Deduction – An important step of O2C process

Deduction is one of the important steps in order to cash cycle which is the complete process, every business enterprise follows.

This step comes into picture when an invoice has been raised and sent to customer which the customer does not pay in full. The personnel involved in this process then raises a new invoice with the amount so settled between customer and company.

For a business enterprise, deduction reduces total amount of sales and hence lead to lower profit. It also increases the total wastage of time for personnel involved in this process.

Reasons for deduction

The main reason for adjusting the amount of an invoice is settlement of trade promotion. Trade promotion is a technique used by companies to attract more retailers and partners.

Deduction is made in payment by customers as a result of poor quality of product, delay in shipment, incorrect invoice raised to customer, return of product by customer or any other reasons.

Days sales outstanding – Meaning & Calcualtion

Days sales outstanding (DSO) is the calculation of average number of days which a company takes in collection of its account receivables. This is an important element of order to cash cycle and it increases the cash flow of company.

DSO is used to check how many days it takes to collect the amount of credit sales during a period. Usually, this figure is calculated for month, quarter or year, however there is no such obligation in this regard.

How days sales outstanding (DSO) is calculated?

DSO is calculated by multiplying the account receivable to the number of days for which DSO is being calculated and dividing the figure by total credit sales made during that period.

Formula:

(Accounts receivable × Number of days) / Total credit sales

Lower value of DSO indicates that the company is more efficient in collecting the amount incurred by credit sales.

Credit Memo – Definition & Reasons

Credit memo (short form of credit memorandum) is a document which is issued by the seller to buyer for adjustment of amount for an invoice. The document can be issued for any of the below reasons:

Reasons for issuing credit memo:

  1. For not delivering the goods or services.
  2. Product is returned by the buyer
  3. To adjust the amount which has already been received by seller through previous invoice
  4. For any discount given/ price change after invoice is raised.
  5. For any other reason by which buyer is paying partial amount to seller.

Credit memorandum usually contains the information like purchase order (PO) number, date of invoice issued, amount of invoice, reason for which credit memo is issued along with the adjusted amount.

The aggregate of credit memorandum is later used to check various reasons for which these notes were issued by the company.

Credit memos which are yet to be issued (Opened credit memos) can be used to offset the amount of account receivable.

Credit memo is also known as ‘credit note’.

Employee stock option plan v/s Employee stock ownership plan

Employee stock option plan and employee stock ownership plan are considered as one but these two terms are very different.

Employee stock option plan v/s Employee stock ownership plan:

Employee stock option plan

Employee stock option plan is a contract between a company and its employees that gives employees the right to buy company’s shares at grant price. Grant price (also known as exercise price) is the price which is decided by the company. This right can be exercised within time frame imposed by the company and only a fixed number of shares can be purchased by the employee.

Employees get benefited from this plan when market price of shares are higher than the grant price.

Employee stock ownership plan

Employee stock ownership plan is a retirement plan in which an organisation distributes its share among its employees. These shares are held in common account and transferred to the employee’s account upon entitlement. In this plan, employees never purchase the shares directly or indirectly. These shares are transferred to employees account when they retire/ terminate from the company.

Employee stock ownership plans are used by companies for a number of reasons. For example to keep the morale of employees higher.

 

Purchase Consideration – Meaning & Methods

In case of amalgamation, purchase consideration is the agreed amount which transferee company (Purchasing company) pays to the transferor company (Vendor company) in exchange of the ownership of the transferor company. It may be in form of cash, shares or any other assets as agreed between both the companies.

For example, XYZ Ltd is purchasing the business of ABC Ltd for an agreed amount of INR 5000K and 100K shares of INR 10 each. Here, purchase consideration is INR 6000K (5000000 + 1000000).

Purchase Consideration

Methods of Purchase Consideration:

There are four various methods which can be used in this calculation:

Net asset method –

Purchase consideration is equal to the total net assets of transferor company.

Total agreed amount of asset – Total agreed amount of liabilities

Net payment method –

Payment made to the shareholders of transferor company in form of cash, shares or debentures.

Lump sum method –

Fixed amount paid by the transferee company to the transferor company. This method does not require any calculation as the amount is decided by mutual consent of both the companies.

Intrinsic value/ Share exchange method –

It is calculated by dividing the net asset value of transferor company by price of one share of transferee company.

The result figure then divided by number of existing shares of transferor company to find out the ratio.

Intrinsic value – Net asset / Number of equity shares.