One of the fundamental accounting assumptions associated with the preparation and presentation of financial statements is the accrual basis of accounting. The following are three accounting foundations that are used by the business.
- Accrual Basis of Accounting
- Cash Basis of Accounting
- Hybrid Accounting
What is Accrual Basis of Accounting
The word â€œAccrualâ€ can be explained as revenue and cost are accrued i.e., they are recognized as earned or incurred (irrespective of whether money is received or paid) and entered in the books of accounts for the period to which they relate.
The procedure of recording transactions by which revenue, cost, assets and liabilities are reflected in the accounts for the period to which they accrue. This includes considerations relating to deferrals, allocations, depreciation and amortization. This basis of accounting is also referred to as â€˜Mercantile Basis of Accountingâ€™.
How Does Accrual Basis of Accounting Works?
Accrual basis of accounting tries to record the financial effects of the transactions, events, and circumstances of an enterprise in the period in which they occur rather than recording them in the time period in which cash is received or paid by the enterprise.
The accrual basis of accounting recognizes that buying, producing, selling and other economic events that affect the enterpriseâ€™s performance often do not coincide with the cash receipts and payments for the given period. The motive behind following the accrual basis of accounting is to relate the accomplishments (measured in the form of revenue ) and the efforts (measured in terms of cost ) so that reported income ( net of expenses ) measures an enterpriseâ€™s performance during a period instead of merely listing its cash receipts and payments.
It also recognizes the assets, liabilities, revenue and accrued expenses for the amounts received or paid in cash in the past, and amounts expected to be paid or received in cash in the future.
Features of Accrual Basis of Accounting
The essential features of the accrual basis of accounting are:
- Revenue is recognized as it is earned.
- Expenses or costs are matched either against revenues so recognized or against the relevant time period to determine periodic income.
- Expenses that are not loaded to the income statement or profit and loss statement are carried forward and are kept under continuous review. So any cost thereafter which appears to have lost its utility or its power to generate future revenue is written-off as a loss.
What is Accrued Expenses
Accrued expenses refer to an expense related to the business operation which is recognized in the books of the accounts before it is paid, and these expenses are recorded in the books for the period they are actually incurred.
Accrued Expenses Recognition Rules
Under accounting by the accrual basis, the costs are matched either against revenues or against the relevant time period in order to determine the net income. All those costs which are not charged against the income of the period are carried forward. If any accrued expense has lost its utility or its power to generate revenue in the future, it is written off as an expense or a loss.
Under the accrual basis of accounting, the expenses are recognized by following the approaches explained below:
Identification with Revenue Transactions
Costs which are directly linked with the revenue recognized during the relevant period (in respect of which the money has been paid or not) are considered as expenses and are charged to income for the period.
Identification with a Time Period
Unlike some costs which have a direct connection with the revenue for the period, in most cases, the relationship is so indirect that it is impractical to attempt to establish its revenue relationship. These costs are regarded as â€˜period costsâ€™ and are considered as an expense in the relevant accounting period. salaries, telephone, travelling charges, depreciation on office building etc. are some of the examples which are identified using this approach.
Following are the treatment of accrued expenses by applying the above approach.
- The benefit of costs which do not clearly extend beyond the accounting period is charged as expenses.
- The benefit of expenses which could be traced to a future period is accounted as prepaid expenses even though they are paid in the current accounting period.
- Expenses of the current year, for which payment has not yet been made (outstanding expenses) are recognized and charged to the profit and loss account for the current accounting period.
- Contingent losses should be provided by a charge in theÂ profit and loss statementÂ only if it is confirmed that an asset has been declared not of use, impaired etc. and a rationale estimate of the resulting loss can be made.
Examples of Accrual Basis of Accounting and Accrued Expenses
|Mr Rehman, an accounting professional from Bangladesh provided accounting services of 10,000 Tk. to Marsh Hardware on 10thÂ December with a credit period of 15 Days. Marsh Hardware paid 10,000 Tk in January.
|Using the accrual basis of accounting, Mr Rehman will report the 10,000 Tk as revenue in the income statement and this will also be reported as accounts receivable in the balance sheet as on 31 December.
|The rule used for the above example is related to revenue recognition: Here, revenue is recognized as when it is earned provided:
Â·Â Â Â Â Â Â Revenue is measurable or the consideration receivable from the sale of goods, the rendering of services or use of resources of the enterprise is reasonably determinable.
Â·Â Â Â Â Â Â Revenue in respect of which there is no uncertainty of collection is immediately recognized.
|Max Enterprises located in Indonesia paid office rent of Rp 1,500 on 31stÂ December. They also incurred Rp 300 for electricity, gas, and sewer/water during December.
Max Enterprises was billed for utilities used on 10thÂ January with a due date to pay the bill by 1stÂ February.
|Using the accrual basis of accounting, Max Enterprises will report the rent expense in December. This is because the rent benefit was consumed, incurred and paid in December,
Max Enterprises will also report estimated utility expenses of Rp 300 so that the income statement provides a better measure of December’s profitability.
In Balance sheet as on 31stÂ December, a liability of Rp 300 towards utilities payable will be reported. This will show the accurate obligation of the company as on 31stÂ December,
|Max Ltd has prepaid wages of Rs. 100,000.
|As per the accrual basis of accounting, this will be recorded as an expense in the income statement. In theÂ balance sheet, this will be shown as pre-paid expenses under the current assets.
Rules used for example 2 and 3 are of matching costs with revenue and relevancy of time period. Here, costs are matched either against revenues so recognized or against the relevant time period to determine periodic income. This is explained in detail in the accrued expenses recognition rules section.
Differences Between Accrual Basis of Accounting and Cash Accounting
The difference between accrual accounting and cash-based accounting is in the timing of recognition of revenues, expenses, gains and losses.
Receipts of cash in a period may largely reflect the effects of enterprise activity in the earlier periods, while many of the cash outlays may relate to activities and efforts expected in future periods. Thus, an account showing cash receipts and cash outlay of an enterprise cannot indicate cash received vs the investment and also to what extent an enterprise is successful. On the other hand, the accrual basis of accounting gives you the complete and accurate view of expenses, income, liabilities etc. and help you measure the business in terms of profitability and financial position.
Cost Estimation is a statement that gives the value of the cost incurred in the manufacturing of finished goods. Cost estimation helps in fixing the selling price of the final product after charging appropriate overheads and allowing a certain margin for profits. It also helps inÂ Inventory ReportsÂ drawing conclusions regarding the cost of production and in determining the necessity to introduce cost reduction techniques in order to improve the manufacturing process.
Cost estimation takes into consideration all expenditure involved in the design and manufacturing along with all related service facilities such as machines setting; tool making as well as a portion of sales marketing andÂ administrative expensesÂ or what we call overhead costs.
Example and Methods
Isnâ€™t it absolutely annoying to pay expenses each month, without knowing the amount that youâ€™re going to write the cheque for? Being able to estimate business costs accurately can help you plan for the future and see trouble on the horizon. There are many ways to estimate costs, and each one is a different blend of difficulty and accuracy. Knowing some of these basic methods may help you choose the right one for your firm.
Least Squares Regression
A perfect amalgamation of accuracy and ease of use, least squares regression, analyses past data using mathematical estimation, to determine the variable and fixed components of a cost and provides an equation that can be used to predict future expenses. While this sounds complicated, the mathematics are built into most commercial spreadsheet programs, so adoption is as simple as entering your bill history and clicking a few buttons.
This is a quick and an easy way to estimate costs that still hold accuracy. This method takes into consideration the highest and lowest levels of activity to calculate the fixed and variable components of the cist, but also ignore all the data that isnâ€™t on the extremes. If the highest and lowest levels of expense are representative of the costs you are estimating, then you’re in good shape. If not, this method can overestimate or underestimate costs.
Another quick and easy method to estimate costs is the Scattergraph method. While it might be the quickest and the easiest method to get your expenses estimates, the values derived post calculations might not be that accurate. To use the scattergraph method, you simply plot the cost vs. the level of activity on a graph and draw what you think is the best-fit line through the points. Once you’ve determined the best-fit line, the slope of the line is the variable cost per unit, and the fixed cost is the point where the line crosses the y-axis. The problem with the scattergraph method is that each person has a different idea of how to draw the best-fit line, giving each person a somewhat different estimate of the cost.
For the largest of small businesses, statistical modelling can be a very accurate method of cost estimation. Industry-specific models are able to predict such complex variables in cost computations as hotel vacancy, food costs, and stock-based compensation expense. While these methods can be very accurate, the cost of implementation can be high, which puts them out of reach for many small firms.
While all these methods might cater to different models, withÂ TallyPrimeÂ you need not worry about which method to use to calculate your cost estimates. Our cutting-edge technology and simple reports give you a consolidated estimation of each inventory at one go.
To view the cost estimation of a particular finished product, select the relevant Stock Group which will display the stock consumption details and cost thereof for each of the stock items falling under that Group. Cost estimation, however, is easier said than done. An accurate estimation method can be the difference between a successful plan and a failed one.
What is revenue expenditure?
Revenue expenditures are short-term expenses that are also known as revenue expenses and operational expenses (OPEX). Revenue expenditure is generally spoken to in relation to fixed assets as it records the expenses which have occurred in connection to a fixed asset. For example, if you have a piece of equipment that requires monthly maintenance then the expense will be termed under revenue expenditure. It involves all costs that are required for the successful running of a business such as salaries for employees and property taxes. Â Revenue expenditure is recorded during an accounting period or a single year.
Revenue expenditure types
Revenue expenditure can be divided into two categories; direct expenses and indirect expenses.
Direct expenses are those costs that are incurred when goods and services are in the process of being produced. The costs that are incurred during the day-to-day operations that take place in the business are also direct expenses. For manufacturing companies, examples of direct expenses include the costs that are incurred for the conversion of raw materials to finished products or goods. Direct expenses also include costs such as electricity used during the production, wages paid to workers, legal expenses, rent, shipping-related costs, and freight charges.
Indirect expenses are the second type of revenue expenditure. These types of expenses are usually incurred when the finished goods and services are being sold and distributed. These expenses include taxes, salaries for employees, depreciation, and interest among others. Indirect expenses also include repairs and maintenance costs. Although these costs arenâ€™t directly linked to the finished products, they are required to ensure the proper functioning of the asset which in turn supports the proper functioning of the business.
Example of revenue expenditure
A company called A&J spends 100000 BDT on a machine used for the production of goods. To ensure the proper functioning of the machine, a monthly fee of 1000 BDT is spent. In this example, the revenue expenditure is 1000 BDT which has been spent on the upkeep of the machine on a monthly basis. When the income statement will be prepared, the 1000 BDT will have an entry for that particular month where the upkeep expenditure was made. In case the machine has an issue and needs to be repaired, the cost of repair will also fall under revenue expenditure and will be reflected on the month during which the expenditure was done.
Revenue expenditure Vs. capital expenditure
Revenue expenditure andÂ capital expenditureÂ are often confused for one another which makes understanding their differences even more vital.
|Revenue expenditure is the expense that is used to run your business on a daily basis. It includes the costs used to ensure the proper functioning of a fixed asset repair costs, maintenance costs, and costs that are incurred for current operations. It differs from the cost used to acquire or buy an asset. Examples of revenue expenditure include rent, utilities, and office supplies.
|Capital expenditure, also known as a capital expense or Capex, is the expense that is used to acquire a capital asset. This asset is a long-term asset that is used to improve how the business functions by boosting efficiency. Examples of capital expenditures include vehicles, computer equipment, land, fixtures, software, office buildings, and so on.
|Revenue expenditure is consumed within a short span of time. For example, the regular upkeep of equipment is done monthly or every quarter depending on the type of equipment used for the production of goods. Â Revenue expenditure is a recurring expense that your business needs to spend every month or every few months. It is not a one-time investment.
|Capital expenditure is consumed over a long period of time until the asset is useful or until the asset has reached its end of life. For example, machinery is used for many years until it is able to function correctly. It is not a recurring expense as your business needs to pay for the cost of the machinery only once.
|Revenue expenditure is reported in the income statement of your business whenever the expense was incurred. It is not stated in theÂ balance sheet. When it comes to charging revenue expenditures, they are charged immediately in the current period during which you paid for it or after a short period of time.
|Capital expenditure is reported in the cash flow statement of your business and in the balance sheet. When being reported in the balance sheet, it is stated under fixed assets. Capital expenditure isnâ€™t immediately charged as an expense. Instead, it is charged over a long period of time until you will use it using depreciation. This is a gradual process.
|The purpose of revenue expenditure is to ensure the assets such as machinery are functioning optimally at all times and so this expenditure comes into the picture after the business has started operating. These expenditures are used to sustain your business. Although these expenditures do not add more capability to the asset, they are used to ensure the asset works as it should.
|The purpose of capital expenditure is to generate more revenue over time. It involves expanding the business and investing in machinery that is going to give ROI and long-term gain. For example, an expensive machine in a manufacturing plant can be acquired to improve current processes so that it can contribute to revenue generation. These expenditures come into the picture before your business starts to operate.
|When it comes to revenue expenditure, the cost associated with them is comparatively lower than that of capital expenditures. Revenue expenditure isnâ€™t the expense related to investment so it is generally smaller. In certain cases, the expense related to revenue expenditures can be large as long as the cost is a period cost or it is an expense related to the revenue.
|Your business will pay much more for anything that falls under capital expenditure. Firms usually have a threshold value that marks the distinction between revenue expenditure and capital expenditure. If the expenditure is more than the threshold value then it is considered a capital expenditure, else it might be a Â revenue expenditure.
Both revenue expenditure and capital expenditure are equally important
It is wrong to say that either is better than the other because both are required for your business to operate without issues and generate profits. Capital expenditure is critical because it can improve business efficiency. Revenue expenditure is vital as it ensures smooth business operations so there is nothing stopping your business from operating fully. Your business must manage and monitor both these expenditures to ensure you are not over-spending on each. If you do so regularly, you can effectively use strategies for regulating these expenses.
TallyPrime is an ERP accounting software that provides a powerful combination ofÂ ERPÂ andÂ accounting software. It can be of help when it comes to both revenue expenditure and capital expenditure. TallyPrime ensures you stay within your budget, know your spending history, and spend wisely. With the help of its robust reports, you get instant insights that can drive your business decisions in the right direction
Using TallyPrimeâ€™s cost centre management will help you stay on top of all the spendingâ€™s even on little expenses and make confident decision. Whatâ€™s more? You can set budget and track the variance.
What is accounting?
To understand the fundamentals of accounting, you must comprehend the definition of accounting.
Accounting is consolidating the financial transactions of a company using a systematic approach. It involves recording, analyzing, reporting, and retrieving financial transactions when required. Accounting is mandatory for legal reasons, taxes, and to understand business health. Accounting ensures that every business transaction is accounted for and if you need to pull out information about any expense you can do so with ease.Â Accounting can be divided into two parts; financial accounting and management accounting.
Financial accounting deals with the proper presentation of the transactions in the form of financial statements such as income statements which are shared with people outside the business. Management accounting is a form of accounting whereby the management department receives financial information so they can take vital business decisions to ensure efficient business continuity. Management accounting is part of the internal process as it is used for improving the overall business. It includes information such as the budget.
Key objectives of accounting
The three key objectives of accounting are as follows.
- Record keeping
The fundamentals of accounting include record keeping which is the primary function of accounting. A business must use standard forms of storing and retaining information so it can be retrieved when the need for it arises. Thorough and accurate storage of records is essential for all transaction-related purposes. A software package such asÂ TallyPrimeÂ can be utilized to store every transaction that takes place.
Financial reporting is a key accounting objective after record keeping. Accounting enables businesses to record and report their financial status at the end of a particular period. It involves putting together transaction details and reports that are necessary to make sense of a certain aspect of a business during a specific time period.Â Financial statementsÂ are results of aggregating financial information of a business and these are useful tools for reporting the financial parts of a business.
The reports which are based on the business records are analyzed in accounting. When business health needs to be determined then the business reports are analyzed. Analysis in accounting enables accountants to find out ways to improve business efficiency, upgrade processes, and to see where unnecessary expenses are being made. Analysis of financial reporting allows your business to run without problems as it ensures no discrepancies are found.
Accounting solutions to help you manage your business just the way you want.
Accounting process and steps
The accounting process is one of the fundamentals of accounting. Also known as an accounting cycle, it follows a transaction from the moment it was recorded to when a report is made using various transactions that occurred in a particular period of time. Businesses can use single-entry accounting orÂ double-entry accounting. Firms use accounting software packages such as TallyPrime to automate the accounting process. The benefits include saving time, effort, and money for storage, analysis, and retrieval purposes. Companies can fully automate their accounting or they can leave some aspects to be manually handled.
Steps of the accounting process
There are 8 steps in the accounting process. This is a framework and it can vary from company to company as each company has an individual model that it works with.
- Step 1: Transaction identification
You need to identify your business transactions first. Every unique transaction needs to be recorded so that it is reflected correctly. All expenses such as costs to acquire, repair, and upgrade need to be accounted for. Additionally, every sale record must be stored so it all sales transactions are in one place.
- Step 2: Journal creation
This step involves recording each transaction in a journal. You can choose between two types of accounting;Â cash accountingÂ andÂ accrual accounting. The difference is when the transactions are recorded and stored. Cash accounting is recorded the moment the cash is paid or received. Accrual accounting is when transactions are recorded as they occur.
- Step 3: General ledger posting
After the entry in the journal, the transaction details need to be reflected in theÂ general ledger. The general ledger allows the categorization of transactions because they are saved according to different accounts. That is, transactions of the same account are recorded in one place and so on. This allows easy monitoring according to particular accounts.
- Step 4: Trial balance
In this step, the trial balance is calculated. Ideally, the debits must be equal to credits for every account. The trial balance throws light on the balances which have not been adjusted yet in every account. When an unadjusted trial balance is found, it is analyzed in the next step of the accounting cycle
- Step 5: Worksheet analysis
Adjustment of the various transaction entries is done in this step of the accounting process. First, you need to create a worksheet and make sure that the credits and debits are equal to each other. In the case of accrual accounting, there is an additional step here which is to adjust the entries for revenue and expense matching purposes.
- Step 6: Journal entries adjustment
This is the stage in theÂ accounting cycleÂ where adjustments need to be made. Once the adjustments have been done, the trial balance is prepared again to ensure that the debits are equal to the credits. Only then can you move on to the next step.
- Step 7: Financial statements
This step involves the financial statements that are generated after all the entries have been adjusted in the journal. In the majority of the cases, the major financial statements will include theÂ cash flow statement,Â income statement, andÂ balance sheet. These uncover the truth behind how the business is doing financially and how much profits it is earning.
- Step 8: Closing
The last step of the accounting cycle is when the books are closed. This holds for the temporary accounts as they are shifted to permanent accounts. For example, the profit and loss statement is transferred to the retained earnings accounts and so on. The closing occurs at the end of the reporting period. After this, the cycle starts again.
Key accounting reports
The critical accounting reports are as follows.
- Balance sheet
The balance sheet contains information about the totalÂ liabilities,Â assets, and stockholder equity. It gives information about the companyâ€™s resources and how these sources are being financed. A balance sheet can help you make better business decisions.
- Profit and loss statement
TheÂ profit and loss statementÂ is also known as P&L and income statement. It shows the revenues and expenses of a business over a period of time. A business is going in the right direction when the profits exceed its losses.
- Statement of cash flows
This report summarizes the cash that is received or paid. It doesnâ€™t reflect the non-cash transactions that take place such as purchases made on the basis of credit. It contains three parts; investing, operating, and financing. It gives information about cash generation.
How accounting software helps businesses
AnÂ accounting softwareÂ tool can take the complexity out of accounting. Whether the business is small, growing, or enterprise-level, every business needs an accounting software package. TallyPrime is the best example of accounting software that handles everything. All you need to do is record the bills and invoices. TallyPrime will automate the rest. It minimizes human errors, automates management of books of accounts, generates informative customized reports and financial statements, and makes tax returns easy. Additionally, it improves inventory management, ensures tax compliance, streamlines business processes, aids in business forecasting, and accurately generates financial statements. This ensures you know how your business is doing at every step of the way.
Some of the key features of TallyPrime:
- Record and bookkeeping
- Invoicing and billing
- Pre-defined chart of accounts
- Accounts receivable and payable management
- Wide range of accounting and financial reports
- Multi-currency support
- Sales and Purchase Management
- Online business reports
- Inventory Management
- Taxation support
Definition of inventory control
Inventory control is an activity of checking a shopâ€™s stock and to maintain the inventory at desired levels, keeping in view the best economic interest of an organization. In simple words, inventory control is a process of ensuring that a business maintains the adequate quantity of stock to meet the forecasted demand with minimum holding cost.
Why do businesses carry an inventory?
The below table explains different inventory types and the reason why such inventories are held by the business.
|The reason for holding raw materials is to reap the price advantage available on purchase of bulk or on any seasonal raw materials which can be procured only during the harvest seasons.
|Inventory in work-in-progress
|The reason is to balance the production flow. Letâ€™s say if any batch order which requires the same kind of raw material, it can be diverted from the batch order that has been postponed by the management for certain time thereby not affecting the production flow.
|A company usually does not produce every component that goes into the product. Sometimes they buy readymade components available in the market. In such a situation, it becomes necessary for the company to hold stock of those readymade inventories which are required in the production of the final product.
|A company stocks the finished goods during the waiting period until it finds its customer. In some cases, more stocks are held to create demand for the product and get a high price for the product.
From the above, itâ€™s quite clear that for various reason, you need to hold inventories in the business. In this process, how much to stock is an important question that needs to be answered. Here is why inventory control plays an important role.
Importance of inventory control
Managing adequate stock is key forÂ managing inventoryÂ successfully. Overstocking will lead toÂ cash flowÂ blockage and the additional cost for managing excess stock. On the other hand, understocking leads to loss of sale due to non-availability of stock at the right time.
As a result, a business needs to implement inventory control so that the right product at the right place and the right time is available.
Inventory control helps the business in knowing the shortfall and quantities to be ordered considering the net stock available. Thus, it ensures that enough stocks are maintained to meet customer needs, at any point in time.
Objectives of inventory control
Inventory control has two key objectives:
Customer service level
Why do you produce goods? The answer is simple it is to sell the goods at a good price. In an open market, there are so many manufactures who may produce the same goods as you may. Then how could you be different and attract customers to your product? The answer here is plain, itâ€™s only through proper customer service.
Customer service means having the right goods available in the right quantity in the right place at the right time. This can only be achieved if you have proper inventory control measures followed up in your organization.
Cost of holding inventories
Another objective of inventory control is to optimize the cost of ordering and carrying inventories. As we know that the overall objective of inventory control is to achieve satisfactory levels of customer service by keeping the inventory costs within reasonable bounds.
Therefore, the cost of ordering inventories and carrying those inventories throughout the production is also important to keep the overall cost of selling as low as possible.
Advantages of inventory control
- Maintaining an optimum level of inventories
- Helps in laying the procurement process considering the wait-time, lead-time etc.
- Periodical inspection of inventories
- Guides us on storing and issuance of inventories from godowns.
- A systematic record of movement of materials.
- It helps to lay out plans for physical verification of inventories.
Steps involved in inventory control
Step 1: Deciding on the minimum levels of inventories
A production department is incomplete if it does not have a good relationship with the sales and marketing department. It is because the demand or need for the product you produce can only be assessed by people who are close to customers such as sales and marketing.
Thereby deciding on the levels of inventory i.e. maximum-minimum limits of inventory is important because as a manufacturer you would not like the raw materials to go obsolete even before the production has begun or to stock up raw materials that have very limited use in the production of a finished product.
Step 2: To decide on the re-order level
The demand for anything is uncertain in this world. Especially with customers taste and preferences. A product manufactured by you may be selling high and you must be ready to decide as how much to produce adhering to customers demand.
For which you have to decide as to when you will be re-stocking the raw materials which will be used in the production of the final product. If the restocking time passes beyond the committed time of the finished product to the customer, then you will not be able to deliver a complete product to the customer.
Step 3: Choosing a sound inventory control method
There are several types of inventory control method available and you can choose the one which suits your business. No matter which method you choose, it is important that the techniques should assist knowing the minimum quantity of stock, point in time at which the stock should be re-ordered and right quantity that should be ordered.
Inventory Control Methods
The following are the different types of inventory control methods used by the business.
Here, the stock is divided into three sections namely A, B and C. A section consist of inventories that are high in value with low sales frequency or consumption. This category of stocks requires to be controlled closely. Category B consists of stocks that are of moderate value and with decent sales frequency. In category C, you have inventories with low value having high sales frequency requiring minimum inventory control.
Just in time (JIT)
Here, the company maintains an inventory level that is required during production. Under this method, you will not be having any excess inventory beyond the production requirements and it helps you get rid of the cost involved in storing excess stock. Â Here, the order of stock is placed when old stock is close to zero and this puts production in risk, even if there are small delays.
Economic order quantity (EOQ)
In this method, the company will get to know how much quantity of inventory should the company order at any point of time and when should they place the order considering the minimum level of inventory.
Fast, slow, and non-moving (FSN)
Here, the inventories are classified based on the movement. All the inventories are categorized as fast-moving, slow-moving, and non-moving. Basis the movement across the categories, the order is placed.
Inventory is money sitting around in another form. You paid money for your inventory, and you will get that money back when you sell it. Until you sell them, you need to hold and manage inventories. Gone are those days where managing inventory was a nightmare. This is because the businesses have started using inventory management software which comes with in-built and automated inventory control techniques.
Basis the consumption of the inventories, theÂ inventory management softwareÂ is smart enough to know the net stock, shortfall, and quantity of stock to be ordered. More importantly, information is available readily at a click which allows the businesses to take timely decisions.
Current state of distribution network in India
What is balance sheet?
Balance sheet refers to a financial statement which reveals the complete financial position of the company for a given date. A companyâ€™s balance sheet tells you the details of assets, liabilities and ownersâ€™ equity for the business. In simple words, the balance sheet is a statement which tells you the assets of the business, the money others need to pay you and the debt you owe others including the ownerâ€™s equity.
Balance sheet is one of the important financial statement used for making business decisions. Balance sheet is used by various stakeholders like management, employees, investors, creditors, banks, regulatory authorities, tax authorities etc.
Balance sheet objectives
A balance sheet is also called as a top financial statement. Letâ€™ us understand this by knowing the purpose and objective of the balance sheet. The following are some of the key objectives of the balance sheet:
- It helps in ascertaining the financial position of the business on a given day.
- Details of ownerâ€™s equity can be determined
- The information from the Balance sheet helps you create provision for future loss/contingencies by creating reserves
- It provides a snapshot of business health including the economic resources the business owns, owes, and the sources of financing for those resources.
- Ascertain if the business is financially autonomous and therefore solvent
- Determine the financial liquidity of the business
Balance sheet components
Balance sheet components are broadly divided into â€˜Assetsâ€™ and â€˜Liabilitiesâ€™. Each of this balance sheet components consists of several sub-components. The following are balance sheet items:
As shown in the above balance sheet illustration, assets are broadly classified into fixed assets, investments and current assets. Similarly, liabilities are classified as ownerâ€™s capital, long-term debts and current liabilities. Letâ€™s understand these balances sheet items in detail.
Something that an entity has acquired or purchased and owned, regarded as having value and available to meet debts, commitments or legacies. Assets are further broadly classified as:
- Fixed Assets
Assets which are purchased for long-term use and are not likely to be converted quickly into cash, such as land, buildings, and equipment.
- Current Assets
A current assets are those assets which can be converted into cash within one year. Examples of current assets are, Cash, Bank balances, Investments, Deposits, Accounts receivables and Inventory
Liabilities are the obligations or Debts payable by the enterprises in future in the form of money or goods. Liabilities are further broadly classified as:
- Equity or Capital:
Money invested in the business to generate income.
- Loans & Borrowings
Money borrowed from a financial institution or from others to be utilized in business for generating income and managing the day to day affairs of the business. Ex: Bank Overdraft, Term Loan.
- Current Liabilities
Current liabilities are debts or obligations payable within a short period of time or one year. Ex: short term debt, trade payables, taxes due, accrued expenses.
Balance sheet format
Below is the balance sheet format
As illustrated above, on the left side of the balance sheet format, all the assets are shown followed with the sub-components of assets. On the right side of the balance sheet format, liabilities followed with sub-components are displayed.
Balance sheet equations
As shown in the above balance sheet format, the balances of total liabilities and assets owned by the business always match. This implies that the total value of assets always adds up to the total liabilities of the business. The following are balance sheet equations:
- Assets = Liabilities + Ownerâ€™s Equity:Â This balance sheet equation tells you that all the assets owned by the business are either sponsored using the ownersâ€™ equity or the amount which company should owe others like suppliers or borrowings like loans
- Liabilities = Assets â€“ Ownerâ€™s Equity:Â The difference of assets and ownerâ€™s investment into business is your liabilities which you owe others in the form of payables to suppliers, banks etc
- Ownersâ€™ Equity = Assets â€“ Liabilities:Â This equation reveals the value of assets owned purely by owner equity
How to prepare a balance sheet?
Balance sheet preparation involves multiple steps to consolidate the accounting records and preparing various statements.
The following are the steps to prepare a balance sheet:
- Posting of accounting records from journal books to individual ledge accounts
- Preparing ledger accounts and ascertaining the closing balance of each ledger accounts
- Preparing trial balance summarizing the closing balance of ledger accounts
- Computing the debit and credit balance in trial balance to ensure the journal and ledger posting are arithmetically accurate.
- If there is any difference in trial balance, errors need to be identified and corrected
- Post correction and fixing the errors, an adjusted trial balance needs to be prepared
- Preparing trading and profit & loss account by considering all the ledgers having income and expenses nature from trial balance
- Finally, preparing a balance sheet in the format shown above by considering all assets and liabilities from the trial balance.
Balance sheet prepared by modern day business
Today, most businesses have automated balance sheet preparation using accounting software. Businesses believe usingÂ accounting softwareÂ helps in saving time and efforts involved in managing books and preparing financial statements such as balance sheet. Further, the use of accounting software facilitates in generating comparative balance sheet â€“ across periods and branches and consolidated balance sheet of all the branches or business verticals.