Days Sales Outstanding (DSO) measures the average time it takes a business to get payment from a client after a transaction.

Business owners can also view DSO as the time it takes for credit sales to be converted to cash or as the time it takes for receivables to be collected.

How to calculate Days Sales Outstanding with the DSO formula

You can calculate your Days Sales Outstanding (DSO) using this simple formula: 

DSO= (Net Credit Sales/Accounts Receivable)x No. Of Days

Let’s understand the above with the help of an example:

As a small business owner, Max sells his goods and collects customer payments within 30 days of each sale. This prompt payment policy helps him keep the cash flow moving and ensures that he can cover his costs and continue to grow his business.

Although the majority of clients pay on time, some frequently miss payments. Max is trying to determine how effective the accounts receivable process is. 

His yearly financial accounts look like this:

• Accounts Receivable: Rs. 50,000
• Net Credit Sales: Rs. 550,000

DSO = (50,000/550,000) * 365 = ~ 33.18

Cash sales transactions are typically excluded from the DSO calculation formula because it only accounts for credit sales.

Divide your final accounts receivable by the total credit sales for the period (monthly, quarterly, or annually), multiply the result by the number of days in the period, and you’ll have your answer.

How does DSO impact your business?

DSO is a helpful indicator that you can use to assess several essential business aspects, including how soon your customers pay you, your firm’s liquidity, the volume of sales you generate over time, the effectiveness of your sales staff, customer satisfaction, and client retention.

There is no one size fits for the DSO number; it depends on your company size. For instance, a DSO of 45 days might not be an issue for a significant company, but it is dreadful for a small company.

You can use that information to improve your business practices by regularly tracking your DSO trends. To get the most accurate results, it’s best to measure your DSO periodically instead of basing changes on individual DSO results.

3 Ways to reduce DSO

There are several ways to reduce DSO, which are:

• Offering incentives for prompt payment

Offering incentives for early payments accelerate the payment process, as discounts and early-bird offers are well-received by customers. Ensure that your invoices contain the late fee terms and conditions so that the customers know about them upfront.

• Improving customer communication and collections processes

When you offer recurring services, auto-charging is usually the best option. Storing your customers’ credit card details means you can charge them automatically on the due date, which makes things much easier for you. All you have to do is inform your customers about this policy when you set up the system. You should also notify them before and after you charge them.

• Invest in online billing software

Your procedure for collecting payments needs to be planned out and precise. You might achieve that by investing in the online billing software. You can promptly charge your clients as soon as a sale is made. And online billing software can help you do that.

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Cost accounting is a method used in business to track, analyse, summarise, and research a company’s expenses related to any process, service, product, or organisation. Hence for every company today, there is a need for cost accounting.

What is the Importance of Cost Accounting?

Cost accounting helps the management in making cost control techniques and strategic planning for your company to increase cost-effectiveness. Additionally, it aids in management’s determination of where they must control the cost. Apart from the needs of cost accounting mentioned, it has many other advantages that can help your business, like:

Managing the Cost of the Product

Your management can predict a product or service’s cost and selling price using cost accounting, enabling you to create business policies. Your management can also come up with ways to keep costs under control while still achieving maximum profitability.

Calculating the Overall Cost Per Unit

Cost accounting procedures establish the overall cost per unit of a good or service and set a selling price for the company.

Displaying Activities Based on Profit

Your management can use this knowledge to stop non-profitable activities while growing and increasing profits.

Cost Comparisons Through Time

You can use data from cost sheets created for multiple periods to compare costs over time for the same good or service.

Cost Accounting Elements

Materials, labour, and costs comprise the three basic cost element categories. Overhead costs are those associated with indirect materials, labour, and expenses.

Material Cost

The price of the raw materials needed to make an item is known as the “material cost. You can classify it as:

1. Direct material: is used directly in producing a product, and you use them as the finished items. For instance, you can use cloth or wood to create things like furniture or shirts.
2. Indirect material: is the material used in the production of completed goods but cannot be ascribed to particular physical units. Using a saw to cut wood for furniture or a pair of scissors to cut fabric for shirts are two examples.

Labour Cost

Labour refers to the people who can turn raw materials into finished things.

1. Direct labour consists of people who participate actively in the production of goods. For instance, people working in manufacturing or production units refer to direct labour.
2. Indirect labour refers to employees whose work you cannot specifically attribute to one product and who do not directly involve in the manufacturing process. For instance, salespeople and directors fall under indirect labour.

Expenses

Costs incurred by a firm usually fall into this category, except for material and labour costs. 

1. Direct expenses: are connected to particular cost units and are also known as chargeable expenses, like the cost of direct labour, raw material costs, utilities, and rent.
2. Indirect expenses: any expense that does not qualify as direct is an indirect expense, such as printing expenses, utility expenditures, and legal advice.

Overhead Costs

Overhead charges are comparable to indirect costs. However, “overhead” has a broader definition that includes indirect labour, materials, and expenses. The following are the three categories that categorise overhead expenses:

1. Factory overhead: refer to the costs associated with manufacturing, production, or other expenses necessary for the efficient operation of a factory. Utilities, insurance, and manufacturing rent are a few examples.
2. Office and administrative overhead: refers to the cost associated with managing and running a business, such as an office equipment like printers and stationery.
3. Selling and distribution overhead: means the costs associated with marketing a product, obtaining orders, and distributing goods and services.

Cost Accounting Methods

Cost accounting techniques are of four types:

1. Standard cost accounting: uses ratios to assess how well you use labour and materials to manufacture things in a typical setting. 
2. Activity-based cost accounting: is a method that uses a specific good or service to assign the cost of each organisation’s operation. The activity analysis decides these cost categories, improving the cost accuracy of goods and services.
3. Lean accounting: is a collection of principles and procedures that manufacturers use to receive quantitative feedback. Lean accounting emphasises visual and lean-focused performance measurements rather than activity-based or standard costing. The price of producing an extra output unit is called the marginal cost is a new name for this approach. 
4. Marginal cost: A marginal cost analysis can investigate the relationship between production volume, selling price, costs, expenses, and profits by subtracting the variable cost from the revenue and dividing the result by the revenue.

In conclusion of cost accounting, don’t forget to make it a point to equip yourself with cost accounting to know the cost of producing every single item for your company.

Read more articles related to Working Capital

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Credit terms should always be set up before a sale can be formed on credit. When the discount is not accepted, the buyer must pay the full amount due on the invoice within 30 credit days after the transaction. This 30-day term serves as the credit period. That is the time period the seller allows the buyer to complete the transaction.

What does it mean to have a “Credit Period”?

Customers are given a specified amount of time to pay an invoice, known as the credit period. The concept shows how much working capital a business is ready to invest in accounts receivable to produce sales. Therefore, greater investment in receivables is necessary to support a longer credit period. In addition, the measure can be compared to competitors’ credit periods to determine if they offer different terms.

The term “credit period” does not mean how long it takes the customer to pay an invoice. Instead, it means how long the seller gives the customer to pay the bill. Therefore, if the vendor offers 30 credit days for payment and the buyer pays within 40 days, the credit period is 30 days. 

On the other hand, if the seller requires many payouts, then the credit period is considered between the initial extension of credit and the due date of the last payment. Therefore, the credit duration is 90 days if the seller agrees to enable three partial payments to be made every month, with the final amount being due in 90 days.

The definition of Credit Period

During a customer’s credit period, the seller gives the customer time to pay for the products they bought from the seller.

There are three crucial elements of the credit period

• Credit Assessment: Credit assessment aims to determine a customer’s trustworthiness. Various financial analysis methodologies can be used for credit analysis; trend analysis can determine whether or not a consumer is likely to repay their debts.
• Collection Procedure: The collection Procedure of an organisation entails the practices that are chosen by the business to recover accounts receivable. It also specifies the late penalties, interest, and additional fees assessed if the payments were late.
• Credit/Sales Terms: Credit terms should specify the credit length, with some vendors preferring 30 credit days while others may offer shorter or longer credit periods based on their sales terms.

Credit Period formula

The formula to compute the credit period:

Credit Period Formula = Average Accounts Receivable / (Net Credit Sales / Credit Days),

Or

The formula for Credit Period = Credit Days/ Receivables Turnover Ratio

Here,

• The Average Receivables: To determine it, the beginning and ending balances of the company’s accounts receivable are added together, and the net result is divided by two.
• Net Credit Sales: The sum of the company’s earnings from net credit sales that occurred during the consideration period.
• Credit Days: The calculation considers the total number of days in a specific period, 365 days a year.
• The Receivable Turnover Ratio: It is determined by dividing the company’s net credit sales by its average accounts receivable.

Credit Period examples

Here are some examples of various credit periods:

1. A credit period of 10 days applies if the customer prefers a 2% early payment discount if the company offers terms of 2/10 net 30, or a 30 day credit period applies if the customer pays the full invoice amount.
2. Terms of 1/5 net 45 signify that if the customer decides to receive a 1% early payment discount, the credit period is five days, and terms of 45 days mean that the payment term is 45 days.

Collection period and discount period

We could refer to this as a byproduct of the credit term. It is the timeframe a creditor or seller must wait to get payment from a buyer or debtor. Depending on a customer’s payment timing, the collection period may be shorter or longer than the credit period. If a business operates on a cash-on-delivery basis, no credit or collection periods are involved in the transaction.

The discount period serves as an incentive to induce early payment from clients. For example, when a customer makes their payment for an item within a certain time after making the purchase, the company may provide them with a special discount. Such business terms make it easy for a company to get paid quickly by its debtors.

Collection period vs Credit period

The term “collection period” refers to the time frame that passes before the seller can get paid. Depending on the buyer’s credit, the collection period is much longer.

When a business needs payment upon delivery, the credit and collection periods are zero days.

Advantages

The following are the benefits:

• Extending the credit duration to customers can help raise sales and expand its buyer base, assisting the company in meeting its sales objective.
• Credit Period assists the business in determining the buyer’s creditworthiness and implementing a filter for future transactions.
• Paying on time ensures that the customers are in good condition with the supplier.

Disadvantages

The following is a list of the disadvantages:

• A company’s working capital cycle may be impacted if the payment deadline is extended too much. If a corporation can’t collect on time, it may have working capital difficulties.
• Extending the credit period or giving the customer too much time to pay may not be appropriate for the debtors’ turnover ratio of the organisation.
• A buyer may be subject to a penalty from the company if they cannot make payment within the specified amount of time. When the purchaser does not comply with the company’s credit policies, the company runs the risk of losing this customer.

Conclusion

A business’ credit period serves two purposes. First, enabling clients to make payments later contributes to an increase in a company’s overall sales. Second, it aids in the maintenance of a company’s working capital cycle. As a result, if there is no credit period available, a company runs the risk of being too relaxed about collecting payments from its customers, resulting in a shortage of working capital.

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No business can afford to conduct all transactions in cash; thus, making credit available to clients is a requirement. But collecting book debts quickly and within the credit period is vital. If this is not done, debt becoming unaffordable will increase. So, what is the effectiveness and quality of a company’s credit collection operations? To address this question, a company’s Debtors turnover ratio is examined.

What Does The Debtor Turnover Ratio Mean?

In business, the debtor turnover ratio is also called Receivables’ Turnover Ratio.

Due to the delay in revenue realisation, receivables are formed when a business offers products on credit. Later on, these receivables are converted to cash. Therefore, the rate at which receivables are recovered directly affects the business’s liquidity condition.

The Debtors’ turnover ratio provides insight into a business’s collection and credit strategies. It measures how effectively a company’s management controls its receivables.

It establishes the rationality of the company’s debtors’ resources and the efficiency with which the company converts debtors to cash. In other terms, it measures how quickly debtors are paid off.

It is an important indicator of a firm’s financial and operational integrity. It can determine whether a company is experiencing difficulties collecting on credit sales.

 The Formula for Calculating Debtors’ Turnover Ratio

The turnover ratio of debtors is computed as the ratio of net credit sales to the average trade debtors. This ratio is specified in terms of times.

Debtors Turnover ratio formula = Net credit sales / Avg AR

Credit sales are the total amount of goods or services sold or supplied on credit by a business to its consumers. These figures are exclusive of any returns or trade discounts.

Average accounts receivable is computed by dividing the sum of beginning and ending receivables for a specified period (usually monthly, quarterly, or annually) by two. Debtors & bills receivables are both included in the category of accounts receivable. They are the amounts customers owe for items sold, services provided, or contractual obligations.  

It is critical to remember that when calculating this ratio, allowances for doubtful debts are not excluded from total debtors or accounts receivables to avoid the perception of a larger collection of receivables.

The trade receivables turnover ratio is often used in financial modelling to forecast the balance sheet. The accounts receivable balance is calculated from the average time (days) in which revenue is expected to be received. To calculate the AR balance for each period, revenue is multiplied by turnover days and then divided by the number of days.

The higher the turnover of debtors, the more effectively the firm manages its credit.

 An example of debtors’ turnover ratio

Consider the following scenario a company has total sales of Rs 5,00,000, of which Rs 3,50,000 are credit sales. Account receivables have an opening balance value of Rs 3,00,000 and a closing balance value of Rs 1,00,000 after the financial year. Therefore, the debtor’s turnover ratio will be as follows

Debtors Turnover Ratio = 3,50,000/2,00,000 = 1.75 times

Credit sales total = 3,50,000

Average AR = (3,00,000+1,00,000) /2 =2,00,000 

High and Low Debtor Turnover Ratio

A high ratio could suggest

• Customers are permitted a short collection period.
• The business may run primarily on a cash basis.
• The company’s accounts receivable collection process is efficient.
• A high proportion of individuals pay off their debts promptly
• The corporation is conservative when it comes to credit extension. 

A low ratio could suggest

• Customers are permitted a prolonged collection period.
• The company has a long credit period with its suppliers, which helps it pay its bills on time.
• High-value cash receivables may be owed to the business.

Why Should You Monitor Accounts Receivable Turnover?

As you are probably aware, the accounts receivable turnover ratio indicates how frequently clients pay invoices due during the year. The higher the percentage, effectively your financial department collects money owed to your organisation. It’s a simple computation based on the tracking period’s net credit sales divided by the average AR. The average accounts receivable balance equals the sum of the AR balances at the start and end of the month divided by two. This computation should be simple enough to complete on a small portable calculator.

Average Debtor Collection Period and How to Calculate It?

An account’s average collection period is the number of days it takes on average to get the money back. It means the average number of days required for a business to convert its receivables to cash. This ratio also called days sales outstanding (DSO), is a common name for the receivables turnover ratio. The average collection period is often referred to as the Receivables (Debtor) velocity.

(i) The following formula is used to determine the Average Collection Period

Average Collection Period = Average Accounts Receivable or Average Debtors / Average Daily Credit Sales.

(ii) If the debtor’s turnover ratio is stated in terms of days, then the average collection period may be determined easily using the following formula

Average Collection Period = 365 days / Debtors Turnover Ratio

The lower the frequency, the better the position is going to be. A shortened collection period indicates prompt debtor payment, while a prolonged collection period indicates excessively generous credit terms and ineffective credit collection performance.

Advantages Of Debtor’s Turnover Ratio In Financial Report

It’s beneficial for the following

• Cash flow forecasting
• Recognising inefficient billing practices
• Your credit policy should be reevaluated.
• Maintaining the effectiveness of your credit policies.
• Customer screening guidelines are effective.
• Accuracy of invoicing.
• Efficacy of the dunning process.
• Deductible preventative initiatives

The Importance of the Debtor’s Turnover Ratio

This is a liquidity ratio combined with a high trade receivables turnover ratio, indicating improved liquidity. As a result, it assists creditors in determining whether the company will be able to pay the bills on time.

• Using this ratio, both employees and lenders may get a clear picture of the business’s financial health.
• It also assists sales managers in forecasting future sales.
• It is also beneficial in setting the organisation’s credit policy. The management may choose to grant a short-term credit facility to its clients to increase the organisation’s liquidity.
• Financial modelling also makes use of the trade receivables turnover ratio. It is used to generate budget projections and preliminary balance sheet figures. This ratio can estimate the number of accounts receivable or other debtors. 

Maximise Your Debtor Turnover Ratio

If your account receivable turnover ratio is too low, you likely need to modify your credit and collection rules and practices. Here are the five best ways to maximise your ratio

• Invoice in a timely and appropriate manner.
• Clearly state the terms of payment.
• Accept a variety of payment methods.
• Create follow-up reminders for yourself.
• Consider providing cash and prepayment discounts.

 Conclusion

When calculating a company’s debtors’ turnover ratio, it considers how quickly it collects outstanding cash amounts from its customers. Therefore, a high ratio is beneficial since it suggests frequent and efficient credit collection. Otherwise, a low receivables turnover ratio may indicate an unstable collection mechanism, inadequate credit guidelines, or customers that aren’t creditworthy.

The presence of a high ratio suggests a conservative credit strategy, whilst a low ratio shows the presence of liberal lending terms. A company’s credit policy should be neither overly liberal nor very restrictive. The former will lead to an increase in fund blockages and bad debts, whereas the latter will result in decreased sales, ultimately resulting in a decrease in profits.

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A cost sheet is a statement that records all the costs a business incurs from production to sales. Using this information, a company can fix the price of its products and services. The main advantage of a cost sheet is that you can compare it with previous cost sheets to measure performance. You can then decide whether the cost of an item can be increased or decreased according to your costs.

You can prepare a cost sheet using previous cost sheets or current estimated costs. A previous cost sheet shows you the actual costs incurred for producing, storing, and selling a product. Using estimated values, you can produce a cost sheet just before the production begins. However, there may be several changes in the estimate and the final figures.

A cost sheet has to contain the following information:

• Cost per unit of a product
• Total cost
• The four main components of a cost sheet:
  • Prime Cost
  • Works Cost
  • Cost of Production
  • Total Cost or Cost of Sales
• Percentage incurred on every expense to the total cost
• If the cost sheet is prepared using historical cost sheets, record of discrepancies, if any
• If two cost sheets of any period are compared, record of discrepancies, if any
• Details about the management for cost control
• Summary of the total cost of the product

Components of a Cost Sheet

Let us see what the different costs mean on a cost sheet:

1. Prime Costs

Under this header, you have to record all the expenses involved in the production process. This is also known as basic or first cost.

For example, if you have a textile store, your prime costs will be the costs of purchasing fabric from weavers, employee salaries, packaging, implements needed to measure and cut cloth, etc.

The formula for calculating prime costs is:

Prime Costs= Direct Labour + Direct Raw Material+Direct Expenses

2. Works Cost

Works cost is the sum of prime costs and overhead costs including factory expenses. Overhead costs are those costs that are not directly related to the production of a product but are required nevertheless. For example, you need to pay electricity bills to keep your production going. Similarly, there are several other taxes and utility costs that fall under the overhead costs category.

3. Cost of Production

Under this header, you should include all the expenses involved in business operations, including rents and work costs. The formula for calculating the cost of production is:

Cost of Production= (Work Costs)+(Administration Overhead Costs)-(Opening and Closing Stock of Finished Goods)

4. Cost of Sales

Cost of sales or total cost contains the details of all the expenses involved in the production and other costs involved in selling and distribution. This value will help you understand how much you spend on a product according to the resources used for producing it. You can decide your selling price according to the cost of sales and know how much profit you will earn from it.

Different Types of Costs

Costs are of four types:

1. Fixed costs

These costs are fixed, that is, they do not change according to the number of products. The price of your land or equipment are some examples of fixed costs.

2. Variable costs

These costs vary according to the number of products. Raw material and labour are some examples of variable costs.

3. Operating costs

Your business incurs these costs to maintain production daily. Utility costs, office supplies, travelling costs, etc. fall under this category.

4. Direct costs

These costs are directly connected to production. For example, if a car company produces a car in four days, the raw materials and labour involved in the production form the direct cost of the car.

Cost Sheet Format

You must keep this format of cost sheet in mind for the correct preparation of cost sheet:

How to Prepare a Cost Sheet?

Here is a step-by-step guide to preparing a cost sheet:

Step 1:

Prime Cost = Direct Material Consumed + Direct Wages + Direct Expenses

Direct Material Consumed = Direct Material Purchased + OP Stock of Raw Material –  CL Stock of Raw Material

Step 2:

Works Cost = Prime Cost + Factory Overheads + OP Stock Work in Progress – CL Stock Work in Progress

Step 3:

Cost of Production = Works Cost + Office and Administration Overhead +  OP Stock of Finished Goods – CL Stock Finished Goods

Step 4:

Total Cost = Cost of Production + Selling and Distribution Overheads

Profit: Sales – Total Cost

Cost Sheet Example

Suppose you are preparing a cost sheet for an automobile company for the year 2020-21. You have to consider the following information to prepare a cost sheet:

• Direct material consumed – INR 30,00,000
• Opening stock of raw materials – INR 18,00,000
• Closing stock of raw materials – INR 2,00,000
• Direct wages – INR 20,00,000
• Direct expenses – INR 10,00,000
• Factory overhead – 100% of direct wages
• Office and administration overhead – 20% of works
• Selling and distribution overhead – INR 10,00,000
• Cost of opening stock for finished goods – INR 2,50,000
• Cost of closing stock for finished goods – INR 3,50,000
• Profit on cost – 20%

Importance of Cost Sheet

Cost sheets are extremely important in the following ways:

1. They help determine the final cost

The main aim of preparing a cost sheet for your business is that it helps you determine the accurate cost of the product. You can use cost sheets to calculate the total cost as well as the cost per unit of a product.

2. They help in calculating the cost break up for each product

Using a cost sheet, you can understand how the costs for a product are broken up. For example, you can get the actual material costs, tax costs, and so on.

3. They help in deciding the selling price

You can use a cost sheet to calculate the selling price of a product according to the materials and resources you have invested in the product. 

4. They help in comparing costs

You can compare the costs of products from previous years with the costs of the current year. If you can take any action to reduce the current year’s costs, you can take it by studying cost sheets.

5. They help control costs

A cost sheet gives you a perspective on the costs incurred by your business to produce and sell a product. You can monitor and control production and marketing costs. An estimated cost sheet will give you an idea of individual costs at each step of production.

6. They help in decision-making

Cost sheets are one of the first documents you need to prepare and study to ensure that your production takes place smoothly. A cost sheet can guide you to make correct business decisions.

7. They help in budgeting

Using cost sheets, you can prepare a robust budget that will help your business run smoothly. You can prepare a budget using historical data or estimated data.

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What is the ledger balance in the savings account?

The ledger balance is also known as the current balance. Ledger amount meaning is the amount of money in a specific checking account at the beginning of each day, which remains unchanged throughout the day.

Your personal checking account’s ledger balance will be updated at the end of each business day after your transactions have been approved and processed. Next business day, your checking account balance will be updated.

What is the function of a Ledger Balance?

Ledger balances update when the bank processes transactions at the end of the working day and reflect a new opening balance for the next day. A ledger balance doesn’t change in real-time.

Banks are allowed by federal regulations to impose a hold on deposited cash for a specified amount of time before making them available for use. A pending deposit is a money on hold that has not yet been authorised for usage. Once the bank confirms receiving the funds from the payee, they’ll add them to your available balance. Withdrawals, wire transfers, and debit card activity are pending transactions.

Initial bank statement balances come from ledger balances. To maintain an accurate ledger balance, record all transactions after receiving the bank statement.

The importance of Ledger Balance

Understanding your ledger balance helps prevent overdraft charges, bounced checks, and inadequate funds for automated debits like bill payments. In addition, you must keep track of your ledger balance if you need to maintain a minimum bank account balance.

Financial planning involves checking ledger balances. This includes budgeting and understanding when to withdraw funds for big and small expenditures since funds aren’t accessible until they’re in your ledger.

To know your financial condition well, you must regularly examine your ledger balance.

What are the differences between Ledger Balance vs Available Balance

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What is Bill of Materials?

BOM is a comprehensive inventory of all the materials and pieces that a manufacturer requires to make a certain product. The BOM must include not just the raw materials but also any subassemblies, subcomponents, and parts, as well as the exact amounts of each.

The precise layout of a bill of materials will differ based on the essence of the commodity being manufactured, but it is common for each product to have two distinct types of bills of materials: 

• one for the engineering phase during which the product is developed, and 
• another for the mass production phase during which the product is shipped to customers.

BOM Structure

Structures related to the methods in which the bill of materials records the components of a product. There are typically two methodologies: single-level BOMs, in which all items are consolidated into a single level, and multi-level BOMs, in which things are nested into two or more layers. Individual product and product family structuring decisions can have a major impact on not just a business, but also its supply network and distribution allies.

Single level-BoM: is a comparatively straightforward enumeration of the components that make up a product. Each assembly or subassembly is shown just once in this type, along with the quantity necessary for each to complete the product. While this form of BOM is simple to create, it is insufficient for complicated products since it does not describe the link between parent and child components or assemblies and subassemblies. When a product malfunctions, a single-level BOM complicates determining which component needs to be replaced or repaired.

Multilevel-BoM: is a BOM with several levels that needs more time to produce but gives more information and specificity about the product’s parent and child components. The total amount of material required is shown in a multilayer bill of materials. Additionally, the product’s indented structure demonstrates the relationship between parent and child products, as well as assemblies and subassemblies. Because the bill of materials serves as the foundation for production planning systems and the information contained within it serves as the foundation for additional business activities such as manufacturing resource planning, product costing, material provision for production, and plant maintenance.

Types of Bill of Materials

Most businesses organize their goods and service BOMs to fulfill their specific internal and external goals. Some organizations utilize distinct systems to structure BOMs for Engineering and Manufacturing reasons for a given product and configuration. These Engineering Bills of Materials (EBOMs) and Manufacturing Bills of Materials (MBOMs) can be standalone or integrated into company-wide managed BOMs.

1. Manufacturing Bill of Materials (mBOM)

When a company wants to display all of the components and assemblies needed to produce a finished product, they use the manufacturing BOM (mBOM). Parts that need to be processed before assembly must also be included in the mBOM. The document includes information that is distributed to all integrated business systems involved in ordering parts and constructing the product, such as enterprise resource planning (ERP), materials resource planning (MRP), and, in certain circumstances, manufacturing execution systems (MES). For a manufacturing business, this is the most frequent sort of BOM.

The accuracy of the quantity of parts ordered during the manufacturing process is critical to the mBOM. This ensures that the buying department can keep an ideal timetable for ordering essential items and negotiating the best possible price from relevant vendors.

2. Engineering Bill of Materials (eBOM)

During the product design process, the engineering BOM (eBOM) is created using Computer-Aided Design (CAD) or Electronic Design Automation (EDA) technologies. The document often lists the items, parts, components, subassemblies, and assemblies in the product as developed by the engineering team, frequently in the order in which they are depicted in the assembly drawings of the parent product. Furthermore, it is not uncommon for more than one eBOM to be connected with a single final product.

3. Service BOM

The Service BOM (which is frequently created by engineers during the design process) generally comprises a list of all the parts, installation methods, and repair instructions that service professionals use while installing or servicing a product onsite at the customer’s location.

4. Sales BOM

A Sales BOM, unlike other types of BOMs, gives details about a final product prior to its assembly during the sales phase. Both the final product and the components show as independent entries in the sales order document in a Sales BOM. Furthermore, the parent item will be displayed as a sales item rather than an inventory item, and the offspring as sub-items.

5. Assembly Bill of Materials

A Sales BOM is similar to an assembly BOM in that the parent item is listed as a sales item rather than an inventory item. However, unlike the Sales BOM, only the final product appears in the sales document; the offspring are not included as sub-items. Assembly BOMs can also be single-level or multi-level.

6. Production BOM

In the production stage, the bill of materials (BOM) is frequently used as the basis for a production order. It includes the components and subassemblies that make up a final product, as well as the pricing, descriptions, quantities, and units of measurement connected with them. Physical components can be transformed into final products throughout the manufacturing process. A completely automated BOM system may automatically add component demands, pricing, and material availability to work orders, ensuring that raw materials are correctly assigned to products.

7. Template Bill of Materials

A Template BOM is a highly adaptable type of BOM that can be used for both Production and Sales BOMs, with the parent items presented first and the components displayed below. In the BOM or on the sales order, the number of such components can be updated, swapped out, and replaced with other components, or deleted.

8. Configurable BOM (cBOM)

A Configurable BOM includes all of the components needed to develop and manufacture material to a customer’s specifications. The cBOM is frequently utilized in areas where goods are highly customizable, such as job shops, heavy machinery, and industrial machines.

9. Single-Level BOM

A single-level BOM is generally utilized for goods with simple structures that do not involve subassemblies. This document typically provides a total count of all the components used in the manufacturing of a product, with the pieces listed in part number order. This sort of document’s structure only allows for one level of children in components, assemblies, and material.

10. Multi-Level BOM

A multi-level BOM, as opposed to a single-level BOM, is used for more complicated structures and hence contains subassemblies, which are sometimes split down into additional layers of subassemblies. Except at the highest level, each item number (raw material or labour) in this document must be associated with a parent item.

Difference between BOQ and BOM

While the BOM is the inventory list of raw materials, parts, and components, the BOQ is the total quantity of goods required to complete a project.

Advantages of using Bill of Materials

BOMs play an important role in product firms since they specify what goes into a product. Because it specifies the level of importance for modifications, BOM management is critical to Quality Management Systems (QMS) and Product Lifecycle Management (PLM).

A well-defined bill of materials (BOM) assists businesses in the following ways:

– Planning raw material purchases.

– Calculate the cost of materials.

– Take control of your inventories.

– Keep track of and plan for your material requirements.

– Maintain complete and accurate records.

– Ensure supply reliability while also reducing waste.

The elimination of ambiguity guarantees that the product can be reliably replicated and that its quality can be managed. Businesses cannot be certain of the following things until they have it:

– Control of the product’s quality.

– The dependability of the product.

– The constancy of the brand.

– Adherence to regulatory requirements.

– Commitments from customers.

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The break even point is the level of output at which the company’s overall revenue and total expenses are the same. At BEP, the company’s revenues from the sale of manufactured goods are equal to the overall production expenses of the product. In accounting terms, the company’s overall profit is zero at this time. As a result, there is no profit and no loss for the business.

The business “breaks even.” Any corporation that wishes to make an abnormal profit demands a break even point.

Financial Break-Even Point enables you to evaluate the extent to which your product or service sales equal your costs. This point at which your sales exceed your operating costs is referred to as your break even point (BEP).

A Break-Even Point can be represented graphically using a break even chart. The break even analysis chart explains the various costs associated with varying levels of sales.

Break-even analysis for new companies is a critical calculation. All new firms want to know when they can anticipate profitability.

How to Calculate Break-Even Point

You can compute your break even point in more than several ways. It can depend on the number of units or sales.

1. Break-even point expressed in terms of units –

Break-Even point (Units) = Fixed Costs ÷ (Revenue per Unit – Variable Cost per Unit)

In the business world, fixed costs remain constant regardless of the number of units sold. Revenue is the amount of price at which things are sold less variable costs such as materials, labour, etc. To obtain the break even point per unit, you must divide the fixed costs by revenue per unit, deducted by variable costs per unit.

2. Break-even point expressed in terms of Sales –

Break-even point= Fixed Costs ÷ Contribution Margin

Divide fixed costs by contribution margin to obtain break even points based on sales volume. To calculate contribution margin, variable costs are subtracted from the product’s selling price (price).

To make both of the Break-Even Point Formulas easier to understand, the components can be summarized as follows:

i) Fixed costs: These costs include rent (for the store and production), assets such as computers and software, as well as advertising and public relations charges, among other things.

ii) Contribution margin: Subtraction of variable cost from selling price yields contribution margin. The differential is utilized for fixed cost recovery.

iii) Contribution margin ratio: This value is determined by the contribution margin reducing fixed costs. After determining the contribution margin ratio, you can compute your break even cost by reducing expenses or increasing income.

iv) Profits: If your sales are equal to the fixed and variable costs, break even is achieved. Any additional revenue contributes to net profit.

When Is Break Even Point Significant:

When it comes to economic principles, the term “break even point” meaning can be traced back to the term “point of indifference.” The calculation of an enterprise break even point is a simple but analytical tool for organizations. In its simplest form, a break even point analysis provides insight into whether or not a product’s or service’s revenue can cover its manufacturing costs. Furthermore, the break even point is beneficial to managers since the information presented can make critical decisions in the corporate world.

If the break even point is higher than the projected demand, resulting in a loss on the product, the manager might use this information to make decisions regarding the product. He may decide to cancel the product, boost advertising, or re-price it to increase demand. Thus, the break even chart displays the cost-income and volume relationships in a straightforward but effective manner that even a layperson can understand.

1. The break even chart assists managers in determining the level of sales required to break even. The break even chart is especially significant because it enables management to quickly visualize the impact of a change in selling, fixed expenses, and variable costs on profitability. Another critical application of the financial break even point is to assist in determining the relative importance of fixed and variable costs. With more flexible labour and equipment, the fixed price is reduced, lowering the break even point. The relevance of the break even point in business and decision-making cannot be emphasized.

2. Break-even analysis is the most effective and crucial managerial method for analyzing cost-output-profit relationships at various output levels. This allows the top management to develop their operational strategy. Additionally, a finance manager can utilize this technique to forecast profitability at varying production and sales levels.

3. The analysis provides valuable insight into the company’s operational risk. A finance manager can measure the degree of profit stability by comparing fluctuations in expected future volume to the estimated break even point. This allows financial management to determine the company’s ability to service debt.

4. Break-even analysis is critical for start-ups. It assists them in determining the profitability of a business concept and in developing pricing strategies and prices.

5. Break-even analysis is also a critically important area of focus for firms when they introduce a new product or service to the marketplace, mainly if producing or operating the good or service involves significant expenditures.

6. Costs might vary significantly when a business changes its strategy, depending on whether it is downsizing or scaling up. Thus, break even analysis is critical for firms when altering their business models and determining selling prices.

Break-Even Analysis Examples:

Suppose you want to start a new business offering smartphone applications. Assume the following facts regarding your costs and revenues:

The average selling price that should be expected is $5.

Fixed costs are estimated to be $75,000. (This amount is sufficient to cover your wage and the price of a small office.)

These costs will remain constant regardless of the number of apps sold.

Variable costs = $0.25 (This is the transaction fees associated with each sale.)

With this information, we can compute the break even point in the following manner:

BEP = $75,000 / ($5 – $0.25)

Consequently, if you round your sales figures up to the next unit, you’d need to sell 15,790 copies of your app to break even.

Importance of Break Even Analysis For Small Businesses

A break even analysis establishes the point at which a small business may anticipate covering all the costs while still earning a profit. Small business owners can specify the number of sales required for business expenditures regularly by identifying start-up costs. Even after a certain period, break even analysis can help determine the appropriate pricing strategy for new products or services.

Many small business entrepreneurs launch a product or service without fully comprehending the total costs.

• Calculation of costs – A break even analysis can assist you in determining if your organization will remain profitable when your fixed costs increase.
• Budgeting and goal setting – A break even analysis can also assist you in budgeting by providing an estimate of your profitability for the coming month, quarter, or year.
• A tool for motivation – A break even analysis can assist you in determining sales targets and can inspire you to work much more complicated when your profitability is at stake.
• The margin of safety – By analyzing the breakeven point to the predicted profitability, you can readily identify when sales are falling short of becoming profitable and successful.
• Ensure the Accuracy – Ascertaining the reliability of a break even analysis requires a thorough analysis of the expenditures and pricing associated with your organization. You must understand the complete expenses related to delivering your services and products to customers.

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Cash credit is a short-term financing source for a company. It is one kind of short-term loan extended by a bank to a company. The account is restricted to only borrowing up to the limit of borrowing. In addition, interest is charged not on the borrowing limit but the amount borrowed. You can read further to know the actual cash credit meaning and its other facts.

Features of Cash Credit  

Check out some of the crucial features of cash credit which are as follows:

1. Interest on Running Balance

The interest is charged not on the total borrowing limit but on the running balance of the cash credit account in contrast with other traditional debt financing methods like loans. 

2. Borrowing Limit

Cash credit is introduced with a borrowing limit decided by the creditworthiness of the borrower. A company can withdraw money up to its prescribed borrowing limit.

3. Credit Period

Cash credit is usually provided for a maximum duration of 12 months after the re-evaluation of the drawing power.

4. Minimum Commitment Charge

The short-term loan is presented with a minimum charge for setting up the loan account regardless of whether the borrower makes use of the available credit. For instance, banks usually involve a clause that needs the borrower to pay a minimum interest amount on the withdrawn amount or a predetermined amount, whichever is higher.

5. Collateral Security

The credit is often secured with the use of property, fixed assets, or stocks as collateral.

Benefits of Cash Credit

Have a look at a few of the advantages of cash credit which are as follows:

1. Easy Arrangement

It can be arranged by a bank easily as the offered collateral security is accessible to be guaranteed and the achievable value of such is determined easily. 

2. Flexibility

One can make withdrawals many times on a cash credit within the borrowing limit and excess fund deposits into the account reduces the burden of interest that the company faces. 

3. Interest Charged

A cash credit lowers the cost of financing of the borrower as the interest is charged only on the minimum commitment charge or the utilized amount. 

4. Source of Working Capital Financing

Cash credit is a crucial source of working capital financing as the company does not need to be concerned about liquidity problems. 

5. Tax-deductible

Payments of interest are tax-deductible and therefore, it decreases the overall burden of tax on the company. 

Difference between Cash Credit and Overdraft

Normally, cash credit and overdraft are identified as the same funding items but there are still nine differences between both which you should understand.

FAQs related to Cash Credit

1. What documents are needed to avail a cash credit loan?

• Business plan
• Duly filled application form along with passport-sized photographs
• Business PAN card
• Business address proof
• Business Incorporation Certificate
• Information of security or collateral to be submitted
• Income proof of last six months’ bank statement
• Ownership proof: Company’s deed
• KYC documents like Voter’s ID card, Applicant’s Passport, PAN card, Driving License, Utility Bills (Electricity/Water Bills), Aadhar card
• Any other document needed by the lender

2. What is the procedure of a cash credit loan?

The very first step of the procedure is that the lender or bank sanctions a limit to an enterprise or business and the business can withdraw funds from the assigned limit as per their requirements. But, the limit sanctioned by the lender or company relies on the existing liabilities and assets of the business. Financially sound and robust establishments are sanctioned with higher limits in comparison to companies with lower credit scores or finance. The rate of interest charged by the lender or bank relies on the creditworthiness and submitted collateral by the organization.

3. How does cash credit operate?

Cash credit allows an organization to withdraw funds from a bank account. One can withdraw funds a number of times until the total sanctioned limit is reached. The limit of cash is determined by the lender according to the applicant’s CIBIL score, profile, and creditworthiness. These factors are on the basis of the company structure of the borrower and its assets as well as liabilities. 

4. What are the salient features of cash credit?

• Cash credit is a short-term loan with a repayment duration of 12 months or 1 year.

• Cash credit is usually provided against security or collateral.

• The rate of interest charged by the lender is not on the sanctioned credit limit but the money withdrawn.

• Cash credit can be repaid in form of half-yearly, quarterly, or monthly repayments.

• A higher limit can be achieved by companies with good credit history.

• The rate of interest paid on a cash credit loan is tax-deductible.

• The credit limit is sanctioned by taking the company’s turnover into consideration.

• Funds can be withdrawn any number of times as per the sanctioned limit.

• The lender has a choice of recalling sanctioned amount at short notice

• Individual borrowers can even take the benefit of cash credit against their fixed deposits.

5. What is the difference between cash credit and a loan?

A loan is a term loan rendered by a financial institution at a prescribed rate of interest to be repaid within a certain period of time. On the other hand, cash credit refers to a short-term working capital loan in the form of a credit limit provided to an organization by a bank. 

6. What is a cash credit loan?

A cash credit loan is a kind of working capital loan in which funds can be withdrawn against the hypothecation of receivables and stocks. Cash credit assists businesses immediately in overcoming the situation of cash crunch during the business period. In fact, this working capital loan can be enjoyed either in kind of unsecured loan or secured loan. The business is restricted to borrow only up to the prescribed limit from the lender or business. Above all, business requires to submit security or collateral to get the benefit of a cash credit loan. However, the collateral that needs to be submitted should be in the form of stock-in-trade, fixed assets, finished goods, raw materials, property, equipment, etc. 

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This article will discuss the meaning of the profit and loss account and all the important terms associated with it.

What is a Profit and Loss Account

When the revenue of a company exceeds its expenditures, the company is said to be in profit. When the expenditure of a company exceeds its revenue, the company is said to incur a loss. A profit and loss statement calculates the revenues and expenses of a company to show its performance.

A profit and loss (P&L) account is a financial statement that shows the outcome of the various business transactions in an accounting period. The company’s incomes and expenses of a certain period are compiled and used to measure the company’s performance during that period.

The P&L account (P&L a/c) of a company shows its ability to generate sales and manage expenses. It is presented using the cash or accrual accounting method.

A Profit and Loss account is also known as a Profit and Loss Statement, Income Statement, Statement of Financial Results or Income, Expenses Statement, Statement of Operations, and Statement of Earnings. 

How Does a Profit and Loss (P&L) Account Work

Every public company has to issue a quarterly and annual financial P&L statement along with a balance sheet and a cash flow statement. The P&L statement is the most common financial statement used to measure the income of a company and the way it is managing its funds.

The main purpose of the profit and loss statement is to check whether a business is making profit or loss over the given financial period. In other words, the profit and loss account of a company shows its efforts in generating income and maintaining its cash flow while running the business.

A Profit and Loss Statement contains all the details of credits, including turnovers, investments, and other incomes and debits, including sales costs, overheads, manufacturing costs, and so on of a business.

Also read about Accounting Vouchers

How Does a Profit and Loss Statement Look

A P&L Statement of a company represents its credits and debits over a certain period, usually quarterly or annually. A P&L statement consists of the following categories:

• Revenue generated (sales)
• Cost of sales
• Selling, General and Administrative (SG&A) expenses
• Marketing costs
• Advertising costs
• Developmental or Research costs
• Interest expenses
• Taxes 
• Other incomes

What is a Profit and Loss Account Used For

The P&L A/c of a company is used to determine its income tax and corporation tax. If the P&L statement of a company is incorrect, it may lead to increased penalties and interests. 

Profit and Loss statements are also used to study the various market trends and their effects on the company over a period of time. These statements include depreciation and inflation costs so it becomes easier to predict the performance of a sector based on the current value of the currency in the market.

P&L statements are also beneficial to investors and shareholders. They can check the statements to see whether a company has profited or lost more money and make their decisions based on the reports.

What are the Types of Profit and Loss Account

There are three types of profit and loss accounts. Each has a set of golden rules that are followed while compiling the profit and loss statement.

1. Personal account

This is a personal account of a person. The person may be a creditor, investor, debtor, or any other person who has a financial dealing with the company.

The golden rules of accounting for this account are that Debit involves the receiver and Credit involves the giver.

2. Real account

This account deals with inventory, that is, the buying and selling of goods and services. A company can have several real accounts based on the number of goods and services it deals with.

The golden rules of accounting for this account are that Debit is what comes in and Credit is what goes out.

3. Nominal account

This account shows the income or expenditure of a company. These accounts are used to study departmental performances.

The golden rules of accounting for this account are Debit includes expenses and losses and Credit includes incomes and profits.

According to the above categories, a company’s Profit and Loss Statement is drawn.

What are the Different Terms in Profit and Loss Account

Several financial parlances are used while making a P&L statement. Here are some of them:

• Net income:This is the income of the company minus the cost of goods sold, expenses, and taxes.
• Gross profit: This is the company’s total revenue/sales minus the cost of the goods sold.
• Operating profit: This is the profit after deducting operative costs like rent from gross profit. It does not include interest and tax deductions.
• Net profit: This is the amount left over after all the working expenses are deducted from gross profit. It is the company’s actual profit.

What is the Format of a Profit and Loss Statement

A P&L statement is divided into two parts: debit and credit. Here is what a typical statement looks like:

In this table, the “Dr” side represents all the debits that the company has incurred including indirect expenses. The “Cr” side represents all the direct and indirect revenues of the company.

What are the Components of a Profit and Loss Account?

A Profit and Loss Account is divided into two main components:

1. Trading Account
2. Profit and Loss Account Statement

Trading account

Trading Account is prepared from the point of view of manufacturing or merchandising. This account statement is used to calculate the gross profit or loss of a company. This calculation is important to measure the success of a business. In this account, you have to consider all direct incomes and expenses.

Here are the different components of a trading account:

Profit and Loss Account Statement

A Profit and Loss Account Statement is the comprehensive accounting statement of all the transactions carried out by the company during a certain financial period. The various categories in this statement are:

The following is an example of a Profit and Loss Account Statement of Tata Motors for the financial year 2019-20.

Courtesy: Tata Motors

The above example shows the gross profit gained by the direct income after deducting direct expenses. The gross profit is then added to the indirect income to get net profit.

How to Prepare a Profit and Loss Statement?

To prepare a profit and loss statement, several other statements are used. 

1. Journal: A journal entry is used to record a transaction showing the Debit and Credit accounts and the amounts involved with a short description for each transaction.
2. Ledger: A ledger is a T-shaped account with the debit side on the left side and the credit side on the right side. The entries in the journal are included in the ledger accounts. Every account has a separate.
3. Trial Balance: A trial balance is a statement that shows debit and credit balances. This list ensures that all the entries have been recorded correctly. The sum of the debits must match the credits.
4. Balance Sheets: All the accounts which haven’t been closed are included in the balance sheet. Unlike a profit and loss statement, a balance sheet is prepared on a certain date.

FAQs related to profit and loss account

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