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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Essentials of Managerial Finance by S. Besley & E. Brigham Slide 2 of 18
Cre!it "olicy encompasses of a set of !ecisions that
incl#!e a firm$s cre!it stan!ar!s% cre!it terms% metho!s
#se! to collect cre!it acco#nts% an! cre!it monitoring
proce!#res
n general% firms 'o#l! rather sell for cash than on
cre!it% b#t competiti(e press#res force most firms to
offer cre!it. Firms prefer to !elay their payments%especially if there are no a!!itional costs associate!
'ith the !elay.
Cre!it ManagementCre!it ManagementCre!it "olicy
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Cre!it Stan!ar!s
) Stan!ar!s that in!icate the minim#m financial
strength a c#stomer m#st ha(e to be cre!it 'orthy
Terms of Cre!it ) The payment con!itions offere! to cre!it c#stomers
) *ength of cre!it perio! an! any cash !isco#nts
offere! Collection "olicy
) The proce!#res follo'e! by a firm to collect its
acco#nts recei(ables
Cre!it "olicyCre!it "olicyFactors !etermining the Cre!it "olicy
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Essentials of Managerial Finance by S. Besley & E. Brigham Slide 4 of 18
The process of e(al#ating the cre!it policy an!payment patterns to !etermine 'hether a shift in the
c#stomers$ 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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Essentials of Managerial Finance by S. Besley & E. Brigham Slide 5 of 18
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$s
recei(ables by age of acco#nt. ) The report !i(i!es recei(ables into specifie! perio!s% 'hich
pro(i!es information abo#t the proportion of recei(ables that
are c#rrent an! the proportion that are past !#e for gi(en
lengths of time.
Metho!s for monitoring recei(ablesMetho!s for monitoring recei(ables
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Essentials of Managerial Finance by S. Besley & E. Brigham Slide 6 of 18
Both the S an! aging sche!#le can be !istorte! ifsales are seasonal or if a firm is gro'ing rapi!ly. A
!eterioration in either the S or the aging sche!#le
sho#l! be ta/en as a signal to in(estigate f#rther% b#t not
necessarily as a sign that the firm$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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ptimal in(entory le(el
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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ptimal in(entory le(el
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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ptimal in(entory le(el
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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Essentials of Managerial Finance by S. Besley & E. Brigham Slide 15 of 18
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