ACCOUNTS RECEIVABLE AND INVENTORY MANAGEMENT

Billy Leon P. |Hesty Oktariza | Trinh Quang Tan (Neww)

Accounts Receivable Management

20-4

Size of Investment in Account Receivables

Percent of Credit Sales to Total Sales Level of Sales Credit and collection policies;
  

Terms of Sale Quality of Customer Collection Efforts

Term of Sale
y Quoted as a/b net c , which means deduct a% if paid

within b days, otherwise pay within c days.

y Example:

3/30 net 60 means deduct 3% if paid within 30 days, otherwise pay the entire amount within 60 days.

Term of Sale
Annualized opportunity cost of foregoing a discount:

Opportunity cost of foregoing 3/30 net 60: = 37.11%

Type of Customer

The costs associated with extending credit to lower-quality customers include: a. Increased costs of credit investigation b. Increased probability of customer default c. Increased collection costs

Credit Scoring
The numerical credit evaluation of each candidate

Edward Altman model

Collection Effort
The key to maintaining control over the collection of accounts receivable is the fact that the probability of default increase with the age of the account

Collection Effort
One common way of evaluating the current situation analysis. is ratio analysis Examining the average collection period Ratio of receivables to assets Ratio of credit sales to receivables (accounts receivable turnover ratio) Amount of bad debts relative to sales over time Aging of accounts receivable schedule

Credit Policy Changes

When is it appropriate for a firm to change its credit policy? Three categories of changes in credit policy that a firm can consider:  A change in the risk class of the customer  A change in the collection process  A change in the discount terms

How to evaluate the situation?

Four steps for performing marginal analysis on a change in credit policy: Step 1: Estimate the change in profit Step 2: Estimate the cost of additional investment in accounts receivable and invetory Step 3: Estimate the cost of discount Step 4: Compare the incremental revenues with the incremental costs

Credit Policy Changes and Profit

INVENTORY MANAGEMENT

Inventory Management
Raw Materials Inventory

The purpose of carrying inventories is to uncouple the operations of the firm.

Stock of Cash

Types of Inventory

Work-InProcess Inventory

Finished Goods Inventory

Trade-Off in Investment Inventory

Too much inventory is expensive and wasteful.

Not enough inventory can result in lost sales

Inventory Management Techniques

y In order to effectively manage the investment in inventory,

there are two problems must be dealt with:

a) Order Quantity Problem b) Order Point Problem

a. Order Quantity Problem

The economic order quantity (EOQ) model attempts to determine the order size that will minimize total inventory costs.

Economic Order Quantity (EOQ) Model

Determining Optimal Inventory (where total costs are minimized)

Total Inventory Cost

Total Carrying Cost

Total Ordering Cost

Inventory Cost
Carrying Costs
C rryi g C st p r U it
y y

Warehouse rent Insurance Security costs Utility costs Maintenance costs Property taxes Move and re-arrange, obsolescence, and Opportunity cost, i.e., using cash for profitable projects rather than being tied up in inventory

Av r g I v t ry

y y y y

Q 2

y y

Wh r : Q = th i v t ry siz (i u it) C = C rryi g c st p r u it

Inventory Level (units)

Order Quantity Q

The EOQ Model assumes the firm orders a fixed amount (Q) at equal intervals.

Time

The EOQ Model

Inventory Level (units)

Average inventory =

Order Quantity 2

Order Quantity Q

Time

The EOQ Model

Cost ($) Carrying Costs

Carrying costs increase as the size of the inventory increases.

Order Size (units)

Inventory Cost
Ordering Costs
Number of Orders Ordering Cost per order

y Clerical expense y Telephone y Material Resource

S Q

Planning (MRP) system y Receiving cost

Where : Q = the inventory size (in unit) S = total demand in units over planning period

The EOQ Model

Cost ($) Ordering Costs, per unit

Ordering costs per unit go down as order size increases. Assumes ordering costs are relatively fixed.

Order Size (units)

The EOQ Model

The economic order quantity is the intersection of the X and Y points where total inventory cost is minimized
Cost ($) Y Carrying Costs = (Q ) C 2

Total Cost = Q x C + S x O 2 Q

Ordering Costs = ( S ) O Q Order Size (units)

Total Inventory Cost

Total Carrying Cost

Total Ordering Cost

Total Inventory = Costs

Where: Q S C O

Q 2

)C

S Q

)O

= Order Size (order quantity) = Annual Sales Volume = Carrying Cost per Unit = Ordering Cost per Order

a. Order Quantity Problem (contd)

Determining Optimal Inventory
y The ordering quantity that minimizes the total

costs of inventory.

Q* =

2 SO C

a. Order Quantity Problem (contd)

Example: Awesome Autos expects to sell 1,560 new automobiles in the next year. It currently costs $40 per order placed with the manufacturer. Carrying costs amount to $50 per auto. a. How many autos should they order each time they place an order? 2(1560)40 = 50 = 49.96 } 50 cars b. How many orders per year? How much does it cost? Q = autos in each order Order/year= S/Q = 1,560/ 50 = 31.2 orders each year Ordering cost = 31.2 x $40 = $1,248

Basic Assumptions in EOQ

1. 2. 3. 4. 5. 6.

Constant unit price regardless of amount ordered. Constant carrying costs per unit. Constant ordering costs per order regardless of the size of the order. Instantaneous delivery. Constant or uniform demand Independent orders.

Inventory Level (units)

Order Quantity Q

The EOQ Model assumes the firm orders a fixed amount (Q) at equal intervals.

Time

b. Order Point Problem

Order Point The quantity to which inventory must fall in order to signal that an order must be placed to replenish an item.
How low inventory should be depleted before it is

reordered? When to order?

b. Order Point Problem (contd)

y Safety Stock

Inventory held to accommodate any unsually large and unexpected usage during delivery time.
y Delivery Time Stock

The inventory needed between the order date and the receipt of the inventory needed.

b. Order Point Problem (contd)

Order new inventory when the level of inventory falls to this level

Deliverytime stock

Safety stock

*Delivery*Delivery-time stock

= Delivery Time X Daily usage

b. Order Point Problem (contd)

Average = Inventory

EOQ 2

+ safety stock

Inventory Management with Safety StockOrder

Inventory Level (units) 70 Inventory Order Point

EOQ 50 Depleted Stock During Delivery Safety Stock 20

Actual Delivery Time

Time

What is the proper amount of safety stock?

Depends on the:
y y y y y

Amount of uncertainty in inventory demand Amount of uncertainty in the delivery time Eficiency of inventory replenishment system Cost of running out of inventory Cost of carrying inventory

Inflation and Relationship Between EOQ Model

y Anticipatory Buying buying in anticipation of a price increase to secure the goods at a lower cost The Inflation Effect inflation affects the EOQ model is through increased carrying costs

Example
Lumber Autos expects to sell 1,560 new automobiles in the next year. It currently costs $40 per order placed with the manufacturer. Carrying costs amount to $50 per auto. How many autos should they order each time they place an order?

Q* =

2SO C

2(1560)40 50

= 49.96 } 50 cars

Objectives
Determining Optimal Inventory
 to determine the order size that will minimize total

inventory costs.

Q* =

2SO C

where Q*= the optimal order quantity in units O = ordering cost per order S = total demand in units over the planning period C = cost of carrying 1 unit in inventory

Just-In-Time Inventory Control

y JIT System is one link in Supply Chain Management

(SCM) y The objective of JIT System is to cut down the inventory at the minimum level, and the time and physical distance between the various production operations also minimized y How about Just-In-Case System?

TOTAL QUALITY MANAGEMENT

Total Quality Management (TQM)

y What is TQM? y Why TQM are needed? y The Financial Consequences of Quality-The Quality-

Traditional View y The Financial Consequences of Quality- The QualityTQM View

The Financial Consequences of Quality-The Traditional View

Preventive Cost  Cost resulting from design and production efforts on the part of the firm to reduce or eliminate defects Appraisal Cost  Cost of testing , measuring, and analyzing to safeguard against possible defects going unnoticed Internal Failure Cost  Cost associated with discovering poor-quality products prior to delivery (reworking the product, downtime cost, discounts) External Failure Cost  Cost resulting from a poor-quality product reaching the customers hand (warranty product, recall product, lost sales cost)

The Financial Consequences of Quality- The TQM View

y The TQM view argues that higher quality will result in

increased sales and market share y In fact, by use TQM model it can drop manufacturing cost significantly