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| Backlog |
What It Is:
Frequently used in manufacturing industries, backlog refers to unfinished work
or to customer orders that have been received but are either incomplete or in
the process of completion.
How It Works/Example:
Let's assume XYZ Company is able to manufacture 10,000 widgets per day. On
Monday morning, the company receives an order for 50,000 widgets. Given the
company's daily production capacity, XYZ Company will end Monday with a backlog
of 40,000 widgets. If each widget sells for $1, XYZ Company would report a
$40,000 backlog.
Backlogs are usually measured in dollars and generally occur when there is a
shortage of labor or supplies. Building products to each customer's
specifications may also lead to backlogs.
Changes in a company's backlog may have profit implications. A rising backlog
may indicate that a company is experiencing either increased sales or production
problems; a falling backlog may indicate the company's sales are falling or that
it is increasing production efficiency.
It is important to study a company's revenue recognition policies when
evaluating backlog. Some companies may use the percentage-of-completion method,
whereby a percentage of the anticipated revenue from the sale of the product is
recognized according to the percentage of work complete on a specific product.
If a company is not able to reasonably measure the costs and revenues
attributable to different stages of the production process, it may use
completed-contract accounting, whereby the revenue is recorded when the project
is complete.
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