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Main Findings
Backlog is a buildup of work that needs to be completed by a business. It can be measured by the backlog level or the backlog ratio. Backlog can have positive or negative implications depending on the situation and the industry. A high backlog may indicate high demand, revenue potential, and customer loyalty; but it may also indicate low efficiency, long delivery time, and customer dissatisfaction. A low backlog may indicate high efficiency, short delivery time, and customer satisfaction; but it may also indicate low demand, revenue potential, and customer loyalty. Backlog management is the process of balancing the backlog level and the backlog ratio to meet the business objectives and requirements.
Backlog in finance is a term that refers to a buildup of work that needs to be completed. It can have different meanings depending on the context, but generally, it indicates the amount of work that exceeds the current capacity or demand of a firm or department.
For example, backlog can refer to the sales orders that are waiting to be filled by a company, or the financial paperwork that needs to be processed, such as loan applications or tax returns.
Why backlog is important in finance?
Backlog is important in finance because it can have implications for the future performance, efficiency, and profitability of a firm or department. Backlog can be a positive or negative indicator depending on the situation.
For example, a rising backlog of sales orders can suggest increasing demand for a product or service, which can boost future revenues and earnings. However, it can also indicate that the firm is unable to meet the demand promptly, which can affect customer satisfaction and loyalty.
Similarly, a falling backlog of sales orders can imply improving production efficiency and delivery speed, which can enhance customer retention and reputation. However, it can also signal declining demand or market share, which can reduce future income and growth.
The formula for backlog in finance
There is no universal formula for backlog in finance, as different firms or departments may use different methods to measure and report their backlog. However, one possible way to calculate backlog is to subtract the completed work from the total work received in a given period.
For example, if a company receives 10,000 sales orders in a month and fulfills 8,000 of them, then its backlog at the end of the month is 2,000 orders. Alternatively, some firms may use the value of the work instead of the quantity to calculate their backlog.
For example, if a company receives $1 million worth of sales orders in a month and fulfills $800,000 of them, then its backlog at the end of the month is $200,000.
How to calculate backlog in finance
To calculate backlog in finance, one needs to have data on the work received and completed in a given period. Depending on the type of work and the unit of measurement, this data can be obtained from various sources, such as sales records, invoices, contracts, financial statements, or reports.
Once the data is collected, one can use the formula mentioned above or any other method that suits their purpose to calculate their backlog. For example, if a company wants to calculate its backlog of loan applications in a quarter, it can use the following steps:
- Obtain the number of loan applications received and processed in each month of the quarter from the loan department's records or reports.
- Add up the number of loan applications received in each month to get the total number of loan applications received in the quarter.
- Add up the number of loan applications processed each month to get the total number of loan applications processed in the quarter.
- Subtract the total number of loan applications processed from the total number of loan applications received to get the backlog of loan applications at the end of the quarter.
Examples
To illustrate how backlog is calculated and managed, let's look at some examples from different industries.
Construction Company
A construction company has a contract to build a bridge that will take 12 months to complete. The company estimates that it will need 20 workers and 10 machines to finish the project on time. The company has a backlog of 10 other projects that are waiting to be started or completed, totaling 240 crew weeks of work.
The company's backlog ratio is 240 / (20 x 52) = 0.23, which means that it has enough work to keep its current workforce busy for 23% of the year. The company can use this ratio to decide whether to hire more workers, buy more machines, or bid for more projects.
Software Company
A software company develops a new app that is in high demand by customers. The company can produce 100 units of the app per day, but it receives 150 orders per day on average. The company's backlog will grow by 50 units per day until it can increase its production capacity.
The company's backlog ratio is 50 / 100 = 0.5, which means that it takes two days to fulfill one day's worth of orders. The company can use this ratio to measure its customer satisfaction, delivery time, and profitability.
Manufacturing Company
A manufacturing company produces widgets that are sold to retailers. The company can produce 1,000 widgets per day, but it receives 800 orders per day on average. The company's backlog is 200 widgets per day, which it keeps as a buffer in case of unexpected demand spikes or supply disruptions.
The company's backlog ratio is 200 / 1,000 = 0.2, which means that it has enough inventory to cover 20% of its daily production. The company can use this ratio to optimize its inventory management, cash flow, and production planning.
Limitations
Backlog is a useful metric to measure the performance and efficiency of a business, but it also has some limitations that should be considered.
- Backlog does not account for the quality or complexity of the work that needs to be done. Some projects may require more time, resources, or skills than others, which may affect the backlog ratio and the completion time.
- Backlog does not account for the uncertainty or variability of the demand and supply conditions. Some orders may be canceled, delayed, or modified by customers, while some resources may be unavailable, damaged, or defective. These factors may cause fluctuations in the backlog level and the backlog ratio.
- Backlog does not account for the opportunity cost or trade-off of accepting or rejecting new orders. Some orders may be more profitable, strategic, or urgent than others, which may influence the decision to increase or decrease the backlog level and the backlog ratio.
Conclusion
Backlog is a buildup of work that needs to be completed by a business. It can be measured by the backlog level, which is the amount of work in terms of hours, units, or dollars; or by the backlog ratio, which is the proportion of work relative to the capacity or output of the business.
Backlog can have positive or negative implications depending on the situation and the industry. A high backlog may indicate high demand, revenue potential, and customer loyalty; but it may also indicate low efficiency, long delivery time, and customer dissatisfaction.
A low backlog may indicate high efficiency, short delivery time, and customer satisfaction; but it may also indicate low demand, revenue potential, and customer loyalty.
Backlog management is the process of balancing the backlog level and the backlog ratio to meet the business objectives and requirements.
It involves planning, scheduling, executing, and monitoring the work that needs to be done; as well as forecasting, allocating, and optimizing the resources that are needed to do the work.
References
- Investopedia: https://www.investopedia.com/terms/b/backlog.asp
- IDCON: https://www.idcon.com/resource-library/work-management-planning-scheduling/how-to-calculate-the-backlog-and-manage-your-resources/
- Finance Strategists: https://www.financestrategists.com/accounting/cost-accounting/inflation-accounting/backlog-depreciation/
- AccountingTools: https://www.accountingtools.com/articles/sales-backlog-ratio
FAQ
A large backlog can indicate strong demand for a company’s products, potentially leading to increased future revenues. However, if a company consistently has a large backlog due to production issues, it may lead to customer dissatisfaction and lost sales.
Backlogs can tie up a company’s resources in unfinished goods, potentially leading to cash flow issues. If a company can’t convert its backlog into sales quickly, it may struggle to pay its short-term liabilities.
Investors often view a growing backlog as a positive sign of increasing demand. However, they also monitor how quickly a company can clear its backlog, as inefficiencies could signal operational issues.
Yes, a significant backlog can strain a company’s supply chain, as suppliers may need to ramp up production to meet increased demand. This could lead to increased costs or supply chain disruptions.
Service companies manage their backlog by prioritizing tasks based on factors like client importance, task urgency, and profitability. They may use project management tools to track and manage their backlog effectively.
