BES’S Institute of management studies &research

Batch: 2009-2011

MARKETING FINANCE

ASSINGMENT

SUBMITTED TO

MANGESH PATIL

Submitted By

AFREEN KHANAM 19
VIMAL NAIR 35
PRASHANT SHEJWAL 53

Q. What is Impact of Accounts Receivable and Inventory on Marketing Cost?

Ans. What Does Accounts Receivable - AR Mean?
Money owed by customers (individuals or corporations) to another entity in exchange for goods
or services that have been delivered or used, but not yet paid for. Receivables usually come in
the form of operating lines of credit and are usually due within a relatively short time period,
ranging from a few days to a year.

On a public company's balance sheet,  accounts receivable is often recorded as an asset

because this represents a legal obligation for the customer to remit cash for its short-term debts

Investopedia explains Accounts Receivable - AR

If a company has receivables, this means it has made a sale but has yet to collect the money from
the purchaser. Most companies operate by allowing some portion of their sales to be on credit.
These type of sales are usually made to frequent or special customers who are invoiced
periodically, and allows them to avoid the hassle of physically making payments as each
transaction occurs. In other words, this is when a customer gives a company an IOU for goods or
services already received or rendered.

Accounts receivable are not limited to businesses - individuals have them as well. People get
receivables from their employers in the form of a monthly or bi-weekly paycheck. They are
legally owed this money for services (work) already provided.

What Does Inventory

Inventory is held in order to have goods available for sale or raw materials for production.
Holding inventory is especially important if sales or production are not stable, continuous and
predictable. In well planned and standardized production (such as a Toyota assembly plant),
inventory can be reduced to nil with just-in-time deliveries of supplies. Inventory is non-existent
in utilities, transportation and services. It is only important in manufacturing, wholesale and
retail. Especially in retail companies, it can represent two thirds of the assets of the company
(e.g. automobile and motorcycle dealers, jewelers, as well as clothing, shoe and sporting goods
stores). In manufacturing, inventory management must deal with scheduling production
(especially if only large batches must be produced), as well as holding inventory for sale. But
raw materials inventory usually represents a small amount of funds, and work-in-progress
inventory is dictated by the need for finished goods. Thus the most important role of inventory is
to make immediate sales possible even if the timing of demand is not known.

The optimum level of inventory is determined by minimizing the combined cost of holding
inventory and being out of stock. The cost of holding inventory is known as the carrying cost,
and consists of warehousing, insurance, funds required, spoilage and obsolescence. The cost of
being out of stock divides into reordering cost and cost of lost sales. Ignoring lost sales first,
inventory control theory offers a precise derivation of economic order quantity (EOQ) by
minimizing total cost TC

TC = Annual ordering cost + Annual carrying cost

TC = (# of orders x cost per order) + (average inventory x unit carrying cost)

TC = ((D/Q) x S) + ((Q/2) x C)

where D = number of units sold, consumed or depleted per year

S = cost per order
C = unit carrying cost
Q = quantity ordered each time
D/Q = number of orders per year
Q/2 = average inventory (i.e. maximum inventory = Q, minimum = 0)

The economic order quantity is obtained by taking the first derivative of TC with respect to Q,
and is equal to

EOQ = Square Root ((2 S x D) / C)

 Example: A hardware distributor sells 20,000 Makita hand drills per year. The cost of having
one drill in inventory for a year is estimated at $5. The cost of ordering and receiving each
shipment is $500. The economic order quantity is

EOQ = Square Root ((2 x 500 x 20,000)/ 5)

EOQ = Square Root (4,000,4000)

EOQ = 2,000 drills

Observe that there will be 10 orders per year (i.e. 20,000 /2,000). The average inventory is 1,000
(i.e. 2,000/2). Annual inventory carrying cost is $5,000 (1,000x$5) and carrying cost is $5,000
(100x$500).

Orders must be place at a reordering point before the inventory is completely depleted, with
sufficient time for the ordered quantity to be shipped and delivered by the supplier (i.e. the time
it takes to receive the order is called lead time).

Returning to lost sales due to stock outs, to avoid them a company must maintain a safety stock
so that it is never completely out of merchandise. This implies ordering ahead of the reordering
point. For seasonal sales (as most products have some seasonal pattern), in addition to safety
stock it is advisable to adjust EOQ upwards for both anticipated higher demand and longer lead
time at season peaks.

Such inventory planning is strictly a managerial task, not even delegated to accountants, but the
task is eased by software that computes automatically EOQ and safety stocks for retail store
buyers, purchasing agents and production managers. An outside analyst would not have the
information needed to judge whether and adequate control of inventory exists in a company.
Inefficiency can, however, be detected indirectly by studying the volume and composition of
inventory on hand (e.g. with inventory turnover ratios), and observing the impact of inventory
management on effectiveness of marketing strategy implementation.

Impact

Generally assets are considered current if they can be converted into cash in the normal
operations of the firm within the operating period. Typically current assets include cash on hand,
accounts receivable and inventories. A marketing cost might have substantial influence on the
terms of repayment (impacting accounts receivable) and the rate at which inventory is turned.

Accounts receivable is an important part of current assets that must be carefully managed. The
marketing manager understands that better terms for customers can potentially increase sales.
However, selling to a bad credit is worse than making no sale at all. In this situation, the business
suffers from a loss in gross margin and a loss from the cost of the goods or services sold.
Additionally, the firm might incur the cost of trying (usually unsuccessfully) to collect the debt.
Finally, long payment terms slow accounts receivable turnover, reducing asset turnover.
Therefore, the marketing manager should consider offering discounts for payments in cash or
within 10 days of receipt as well as counsel to the sales force concerning sales to slow/no paying
customers.