Trailing Twelve Months (TTM): Meaning, Definition, Calculation, Example, Formula, Template

When it comes to analyzing a company’s financial performance, there are several metrics that investors commonly use, one of which is known as the trailing twelve months (TTM).

This metric allows investors to see a company’s financial performance over the most recent 12-month period, providing a useful snapshot of its current standing.

This could be a valuable tool for investors, especially those who want to get a sense of how the company is doing in comparison to its past performance.

What is Trailing Twelve Months

Trailing twelve months (TTM) is a financial metric used to evaluate a company’s performance over the past 12 months.

The TTM metric is commonly used by investors, analysts, and financial professionals to gain a more comprehensive understanding of a company’s current financial performance.

The TTM period is a rolling window that moves forward over time, allowing investors to continuously track a company’s performance.

The metric can be calculated for various financial indicators such as revenue, earnings, or cash flow, and is often used to assess a company’s growth rate or compare its latest performance to previous periods.

How Trailing Twelve Months Works

Trailing Twelve Months (TTM) is calculated by adding up a company’s financial indicators over the past 12 months, such as revenue or net income, and dividing them by the number of months in that period.

The resulting figure provides a snapshot of a company’s financial performance over the most recent 12-month period. The TTM metric is a rolling value, meaning that it’s continuously updated to reflect the most recent financial information available.

For example, if a company wants to calculate its TTM revenue on June 30th, the metric will include the revenue figures for the period between July 1st of the previous year and June 30th of the current year.

As the months roll forward, the TTM period moves forward as well, allowing investors and analysts to gain a better understanding of a company’s ongoing financial performance over time.

The Importance of Trailing Twelve Months

Trailing twelve months (TTM) is an important metric in financial analysis because it provides investors and analysts with a snapshot of a company’s current financial performance over a while.

By examining a company’s financial indicators over the most recent 12-month period, investors can gain insight into how the company has been performing and use this information to make more informed investment decisions.

The TTM period is particularly useful because it helps to capture recent trends and changes in a company’s financial performance, which could be missed if only looking at a single quarterly or annual report.

Additionally, TTM can be used to compare a company’s current performance to historical periods, enabling investors to identify areas of growth or decline.

In addition to investors, it also helps businesses to understand how their operations are performing over time, and make adjustments to optimize their financial performance.

Conclusion

Trailing Twelve Months (TTM) is a valuable metric that can help investors and analysts to better understand a company’s current financial performance over the past 12 months. The TTM metric captures recent trends and changes in a company’s financial performance, providing investors with an up-to-date snapshot of its standing.

Article Source Here: Trailing Twelve Months (TTM): Meaning, Definition, Calculation, Example, Formula, Template

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Who Cashes Handwritten Payroll Checks?

In today’s digital age, where direct deposit and electronic payment systems are prevalent, the act of cashing handwritten payroll checks may seem antiquated. However, there are still instances where handwritten payroll checks are issued, such as in small businesses or certain unique circumstances. This blog post aims to explore the various options individuals have for cashing handwritten payroll checks and the considerations involved.

Options for Cashing Handwritten Payroll Checks

Banks and Credit Unions

Banks and credit unions are the primary financial institutions where individuals can cash their handwritten payroll checks. Many banks offer this service to their account holders, allowing them to deposit or cash the checks based on their preferences. It is advisable to have an account with the bank where the check is drawn, as they are more likely to accept and process the check without charging additional fees. Non-account holders may still be able to cash the check, but they may be subject to a fee or certain restrictions.

Check Cashing Services

Check cashing services are alternative options for individuals who do not have a bank account or face difficulties cashing their handwritten payroll checks at traditional financial institutions. These services specialize in cashing various types of checks, including payroll checks. They typically charge a fee, which can be a percentage of the check amount or a flat fee, for providing immediate access to the funds. It is important to compare the fees and terms of different check cashing services to ensure a fair and affordable transaction.

Retail Stores

Some retail stores, particularly large chain stores, offer check cashing services as an added convenience to their customers. They may cash handwritten payroll checks, subject to their specific policies and fees. It is advisable to inquire beforehand about the types of checks they accept and any associated charges. Additionally, certain retail stores may require individuals to have a membership or loyalty card with them to access check cashing services.

Considerations and Best Practices

When cashing a handwritten payroll check, it is crucial to verify the legitimacy of the check and the issuer to avoid potential fraud or bounced checks. Here are some best practices to follow:

Endorsement and Identification

Ensure that you endorse the check on the back before presenting it for cashing. The endorsement typically involves signing your name and writing “For Deposit Only” or “For Cash.” Additionally, be prepared to provide a valid form of identification, such as a driver’s license or passport, as most institutions require it as part of their check cashing process.

Check Verification

If you have any doubts about the authenticity of the check or the issuer’s credibility, you can contact the issuing company or individual to verify the check’s validity. This step can help protect you from potential scams or fraudulent checks.

Fee Comparison

If you are considering using a check cashing service, it is essential to compare fees and terms among different providers. This can help you find the most cost-effective option and avoid excessive fees that may erode a significant portion of your paycheck.

Conclusion

While the prevalence of handwritten payroll checks has decreased in recent years, there are still scenarios where individuals may encounter them. Banks, credit unions, check cashing services, and select retail stores are potential avenues for cashing these checks. Understanding the options available and following best practices such as check verification and fee comparison can help individuals make informed decisions and ensure a smooth and secure process when cashing handwritten payroll checks.

Originally Published Here: Who Cashes Handwritten Payroll Checks?

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Tail Risk Hedging Using Put Options: Is It Effective?

Tail risk hedging using put options is a risk management strategy employed by portfolio managers to protect against severe market downturns and mitigate potential losses. Put options are financial instruments that give the holder the right, but not the obligation, to sell an underlying asset at a predetermined price within a specific timeframe. In the context of tail risk hedging, investors purchase put options on their existing portfolio holdings or market indices to provide insurance against significant market declines. In the event of a market crash or significant downturn, the value of the put options increases as the underlying asset or market index declines. This allows investors to offset their losses in the underlying assets with gains from the put options, effectively providing downside protection. Tail risk hedging using put options can act as a form of portfolio insurance, helping to preserve capital and mitigate the impact of extreme market events.

How effective is the tail-risk hedging strategy? We have discussed in a previous post the effectiveness of the tail risk hedging strategy. In short,  it is not effective due to the premium paid for acquiring put options which can be substantial, especially when considering the need to continuously roll over or renew the options to maintain protection over an extended period. This cost can significantly eat into investment returns and erode overall portfolio performance.

Reference [1] proposed a novel approach to tail-risk hedging. The authors utilized a dynamic programming approach with the variance and CVaR being the risk measures. They pointed out,

In this paper, we present a mixed risk-return optimization framework for selecting long put option positions for hedging the tail risk of investments in the S&P 500 index. A tractable formulation is developed by constructing hypothetical portfolios that are constantly rolling put options. Variance and sample CVaR are used as risk measures. The models are tested against out-of-sample historical S&P 500 index values as well as the values of the index paired with long put options of varying strike prices. The optimized hedged portfolio could provide sufficient protection in market downturns while not losing significant return the long horizons. This is achieved by dynamically adjusting the put option compositions to market trends in a timely manner. Allocations to different put options are analyzed in various market trends and investor risk aversion levels. The strategy overcomes the traditional drawbacks of protective put strategies and outperforms both directly investing in the underlying asset and holding a constant long position in a particular put option.

In short, contrary to prior research, the article demonstrated that an effective tail-risk hedging strategy can be designed by using an optimization-based approach.

Let us know what you think in the comments below or in the discussion forum.

References

[1] Yuehuan He and Roy Kwon, Optimization-based tail risk hedging of the S&P 500 index, THE ENGINEERING ECONOMIST, 2023

Article Source Here: Tail Risk Hedging Using Put Options: Is It Effective?

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Overhead Variances: Definition, Types, Formula, Calculation, Example, Analysis

Companies can calculate variances for several areas of their operations. One of these areas also includes overheads. Typically, these include the indirect costs of running a company not directly tied to goods or services. Any differences in these amounts fall under overhead variances.

What are Overhead Variances?

Overhead variances refer to the differences between the actual overhead costs incurred and the budgeted or expected overhead costs for a given period. Companies use these to evaluate their performance and express it in dollar amounts or percentages. Overhead variances can provide insights into a company’s spending patterns and efficiency, allowing for adjustments to improve financial performance.

Overhead variances are a critical tool to monitor and control the costs of running a company. By analyzing the differences between actual and expected overhead costs, companies can identify areas where they may be overspending or underperforming. This information can help adjust budgets, staffing levels, or production processes to improve financial performance.

What are the types of Overheads Variances?

Typically, companies have two types of overheads. These can either be variable or fixed. For each of these types, companies can calculate two types of overhead variances, spending, and volume. An explanation for each of these is as below.

Spending Variances

Spending variance measures the difference between the actual overhead costs incurred and the budgeted overhead costs for a particular period. If actual overhead costs are higher than budgeted, it results in an unfavourable variance. If actual overhead costs are lower than budgeted, it results in a favourable variance.

Volume Variances

Volume variance relates to the level of activity carried out by a company, typically measured in units produced. It measures the difference between the budgeted and actual overhead costs based on activity levels. If actual overhead costs are higher than expected due to a higher production volume, it creates an unfavourable variance. If actual costs are lower than expected due to lower production volume, it shows a favourable variance.

How to calculate Overheads Variances?

Companies can calculate spending, volume, or total overhead variances using different formulas, as listed below.

Spending Variance = Actual Overhead Costs – Budgeted Overhead Costs

Spending variance is favourable if actual costs are less than budgeted and unfavourable if actual costs are more than budgeted.

Volume Variance = Budgeted Overhead Costs – Applied Overhead Costs

Volume variance is favourable if applied costs are more than budgeted and unfavourable if vice versa.

Total Overhead Variance = Actual Overhead Costs – Applied Overhead Costs

Total overhead variance is favourable if applied costs exceed actual costs and unfavourable if the opposite.

Example

Green Co. has budgeted overhead costs of $500,000 this year and expects to use 50,000 direct labour hours. It gives a predetermined overhead rate of $10 per direct labour hour ($500,000 / 50,000). During the year, Green Co. incurred $490,000 in overhead costs and used 48,000 direct labour hours. The overhead variances for the company based on the above information is as below.

Spending variance = Actual Overhead Costs – Budgeted Overhead Costs

Spending variance = $490,000 – $500,000

Spending variance = -$10,000 (Unfavorable)

Volume variance = Budgeted Overhead Costs – Applied Overhead Costs

Volume variance = $500,000 – (48,000 hours x $10 per hour)

Volume variance = $20,000 (Favorable)

Total Overhead variance = Actual Overhead Costs – Applied Overhead Costs

Total Overhead variance = $490,000 – (48,000 hours x $10 per hour)

Total Overhead variance = -$10,000 (Unfavorable)

Conclusion

Overhead variance refers to the difference between actual and expected indirect expenses during a period. Companies can divide this variance into spending, volume, and total overhead variance. Ideally, companies aim to keep these expenses at the lowest possible. However, overhead variances may exist, which can either be favourable or unfavourable.

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Production Budget: Definition, Formula, Calculation, Template, Example

A production budget is an essential aspect of financial planning for organizations that manufacture products. It provides a detailed estimate of the quantity of goods that a company must produce to meet the forecasted sales demand.

The production budget is not only an essential component of the operating budget but also helps to plan future orders of raw materials, schedule production timelines, and manage inventory levels.

What is Production Budget

A production budget is a financial document that outlines the estimated number of units of a specific product that an organization needs to produce in order to align with the forecasted sales quantity.

It is typically created on a quarterly or monthly basis and forms a part of the overall operating budget. The production budget is an essential financial planning tool that helps companies prepare for future sales, manage inventory levels, and assess their material requirements.

In simple words, the production budget outlines how much of a product needs to be manufactured, when it needs to be finished, and the estimated cost associated with producing those products.

This information helps companies make informed decisions about their future production plans.

Important Components of Production Budget

Here are some of the important components of a production budget

1. Forecasted Sales: The forecasted sales quantity helps to determine the total units of goods that need to be produced.
2. Number of Units Produced: This component outlines how many units have already been manufactured and how many additional units need to be produced for meeting the demand.
3. Cost of Raw Materials: The cost of raw materials will vary depending on the type and quantity of goods that are being produced.
4. Labor Costs: Estimating labor costs helps to determine the total production cost associated with manufacturing a specific number of units.
5. Overhead expenses: These include any additional costs related to running the production process such as utilities, rent, and taxes.
6. Current inventory levels: Estimating current inventory levels helps to determine the number of additional units that need to be produced for meeting the forecasted demand.
7. Production timeline: This component outlines when production should begin and how long it will take to complete the process.
8. Production capacity: The production capacity helps to estimate how quickly a company can produce goods to meet the forecasted sales quantity.

Calculating Production Budget

To calculate the production budget, start by estimating the forecasted sales quantity. Then calculate the total cost of raw materials, labor costs, and overhead expenses associated with producing those goods.

Next, take into account current inventory levels and production capacity to determine how quickly a company can produce goods to meet the forecasted demand.

Finally, estimate when production should begin and how long it will take to complete the process.

Conclusion

The production budget helps companies make informed decisions about their future production plans and manage inventory levels. It is an essential aspect of financial planning and provides a detailed estimate of the number of goods that a company must produce to align with the forecasted sales demand.

Article Source Here: Production Budget: Definition, Formula, Calculation, Template, Example

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Pledging Accounts Receivable: Definition, Example, Assigning, Meaning, Advantages and Disadvantages

Accounts receivables are balances owed to a company by its customers. For the company, it represents an asset that can result in future cash inflows. Usually, companies track how soon they can expect customers to pay as a part of their cash budgets. The duration typically depends on the credit terms agreed with the customer.

Sometimes, companies may struggle to manage and recover accounts receivable balances. In those cases, they may look for alternative forms of finance, for example, loans. Companies can use pledging accounts receivable to secure these loans.

What does Pledging Accounts Receivable mean?

Pledging accounts receivable is a financing method that allows a company to use its receivables as collateral for a loan. It means the company borrows money by promising the lender the right to collect on outstanding invoices if it fails to repay according to the agreed-upon terms. Once the loan gets repaid, the company regains the rights to collect on the accounts.

If the company defaults on the loan, the lender can collect on the accounts receivable. The lender may do so by contacting the customers directly to collect payment. Nonetheless, pledging accounts receivable can be a way for companies to obtain short-term financing without providing additional collateral. However, it is crucial to consider the costs and risks associated with this type of financing.

How does Pledging Accounts Receivable work?

Pledging accounts receivable is a financing method that enables companies to borrow money through their accounts receivable as collateral. Essentially, the company is promising to pay back the loan with the recovery it expects to receive from its customers who owe it money. A company first applies for a loan from a lender and provides information about its accounts receivable for pledging.

The lender reviews the information and decides on a percentage of the value of the accounts receivable that it is willing to lend to the company. This is usually around 70-90% of the total value of the accounts. Once the loan gets approved, the company assigns the right to collect its accounts receivable to the lender. The lender then advances the agreed-upon amount of the loan to the company.

The company then uses the loaned funds for its operations or investments while continuing to collect payments from its customers. If the company fails to repay the loan at the agreed-upon terms, the lender has the right to collect the outstanding invoices from customers directly to recover its funds.

What are the advantages and disadvantages of Pledging Account Receivables?

The primary advantage of pledging accounts receivable is that it allows companies to access financing quickly and easily. By using their accounts receivable as collateral, companies can often obtain loans more easily and at a lower cost than they would with other types of financing. It can be beneficial for small businesses or those with limited assets. Additionally, because the loan is secured by the company’s accounts receivable, there is no need to provide additional collateral.

A disadvantage of pledging accounts receivable is that it can be expensive. Interest rates on loans secured by accounts receivable can be higher than other financing and may come with higher fees associated with setting up and maintaining the loan. Additionally, if the company’s customers are slow to pay their invoices or default on them entirely, it may be responsible for repaying the loan out of its funds.

Conclusion

Companies can use their accounts receivable balances as collateral by pledging those balances. It involves obtaining a loan from a lender in exchange for the right to collect the owed amounts from customers. This process comes with some advantages and disadvantages for both parties involved. It may also cover factoring, which requires selling accounts receivable in exchange for cash.

Originally Published Here: Pledging Accounts Receivable: Definition, Example, Assigning, Meaning, Advantages and Disadvantages

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Direct Materials Cost: Definition, Formula, Calculation, Example, Method

Direct expenses are costs specifically and directly attributable to a particular product, project, or department. Companies incur these expenses when producing or delivering goods or services. Therefore, they relate directly to the revenue generated by those goods or services. Companies can understand their cost structure and profitability by tracking and managing direct expenses.

For most companies in the manufacturing or retail sectors, direct materials are a significant part of direct expenses. These materials come with a cost that companies can calculate through various techniques. However, it is crucial to understand what these materials include.

What are Direct Materials?

Direct materials are the raw materials or components companies use in manufacturing a product or delivering a service. These materials are “direct” because they are an integral part of the finished product and easily tracible and attributable to it. Direct materials can include anything from steel and plastic used in manufacturing to the ingredients in a recipe for a baked good.

Companies track and account for direct materials separately from other costs, such as labour or overheads. It allows them to estimate the cost of goods sold. Consequently, it helps companies determine the accurate cost of producing a product and helps them make decisions about pricing, production levels, and inventory management.

How to calculate Direct Materials Cost?

Calculating the cost of direct materials involves determining the total cost of the raw materials or components used to manufacture a finished product. This information is essential for companies to make informed decisions about pricing, production levels, and inventory management. Usually, calculating direct materials cost involves several steps, as listed below.

1.      Identify the direct materials used

It involves determining the raw materials or components used in producing the finished product.

2.      Determine the quantity of each direct material used

It involves measuring the amount of each type of direct material used in the production process. Companies can measure it in units of weight, volume, or other relevant measures.

3.      Determine the cost per unit of each direct material used

It involves determining the cost of each unit of each type of direct material used in the production process. It includes the cost of the raw materials and any additional costs, such as shipping, handling, or processing fees.

4.      Calculate the total cost of direct materials

It involves multiplying the quantity of each type of direct material used by its corresponding cost per unit and then summing the costs of all types of direct materials. It will provide the total cost of direct materials used in production.

Example

Red Co. manufactures bicycles, and the direct materials used in production include steel frames, aluminium rims, rubber tires, and plastic pedals. During the last period, the company required 500 steel frames, 1,000 aluminium rims, 1,500 rubber tires, and 2,000 plastic pedals. The cost per unit for steel frames is $30, aluminium rims are $20, rubber tires are $10, and plastic pedals are $5.

Based on the above information, the direct materials cost for Red Co. will be as below.

• Steel frames: 500 units x $30 = $15,000
• Aluminum rims: 1,000 units x $20 = $20,000
• Rubber tires: 1,500 units x $10 = $15,000
• Plastic pedals: 2,000 units x $5 = $10,000

The total direct materials cost for the company will be $60,000 after adding all the above-listed costs.

Conclusion

Direct materials are items used in production directly attributable and tracible to a specific product or unit. Tracking and accounting for the cost of these products is crucial for companies. Consequently, companies can calculate direct materials cost in several steps. This process can help companies improve efficiency and profitability in the production process.

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Assets Under Management (AUM): Definition, What It Is, Example, Meaning, Classifications, Calculation

Assets under management, commonly referred to as AUM, is a critical metric used in the financial industry to measure the total market value of assets that a particular investment firm manages on behalf of its clients.

The AUM encompasses a diversified range of assets, including bonds, stocks, options, and other securities, and it is widely used as an indicator of the success and growth potential of financial institutions.

Understanding AUM is important for any investor or financial institution, as the size of the assets under management can be indicative of the level of expertise and resources a given firm has.

What is Assets Under Management (AUM)?

Assets Under Management (AUM) refers to the total value of assets that a financial institution, such as a bank, investment company, or hedge fund, manages on behalf of its clients.

AUM includes a variety of financial products and investments, including stocks, bonds, real estate, and commodities.

The AUM figure is calculated by adding up the market value of all the assets that are currently being managed by the institution, including any cash or cash equivalents that are held within the accounts.

AUM is an important metric used to evaluate the size and success of a financial institution and its ability to generate revenue from managing investments on behalf of clients.

How Assets Under Management (AUM) Works

Assets Under Management (AUM) is a measure of the total value of assets that a financial firm or institution manages on behalf of its clients. This value includes all of the assets held in a portfolio, such as stocks, bonds, mutual funds, real estate, and any other financial assets.

The AUM figure is calculated by adding up the market value of all of the assets held in these portfolios.

When an individual or institutional investor hires a financial institution to manage their investments, they transfer ownership of their assets to the financial institution. Then the firm or institution uses these assets to make investments on behalf of the client.

The institution is responsible for making investment decisions based on the client’s specific financial goals and risk tolerance.

As the financial institution manages the assets, the market value of the investments will fluctuate depending on a variety of factors such as market conditions, geopolitical events, and other news.

The institution must constantly monitor these investments and make strategic decisions to buy, hold or sell them based on their assessment of the market.

The institution charges fees for managing these assets, which are typically a percentage of the AUM. This fee structure incentivizes the institution to maximize the value of the assets they are managing, as their revenue is directly tied to the performance of the portfolio.

AUM is an important metric to track as it provides insight into the size and success of the financial institution. AUM growth can be an important indicator of the institution’s ability to attract and retain clients and generate revenue through asset management services.

Example of Assets Under Management (AUM)

Let’s say that a financial institution manages a portfolio of investments on behalf of its clients, which includes stocks, bonds, and mutual funds. The total market value of these assets is $10 million.

The financial institution charges a fee of 1% of AUM annually. This means that its revenue from managing these assets will be $100,000 (1% of $10 million).

Over time, the market value of the assets held in the portfolio may increase or decrease depending on market conditions.

If the market value increases by 10% to $11 million, then the financial institution’s revenue from managing these assets will increase to $110,000 (1% of $11 million).

Conversely, if the market value decreases by 10% to $9 million, then the financial institution’s revenue will decrease to $90,000 (1% of $9 million).

In this example, the financial institution’s AUM is $10 million, which is a key metric used to evaluate its size and success in managing assets for its clients.

Conclusion

Assets Under Management (AUM) is a very important metric used to evaluate the size and success of a financial institution. AUM is an important indicator for institutions as it provides insight into their ability to attract and retain clients and generate revenue from asset management services. By understanding how AUM works, investors can make sound decisions when selecting asset managers.

Originally Published Here: Assets Under Management (AUM): Definition, What It Is, Example, Meaning, Classifications, Calculation

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Contract Account: Definition, What It Is, Types, Format, Treatment

Companies operating in the manufacturing, construction, and consulting industries may use a contract structure for their clients. It allows them to treat each job separately and work on it according to the client’s needs. In accounting, these companies may use a contract account to track these jobs. Therefore, it is crucial to understand what it is.

What is a Contract Account?

A contract account is a type of account in accounting that records the financial transactions related to a specific contract. Companies use it to track and record all costs and earnings associated with a particular contract or project. Nonetheless, it helps ensure that costs and revenues related to a job get tracked separately from other transactions. Overall, it makes it easier to analyze the financial performance of a specific project or contract.

Contract accounts typically record several aspects of a contract. The contract price is the amount agreed upon by the parties involved in the agreement. In contrast, the contract costs include all the costs associated with the contract, such as labour, materials, and other expenses. The estimated costs to complete are the costs that get anticipated to complete the project. Lastly, the estimated total profit or loss is the difference between the contract price and the total estimated costs.

What are the components of a Contract Account?

A contract account typically consists of several components, including the following.

Contract price

It is the amount that the customer has agreed to pay for the goods or services provided under the contract.

Cost of goods sold

It includes all costs associated with producing and delivering the goods or services, such as labour costs, materials, and overhead expenses.

Gross profit

It is the difference between the contract price and the cost of goods sold.

Progress billings

These are invoices that are issued to the customer as the work progresses. The amount billed typically depends on the percentage of completion of the contract.

Costs over billings

It represents the costs that have been incurred on the contract but have not yet been billed to the customer.

Billings above costs

It represents the amount billed to the customer more than the costs incurred on the contract.

Retainage

It is a portion of the contract price that the customer withholds until the work is complete.

Why is the Contract Account important?

A contract account is crucial for companies to manage and track financial transactions related to a specific contract or project. It helps to keep track of the costs and revenues associated with the project, including any changes or modifications made along the way. By maintaining a contract account, a company can monitor the project’s profitability and make informed decisions about future projects based on the results.

In addition, a contract account can help to ensure that all parties involved in the project are paid correctly and on time. It can serve as a record of the services provided and the expenses incurred, making it easier to prepare invoices and resolve any disputes that may arise. Overall, the purpose of a contract account is to provide a comprehensive and accurate record of the financial transactions associated with a particular contract or project.

Conclusion

A contract account is a type of financial account that tracks all contract-related transactions. Companies may have a separate contract account for every job to enable better tracking of revenues, expenses, and other aspects. Similarly, these accounts come with several components. For companies in those industries, the contract account is highly crucial.

Originally Published Here: Contract Account: Definition, What It Is, Types, Format, Treatment

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Direct Materials Price Variance: Definition, Formula, Calculation, Example, Reasons, Meaning

Direct materials refer to the tangible components or raw materials used directly in manufacturing a finished product. They are physically identifiable and traceable materials in the final product. Similarly, direct materials are a critical part of the production process, as they get transformed with other materials to create the end product.

Companies must track the price paid for these materials to ensure they don’t exceed the budget. While the quantity may differ due to differences in production levels, the prices are more crucial. Companies can use direct materials price variance to track it.

What is Direct Materials Price Variance?

The direct materials price variance is a concept in managerial accounting that measures the difference between the actual and the standard cost of direct materials. It arises due to differences in the price paid for direct materials compared to the standard price predetermined by the company. As the name implies, it does not account for indirect materials used in production.

The direct materials price variance is crucial for cost control and performance evaluation. It allows companies to identify and analyze the reasons behind the differences in actual and standard costs of direct materials and take appropriate corrective actions to manage costs effectively. Several factors can impact direct materials price variance, including the following.

• Changes in market prices
• Supplier negotiations
• Quality issues
• Other external or internal factors affect the cost of acquiring direct materials for production.

How to Calculate Direct Materials Price Variance?

The formula for direct materials price variance is the same as other similar variances. However, it only accounts for materials the company can directly trace to a specific product. Nonetheless, the direct materials price variance formula is as below.

Direct materials price variance = (Actual direct materials quantity purchased x Actual rate per unit) – (Actual direct materials quantity purchased x Standard rate per unit)

Alternatively, the direct materials price variance formula may look as below.

Direct materials price variance = (Actual rate – Standard rate) x Actual direct materials quantity purchased

How to interpret the Direct Materials Price Variance?

Direct materials price variance can either be favourable or unfavourable. If the direct materials price variance is positive, it indicates that the actual cost of direct materials was lower than the standard cost. It may result from favourable factors such as lower market prices for raw materials, negotiating better supplier deals, or using lower-cost materials. It could also indicate effective cost management, purchasing efficiencies, or favourable exchange rates for imported materials.

If the variance is negative, it indicates that the actual cost of direct materials was higher than the standard cost. It may result from unfavourable factors such as higher market prices for raw materials, unexpected price increases from suppliers, poor supplier performance, or higher freight or handling charges. It could also indicate problems with purchasing, inventory management, or quality control that result in higher costs.

Example

A company, Red Co., purchased 10,000 units of direct materials during the period. The actual rate for these purchases was $10 per unit. However, the standard rate estimated at the start of that period was $8. Based on the above information, the direct material price variance for Red Co. is as follows.

Direct materials price variance = (Actual rate – Standard rate) x Actual direct materials quantity purchased

Direct materials price variance = ($10 – $8) x 10,000 units

Direct materials price variance = $20,000 (Adverse/Unfavorable)

Conclusion

Direct materials price variance refers to the difference between the standard price and the actual price paid for direct materials during a period. It is a crucial part of variance analysis for many companies. Essentially, it shows whether a company has incurred more or less for direct materials than anticipated through the standard rate.

Originally Published Here: Direct Materials Price Variance: Definition, Formula, Calculation, Example, Reasons, Meaning

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