Chapter 15. Management of Accounts Receivable and Inventories.

For most companies, accounts receivable and inventories are very important investments, often dominating fixed-asset investments. With the concern for return on assets expressed by many companies in recent years, there has come ever-increasing focus on the funds committed to receivables and inventories.

CREDIT POLICIES.
Economic conditions and the firm's credit policies are the chief influences on the level of a firm's account receivable.

Credit policy embraces terms of sale and quality standards for acceptance.

Credit Standards.
Credit policy can have a significant influence on sales. In theory, the firm should lower its quality standard for accounts accepted as long as the profitability of sales generated exceeds the added costs of the receivables.

The longer the credit period, the more funds that are tied up in receivables.

Credit Period.
Credit terms involve both the length of the credit period and the discount given. The term "2/10, net 30" means that a 2 percent discount is given if the bill is paid before the tenth day after the date of invoice; payment is due by the thirtieth day.

Discount Given.
Varying the discount given involves an attempt to speed up the payment of receivables. To be sure, the discount also may have an effect on demand and bad-debt losses. Holding constant these factors, we must determine whether a speedup in collections would more than offset the cost of an increase in the discount.

Seasonal Datings.
During periods of slack sales, firms will sometimes sell to customers withouth requiring payment for some time to come.

Datings can also be used to avoid inventory carrying costs. If sales are seasonal and production is steady throughout the year, there will be buildups in finished goods inventory during certaint times of the year.

Default Risk.
In the foregoing examples, we assumed no bad-debt losses. Our concern in this section is not only the slowness of collection but also the portion of the receivables defaulting.


COLLECTION POLICY.
The firm determines its overall collection policy by the combination of collection procedures it undertakes. These procedures include telephoning the customer, sending a letter, resending the invoice, sometimes paying a person a visit, and legal action.

The Trade-off.
If sales are independent of the collection effort, the appropriate level of collection expenditure again involves a trade-off with the reduction in the cost of bad-debt losses and reduction in receivables on the other.

Collection efforts provide diminishing returns beyond some point.

Other Considerations.
In most cases, sales are likely to be affected adversely if the collection efforts of the firm become too intense and customers become increasingly irritated.

Summary of Credit and Collection Policies.
We see that the credit and collection policies of a firm involve several decisions:
(1) the quality of the account accepted,
(2) the credit period,
(3) the cash discount given,
(4) any special terms such as seasonal datings, and
(5) the level of collection expenditures.

In each case, the decision should involve a comparison of possible gains from a change in policy and the cost of change.

Effects of Changing Credit Standards. For most policy variables, profits increase at a decreasing rate up to a point and then decrease as the policy is varied from no effort to an extreme effort.


EVALUATING THE CREDIT APPLICANT.
Having established the terms of sale to be offered, the firm must evaluate individual credit applicants and consider the possibilities of a bad debt or slow payment.

Sources of Information.
A number of sources supply credit information, but for some accounts, especially small ones, the cost of collecting it may outweigh the potential profitability of the account. The firm extending credit may have to be satisfied with a limited amount of information on which to base a decision.

The credit analyst may use one or more of the following sources of information:
* Financial Statement.
* Credit Ratings and Reports.
* Bank Checking.
* Trade Checking.
* The Company's Own Experience.

Credit Analysis.
Having collected credit information, a company must make a credit analysis of the applicant and determine if the company falls above or below the minimum quality standard.

In addition to analyzing financial statements, the credit analyst will consider the character and strength of the company and its management, the business risk associated with its operation, and various other matters.

Credit Scoring. Discriminant analysis, a statistical technique, is used to determine a credit score for a credit applicant.

Sequential Investigation Process. The amount of information collected should be determined in relation to the expected profit from an order and the cost of investigation. More sophisticated analysis should be undertaken only when there is a chance that a credit decision based on the previous stage of investigation will be changed.

The value of more information must be balanced against its cost.

The Credit Decision.
Once the credit analyst has marshaled the necessary evidence and has analyzed it, a decision must be reached on the disposition of the acount.

In an initial sale, the first decision to be made is whether or not to ship the goods and extend credit. If repeat sales are likely, the company will probably want to establish procedures so that it does not have to evaluate the extension of credit each time an order is received (for example, establish a line of credit for an account).

Outsourcing Credit and Collections.
The entire credit/collection function can be outsourced. As with the outsourcing of any business function, it is a question of core competence.


INVENTORY MANAGEMENT AND CONTROL.
Inventories form a link between production and sale of a product. A manufacturing company must maintain certain amount of inventory during production, the inventory known as work in process (WIP).

Benefits versus Costs.
Although other types of inventory -namely, raw materials and finished goods- are not necessary in the strictest sense, they allow the company to be flexible. Raw materials inventory gives the firm flexibility in its purchasing. Finished goods inventory allows the firm flexibility in its production scheduling an in its marketing.

The obvious disadvantages are the total cost of holding the inventory, and the required return on capital tied up in inventory. An additional disadvantage is the danger of obsolescence.

Economic Order Quantity.
The economic order quantity (EOQ) is an important concept in the purchase of raw materials and in the storage of finished goods and in-transit inventories. In our analysis, we wish to determine the optimal order quantity for a particular item of inventory, given its forecasted usage, ordering cost (O), and carrying cost (C).

Total Costs = Carrying costs + Ordering costs
T = CQ/2 + SO/Q

EOQ: The Famous Formula.
To determine the optimal order quantity, Q*, we differentiate the equation above with respect to Q and the set the derivative equal to zero.

Q* = Sq.Rt.(2SO/C)

EOQ balances fixed ordering costs against variable carrying costs.


UNCERTAINTY AND SAFETY STOCK.
Typically, the demand for finished goods inventory is subject to the greatest uncertainty. In general, the use of raw materials inventory and in-transit inventory, both of which depend on the production scheduling, is more predictable.

Order Point and Safety Stock.
When we allow for uncertainty in demand for inventory as well as in lead time, a safety stock becomes advisable. The order point determines the amount of safety stock held. Safety stock is important in absorbing random fluctuations in usage and in lead times.

The Amount of Safety Stock.
The proper amount of safety stock to maintain depends on several things:
* The uncertainty associated with the forecasted demand for inventory.
* The uncertainty of lead time to replenish stock.
* The cost of running out of inventory.
* The cost of carrying additional inventory is crucial. If it were not for this cost, a firm could maintain whatever stock was necessary.

Just-in-Time Inventory Control and the Internet.
Just-in-time (JIT) inventory control implies the idea that inventories are acquired and inserted in production at the exact times they are needed. This requires efficient purchasing, very reliable suppliers, and an efficient inventory-handling system. The coordination of various suppliers in an efficient manner is known as supply chain management.

For standard inventory items, the use of Internet has greatly facilitated supply chain managmente. A number of exchanges have developed for business-to-business (B2B) types of transactions.


INVENTORY AND THE FINANCIAL MANAGER.
A financial manager's concern is with inventory turns and monies tied up in inventories.

Monitoring Amounts Tied Up in Inventories.
It is very important for the financial manager to watch the inventory turnover ratio. A deteriorating trend over time (decreasing inventory turns from one period to the next) should set off an alarm. More and more funds are being tied up in inventory.

Also, a deteriorating turnover ratio may indicate obsolescence problems in addition to the cost of carrying inventories.

Watching Inventory Risks.
The major risk is that the market value of specific inventories will be less than the value at which they were acquired. Certain types of inventory are subjecto to obsolescence, whether it be in technology or in consumer tastes. Other inventories, such as agricultural products, are subject to physical deterioration. In other situations, the principal risk is that of fluctuations in market price.

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EJERCICIOS - Serie 3 - Capítulo 15