Ch10 Accounts Receivable and Inventory Management
Ch10 Accounts Receivable and Inventory Management
Ch10 Accounts Receivable and Inventory Management
Accounts Receivable
and Inventory
Management
10-1
10-2
Length of
Credit Period
(1) Average
Collection Period
(2) Bad-debt
Losses
Possible Cash
Discount
10-3
Firm
Collection
Program
Credit Standards
Credit Standards -- The minimum quality
of credit worthiness of a credit applicant
that is acceptable to the firm.
Why lower the firms credit standards?
The financial manager should continually
lower the firms credit standards as long as
profitability from the change exceeds the extra
costs generated by the additional receivables.
10-4
Credit Standards
Costs arising from relaxing
credit standards
10-5
Bad-debt losses
Opportunity costs
Example of Relaxing
Credit Standards
Basket Wonders is not operating at full capacity
and wants to determine if a relaxation of their
credit standards will enhance profitability.
10-6
Example of Relaxing
Credit Standards
Example of Relaxing
Credit Standards
Profitability of
additional sales
Additional
receivables
Investment in
add. receivables
($20/$25) x ($30,000) =
$24,000
Yes!
10-8
Length of
Credit Period
(1) Average
Collection Period
(2) Bad-debt
Losses
Possible Cash
Discount
10-9
Firm
Collection
Program
Credit Terms
Credit Terms -- Specify the length of time
over which credit is extended to a customer
and the discount, if any, given for early
payment. For example, 2/10, net 30.
Credit Period -- The total length of time over
which credit is extended to a customer to pay
a bill. For example, net 30 requires full
payment to the firm within 30 days from the
invoice date.
10-10
Example of Relaxing
the Credit Period
Basket Wonders is considering changing its
credit period from net 30 (which has resulted
in 12 A/R Turns per year) to net 60 (which is
expected to result in 6 A/R Turns per year).
10-11
Example of Relaxing
the Credit Period
10-12
Example of Relaxing
the Credit Period
Profitability of
additional sales
Additional
receivables
Investment in add.
($20/$25) x ($41,667) =
receivables (new sales) $33,334
Previous
receivable level
10-13
Example of Relaxing
the Credit Period
New
receivable level
Investment in
add. receivables
(original sales)
$333,333 - $166,667 =
$166,666
Total investment in
add. receivables
$33,334 + $166,666 =
$200,000
10-14
Yes!
Length of
Credit Period
(1) Average
Collection Period
(2) Bad-debt
Losses
Possible Cash
Discount
10-15
Firm
Collection
Program
Credit Terms
Cash Discount Period -- The period of time
during which a cash discount can be taken for
early payment. For example, 2/10 allows a
cash discount in the first 10 days from the
invoice date.
Cash Discount -- A percent (%) reduction in
sales or purchase price allowed for early
payment of invoices. For example, 2/10
allows the customer to take a 2% cash discount
during the cash discount period.
10-16
Example of Introducing
a Cash Discount
A competing firm of Basket Wonders is
considering changing the credit period from
net 60 (which has resulted in 6 A/R Turns
per year) to 2/10, net 60.
10-17
Example of Introducing
a Cash Discount
10-18
Example of Using
the Cash Discount
Receivable level
(Original)
Receivable level
(New)
Reduction of
investment in A/R
$833,333 - $555,556 =
$277,777
10-19
.02 x .3 x $5,000,000 =
$30,000.
Yes!
Seasonal Dating
Seasonal Dating -- Credit terms that
encourage the buyer of seasonal products
to take delivery before the peak sales period
and to defer payment until after the peak
sales period.
10-21
Length of
Credit Period
(1) Average
Collection Period
(2) Bad-debt
Losses
Possible Cash
Discount
10-22
Firm
Collection
Program
$2,400,000
Policy A
Policy B
$3,000,000 $3,300,000
$ 600,000 $ 300,000
2%
10%
18%
2 months
3 months
1 month
Policy B
1.
2.
3.
4.
5.
6.
44,000
60,000
54,000
75,000
60,000
12,000
66,000
(6,000)
Collection Policy
and Procedures
Letters
Phone calls
Personal visits
Legal action
10-25
Bad-Debt Losses
Collection
Procedures
Saturation
Point
Collection Expenditures
Analyzing the
Credit Applicant
10-26
Sources of Information
The company must weigh the amount
of information needed versus the time
and expense required.
required
10-27
Financial statements
Credit ratings and reports
Bank checking
Trade checking
Companys own experience
Credit Analysis
A credit analyst is likely to utilize
information regarding:
10-28
Sequential
Investigation Process
The cost of investigation (determining
the type and amount of information
collected) is balanced against the
expected profit from an order.
An example is provided in the following
three slides 10-30 through 10-32.
10-29
Sample Investigation
Process Flow Chart (Part A)
Pending Order
Stage 1
$5 Cost
No
Bad
past credit
experience
Yes
Reject
10-30
Sample Investigation
Process Flow Chart (Part B)
Credit rating
limited and/or other
damaging information
unearthed?
No
Accept
10-31
No
Credit rating
fair and/or other
close to maximum
line of credit?
Yes
Yes
Reject
Sample Investigation
Process Flow Chart (Part C)
Stage 3
$30 Cost
Fair
Accept
Poor
Reject
Accept, only upon
domestic irrevocable
letter of credit (L/C)**
10-32
Other Credit
Decision Issues
Credit-scoring System -- A system used to
decide whether to grant credit by assigning
numerical scores to various characteristics
related to creditworthiness.
Line of Credit -- A limit to the amount of credit
extended to an account. Purchaser can buy on
credit up to that limit.
10-33
Other Credit
Decision Issues
Outsourcing Credit and Collections
The entire credit and/or collection function(s)
are outsourced to a third-party company.
10-34
Inventory
Management and Control
Inventories form a link between
production and sale of a product.
Inventory types:
10-35
Raw-materials inventory
Work-in-process inventory
In-transit inventory
Finished-goods inventory
Inventory
Management and Control
Inventories provide flexibility
for the firm in:
10-36
Purchasing
Production scheduling
Appropriate
Level of Inventories
How does a firm determine
the appropriate level of
inventories?
Employ a cost-benefit analysis
Compare the benefits of economies of
production, purchasing, and product
marketing against the cost of the
additional investment in inventories.
10-37
ABC Method of
Inventory Control
Review A items
most frequently
Review B and C
items less rigorously
and/or less frequently.
10-38
100
Cumulative Percentage
of Inventory Value
ABC method of
inventory control
90
70
B
A
0
15
45
Cumulative Percentage
of Items in Inventory
100
INVENTORY
(in units)
Q/2
TIME
10-40
Q* =
2 (O
( ) ( S)
C
Example of the
Economic Order Quantity
Basket Wonders is attempting to determine the
economic order quantity for fabric used in the
production of baskets.
Q* =
10-43
2 ($200
) (10,000)
(
$1
Q* = 2,000 Units
Costs
10-44
Q*
When to Order?
Issues to consider:
Lead Time -- The length of time between the
placement of an order for an inventory item and
when the item is received in inventory.
Order Point -- The quantity to which inventory
must fall in order to signal that an order must
be placed to replenish an item.
Order Point (OP)
OP = Lead time X Daily usage
10-45
UNITS
2000
Order
Point
200
0
10-47
Lead
Time
18
20
38
DAYS
40
Safety Stock
Safety Stock -- Inventory stock held in reserve
as a cushion against uncertain demand (or
usage) and replenishment lead time.
Our previous example assumed certain demand
and lead time. When demand and/or lead time are
uncertain, then the order point is:
Order Point =
(Avg. lead time x Avg. daily usage) + Safety stock
10-48
Order Point
with Safety Stock
2200
UNITS
2000
Order
Point
400
200
Safety Stock
0
10-49
18 20
DAYS
38
Order Point
with Safety Stock
2200
UNITS
2000
Actual lead
time is 3 days!
(at day 21)
The firm dips
into the safety stock
Order
Point
400
200
Safety Stock
0
10-50
18
21
DAYS
10-51
Just-in-Time
Just-in-Time -- An approach to inventory
management and control in which inventories
are acquired and inserted in production at the
exact times they are needed.
Requirements of applying this approach:
10-52