kank ch 15v14

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Essentials of Managerial Finance by S. Besley & E. Brigham Slide 1 of 18

Chapter 15Chapter 15

Managing

Short-Term

Assets

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Cre!it "olicy encompasses of a set of !ecisions that

incl#!e a firm$s cre!it stan!ar!s% cre!it terms% metho!s

#se! to collect cre!it acco#nts% an! cre!it monitoring

proce!#res

n general% firms 'o#l! rather sell for cash than on

cre!it% b#t competiti(e press#res force most firms to

offer cre!it. Firms prefer to !elay their payments%especially if there are no a!!itional costs associate!

'ith the !elay.

Cre!it ManagementCre!it ManagementCre!it "olicy

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Cre!it Stan!ar!s

) Stan!ar!s that in!icate the minim#m financial

strength a c#stomer m#st ha(e to be cre!it 'orthy

Terms of Cre!it ) The payment con!itions offere! to cre!it c#stomers

) *ength of cre!it perio! an! any cash !isco#nts

offere! Collection "olicy

) The proce!#res follo'e! by a firm to collect its

acco#nts recei(ables

Cre!it "olicyCre!it "olicyFactors !etermining the Cre!it "olicy

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The process of e(al#ating the cre!it policy an!payment patterns to !etermine 'hether a shift in the

c#stomers$ payment pattern occ#rs or 'hether the

cre!it policy nee!s mo!ifications

Cre!it ManagementCre!it Management+ecei(ables Monitoring

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The days sales outstanding (DSO) represents the

a(erage length of time re,#ire! to collect acco#nts

recei(able.

) The S is calc#late! by !i(i!ing acco#nts recei(able by !aily

cre!it sales.

) The S can be compare! 'ith the in!#stry a(erage an! the

firm$s o'n cre!it terms to get in!ication of ho' 'ell c#stomers

are a!hering to terms prescribe! an! ho' c#stomers$

payments% on a(erage% compare 'ith the in!#stry a(erage.

An aging schedule is a brea/!o'n of a firm$s

recei(ables by age of acco#nt. ) The report !i(i!es recei(ables into specifie! perio!s% 'hich

pro(i!es information abo#t the proportion of recei(ables that

are c#rrent an! the proportion that are past !#e for gi(en

lengths of time.

Metho!s for monitoring recei(ablesMetho!s for monitoring recei(ables

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Both the S an! aging sche!#le can be !istorte! ifsales are seasonal or if a firm is gro'ing rapi!ly. A

!eterioration in either the S or the aging sche!#le

sho#l! be ta/en as a signal to in(estigate f#rther% b#t not

necessarily as a sign that the firm$s cre!it policy has

'ea/ene!.

f a firm generally e0periences 'i!ely fl#ct#ating sales

patterns% some type of mo!ifie! aging sche!#le sho#l!be #se! to correctly acco#nt for these fl#ct#ations.

f the a(erage collection perio! or S is increasing the

firm sho#l! consi!er to#ghening its cre!it policy to

pre(ent cre!it to more c#stomers

Monitoring recei(ablesMonitoring recei(ablesBEA+E2 Things to note2

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Marginal Costs an! Benefits 3'ill re(en#es rise more

than costs4

Analy6e change in sales% change in (ariable operating

costs% change in a(erage collection perio! an! change in

carrying cost of recei(ables

"ropose! changes sho#l! be e(al#ate! the same 'ayas capital b#!geting pro7ects 'o#l! be8 changes sho#l!

be ma!e only if 9": "roposal ; <.

BEA+E= There is ,#ite a bit of #ncertainty in cre!it

policy change analysis beca#se the (ariables are (ery!iffic#lt to estimate. F#rther% the en! res#lt !epen!s on

competitors$ reactions. Th#s% the final !ecision is base!

on the ,#antitati(e analysis pl#s a great !eal of informe!

7#!gment.

Analysis of changes in cre!it policy Analysis of changes in cre!it policy

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+a' Materials

) n(entories p#rchase! from s#ppliers that 'ill

#ltimately be transforme! into finishe! goo!s

or/ n-"rocess ) n(entory in (ario#s stages of completion

Finishe! >oo!s

) n(entories that ha(e complete! the pro!#ctionprocess an! are rea!y for sale

n(entory Managementn(entory ManagementTypes of in(entory

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The goal of in(entory management is to pro(i!e thein(entories re,#ire! to s#stain operations at the lo'est

possible cost. Steps= 3a !entification of costs in(ol(e!

in p#rchasing an! maintaining in(entory% 3b

etermination at 'hat point those costs are minimi6e!. There are ? categories of in(entory costs.

) Carrying costs are associate! 'ith ha(ing in(entory% s#ch as

rent pai! 'here the in(entory is store!% an! they generally

increase in proportion to a(erage amo#nt of in(entory carrie!. ) Ordering costs are associate! 'ith placing an! recei(ing an

or!er for ne' in(entory% incl#!ing costs of generating memos

etc. The costs of each or!er are fi0e! regar!less of or!er si6e.

) Costs associate! 'ith r#nning short of in(entory 3stoc/o#ts.

n(entory Managementn(entory Managementptimal in(entory le(el

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ptimal in(entory le(el

= +

Totalinventory

costs (TIC)

Totalcarrying

costs

Totalordering

costs

( )

×+

××=

×+

×=

Q

T

O 2

Q

PPC

ordersof Number

order

per Cost

inventoryin

unitsAverage

unit/tcos

Carrying

C – carrying cost as a percent O – cost per order

PP – purchase price of inventory T – total demand in units

Q – quantity

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Economic r!er @#antity Mo!el 3E@

) The optimal ,#antity that sho#l! be

or!ere!

) t is the ,#antity that 'ill minimi6e the totalin(entory costs.

) The Form#la for !etermining the or!er

,#antity that 'ill minimi6e total in(entorycosts is the follo'ing=

PPC

TO2 EOQ

×

××=

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Ass#mptions of the E@ mo!el

sales are e(enly !istrib#te! thro#gho#t the perio!e0amine! an! sales can be forecaste! perfectly%

or!ers are recei(e! 'hen e0pecte!

the p#rchase price% ""% of each item in in(entory is the

same regar!less of the ,#antity or!ere!. ) The follo'ing res#lts occ#r=

As amo#nt or!ere! increases% total carrying costs

increase b#t total or!ering costs !ecrease% an! (ice

(ersa. f less than the E@ amo#nt is or!ere!% then the higher

or!ering costs more than offset the lo'er carrying costs.

f greater than the E@ amo#nt is or!ere!% the higher

carrying costs more than offset the lo'er or!ering cost.

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B#t E@ mo!el sho#l! be e0ten!e! beca#se

ass#mptions for the basic E@ are #nrealistic ) f there is a !elay bet'een the time in(entory is or!ere! an!

'hen it is recei(e!% the firm m#st reor!er before it r#ns o#t of

in(entory. So% the reorder point is the le(el of in(entory at 'hich

an or!er sho#l! be replace!.

) E(en if a!!itional in(entory is or!ere! at the appropriate reor!er

point% #ne0pecte! !eman! might ca#se it to r#n o#t of in(entorybefore the ne' in(entory is !eli(ere!. To a(oi! this% the firm

co#l! carry safety stocks.

) S#ppliers often offer !isco#nts for or!ering large ,#antities8 s#ch

!isco#nts are calle! quantity discounts. To e(al#ate ta/ing or not

ta/ing a ,#antity !isco#nt% the sa(ings of the ,#antity !isco#ntare compare! against the increase! costs of or!ering 3an!

hol!ing a nonoptimal amo#nt.

) For most firms% it is #nrealistic to ass#me that !eman! for an

in(entory item is #niform thro#gho#t the year. Th#s% the E@

mo!el cannot be #se! on an ann#al basis.

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So% ho' to !etermine a s#ccessf#l in(entory

management4

A s#ccessf#l in(entory management is a m#lti-management process that re,#ires interaction

'ith !epartments% s#ch as sales an!

pro!#ction% b#t also /no'le!ge of the economyan! the b#siness cycles are important to be

able to e(al#ate% for instance% #ne0pecte!

!eman!.

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The E@ mo!el can be #se! to help establishthe proper in(entory le(el% b#t in(entory

management also in(ol(es the establishment of

an inventory control system. These systems

(ary from the e0tremely simple to the (ery

comple0.

n(entory Control Systemsn(entory Control Systemsntro!#ction

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+e!-*ine Metho! ) An in(entory control proce!#re in 'hich a re! line is

!ra'n aro#n! the insi!e of an in(entory-stoc/e! bin

to in!icate the reor!er point le(el

Comp#teri6e! n(entory Control System

) A system of in(entory control in 'hich a comp#ter is

#se! to !etermine reor!er points an! to a!7#st

in(entory balances

n(entory Control Systemsn(entory Control SystemsControl proce!#res

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#st-n-Time System ) A system of in(entory control in 'hich a

man#fact#rer coor!inates pro!#ction 'ith s#ppliers

so that ra' materials or components arri(e 7#st as

they are nee!e! in the pro!#ction process

#tSo#rcing

) The practice of p#rchasing components rather than

ma/ing them in-ho#se

n(entory Control Systemsn(entory Control SystemsControl proce!#res

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"ropose! problem"ropose! problemST-? change in cre!it policy 3page 1<

kank ch 15v14

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