Accounts Receivable and Inventory Management

Billy Leon P.|Hesty Oktariza | Neww

Accounts Receivable Management
Size of Investment in Accounts Receivable ‡Percent of Credit Sales to Total Sales ‡Level of Sales ‡Credit and collection policies Terms of Sale Quality of Customer Collection Efforts

‡ Terms of Sale
‡ Quoted as a/b net c , which means deduct a% if paid within b days, otherwise pay within c days. ‡ Example: 3/30 net 60 means deduct 3% if paid within 30 days, otherwise pay the entire amount within 60 days.
Chapter 20 : Accounts Receivable and Inventory Management

Terms of Sale
‡ Annualized opportunity cost of foregoing a discount:

‡ Opportunity cost of foregoing 3/30 net 60: = 37.11%
Chapter 20 : Accounts Receivable and Inventory Management

Type of customer
The costs associated with extending credit to lower-quality customers include: a. Increased costs of credit investigation b. Increased probability of customer default c. Increased collection costs

Chapter 20 : Accounts Receivable and Inventory Management

Credit scoring
The numerical credit evaluation of each candidate

Chapter 20 : Accounts Receivable and Inventory Management

Collection efforts
The key to maintaining control over the collection of accounts receivable is the fact that the probability of default increase with the age of the account

Chapter 20 : Accounts Receivable and Inventory Management

One common way of evaluating the current situation is ratio analysis. ‡ examining the average collection period ‡ ratio of receivables to assets ‡ ratio of credit sales to receivables (accounts receivable turnover ratio) ‡ amount of bad debts relative to sales over time ‡ aging of accounts receivable schedule
Chapter 20 : Accounts Receivable and Inventory Management

‡ Once delinquent accounts have been identified, the third and final variable is determined by the firm s collection policies. A direct trade-off does exist between collection expenses and lost goodwill on one hand and non-collection of accounts on the other, and this trade-off is always part of making the decision.
Chapter 20 : Accounts Receivable and Inventory Management

‡ Credit should be extended to the point that marginal profitability on additional sales equals the required rate of return on the additional costs we have to consider investment in inventories + receivables + change in cost of cash discount to generate those sales.

Chapter 20 : Accounts Receivable and Inventory Management

INVENTORY MANAGEMENT

Inventory Management
Raw Materials Inventory

The purpose of carrying inventories is to uncouple the operations of the firm.

Stock of Cash

Types of Inventory

Work-InProcess Inventory

Finished Goods Inventory

Chapter 20 : Accounts Receivable and Inventory Management

Trade-Off in Investment on Inventory
Too much inventory is expensive and wasteful.

Not enough inventory can result in lost sales
Chapter 20 : Accounts Receivable and Inventory Management

Inventory Management Techniques

‡ In order to effectively manage the investment in inventory, there are two problems must be dealt with: a) Order Quantity Problem(how much to order) b) Order Point Problem (how often to order)

Chapter 20 : Accounts Receivable and Inventory Management

a. Order Quantity Problem

The economic order quantity (EOQ) model attempts to determine the order size that will minimize total inventory costs.

Chapter 20 : Accounts Receivable and Inventory Management

Economic Order Quantity (EOQ) Model Quantity
‡ Determining Optimal Inventory (where total costs are minimized)

Total Inventory Cost

Total Carrying Cost

Total Ordering Cost

Chapter 20 : Accounts Receivable and Inventory Management

Inventory Cost
Carrying Costs
Average Inventory Carrying Cost per Unit

Q 2

‡ ‡ ‡ ‡ ‡ ‡ ‡

C
Where : Q = the inventory size (in unit) C = Carrying cost per unit

Warehouse rent Insurance Security costs Utility costs Maintenance costs Property taxes Move and re-arrange, obsolescence, and ‡ Opportunity cost, i.e., using cash for profitable projects rather than being tied up in inventory

Chapter 20 : Accounts Receivable and Inventory Management

Inventory Level (units)

The EOQ Model assumes the firm orders a fixed amount (Q) at equal intervals.

Order Quantity Q

Time
Chapter 20 : Accounts Receivable and Inventory Management

The EOQ Model
Inventory Level (units)

Average inventory =

Order Quantity 2

Order Quantity Q

Time
Chapter 20 : Accounts Receivable and Inventory Management

The EOQ Model
Cost ($)

Carrying Costs

Carrying costs increase as the size of the inventory increases.

Order Size (units)
Chapter 20 : Accounts Receivable and Inventory Management

Inventory Cost
Ordering Costs
Number of Orders Ordering Cost per order

‡ Clerical expense ‡ Telephone ‡ Material Resource Planning (MRP) system ‡ Managementtime ‡ Receiving cost

S Q

O
Where : Q = the inventory size (in unit) S = total demand in units over planning period
Chapter 20 : Accounts Receivable and Inventory Management

The EOQ Model
Cost ($) Ordering Costs, per unit

Ordering costs per unit go down as order size increases. Assumes ordering costs are relatively fixed.

Order Size (units)
Chapter 20 : Accounts Receivable and Inventory Management

The EOQ Model
The economic order quantity is the intersection of the X and Y points where total inventory cost is minimized

Total Cost = Q x C + S x O 2 Q
Cost ($) Y

Carrying Costs = ( Q ) C 2

X

Ordering Costs
Chapter 20 : Accounts Receivable and Order Size (units) Inventory Management

= (S) O Q

Total Inventory Cost

Total Carrying Cost

Total Ordering Cost

Total Inventory Costs
Where: Q S C O

=

(

Q 2

)C +(

S Q

)O

= Order Size (order quantity) = Annual Sales Volume = Carrying Cost per Unit = Ordering Cost per Order
Chapter 20 : Accounts Receivable and Inventory Management

a. Order Quantity Problem (cont d)
Determining Optimal Inventory ± The ordering quantity that minimizes the total costs of inventory.

Q* =

2 SO C

Chapter 20 : Accounts Receivable and Inventory Management

a. Order Quantity Problem (cont d)
Example: Awesome Autos expects to sell 1,560 new automobiles in the next year. It currently costs $40 per order placed with the manufacturer. Carrying costs amount to $50 per auto. a. How many autos should they order each time they place an order? 2(1560)40 50

Q=

2xSxO C

=

= 49.96 } 50 cars

b. How many orders per year? How much does it cost? ‡ Q = autos in each order ‡ Order/year= S/Q = 1,560/ 50 = 31.2 orders each year ‡ Ordering cost = 31.2 x $40 = $1,248
Chapter 20 : Accounts Receivable and Inventory Management

Basic Assumptions in EOQ
1. 2. 3. 4. Constant or uniform demand. Constant unit price regardless of amount ordered. Constant carrying costs per unit. Constant ordering costs per order regardless of the size of the order. 5. Instantaneous delivery. 6. Independent orders.

Chapter 20 : Accounts Receivable and Inventory Management

b. Order Point Problem
Order Point The quantity to which inventory must fall in order to signal that an order must be placed to replenish an item. ‡ How low inventory should be depleted before it is reordered? ‡ When to order?

Chapter 20 : Accounts Receivable and Inventory Management

b. Order Point Problem (cont d)
‡ Safety Stock Inventory held to accommodate any unsually large and unexpected usage during delivery time. ‡ Delivery Time Stock The inventory needed between the order date and the receipt of the inventory needed.
Chapter 20 : Accounts Receivable and Inventory Management

b. Order Point Problem (cont d)

Order new inventory when the level of inventory falls to this level

Delivery-time stock

Safety stock

*Delivery-time stock = Delivery Time X Daily usage

Chapter 20 : Accounts Receivable and Inventory Management

b. Order Point Problem (cont d)

Average = inventory

EOQ 2

+ safety stock

Chapter 20 : Accounts Receivable and Inventory Management

Inventory Management with Safety Stock- Order
Inventory Level (units) 70 Inventory Order Point

EOQ
50

Depleted Stock During Delivery Safety Stock
20

Actual Delivery Time
Chapter 20 : Accounts Receivable and Inventory Management

Time

What is the proper amount of safety stock?
Depends on the: ‡ ‡ ‡ ‡ Amount of uncertainty in inventory demand Amount of uncertainty in the delivery time Cost of running out of inventory Cost of carrying inventory

Chapter 20 : Accounts Receivable and Inventory Management

Inflation and Relationship Between EOQ Model
‡ Anticipatory Buying
buying in anticipation of a price increase to secure the goods at a lower cost ‡ The Inflation Effect inflation affects the EOQ model is through increased carrying costs

Chapter 20 : Accounts Receivable and Inventory Management

Objectives 
Determining Optimal Inventory  to determine the order size that will minimize total inventory costs.

Q* =

2SO C

‡ where Q*= the optimal order quantity in units O = ordering cost per order S = total demand in units over the planning period C = cost of carrying 1 unit in inventory Chapter 20 : Accounts Receivable and
Inventory Management

‡ Example:

Lumber Autos expects to sell 1,560 new automobiles in the next year. It currently costs $40 per order placed with the manufacturer. Carrying costs amount to $50 per auto. How many autos should they order each time they place an order?

Q* =

2SO C

=

2(1560)40 50

= 49.96 } 50 cars

Chapter 20 : Accounts Receivable and Inventory Management

Just-In-Time Inventory Control
‡ JIT System is one link in Supply Chain Management (SCM) ‡ JIT is an approach to inventory management and control in which inventories are acquired and inserted in production at the exact times they are needed ‡ The objective of JIT System is to cut down the inventory at the minimum level, and the time and physical distance between the various production operations also minimized ‡ How about Just-In-Case System? Chapter 20 : Accounts Receivable and
Inventory Management

Total Quality Management (TQM)
‡ What is TQM? ‡ Why TQM are needed? ‡ The Financial Consequences of Quality-The Traditional View ‡ The Financial Consequences of Quality- The TQM View

Chapter 20 : Accounts Receivable and Inventory Management

The Financial Consequences of QualityThe Traditional View
‡ Preventive Cost  Cost resulting from design and production efforts on the part of the firm to reduce or eliminate defects ‡ Appraisal Cost  Cost of testing , measuring, and analyzing to safeguard against possible defects going unnoticed ‡ Internal Failure Cost  Cost associated with discovering poor-quality products prior to delivery (reworking the product, downtime cost, discounts) ‡ External Failure Cost  Cost resulting from a poor-quality product reaching the customers· hand (warranty product, recall product, lost sales cost) Chapter 20 : Accounts Receivable and
Inventory Management

The Financial Consequences of QualityThe TQM View
‡ The TQM view argues that higher quality will result in increased sales and market share ‡ In fact, by use TQM model it can drop manufacturing cost significantly

Chapter 20 : Accounts Receivable and Inventory Management

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