Chapter 6

Inventory and Account

Receivables Management

 Inventory Management
 Account Receivable Management
Introduction
 Proper inventory management is as important as the
management of other assets in the firm’s working
capital.
 Financial manager should monitor the progress and to
influence the firm’s inventory management as it will
affects the profitability level of the firm.
 Proper management of these inventories is important as
they provide the basis for production and sales and
represents a significant investment for most firms.
Inventory Management
 Types Of Inventory
 Raw material – basic input of production
 Work-in-progress – semi - finished goods
 Finished goods – good that ready for Sell

 Investment in Inventories also involve Risk-

Return Trade-off (i.e. Low Return)
Inventory Management (cont..)
Objective:
To carry sufficient inventories – to support
sales and demand
To maximize inventory turnover – minimize
the investment in Inventories
 Inventory Usage Over Time
Order quantity = Q
Usage Rate
(maximum Average
inventory level) Inventory
(Q*/2)
Inventory Level

Minimum
inventory
0
Time
Inventory Management (cont..)
Cost of Handling Inventories
 Carrying costs - associated with holding or
“carrying” inventory over time; e.g. obsolescence,
insurance, extra staffing, interest, pilferage, damage,
warehousing, etc.
 Ordering costs - associated with costs of placing
order and receiving goods; e.g.. Supplies, forms,
order processing, clerical support, etc.
 Total Inventory Costs - Carrying costs plus
Ordering costs
Inventory Management (cont..)
Economic Order Quantity (EOQ)
Method use to control Inventory
Purpose:
 To Minimize cost
 How many to order
EOQ Model
How Much to Order?
Annual Cost

Minimum
total cost

Order (Setup) Cost Curve

Optimal Order
Order Quantity (Q*) quantity
 EOQ Model Equations
Optimal Order Quantity 2 ×D ×O
= Q* =
C
D
Expected Number of Orders =N =
Q*
Expected Time Between Orders Working Days / Year
=T =
N
D D = Demand per year
d =
Working Days / Year S = Setup (order) cost per order
H = Holding (carrying) cost
d = Demand per day
L = Lead time in days
Inventory Management (cont..)
Total Ordering Cost
TOC = (D/Q) X O

Total Carrying Cost

TCC = [(Q/2) + SS] X C, where SS is Safety Stock

Reorder Point (ROP)

ROP = (d X l) + SS, where d is daily demand, and l is the
lead time
Inventory Management (cont..)
Example of EOQ Model
DEF Corp has an annual usage of 4,000 units.
The ordering cost is RM 100 per order while
the carrying cost is RM 0.80 per unit. The
company holds 17 units as safety stocks. It
takes 7 days for the shipment to arrive.
Inventory Management (cont..)
Solution:
EOQ = √[(2DO)/C]
= √ [(2 X 4,000 X 100) /0.80], 1,000 units
ROP = (d X l) + SS
= (11 X 7) + 17, 95 days
TOC = (D/Q) X O
= (4,000/1000) X 100, RM 400
TCC = [(Q/2) + SS] X C
= [(1,000/2) + 17] X 0.80, RM 413.6
A/C Receivable Management
 A/c Receivable - outstanding amounts owed
to a firm by its customers, as result of credit
sales
 The amount of Acc. Rec. is determined by;
 Volume of credit sales
 Average length of time between sales &
collections (average collection period)
A/C Receivable Management (cont..)
Credit Policy
 Is a system for managing Acc. Rec. that includes
 credit standards

 credit terms, and

 collection policy

 It provides service to customers, smooth out sales and

attract more sales
 One of the variables that could affect the Firm’s Sales (i.e.
besides price, quality, advertising)
 Changes in credit policy involve direct trade-offs between
cost and benefits (i.e. ease credit policy, increases sales
and profits but it could also increase bad debt, cost for
discount )
Credit Standards
 Refers to minimum financial strength and moral standings
of acceptable credit customers.
 Factors involve;
 The willingness to pay
 The ability to pay
 5 C’s of credit;
 Character, attitude (i.e. to honor the obligations)
 Capacity, customer’s ability to pay
 Capital, working capital of customer
 Collateral, assets as a backup for credit
 Conditions, market situation
Credit Terms

 Open terms, line of credits (i.e. 10 days grace period)

 Cash before delivery (CBD), receive cash before
delivery
 Cash in advance (CIA), similar to CBD
 Cash on delivery (COD), immediate cash payment
 Net 30, payment in full within 30 days
 2/10 net 30, entitle for 2% discount if payment made
within 10 days, or payment in full within 30 days
Collection Policy
Guidelines for Violating Collection Policy
 Reminder, duplicate invoice or brief notes

 Follow Up, follow up letters or personal visit

 Drastic Action, using attorney or collecting agent

Implications of changes in Credit Policy
 Credit terms: Lowers price. Attracts new customers and
reduces DSO. Shorter period reduces DSO and average A/R, but
it may discourage sales.
 Credit Standards: Tighter standards reduce bad debt losses,
but may reduce sales. Fewer bad debts reduces DSO.
 Collection Policy: Tougher policy will reduce DSO, but may
damage customer relationships.

A tighter credit policy may discourage sales but increases

cash holdings, invest the cash in more productive assets