Lecture 12 - Accounts Receivable and Inventory Management PDF

12/04/2011
Instructors: ANTHONY ESSEL-ANDERSON & EBENEZER SIMPSON
Accounts Receivable and Inventory Management
Prepared by A. Essel-Anderson
Jan. 11, 2009
Accounts Receivable
Accounts receivable refer to amounts owed to the firm by customers who bought its goods or enjoyed its services on credit. Credit Policy and credit standard Terms of credit Evaluation of credit applicant It is a component of current assets and as such a working capital.
It is also referred to as trade debtors or simply receivables.

3 Prepared by A. Essel-Anderson Feb 6, 2010 4
Feb 6, 2010
12/04/2011
Determinants of Demand
Credit Policy
A firms credit policy is a set of decisions that include the following:
Credit standards, Terms of credit, and Collection policy and procedures.
Feb 6, 2010
Feb 6, 2010
Credit Standards
Standards that indicate the minimum quality of creditworthiness of a credit applicant that is acceptable to the firm. Credit standards are applied to determine which customers qualify for the regular credit terms and how much credit to grant. A relaxed credit standards is likely to increase
demand and profit generated on the additional sales. credit cost and opportunity cost of carrying additional accounts receivables.
Activity 2
Illustration
Value GH200,000 GH8 per unit GH6 per unit 1 month
Current Situation Current credit sales level (annual) Sales price Variable cost Average collection period
A more liberal credit standard is worthwhile if the additional profit is greater than the required return on the additional investment in receivables.
Prepared by A. Essel-Anderson Feb 6, 2010 7
Assume that the firm would like to embark on a more liberal credit policy which will result in an average collection period of 2 months for new customers. This policy initiative is expected to increase credit sales by 30%.
Opportunity cost of investment in receivables is 20%.
12/04/2011
Suggested Solution to Activity 2

(a)
(b) (c) (d) (e) (d)
Terms of Credit
Terms of Credit
The payment conditions offered to credit customers. The terms include the credit period, any cash discount, and any seasonal dating.
Additional credit sales

Additional contribution Additional receivables Additional investment in receivables Cost of additional investment Excess contribution over cost of additional investment
GH200,000 X 30%
(a) * CM ratio GH60,000 x 25% (a) * Receivables Turnover GH60,000 x (2/12) (c) * VC ratio GH10,000 x 75% (d) * Opp. Cost GH7,500 x 20% (b) (e) GH15,000 - GH1,500
GH60,000
GH15,000 GH10,000
Credit Period
GH7,500 GH1,500 GH13,500 The strategy would result in a net gain and so would be worthwhile. The length of time for which credit is granted.
Cash Discounts
A reduction in the invoice value of goods to encourage early payment.
Seasonal Dating
Customers are offered goods during before peak and pay after peak sales period.
Feb 6, 2010
Credit Terms Quotes

Net 30 This implies that customers who buy on credit have a grace period of 30 days to pay for the invoice value. No cash discount is offered. 2/10, net 30 This implies that credit customers can pay within 10 days to enjoy 2% cash discount or pay anytime from the 11th day to the 30th day without cash discount.
Variations in Credit Terms
The firm may vary its credit policy to speed up sales and receipts from customers.
The firm may:

Extend the credit period (to say 45 days) or Increase the percentage cash discount (to say 5%) or Extend the cash discount period (to say 15 days) or Employ a combination of the above.
In evaluating a new policy, consider the profitability of additional sales, additional savings/(costs) associated with decrease/(increase) in investments in inventory, and cost of discount.
Feb 6, 2010
12/04/2011
Default Risk
An important risk associated with credit sales is default on the part of customers.
Collection Policy
This refers to a set of decisions and related procedures followed by a firm to collect its accounts receivable.
In evaluating the profitability of a policy change, consider default risk (possible increase in bad debt).
Collection procedures include:

Reminders through letters, faxes, telephone calls, and personal visits. Arrangements with collection agencies to collect debts. Legal actions to collect overdue amounts.
One must use his/her judgement to make a reasonable estimate of possible increase in bad debt.
The judgement may be influenced by :

past experience average bad debts in the industry economic conditions
An important decision variable is the amount of money spent on collection procedures.
Feb 6, 2010
14
Receivables Monitoring
Analysing Credit Applicant
The process of evaluating the credit policy to determine any variance in the customers payment pattern. Common methods used to monitor the time credit remain outstanding are:
Average collection period Aging schedule
Prepared by A. Essel-Anderson Feb 6, 2010 15 Prepared by A. Essel-Anderson Feb 6, 2010 16
12/04/2011
Analysing Credit Applicant

The information about the credit applicant is analysed to determine the applicants creditworthiness in terms of:
Character, Capacity, Capital, Conditions and Collateral.
Credit Evaluation and Approval
The analysis is be done using methods such as:

Sequential investigation process and Credit-scoring system.
Feb 6, 2010
17
Feb 6, 2010
18
Credit Scoring
Applying Fair Isaacs Method How promptly the applicant has paid in the past (35% of score) How much debt of each type is outstanding (30% of score) The length of the applicants credit history (15% of score) The number of credit cards and recently opened credit accounts that the applicant has (10% of score) The mix of regular credit cards, store card, and margin account (10% of score)
Index of Credit Worthiness

Using return on asset and current ratio as indicators of credit worthiness, we could devise a scoring system thus:
Z-score = return on asset + 10(current ratio)
Rule of thumb:
If applicants z-score is over 15 then he could pay so grant credit If applicants z-score is below 15, then he will not be able to pay.
Feb 6, 2010
19
Feb 6, 2010
20
12/04/2011
Types of Inventories
Raw Materials and Components Materials and supplies that are consumed in production. Work-in-process Assets held in the production process for sale in the ordinary course of business. Finished Goods Assets held for sale in the ordinary course of business
Feb 6, 2010 21 Prepared by A. Essel-Anderson Feb 6, 2010 22
Goal of inventory management Inventory costs The EOQ model ABC classification & control of inventory The JIT system
Advantages of Holding Inventories

Inventories in transit allow efficient production scheduling and utilisation of resources.
Disadvantages for Holding Inventories If too much inventories are held the firm may incur inventory costs such as: Obsolescence. Storage costs including warehousing rent. Insurance premium. Opportunity costs in the form of returns that could have been earned on investment in inventories.
Raw materials inventory allow the firm to be flexible in its purchasing.
Finished goods inventory allow the firm to be flexible in its production and marketing.
Large inventories allow the firm to meet its customers demand efficiently.
Stock-out costs such as high cost of rush purchases, production stoppages and idle time, and lost sales and customer confidence are avoided or reduced.
Prepared by A. Essel-Anderson Feb 6, 2010
12/04/2011
The Goal of Inventory Management The goal of inventory management is to provide an optimal level of inventory to sustain operations at least cost. Inventory management involves:
Establishing and maintaining proper inventory level. Establishing and maintaining inventory control systems.
Optimal Inventory Level
Steps involved in determining the optimal inventory level Indentifying the costs involved in purchasing and maintaining inventory. Determining the point at which those costs are minimised.
Inventory Costs
Carrying costs Costs associated with holding inventory storage costs, insurance, costs of tying up funds etc. Ordering costs Costs associated with placing and receiving an order for new inventory. Stock-out costs Costs associated with running out of inventory.
The EOQ Model

EOQ Model A calculus based model used to determine the point at which total inventory cost is minimised. The Economic Order Quantity (EOQ) is the optimum units to order so as to minimise total inventory cost. Assumptions Inventory usage is evenly distributed throughout the period under review and can be forecasted precisely. Orders are received when expected. The purchase price of each item is the same regardless of the quantity ordered.
12/04/2011
... The EOQ Model

If the right amount of inventories are kept stock-out costs can be avoided. Thus, total inventory cost (TIC) can be expressed as follows:
TIC = Total Carrying Cost (TCC) + Total Ordering Costs (TOC) and: TCC = (carrying cost per unit) x (average inventory) = C (Q/2) TOC = (cost per order) x (number of orders) = O(Total Usage/Q)
... The EOQ Model
The EOQ is the quantity that will minimise the total inventory costs. Applying the rules of minimisation:
1. The first derivative of the TIC function must be equal to zero (i.e. = 0) and 2. The second derivative must be positive (i.e. )
Thus, TIC = C (Q/2) + O (U/Q)

Solve for Q in the resulting equation in point 1 to get the optimum quantity (Q* or EOQ).
The EOQ Formula
Activity 1
The following data relates to DML Ltd a distributor of an antitoxic rubber.
Total demand = 7,800 packs per year. Carrying cost = 20% of purchase price. Purchase price = GH4 per pack. Selling price = GH8 per pack. Ordering cost = GH100 per order
The EOQ formula is as follows:
Where:
Q* = the optimal order quantity (in units) O = cost per order U = total usage C = carrying cost per unit
Required:
Compute the optimal order quantity. Determine the number of times orders should be placed Compute the total cost when the optimal order size is purchased.
12/04/2011
Suggested Solution to Activity 1
Key Inventory Levels

Safety Stock
Additional inventory held in reserve as guard against uncertain demand/usage or production/delivery delays. Safety stock increases with (1) uncertainty of demand forecast; (2) stock-out costs; (3) possibility of delays in delivery of new orders.
The optimal order quantity is given by:
The number of orders to place is the total demand divided by the optimal order quantity
7,800/1396 = approximately 6 times.
Re-order Level
This is the inventory level at which order for new inventory should be placed to replenish inventory. Re-order Level = Lead Time x Daily Usage Re-order Level = (Avge. Lead Time x Avge. Daily Usage) + Safety Stock
Total cost when the optimal order size is purchased is:

TIC = (0.2* GH4)(1396/2) + (GH100)(6) = GH1,158.4
Feb 6, 2010
Inventory Control Systems

Red-line Method
An inventory control procedure where a red line is drawn around the inside of a stock bin to indicate the re-order level.
Just-In-Time
Successful implementation of a JIT inventory management system requires:

Computerised Inventory Control System

Computer applications are used to determine re-order points and to adjust inventory balances.
Accurate production with few or no defective products. Highly efficient purchasing. Very reliable suppliers. Accurate inventory information system. Efficient inventory handling system.
Just-In-Time System
Raw materials and components are ordered and received just as they are needed in the production process.
The objective of JIT system is to reduce inventory costs by:
Outsourcing
Components are purchased instead of producing in-house and storing in the production process.
Ordering in small lots to meet production demands to reduce carrying costs. Requiring suppliers to supply materials and components with no defect thus reducing inspection costs Improving on plant layout, product features, and production processes to reduce setup time and costs.
12/04/2011
The ABC Method of Inventory Classification & Control

Under the ABC system inventories are classified into 3:
The Role of the Finance Manager

A About 15% of items of inventory which account for 70% of total inventory value (more valuable items). B About 30% of items of inventory which account for 20% of total inventory value (valuable items). C About 55% of items of inventory which account for 10% of total inventory value (less valuable).
Under the ABC system more valuable items of inventory are closely monitored than less valuable items.
Inventory control activities are usually carried out by account staff. However, investment of funds in inventory is an important aspect of financial management. Thus, the finance manager must be familiar with systems of inventory control to ensure efficient capital allocation and appropriate investment in inventories. The finance manager should work hand-in-hand with the heads of production, marketing, purchasing and account departments in the management and control of inventories.
10

Lecture 12 - Accounts Receivable and Inventory Management PDF

Hochgeladen von

Dokumentinformationen

Originalbeschreibung:

Originaltitel

Copyright

Verfügbare Formate

Dieses Dokument teilen

Dokument teilen oder einbetten

Freigabeoptionen

Stufen Sie dieses Dokument als nützlich ein?

Sind diese Inhalte unangemessen?

Copyright:

Verfügbare Formate

Lecture 12 - Accounts Receivable and Inventory Management PDF

Hochgeladen von

Copyright:

Verfügbare Formate

12/04/2011

Instructors: ANTHONY ESSEL-ANDERSON & EBENEZER SIMPSON

Accounts Receivable and Inventory Management

Jan. 11, 2009

It is also referred to as trade debtors or simply receivables.

Suggested Solution to Activity 2

Additional credit sales

Credit Terms Quotes

Variations in Credit Terms

The firm may:

Collection procedures include:

The judgement may be influenced by :

An important decision variable is the amount of money spent on collection procedures.

Analysing Credit Applicant

Analysing Credit Applicant

Credit Evaluation and Approval

The analysis is be done using methods such as:

Index of Credit Worthiness

Z-score = return on asset + 10(current ratio)

Advantages of Holding Inventories

Raw materials inventory allow the firm to be flexible in its purchasing.

Optimal Inventory Level

The EOQ Model

... The EOQ Model

... The EOQ Model

Thus, TIC = C (Q/2) + O (U/Q)

The EOQ Formula

The EOQ formula is as follows:

Suggested Solution to Activity 1

Key Inventory Levels

The optimal order quantity is given by:

Total cost when the optimal order size is purchased is:

Inventory Control Systems

Successful implementation of a JIT inventory management system requires:

Computerised Inventory Control System

The objective of JIT system is to reduce inventory costs by:

The ABC Method of Inventory Classification & Control

The Role of the Finance Manager

Das könnte Ihnen auch gefallen