caps vary by state, and what is enforceable in one jurisdiction may not be in another.
A seller who discovers that a buyer was insolvent when it received goods on credit has a narrow window to reclaim those goods under the Uniform Commercial Code. The seller must demand the goods back within ten days of the buyer receiving them. That window extends if the buyer made a written misrepresentation of solvency within three months before delivery. Either way, the seller’s reclamation right is subordinate to any good-faith purchaser who already bought the goods from the buyer.
If the seller hands the debt to a third-party collection agency, that agency is subject to the Fair Debt Collection Practices Act (FDCPA). The original creditor collecting in its own name generally falls outside the FDCPA, but a creditor that uses a different name to make it look like a third party is collecting loses that exemption.
Every state sets a deadline for filing a lawsuit to collect a past-due receivable. These statutes of limitations range from as short as one year to as long as ten, depending on the state and whether the agreement was written or oral. Once the clock runs out, the debt does not disappear, but the seller loses the ability to enforce it in court.
Deducting Bad Debts on Your Taxes
When a credit sale goes bad, the federal tax code offers a deduction. Under 26 U.S.C. ยง 166, a business can deduct a debt that becomes wholly or partially worthless during the tax year. The deduction for a fully worthless debt equals the entire unpaid balance; for a partially worthless debt, the IRS allows a deduction only up to the amount the business has actually charged off on its books.
One prerequisite controls who can use the deduction: the amount owed must have already been included in the business’s gross income. Most accrual-basis businesses report credit sales as revenue when the sale occurs, so this requirement is automatically satisfied. A cash-basis business that never reported the receivable as income cannot deduct it as a bad debt. You cannot deduct money you never counted as earned.
To claim the deduction, the business must show it took reasonable steps to collect and that payment is not realistically expected. Filing a lawsuit is not required if a court judgment would be uncollectible anyway. Sole proprietors report the deduction on Schedule C (Form 1040); other entities use their applicable return. The deduction is only available in the year the debt becomes worthless, and a business that misses that window may need to file an amended return to claim it.
A Note on Sales Tax Timing
In states that impose sales tax, the timing of remittance depends on the seller’s accounting method. An accrual-basis business owes sales tax in the period the credit sale is invoiced, not when cash is collected. A cash-basis business reports and remits sales tax when payment actually comes in. That difference can create a real cash-flow pinch for accrual-basis sellers, who may owe the state tax on a sale before the customer has paid anything. Specific rules vary by state, so checking your state revenue department’s guidance before your first credit sale closes is worth the time.