A credit sale is a transaction where a business delivers goods or completes a service and accepts the customer’s promise to pay later, usually within 10 to 60 days. The seller books the revenue and an account receivable right away; the cash catches up when the customer pays. That timing gap is the whole reason credit sales need their own set of accounting entries, credit-risk practices, and collection rules.
How a Credit Sale Differs From a Cash Sale
In a cash sale, Cash and Sales Revenue both go up at the moment of the transaction. In a credit sale, Sales Revenue goes up and Accounts Receivable (A/R) goes up, but Cash stays flat until the invoice is paid. A/R is the running total of what customers owe you for credit sales, and it sits on the balance sheet as a current asset because you expect to convert it to cash within a year.
The arrangement is often called trade credit: one business extending short-term, usually interest-free, financing to another for the length of the agreed payment window. It’s distinct from a note receivable, which involves a signed promissory note and typically carries interest. Most everyday business-to-business credit sales run through A/R without any formal note.
The practical consequence of that timing gap is real. A company can look profitable on paper while struggling to make payroll because its earnings are locked in receivables. That is why the mechanics below matter as much as the sale itself.
How to Record a Credit Sale
Double-entry accounting requires two sides for every credit sale. The seller debits Accounts Receivable and credits Sales Revenue for the same 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, that is the sale.
This treatment follows the accrual basis required under U.S. Generally Accepted Accounting Principles. Revenue is recognized when earned, not when the cash arrives. Under ASC 606, “earned” means you have satisfied your performance obligation by transferring control of the goods or services to the buyer, which for a straightforward product shipment usually happens at delivery.
When the Customer Pays in Full
Payment with no discount is a simple swap of assets: debit Cash and credit Accounts Receivable for the invoice amount. Revenue doesn’t move, because it was recorded at the time of sale.
When the Customer Takes an Early-Payment Discount
Under the gross method, the seller records three lines: a debit to Cash for what was actually received, a debit to Sales Discounts for the discount given, and a credit to Accounts Receivable for the original invoice amount. Sales Discounts is a contra-revenue account that reduces gross sales on the income statement.
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 you actually collected.
When the Customer Returns Goods
Returns and price adjustments reduce the outstanding receivable. Debit Sales Returns and Allowances (also a contra-revenue account) and credit Accounts Receivable. Some small businesses just debit Sales Revenue directly, but the contra-account gives you visibility into how much revenue is being lost to returns.
Standard Payment Terms and What They Mean
The invoice states when payment is due. Net 30 is the most common: the full amount is owed within 30 days of the invoice date. Net 60 and Net 90 are used in industries where buyers need longer to resell or use what they purchased.
Sellers often offer an early-payment discount. “2/10 Net 30” means the buyer gets 2% off by paying within 10 days; otherwise the full amount is due by day 30. Variations like 1/10 Net 30 and 3/10 Net 60 follow the same pattern: discount percentage, discount window, outer deadline.
For the buyer, skipping that discount is expensive. Paying an extra 2% to keep the money for 20 more days works out to an annualized cost of roughly 36% to 37%, depending on whether you use a 360- or 365-day year. Unless your cost of borrowing is higher than that, taking the discount almost always wins.
Estimating Bad Debts
Not every customer pays. GAAP requires you to estimate those losses upfront rather than waiting for a specific invoice to go bad, so the cost of uncollectible accounts lands in the same period as the sales that produced them.
The standard tool is the allowance method. You estimate future losses using historical default rates, an aging schedule, or both, then debit Bad Debt Expense and credit the Allowance for Doubtful Accounts (AFDA). AFDA is a contra-asset that reduces gross A/R on the balance sheet. Gross A/R minus AFDA equals net realizable value, which is what you actually expect to collect.
Since 2023, all U.S. companies, including private and smaller reporting companies, must use the Current Expected Credit Losses (CECL) model under ASC 326 to estimate those losses. CECL requires you to estimate total expected losses over the life of the receivable at the time the sale is booked, using forward-looking information rather than waiting for a trigger event. SEC filers adopted CECL starting in 2020; all other entities followed with fiscal years beginning after December 15, 2022.
When a specific account is finally uncollectible, you write 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 doesn’t change. The loss was already recognized in the estimate.
The direct write-off method, which waits until a specific customer defaults and then records Bad Debt Expense, violates the matching principle because the expense lands in a different period from the sale. GAAP prohibits it for any business with material credit sales. It’s really only acceptable for very small operations where uncollectible amounts are trivial.
Screening Customers Before You Ship
Estimating bad debts is necessary, but preventing them is cheaper. Most business-to-business credit decisions start with a credit application that asks for trade references, bank information, and permission to pull a commercial credit report.
The most widely used commercial credit metric is the PAYDEX score from Dun & Bradstreet. 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. 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 hurts more than a small one.
Vendors use these scores to set credit limits and terms. A customer with a PAYDEX of 90 might get Net 60 and a $50,000 line, while one at 55 might be capped at Net 30 with a $5,000 limit or asked to prepay entirely.
Measuring How Well Your Credit Sales Convert to Cash
The accounts receivable turnover ratio is the main gauge. 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 about once a month.
A high ratio points to efficient collection and creditworthy customers. A low ratio suggests you’re extending credit too loosely, collecting too slowly, or both. Watching the trend over time often catches a weakening credit policy 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. In the example above, that’s 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 collections.
Collecting on Past-Due Accounts
When invoices go unpaid, most businesses start with reminder notices and phone calls. Late fees are only enforceable if the original invoice or contract disclosed them, and state-level caps on those fees vary, so what works in one jurisdiction may not hold up in another.
The federal Prompt Payment Act requires federal agencies to pay interest on late invoices at a Treasury-set rate (4.125% for the first half of 2026). It doesn’t govern private commercial transactions, but businesses sometimes use the rate as a reference when setting their own late-payment terms.
If a buyer was insolvent when it received goods on credit, the Uniform Commercial Code lets the seller demand the goods back within ten days of delivery. That window extends if the buyer made a written misrepresentation of solvency within three months before delivery. The reclamation right is subordinate to any good-faith purchaser who already bought the goods from the buyer.
A seller collecting in its own name generally falls outside the Fair Debt Collection Practices Act, but a third-party collection agency does not. A creditor that collects under a different name, making it look like a third party is involved, loses the in-house exemption.
Every state sets a deadline for filing suit to collect a past-due receivable. 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 doesn’t vanish, but you lose the ability to enforce it in court.
Tax Treatment of Bad Debts
Under 26 U.S.C. ยง 166, a business can deduct a debt that becomes wholly or partially worthless during the tax year. A fully worthless debt is deductible for the entire unpaid balance; a partially worthless debt is deductible only up to the amount actually charged off on the books.
There’s a prerequisite: the amount must have already been included in gross income. For accrual-basis businesses that recognize credit sales as revenue when the sale happens, that’s automatic. A cash-basis business that never reported the receivable as income cannot deduct it as a bad debt, because you can’t deduct money you never counted as earned.
You also have to show reasonable collection efforts and that the facts point to no realistic expectation of payment. Filing a lawsuit isn’t required if a judgment would be uncollectible anyway. Sole proprietors claim the deduction on Schedule C (Form 1040); other business entities use their applicable return. The deduction is available only in the year the debt becomes worthless, so missing that window may require an amended return.
Sales Tax Timing on Credit Sales
In states with sales tax, when you owe the tax depends on your accounting method. An accrual-basis seller owes sales tax in the period the credit sale is invoiced, not when the cash comes in. A cash-basis seller remits sales tax when payment actually arrives. For accrual-basis sellers, that creates a real cash-flow pinch: you can owe the state before the customer has paid you anything. Rules vary by state, so check your state revenue department’s guidance before your first credit sale closes.