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8/17/2019 Lecture 5 - Account Receivables and Inventory Management
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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&
8/17/2019 Lecture 5 - Account Receivables and Inventory Management
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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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Credit !tandardsCredit !tandards
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
8/17/2019 Lecture 5 - Account Receivables and Inventory Management
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"#ample of Rela#ing"#ample of Rela#ing
Credit !tandardsCredit !tandards
;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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"#ample of Rela#ing"#ample of Rela#ing
Credit !tandardsCredit !tandards
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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"#ample of Rela#ing"#ample of Rela#ing
Credit !tandardsCredit !tandards
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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Credit and CollectionCredit and Collection
Policies of the irmPolicies of the irm
!7 Average#ollection Period
27 ;ad.debt
Losses
6uality of :rade Account
Lengt( of Lengt( of
#redit Period#redit Period
Possible #as()iscount
Firm#ollectionProgram
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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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"#ample of Rela#ing"#ample of Rela#ing
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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"#ample of Rela#ing"#ample of Rela#ing
the Credit Period the Credit Period
:(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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"#ample of Rela#ing"#ample of Rela#ing
the Credit Period the Credit Period
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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"#ample of Rela#ing"#ample of Rela#ing
the Credit Period the Credit Period
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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Credit and CollectionCredit and Collection
Policies of the irmPolicies of the irm
!7 Average#ollection Period
27 ;ad.debt
Losses
6uality of :rade Account
Lengt( of #redit Period
Possible #as(Possible #as(
)iscount)iscount
Firm#ollectionProgram
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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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"#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
"conomic 5rder 6uantity "conomic 5rder 6uantity
+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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"conomic 5rder 6uantity "conomic 5rder 6uantity
*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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"#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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5rder Point5rder Point
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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5rder Point5rder Point
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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10 41
!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&