FI

NANCI
ALMANAGEMENT-
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WORKI
NGCAPI
TALMANAGEMENT

Wor
kingCapi
tal
Oper
ati
ngCy
cle
Iscommonyr eff
erdtoasTurn-OverPeri
od,Col
l
ecti
onPeri
odorPay mentperiod.
Wor kingcapit
aloper
ati
ngcycleisaprocessofcashgener
ati
onwhi chinv
olves
conv ert
ingit
emsofWor ki
ngCapitalfr
om onestaget
oanother.
Itchangesdependingon
typeofI ndust
ry.

1.FORNONMANUFACTURI
NGCOMPANI
ES

WORKI
NGCAPI
TAL=CURRENTASSETS-CURRENTLI
ABI
LITI
ES(
WC=CA-
CL)

2.FORMANUFACTURI
NGCOMPANI
ES
Ov
ercapi
tal
i
zat
ionandOv
erTr
adi
ng
Ov
ercapi
tal
i
zat
ion

Over
capi
tal
izat
ioni
stheexcessi
nvest
mentinCAssets.Thisi
sevidenti
fforexamplea
companyhasexcessst
ockandcashinthebankwhil
er eci
avabl
esandliabi
li
ti
esarefew.

Ov ercapi
tal
i
zati
onofaf i
rmr educestheLi
qui
dit
yposit
ionofafi
rm,
howevert
heret
urns
oft hatfi
rmreducesbecausethef undsar
ehel
dintheCAssetsI
nst
eadofFi
xedAssets
thatcouldimprovetheprofi
tabi
li
ty.

Thei
mpl
i
cat
ionsofOv
ercapi
tal
i
zat
ion

• Causesthecur
rentr
ati
otobei
nggr
atert
han2:
1andt
hequi
ckr
ati
obei
nggr
ater
than1:
1

• Causesexcessi
veTur
nOv
erf
orst
ockandDebt
ors

• Causesshor
terCreditPer
iodbyCr
edi
tor
sthusl
eadi
ngt
oexcessst
ockand
debt
orsandlesscredit
ors

Ov
erTr
adi
ng

Overtr
adingisev i
dentwhereacompanyt r
iestoi
nvestt
ooquicklywithlessLong-
Term
Capi
tal.Overtradi
ngmayi mpr ov
epr of
it
abil
it
yofafi
rm butt
heliquidi
typosit
ionofthat
fi
rm detori
atestothewor st
,thefir
mi snotablet
omeetitsfi
nancialobl
igati
onssincei
t
l
acksenoughcapi t
al.Anexampl eofovert
radi
ngiswhereafi
rmt ri
estoi mprovei
ts
st
ockwi thal owcapital
base.

Si
gnsofOv
ert
radi
ng

• Rapi
dincr
easei
nCAsset
sandsomet
imesi
nFAsset
s

• Rapi
dincr
easei
ntur
nov
erandsal
esv
olume

• Asli
ghtincr
easeinownersequi
tyandLong-
ter
m debtandmosti
nvest
ment
s
f
inancedusingShor
t-
ter
mf undse.
g.,
Overdr
aftandTradeCr
edi
ts

• Li
qui
dit
yr at
iossuchasCur
rentandQui
ckr
ati
osmaydecr
ease,
sucht
hatt
her
e
ar
eli
quidi
tydefi
cit
s

TheOper
ati
ngWCCy
cle

TheWCoper ati
ngcycl
eisthel
engt hofti
met akentoconvertanit
em ofWCf r
om one
staget oanot
herint
heprocessofcashgener ati
on.I
tsactuall
ythel
engthofti
metaken
fr
om t heti
mecashisspentonr awmat eri
alsuptotheti
mecashwi l
lfl
owint
othe
businessfrom t
hesaleoft
hefinishedproduct.
Exampl
e1;
Thef
oll
owi
ngi
nfor
mat
ionr
elat
est
oMaf
utaSaf
iLTD

pur
chaseofRawMat
eri
als6,
700 Av
erager
awmat
eri
alsst
ock 1,
200

Usageofr
awmat
eri
als 6,
500 Av
erageWI
P 1,
000

Sal
eofFG(
all
oncr
edi
t) 25,
000 Av
erageFGst
ock 2,
100

Costofsal
es(
Fini
shedGoods) 18,
000 Av
arageDebt
ors 4,
700

Av
eragecr
edi
tor
s 1,
400

Assumea365day
syear
.Recqui
red;
Thel
engt
hofoper
ati
ngcashcy
cle

Sol
uti
on-
--
--
--

Exampl
e2;
Thef oll
owinginf
ormati
onwasextr
act
edf
rom booksofChangaLTDatt
he
endoft
hef
inancialyear
s31.Oct2006&2007

shs shs

St
ockofRawMat
eri
als 40,
000 60,
000

WI
P 10,
000 18000

FGst
ock 50,
000 70,
000

Tr
adeDebt
ors 140,
000 180,
000

Annual
sal
es 2,
000,
000 2,
200,
000

CostofPr
oduct
ion 1,
000,
000 1,
050,
000

Annual
costofsal
es 1,
200,
000 1,
250,
000

Tr
adeCr
edi
tor
s 110,
000 100,
000

Annual
Pur
chaseofRM 700,
000 780,
000

Requi
red;
TheWor
kingCy
cle(
inday
s)0fChangaLTD.

Br
ief
lyexpl
ain2way
sinwhi
chChangaLTDmi
ghtr
educei
tsWor
kingCapi
tal
Cycl
e

Sol
uti
on-
--
--
--
--
--

Howt
oreduceWCcy
clePer
iod

I
. Gi
vedi
scount
stocust
omer
stoencour
aget
hem t
opayear
ly

I
I.Requestl
ongerCr
edi
tPer
iodsf
rom Cr
edi
tor
s
 I
II
.Reducetheper
iodofpr
oduct
iont
hroughuseofef
fi
cientwor
kfor
ceand
machi
nes

I
V.Reducet
hel
engt
hofRawMat
eri
alsr
emai
ningi
nst
orebef
orepr
oduct
ion
commences

V.Reducet
helengt
hoft
imeFi
nishedgoodsr
emai
ninst
orebef
oret
heyar
esol
dto
cust
omers

CashManagement
Cashflowsintothefi
rm whencust
omerspayf orgoodsandser
vices,
ont heotherhand
cashflowsoutofthefir
m whenthefi
rm paysforgoodsandser
vicesithasacquir
ed.
Mnagementofcashi simport
antsoastot r
ackhowcashf l
owsinandoutoft hefir
m as
wellasthestockofcashweareholdi
ngathand.

I
tsimpor
tantf
orever
yfi
rmtoforecasti
tsneedsanddeci
detheammountofcashto
hol
dataparti
cul
arti
me.Thel
evelofcashtobeheldcanbedeci
deduponbyusingt
he
BAUMELCashManagementModel .

Baumel
CashManagementModel

Itisbasedont heEconomi cOr

derQual i
ty(EOQ)developedf ori
nventorymanagement.
TheEOQdet erminestheammountofcasht hatminimizesthesum oft hehol
dingcost
andt ransact
ionscost.Thehol
dingcostincludesthecostofadmi nist
rati
on(keepi
ng
trackoft hecash)andtheopportuni
tycostofinvest
ingthecashel swhere.Tr
ansacti
on
costist hecostofgatheri
ngmorecashei t
hert hr
oughselli
ngsecur i
ti
esorthrough
bor r
owing.

TheEOQisthel
evelofcashinf
usion(
from sel
l
ingsecur
it
iesorbor
rowi
ng)t
hat
mini
mizest
hetot
alcostassoci
atedwit
hcash

Baumel
'
smodel
denot
edbyCi
sthus;

Wher
e;Ci
sopt
imal
cashbal
ancet
ober
aisedbysel
l
ingsecur
it
ies

Fi
sthef
ixedt
ransact
ionofmaki
ngt
hesecur
it
iest
radabl
e

Ti
sthet
otal
amountofcashneededf
ort
heent
ir
eper
iod

Ki
sthei
nter
estr
ateonsecur
it
ies,
theoppor
tuni
tycostofhol
dingt
hecash
Assumpt
ionsoft
hemodel

• Thecompany
'scashexpendi
tur
eisknowni
nadv
anceandexpect
edt
oremai
n
const
ant

• Ther
ateatwhi
chcashl
oosesv
aluei
sconst
ant

• Ther
eareinvest
mentopport
unit
iesi
nwhi
chshort
-t
erm cashcanbeinvest
edand
i
tispossi
bletotur
nthosei
nvest
mentsi
ntol
i
quidcashinashortper
iodoftime.

• Cashi
suseduni
for
mlyt
hrought
heper
iod

Exampl
e;ThemanagementofKLTDhasest i
mat edthatthecompanywillr
equi
re2.5M
i
ncashfortransactionsdur
ingthecommi ngf
inancialyear
.Theint
erestr
ateon
market
ablesecurit
iesis10%,thecostofconv
erti
ngt hemar ket
abl
esecuri
ti
estocashi
s
50pertr
ansaction.

Usi
ngBamuel
smodel
det
ermi
ne;
-Opt
imal
cashconv
ersi
onsi
ze

-
Aver
agecashbal
ance

Sol
uti
on-
--
--
--
-

Mi
l
ler
-Or
rCashManagementModel

Itwasdev elopedoutofthel
imitat
ionsofBamuel smodel f
orexampl
e;cashcanbeused
unifor
mlyt hroughout
.Thismodel int
roducesuncert
aini
ti
esincashmanagementt
hus
alsoreff
eredt oasProbabi
li
sti
c/Stochasti
c.Accordi
ngtothemodel,
cashhasthe
foll
owinglev el
s

• Thelowerli
mmi tbel
owwhichi
nvent
orydoesnotfal
l.Iti
sthesafet
yst
ockof
cashandthecashonhandmustneverfal
lbel
owthislevel
.Thelowerl
i
mmiti
s
deter
minedbyapplyi
ngex
peri
enceandjudgment

• Ther et
urnpointie,
.thet
argett
ocheckift
heupperandlowerli
mmi t
sar
e
reached.Levelsofcashbelowther
etur
npointar
etol
eratedunt
ilt
heyhi
tthe
safetystocklevel
.

• Theupperli
mitabov
ewhichcashdoesnotr
ise.Thecasht
hatr
isesabov
ethi
s
l
eveli
sinvest
edinmarket
abl
esecuri
ti
es.

• Theretur
npoi
ntandupperl
i
mitar
econsi
der
edasl
evel
stomi
nimi
zet
hecostof
cash.

Desi
cionr
uleofMi
l
ler
-Or
rModel

a.I
fthecashl
i
mithi
tst
heupperl
i
mit
s(H)t
hecompanyshoul
dinv
estH-
Zinshor
t-
 t
erm mar
ket
abl
esecur
it
ies

b.Ift
hecashbal
ancefal
lst
othelowerl
i
mit
(L)t
hecompanyshoul
dconv
ertZ-
Lint
o
cashf
rom market
abl
esecur
it
ies

c. Ift
hethecashbal
ancei
sal
ongt
het
arget
(Z)t
hecompanyneednott
akeany
acti
on

i
. Ther
etur
npoi
ntdenot
edbyZcanbedet
ermi
nedasf
oll
ows;

Wher
e;bi
sthet
ransact
ioncostpert
ransact
ion

d2i
sthev
ari
anceoft
hedai
l
ycashf
low

i
ist
hedai
l
ymar
keti
ntr
estr
atef
ormar
ket
abl
esecur
it
ies

Li
sthel
owerl
i
mit

i
. Theupperl
i
mi H) H=
t( 3Z-2L
i
i
. Theav
eragecashbal
ance

i
v ead=H-
.Spr L
Example;ABCLTDmaintai
nsacashbal anceofksh500,000.Thestandar
ddev i
ati
onof
thecompany '
sdai
l
ycashisksh200,000.Theannualint
erestis14%.Thetransact
ion
costofsell
i
ngandbuyi
ngsecurit
iesisksh150pertransacti
on.

Requi
red;
Usi
ngMi
l
ler
-Or
rcashmodel
det
ermi
ne-

(
a)Theupperl
i
mit(
b)Av
gcashbal
ance (
c)Ret
urnpoi
nt

Sol
uti
on-
--
--
--
-

Debt
orsManagement
Debt
orsar
ecreat
edwhenfir
msall
owthei
rcustomer
stomakepay
ment
satal
aterdat
e.
Byal
lowi
ngpaymentl
atert
hecompanycr
eatestr
adecr
edi
t.
Reasonswhyf
ir
mssel
loncr
edi
t

i
. Tomakesal
esat
tr
act
ivesoast
oincr
easesal
esi
nthel
ongr
un

i
i
. Tomakei
tsst
ockmor
efastandav
oidobsol
escence

i
i
i.Tomai
ntai
nnewcust
omer
swhi
l
eacqui
ri
ngnewones

i
v.Toenabl
euscust
omer
stakeadv
ant
ageofquant
it
ydi
scount
s

v
. Of
fer
ingt
radecr
edi
tswoul
dal
sor
educef
luct
uat
ionsi
npr
ices

Costassoci
atedwi
thgr
ant
ingcr
edi
t

i
. Thefir
mi sf
oregoi
ngtheuseoffundsf
oraper
iodsot
her
eisanoppor
tuni
tycost
associ
atedwit
hgrant
ingcredi
t

i
i
. Costofadmi
nist
eri
ngdebt
ssuchasr
ecor
dkeepi
ngandkeepi
ngt
rackofwhati
s
owed

i
i
i.Theuner
tai
nit
iesofdef
aul
tbyt
hecust
omer

Fact
orst
oconsi
derbef
oregr
ant
ingcr
edi
t

• Howsensi
ti
vet
hegoodsorser
vicey
ouar
eof
fer
ingar
e

• Pr
obabi
l
ityofcust
omer
sdef
aul
ti
ngorpay
ingl
ate

• Whatpr
opot
ionofcust
omer
swi
l
lpaywi
thi
nthedi
scountper
iodi
fdi
scount
sar
e
of
fer
ed

Thedebt
orsattheendoft
heperi
odwillbedet
ermi
nedbyt
hecompany
'scr
edi
tsal
esas
wel
lastheaver
agedebtor
scol
lect
ionperi
od.

TheAv
erageDebt
orsar
ecomput
edasf
oll
ows;

Theav
eragecol
l
ect
ionper
iodi
sdet
ermi
nedbyamongot
herf
act
ors

a.Thecr
edi
tst
andar
d

b.Thecr
edi
tper
iod

c. Di
scountgi
vent
ocust
omer
sforset
tl
ingt
hei
rcr
edi
tear
li
ert
hant
her
equi
redt
ime
 d.Thecompany
'scr
edi
tcol
l
ect
ionper
iod

TheCr
edi
tPol
i
cy
Credi
tpoli
cyconsi
stoftheammountofcr edi
tandtheper
iodal
lowedforpayment.
Thesearetwocommont ypesofpol
ici
esundert
akenbyfi
rmsi.
e,.TheLeni
entCr
edit
poli
cyandtheStri
ngetCreditpol
i
cy.

St
ri
ngetpol
i
cygrant
st hecredi
tter
msonasel
ect
ivebasi
stocust
omer
sthatar
ecr
edi
t
wort
hyandfi
nanci
alystabl
e.

TheLeni entPoli
cyisleni
entandgrantsthecr
edittermsequallytoal
l customers.I
ttur
ns
resultst
oi ncr
easedsalesandcontri
buti
onmar ginbutalsoleadstoi
ncr easedcostse.
g,.
I
ncr easeinopportunit
ycoststi
edupasaccount sreciev
able.Col
lect
ioncost salso
i
ncreaseaswel l
asi ncr
easeindebtexpenses

Cr
edi
tri
skManagement
Itr
eferstopr
oceduresandcont r
olsputinplacebyacompanyt oensurethatt
hereis
eff
ecientcol
l
ectionoft
hecompany '
sdebtsandt oensurethatt
heriskonnon-
pay ment
ofthosedebtorshasbeenreduced.Themai nar eaofconcernincredi
tmanagementi s
whethertograntacust
omercr editornotandconsi der
ationsofhowlongtograntit
.
Credi
tManagementi sgovernedbyt hefol
lowing;

• Cr
edi
tsel
ecti
on-i
.e,
.thepr
ocessofchecki
ngi
facust
omeri
swor
thbei
ng
gr
ant
edcredi
tandupt owhatl
imi
t

• Credi
tStandards-
i.
e.,
Themini
mum accept
abl
econdi
ti
onst
hatacust
omermust
complybeforebei
nggrant
edcredi
t

• CreditTerms-Theprocessofset
ti
ngoutthepaymentperi
odandanydiscount
offer
edi ft
hecredi
tismadeanytimebeforet
hesetperi
od.Afir
m shoul
dcheck
i
tscust omerscashf
lows,ot
hercompeti
ti
vefi
rms'measuresandal
sohow
equit
abl et
hecredi
ttermswil
lbebefor
esetti
ngpol
ici
es

• Col
lectionPolicy-Ar
etheprocedur
esandr ul
esgoverni
ngthecoll
ect
ionofdebt
wheni tbecomesdue.Thepr ocessshouldst
artwit
hpolit
ereminder
sconti
nuing
i
npr ogressi
vley,sev
erest
epsandendi ngupplaci
ngthedebtor
sinthehandsofa
col
lectingagency

Cr
edi
tSel
ect
ion/Scr
eeni
ng

Ifacompanyi stominimizetheri
skofbaddebts,i
thast oper form asound
screeningtoitscust
omer stocheckiftheyarewort
hyofr ecievingthedebt
s.
Therear eseveralmethodsthatcompaniesuseinassessingt hecustomers
wor t
hiness,butthemostcommoni sthatof5CSwhichincludest hefol
lowi
ng;

• Capaci
ty-
Thefir
m wi
llassesst
hecompany'
sabili
tyt
or epaythedebt
.The
anal
ysi
sinthi
scasechecksthecust
omer
sfinanci
alstabil
it
y.
 • Char
act
er-
iti
sthewi
l
li
ngnessoft
hecust
omert
opayt
hedebt
.

• Coll
ater
al-I
tinv
olv
esanal
yzi
ngandev
aluat
ingi
fthecust
omerhasasset
s
tosecurehi
sdebts.

• Condit
ion-I
nvolvesanal
yzi
ngthesensi
ti
vi
tyofthecust
omersabi
l
ityt
opay
wit
hintheunderlyi
ngenvi
ronmente.
g.,
theprev
ail
ingeconomi
cand
marketcondit
ions

• Capital-
Thisinv
olv
esassesi
nghowsust
ainabl
ethecust
omer
scapi
tal
resourcesare.

Fi
rmsuset
hef
oll
owi
ngsour
cest
oassest
hecr
edi
twor
thnessofacust
omer

i
. Pr
evi
ousexper
ienceswi
tht
hecust
omer

i
i
.Ot
hercr
edi
tor
s

i
i
i.Bankr
efer
ences

i
v.Fi
nananci
alaccount
soft
hecust
omer

v
.Cr edi
trat
ingagenci
est
hatpubl
i
shCr
edi
tRat
ingsofv
ari
ouscompani
es
andindi
vi
duals

Fi
nanci
ngofAcount
sReci
evabl
e
Ther
ear
etwoway
soff
inanci
ngaccount
srecdi
evabl
e;-
Pledgi
ng & -
Fact
ori
ng

Pl
edgi
ng

Int
hiscaset hecompanyborrowsandthenusestheaccountsreci
evabl
eascoll
ateral
.
Thearrangementisusual
lybetweent
hecompanyandt helendersandnotthecustomer
whoist hedebtor
.Theri
skofnon-pay
mentisthuswiththecompany .Thecust
omer
paystot hecompanywhereheisadebtorandnottothecompanywher etheyareused
ascoll
at er
al.

Fact
ori
ng

I
nt hiscasethecompanysel l
stheaccountrecievablestoathir
dpartyknownasafact
or.
Ther i
skofnon-paymentinthi
scaseiswiththef actor,
thusthefact
orchargeshi
gh
i
ntrestratesduetouncert
aini
ti
es.Thecust
omer sarerequi
redtopaydirect
lytot
he
factor.Thefact
orpr
ovidesthefol
lowi
ngservices;

• Sal
esl
edgeradmi
nist
rat
ionandcr
edi
tmanagement

• Cr
edi
tpr
oject
ionagai
nstdef
aul
ti
ngcust
omer
s

• Managementoft
hecl
i
ent
sli
qui
dit
y
 • Fi
nanci
aladv
ice

I
nret
urnt
osel
l
ingr
eci
evabl
est
ofact
orst
hef
act
orsear
ntwot
ypesoff
ees;

• Commi
ssi
onf
eechar
gedf
ort
hef
act
ori
ngagr
eenment

• I
nter
estchar
gesi
.e.
,Compensat
ionf
ort
imev
alueofmoney

Di
ff
err
encesbet
weenFact
ori
ngandPl
edgi
ng
1.Pl
edgi
ngi
nvol
vesuseofdebt
orsassecur
it
ywhi
l
efact
ori
ngi
nvol
vessal
eof
debt
orst
oat
hir
dpar
ty(
fact
or)

2.I
npl
edgi
ngdebt
orsar
enotnot
if
iedoft
heagr
eenmentwhi
l
einFact
ori
ng,
debt
ors
ar
enot
if
iedoft
heagr
eement

3.I
npl
edgi
ngdebt
orsar
erequi
redt
opaydi
rect
lyt
othecompany
,howev
eri
n
f
act
ori
ng,
thedebt
orsar
erequi
redt
opaydi
rect
lyt
othef
act
or

4.I
npl
edgi
ng,
thecompanyi
sresponsi
blef
ordef
aul
tri
ski
ncaseofanon-
pay
ment
whi
l
einf
act
ori
ng,
thef
act
ori
sresponsi
blef
ort
hedef
aul
tri
sk.

5.Whi
l
epl
edgi
ngt
hecompanycar
ri
esoutt
hecr
edi
tanal
ysi
s,ont
heot
herhandt
he
f
act
orcar
ri
esoutt
hecr
edi
tanal
ysi
s

6.I
npl
edgi
ngt
hecompanymanagesi
tsownl
edgeraccount
swhi
l
einf
act
ori
ng,
the
f
act
ormai
ntai
nst
hesal
esanddebt
oraccount
sonbehal
foft
hecompany

St
epsi
nanal
yzi
ngt
heFact
oragr
eenment
• Comput
etheav
eragedebt
ors(
AVdebt
ors=AvCol
l
ect
ionPer
iod/
365xCr
edi
t
sal
es)

• Comput
etheammountofr
eser
ve-ar
eser
vei
sapr
ovi
sioni
ncaseofdamage
whi
l
eint
ransi
storwhenr
etur
nedbycr
edi
tbuy
erorsel
l
er

• Comput
etheammountofi
nter
estchar
ges

• Det
ermi
net
heammountadv
ancedusi
ngt
hef
ormul
a;
Amountadv
anced=Debt
ors-
Reser
ves-
Ser
vi ees-
cef Int
erestchar
ge
di
scount
ed

• Comput
eef
fect
iveannual
per
cent
agecost

=
NB;Ifint
aer
estrat
esaredi
scount
editmeansthatthei
nter
estchar
gesarereci
evedi
n
advancedandthusthecompanywil
lreci
evet
heloanammountnetoftheinter
est
charges.

Example1;Acompanyhasannual salesofksh2M, i
nter
estratepais18%andt he
companyisconsideri
ngf
actor i
ngitsdebtorswhereaser vi
cefeeof1. 5%ofammountof
debt
orsfactoredisr
equi
red.A15%r eser
viceisrequi
redbyt hefact
or,andthecompany
hasacreditperi
odof60day s.Assumeay earhas360day sandi nt
erestr
atesare
di
scounted.

Requi
red;
Comput
ethef
undsf
rom t
hef
act
oraswel
last
heef
fect
iveannual
Per
cent
age
cost

Sol
uti
on-
--
--
--
-

Exampl e2;DawamuLTDwhi choper atesintheretailsect

orsel
li
ngasinglepotis
consideri
ngachangeofcreditpolicywhi chwillr
esultinanincr
easeintheaverage
col
lecti
onperiodofdebtor
sf rom onet otwomont hs.Therel
axati
onofthecreditpoli
cy
i
sexpect edtoproduceanincreaseinsal esineachy earammount i
ngto25%oft he
curr
entsalesvolume.Thef ol
lowingi nformati
onisav ail
abl
e;

I
. SPperuni
tis1000

I
I.VCperuni
tis850

I
II
.Cur
rentannual
sal
esi
sksh240M

I
V.Dawamu'
srequi
redr
ateofr
etur
noni
nvest
menti
s20%

V.Iti
sexpectedt
hatthei
ncr
easei
nsal
eswoul
dresul
tinaddi
ti
onal
stockof10M
andaddit
ional
credi
tor
sof2M

Requi
red;
AdviceDawamuoneit
herornottoextendthecredi
tper
iodof
fer
edt
o
cust
omersif
; i )Al
lcust
omer
stakethelongestcr
editof2months

i
i)Exi
sti
ngcust
omersdonotchangethei
rpaymenthabi
tsandonl
ythenew
cust
omer s wi
llt
aket
heful
l2mont hscr
edit

Sol
uti
on-
--
--
--
--
-

I
nvent
oryManagement
I
nventoryr
efer
stoi
nvest
menti
nrawmat
eri
als,
Wor
kInPr
ogr
ess(
WIP)andFi
nished
Goods(FG)

Reasonswhyf
ir
mshol
dst
ock
i
. Tr
ansact
ional
Mot
ive-
hol
dingst
ockt
ocont
inuer
unni
ngt
hebusi
ness

i
i
. Specul
ati
veMot
ive-Tot
akeadv
ant
ageofanypr
icef
lact
uat
ions

i
i
i.Pr
ecaut
ionar
yMot
ive-
Thef
ir
msmusthol
dsuf
feci
entst
ockt
osaf
eguar
dagai
nst
 possi
bil
i
tiesofst
ockout
s

I
nvent
orymanagementai
msatmi
nimi
zi
ngcost
sassoci
atedwi
thI
nvent
oryi
.e.
,

a.Or
dinar
yCost
s-Costofi
nsur
ance,
transpor
tandor
derpr
ecessi
ngcost
s

b.Holdi
ng/
Carr
yingCost
s-I
nsur
ancei
nthewar
ehouse,
per
ishabi
l
itycost
s,t
hef
tof
goodse.
t.
c

c. Pur
chasePr
ice

Asthequal
i
tyheldinthewar
ehouseincr
eases,
theholdi
ngcost
sincr
easeandt
he
or
deri
ngcostdecreaseast
hequanti
tyorder
edincr
eases.

I
ftheEconomi
cOr
derQUal
i
ty(
EOQ)model
isusedt
her
efor
e;

Q-
istheopti
mal
stocksi
zewhent
hehol
dingandor
der
ingcost
sar
eequal
and
mi
nimized

P-
ist
hepur
chasecost

D-
ist
heannual
demand

CO-
ist
hecostperor
der

CH-
hol
dingcostperuni
t/i
nter
estf
oregone

Tot
alSt
ockCost=Pur
chaseCost+Or
der
ingCost+Hol
dingCost

Exampl e;Thedemandf oracomponentmanuf acturedbyacert

aincompanytendst
obe
constantatarateof400unitsp.a.Thecostperunitoft
hiscomponenti
sksh2andt he
costofplacinganorderisksh50.Thecompanyest i
matesthatt
heannualcar
ryi
ngcost
ofthecomponenti sapercentageofpurchasecost20%

Det
ermi
neEOQandt
het
otal
costassoci
atedei
tht
hest
ocks

Sol
uti
on-
--
--
--
--
-

Exampl
e;Cl
eanwashLTDmanuf
act
uresandmar
ket
swashi
ngmachi
nes.Amongt
he
manyhundr edsofcomponent swhichitpurchaseseachy earfrom external suppli
ersfor
assemblingint
of ini
shedart
icl
esaredri
vebel t
swhichituses400, 000uni tsp. a.I
tis
consider
ingconv ert
ingi
tspurchasi
ng,
deliv
eryandst ockcontroll
oft hisit
em t o(
JIT)
system.Thiswil
l rai
sethenumberofordersplacedbutl owertheadmi nistrativeand
othercostsofplacingandreciev
ingor
ders.Ifsuccessful,
thi
swi l
lprovidethemodel f
or
switchi
ngmostofi t
sinwardsuppli
esi
ntothissystem.

Det
ail
soft
hecur
rentandpr
oposedsy
stem

cur
rent pr
oposed

Or
der
ingcostperor
der 10,
000 2,
500

Pur
chasecostperi
tem 25 25

I
nvent
oryhol
dingcost(
asa%ofpur
chasecost
) 20% 20%

Toimplimentt henewarr
angementwillr
equir
eaone-offr
eorgani
zati
oncostsesti
mated
atksh140,000whi chwil
lbetr
eatedasrevenuei
tem f
ortaxpurposes.Ther
ateof
corpor
ati
ont axis32.5%andclearwashLTDcanobtainfi
nanceatanef f
ect
ivecostof
18%.Thelifespanofthenewitem i
s8years

Requi
red;-EOQ

-
TheNPVoft
henewar
rangement
,ist
henewar
rangementwor
thwhi
l
e?

Sol
uti
on-
--
--
--
--
--
--

I
nvent
oryCont
rol
lsy
stems
I
nvent
orymanagementi
nvol
vesinv
ent
orycont
rol
l
syst
emst
hatmoni
tort
hel
evel
of
i
nvent
orydur
ingapar
ti
cul
arperi
od

Two-binMethod-i
sacont
rol
lsy
stem wher
eanor
deri
spl
acedwhenoneoft
hei
nvent
ory
st
ockingequipmenti
sempty

Red-Li
neMethod-i
saproduceinwhichanor
deri
spl
acedoncet
her
edl
i
neusual
l
y
drawnontheinv
entor
yequipmentappear
s

Comput
eri
zedSyst
em -
Usedbymailnl
ylargecompani
est
odet
ermi
net
her
e-or
derpoi
nt
andmakeadj
ust
mentsoncethei
nventoryreci
eved

Outsourci
ngProduct
ion-
Thi
sappear
swhenacompanypur
chasesr
awmat
eri
alsi
nst
ead
ofproduci
ngthem

JustI
nTime(JI
T)-
iswhenthemater
ial
sar
ri
veatt
hest
oresj
ustbef
oret
heyar
eputt
o
useorsol
d.Obj
ect
ivesofJI
Tare;

a.Toel
i
minat
ewast
e

b.Tor
educet
her
e-or
derper
iod
c. Enhanceef
fi
ciencyi
nthepr
oduct
ion

d.Mi
nimi
zest
ockhol
dingcost
s

e. I
mpr
ovequal
i
tyoft
hepr
oduct
s

f
. Reducepr
oduct
ioncost
s

g.Mai
ntai
ngoodr
elat
ionshi
pbet
weensuppl
i
ersandt
hef
ir
m