Lecture 5 - Account Receivables and Inventory Management

8/17/2019 Lecture 5 - Account Receivables and Inventory Management

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10-1

Chapter 10 Chapter 10

Accounts ReceivableAccounts Receivable

and Inventoryand Inventory

ManagementManagement © Pearson Education Limited 2004

Fundamentals of Financial Management !2"e#reated by$ %regory A& 'u(lemeyer P(&)&

#arroll #ollege *au+es(a *I


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After studying Chapter 10, After studying Chapter 10,

you should be able to:you should be able to:

List t(e +ey factors t(at can be varied in a firm,s credit -olicy andunderstand t(e trade.off bet/een -rofitability and costs involved&

nderstand (o/ t(e level of investment in accounts receivable isaffected by t(e firm,s credit -olicies&

#ritically evaluate -ro-osed c(anges in credit -olicy includingc(anges in credit standards credit -eriod and cas( discount&

)escribe -ossible sources of information on credit a--licantsand (o/ you mig(t use t(e information to analy1e a credita--licant&

Identify t(e various ty-es of inventories and discuss t(eadvantages and disadvantages of increasing"decreasinginventories&

)escribe e-lain and illustrate t(e +ey conce-ts andcalculations necessary for effective inventory management andcontrol including classification economic order 3uantity E567order -oint safety stoc+ and 8ust.in.time 9I:7&


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Accounts Receivable and Accounts Receivable and

Inventory Management Inventory Management

#redit and #ollection

Policies Analy1ing t(e #redit

A--licant

Inventory Management and#ontrol


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Credit and CollectionCredit and Collection

Policies of the irmPolicies of the irm

!7 Average#ollection Period

27 ;ad.debt

Losses

6uality of 6uality of

:rade Account:rade AccountLengt( of

#redit Period

Possible #as()iscount

Firm#ollectionProgram


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Credit !tandardsCredit !tandards

:(e financial manager s(ould continually

lo/er t(e firm


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10-6


A larger credit de-artment

Additional clerical /or+

=ervicing additional accounts ;ad.debt losses

5--ortunity costs

#osts arising from relaing#osts arisin

g from relaing

credit standardscredit standards


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"#ample of Rela#ing"#ample of Rela#ing


;as+et *onders is not o-erating at full ca-acity;as+et *onders is not o-erating at full ca-acity

and /ants to determine if a relaation of t(eirand /ants to determine if a relaation of t(eir

credit standards /ill en(ance -rofitability&credit standards /ill en(ance -rofitability& :(e firm is currently -roducing a single

-roduct /it( variable costs of ?20 and selling

-rice of ?2@& Relaing credit standards is not e-ected to

affect current customer -ayment (abits&


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Additional annual credit sales of ?!20000 and anaverage collection -eriod for ne/ accounts of mont(s is e-ected&

:(e before.ta o--ortunity cost for eac( dollar offunds Btied.u-C in additional receivables is 20D&

Ignoring any additional bad.debt lossesIgnoring any additional bad.debt lossest(at may arise s(ould ;as+et *onderst(at may arise s(ould ;as+et *onders

rela t(eir credit standards>rela t(eir credit standards>


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Profitability of ?@ contribution7 400 units7 additional sales ?24000?24000

Additional ?!20000 sales7 " 4 :urns7 receivables ?0000

Investment in ?20"?2@7 ?00007 add& receivables ?24000

Re3& -re.ta return 20D o--& cost7 ?24000 on add& investment ?400?400

GesH GesH Profits Re3uired -re.ta return


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27 ;ad.debt

Losses

6uality of :rade Account

Lengt( of Lengt( of

#redit Period#redit Period

Possible #as()iscount



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Credit $ermsCredit $erms

#redit Period#redit Period .. :(e total lengt( of time over

/(ic( credit is etended to a customer to -aya bill& For eam-le %net &0'%net &0' re3uires full

-ayment to t(e firm /it(in 0 days from t(einvoice date&

#redit :erms#redit :erms .. =-ecify t(e lengt( of timeover /(ic( credit is etended to a customer

and t(e discount if any given for early-ayment& For eam-le %()10, net &0*' %()10, net &0*'


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the Credit Period the Credit Period

+aset -onders+aset -onders is considering c(anging itscredit -eriod from %net &0'%net &0' /(ic( (as resultedin !2 A"R B:urnsC -er year7 to %net .0'%net .0' /(ic( ise-ected to result in J A"R B:urnsC -er year7&

:(e firm is currently -roducing a single -roduct/it( variable costs of ?20 and a selling -rice of

?2@&

Additional annual credit sales of ?2@0000 fromne/ customers are forecasted in addition to t(e

current ?2 million in annual credit sales&


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:(e before.ta o--ortunity cost for eac( dollarof funds Btied.u-C in additional receivables is20D&

Ignoring any additional bad.debt lossesIgnoring any additional bad.debt losses

t(at may arise s(ould ;as+et *onderst(at may arise s(ould ;as+et *onders

rela t(eir credit -eriod>rela t(eir credit -eriod>


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Profitability of ?@ contribution7!0000 units7 additional sales ?@0000?@0000

Additional ?2@0000 sales7 " J :urns7 receivables ?4!JJK

Investment in add& ?20"?2@7 ?4!JJK7 receivables ne/ sales7 ?4

Previous ?2000000 sales7 " !2 :urns7 receivable level ?!JJJJK


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e/ ?2000000 sales7 " J :urns7 receivable level ?

Investment in ? . ?!JJJJK add& receivables ?!JJJJJoriginal sales7

:otal investment in ?4 ?!JJJJJ

add& receivables ?200000

Re3& -re.ta return 20D o--& cost7 ?200000 on add& investment ?40000?40000

GesH GesH Profits Re3uired -re.ta return


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27 ;ad.debt

Losses

6uality of :rade Account

Lengt( of #redit Period

Possible #as(Possible #as(

)iscount)iscount



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Credit $ermsCredit $erms

#as( )iscount#as( )iscount .. A -ercent D7 reduction in

sales or -urc(ase -rice allo/ed for early-ayment of invoices& For eam-le %()10'%()10'

allo/s t(e customer to ta+e a 2D cas( discount

during t(e cas( discount -eriod&

#as( )iscount Period#as( )iscount Period .. :(e -eriod of timeduring /(ic( a cas( discount can be ta+en forearly -ayment& For eam-le %()10' %()10' allo/s acas( discount in t(e first !0 days from t(e

invoice date&


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10-18

"#ample of Introducing"#ample of Introducing

a Cash /iscount a Cash /iscount

A com-eting firm of ;as+et *onders isconsidering c(anging t(e credit -eriod from

%net .0'%net .0' /(ic( (as resulted in J A"R B:urnsC-er year7 to %()10, net .0*' %()10, net .0*'

#urrent annual credit sales of ?@ million aree-ected to be maintained&

:(e firm e-ects 0D of its credit customers indollar volume7 to ta+e t(e cas( discount andt(us increase A"R B:urnsC to &


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:(e before.ta o--ortunity cost for eac( dollarof funds Btied.u-C in additional receivables is20D&

Ignoring any additional bad.debt lossesIgnoring any additional bad.debt losses

t(at may arise s(ould t(e com-eting firmt(at may arise s(ould t(e com-eting firm

introduce a cas( discount>introduce a cas( discount>

"#ample of Introducing"#ample of Introducing

a Cash /iscount a Cash /iscount


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"#ample of sing"#ample of sing

the Cash /iscount the Cash /iscount

Receivable level ?@000000 sales7 " J :urns7 5riginal7 ?

Receivable level ?@000000 sales7 " N :urns7 e/7 ?@@@@@J

Reduction of ? . ?@@@@@J investment in A"R ?2KKKKK


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Pre.ta cost of &02 & ?@000000 t(e cas( discount ?0000?0000&&

Pre.ta o--& savings 20D o--& cost7 ?2KKKKK on reduction in A"R ?@@@@@?@@@@@&&

GesH GesH =avings #osts

:(e benefits derived from released accountsreceivable eceed t(e costs of -roviding t(e

discount to t(e firm


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InventoryInventory

Management and Control Management and Control

Ra/.materials inventory

*or+.in.-rocess inventory

In.transit inventory

Finis(ed.goods inventory

Inventories form a lin bet/een-roduction and sale of a -roduct&

Inventory ty-esInventory ty-es$$


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InventoryInventory

Management and Control Management and Control

Purc(asing

Production sc(eduling Efficient servicing of customer

demands

Inventories -rovide fleibilityInventories -rovide fleibility

for t(e firm in$for t(e firm in$


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Appropriate Appropriate

evel of Inventoriesevel of Inventories

Em-loy a cost.benefit analysisEm-loy a cost.benefit analysis

#om-are t(e benefits of economies of-roduction -urc(asing and -roductmar+eting against t(e cost of t(e

additional investment in inventories&

2o3 does a firm determine2o3 does a firm determine

the appropriate level ofthe appropriate level of

inventories4 inventories4


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A+C Method of A+C Method of

Inventory Control Inventory Control

Met(od /(ic( controlse-ensive inventory

items more closely t(anless e-ensive items&

Revie/ BAC itemsmost fre3uently

Revie/ B;C and B#Citems less rigorouslyand"or less fre3uently&

A+C method of A+C method of

inventory control inventory control

0 !@ 4@ !000 !@ 4@ !00

#umulative Percentage#umulative Percentage

of Items in Inventoryof Items in Inventory

K0K0

N0N0

!00!00

# u m

u l a t i v e

P e r c e n

t a g e

# u m

u l a t i v e

P e r c e n

t a g e

o

f I n v e n

t o r y

O a l u e

o f I n v e n

t o r y

O a l u e

AA

;;##


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2o3 Much to 5rder4 2o3 Much to 5rder4

Forecast usage

5rdering cost

#arrying cost

:(e o-timal 3uantity to order:(e o-timal 3uantity to order

de-ends on$de-ends on$


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Ordering costsOrdering costs

The variable costs can include:

the cost of preparin a purchase re!uisition"

the cost of creatin the purchase order" the cost of revie#in inventor$ levels"

the costs involved in receivin and chec%in ite&s

as the$ are received fro& the vendor"

and the costs incurred in preparin and processin

the pa$&ents &ade to the vendor #hen the invoice

is received'


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$otal Inventory Costs$otal Inventory Costs

##$ #arrying costs -er unit -er -eriod

55$ 5rdering costs -er order

==$ :otal usage during t(e -eriod

:otal inventory costs :7 :otal inventory costs :7

## 6 " 26 " 27 7 55 == " " 6677

:IME:IME

6 " 26 " 2

66AverageAverage

InventoryInventory

I L O E L : 5 R G

I L O E L : 5 R G

4 i n u n

i t s

7

4 i n u n

i t s

7


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"conomic 5rder 6uantity "conomic 5rder 6uantity

:(e E56 or

optimal7uantity 67 is$

:(e 3uantity of an inventory item to orderso t(at total inventory costs are minimi1ed

over t(e firm


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"#ample of the"#ample of the


+aset -onders+aset -onders is attem-ting to determine t(eeconomic order 3uantity for fabric used in t(e

-roduction of bas+ets&

!0000 yards of fabric /ere used at a constantrate last -eriod&

Eac( order re-resents an ordering cost of ?200&

#arrying costs are ?! -er yard over t(e !00.day-lanning -eriod&

*(at is t(e economic order 3uantity>*(at is t(e economic order 3uantity>


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*e /ill solve for t(e economic order 3uantitygiven t(at ordering costs are ?200 -er ordertotal usage over t(e -eriod /as !0000 units

and carrying costs are ?! -er yard unit7&

66 2 2 ?2007 7 !0000!000077?!?!

66 2000 nits2000 nits


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$otal Inventory Costs$otal Inventory Costs

E56 67 re-resents t(e minimumE56 67 re-resents t(e minimum

-oint in total inventory costs&-oint in total inventory costs&

:otal Inventory #osts:otal Inventory #osts

:otal #arrying #osts:otal #arrying #osts

:otal 5rdering #osts:otal 5rdering #osts

66 5rder =i1e 675rder =i1e 67

#

o s

t s

#

o s

t s


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-hen to 5rder4 -hen to 5rder4

5rder Point5rder Point .. :(e 3uantity to /(ic( inventory

must fall in order to signal t(at an order mustbe -laced to re-lenis( an item&

5rder Point5rder Point 5P5P7 Lead timeLead time Q )aily usage

Issues to consider Issues to consider $$

Lead :imeLead :ime .. :(e lengt( of time bet/een t(e

-lacement of an order for an inventory item and/(en t(e item is received in inventory&


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"#ample of -hen to 5rder "#ample of -hen to 5rder

9ulie Miller of +aset -onders+aset -onders (as determinedt(at it ta+es only 2 days to receive t(e order of

fabric after t(e -lacement of t(e order&*(en s(ould 9ulie order more fabric>*(en s(ould 9ulie order more fabric>

Lead timeLead time 2 days2 days

)aily usage)aily usage !0000 yards " !00 days !0000 yards " !00 days !00!00yards -er dayyards -er day

5rder Point5rder Point 2 days2 days !00 yards -er day!00 yards -er day 200 yards200 yards


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10-35

"#ample of -hen to 5rder "#ample of -hen to 5rder

00 ! 20 40 ! 20 40LeadLead

:ime:ime

200200

20002000

5rder 5rder

PointPoint 0 L I : =

0 L I : =

)AG=)AG=

Economic 5rder 6uantity 67Economic 5rder 6uantity 67


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!afety !toc !afety !toc

5ur -revious eam-le assumed certain demandand lead time& *(en demand and"or lead time are

uncertain t(en t(e order -oint is$

5rder Point5rder Point

Avg* lead time Avg* daily usage7 =afety stoc+=afety stoc+

=afety =toc+=afety =toc+ .. Inventory stoc+ (eld in reserveas a cus(ion against uncertain demand or

usage7 and re-lenis(ment lead time&


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3ith !afety !toc 3ith !afety !toc

0 ! 20 0 ! 20

400400

20002000

5rder 5rder

PointPoint 0 L I : =

0 L I : =

)AG=)AG=

22002200

=afety =toc+=afety =toc+200200


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10-38


3ith !afety !toc 3ith !afety !toc

0 L I : =

0 L I : =

)AG=)AG=

=afety =toc+=afety =toc+

Actual leadActual lead

time is daysHtime is daysHat day 2!7at day 2!7

22002200

20002000

5rder 5rder

PointPoint

400400

200200

0 ! 2!0 ! 2!

:(e firm Bdi-sC:(e firm Bdi-sC

into t(e safety stoc+into t(e safety stoc+


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2o3 Much !afety !toc4 2o3 Much !afety !toc4

Amount of uncertainty in inventory demand

Amount of uncertainty in t(e lead time #ost of running out of inventory

#ost of carrying inventory

*(at is t(e -ro-er amount of*(at is t(e -ro-er amount of

safety stoc+>safety stoc+>

)e-ends on t(e)e-ends on t(e$$


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8ust9in9$ime8ust9in9$ime

A very accurate -roduction and

inventory information system ig(ly efficient -urc(asing Reliable su--liers Efficient inventory.(andling system

9ust.in.:ime9ust.in.:ime .. An a--roac( to inventorymanagement and control in /(ic( inventoriesare ac3uired and inserted in -roduction at t(e

eact times t(ey are needed&

Re3uirements of a--lying t(is a--roac(Re3uirements of a--lying t(is a--roac($$


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!upply Chain Management !upply Chain Management

9I: inventory control is one lin+ in =#M& :(e internet (as en(anced =#M and

allo/s for many business.to.business;2;7 transactions

#om-etition t(roug( ;2; auctions (el-sreduce firm costs S es-eciallystandardi1ed items

=u--ly #(ain Management =#M7=u--ly #(ain Management =#M7 S Managingt(e -rocess of moving goods services and

information from su--liers to end customers&

Documents

Lecture 5 - Account Receivables and Inventory Management