6-2. Working Capital Management Flashcards
A/R Management: What is it concerned with?
- Conditions leading to the recognition of receivables
* Process that results in elimination (e.g. collection) of receivables
A/R Management: What is involved in the process?
- Establish general terms of credit
- Determine customer creditworthiness and setting credit limits
- Collecting A/R
A/R Management: what must a firm selling on credit establish?
General terms under which credit will be granted - will be influenced by terms common in its industry.
A/R Management: What are elements of general terms of credit decisions?
- Total credit period - the maximum period for which credit may be extended
- Discount to be offered for early pmt if any
- Penalty for late pmt
- Nature of credit sales documentation if any
A/R Management: What is the objective when deciding whether or not to grant credit to each customer and how much?
Maximize profits, not minimize credit losses.
A/R Management: What happens when the credit policy is too strict?
Strict: Reduces uncollectible accounts, but may result in not making credit sales that would be collected.
What are 2 major approaches to determine whether or not to grant credit?
- Use credit-rating service: obtain and use a rating report from a credit agency (Equifax, Experion, Transunion, Dun & Bradstreet)
- Do financial analysis - usually done by large firms or in special circumstances
A/R Management: What is the objective for collection?
To keep post-sales losses to a minimum.
A/R Management: What are process?
- Monitoring A/R continuously
- Identify overdue accounts
- Prompt collection action
A/R Management: what can a firm use to monitor A/R at aggregate level?
Use averages and ratios;
- Average collection period
- Day’s sales in A/R
- A/R turnover
- A/R to current or total assets
- Bad debt to sales
A/R Management: what can a firm use to monitor A/R at the individual account level?
Use aging of A/R
*Shows the amount owed and how long it has been due for each customer
*amount would be grouped by;
not yet due, 1-30 days over due, 30-60 days, greater than 60 days etc.
A/R Management: What costs may drastic collection actions have?
Financial and goodwill costs
Inventory Management: What is a risk-reward tradeoff?
Under investing to save costs = risk of shortages
Over investing to provide cushion = risk of excessive costs
Inventory Management: Objective?
To neither under invest nor over invest.
Inventory Management: What are 2 general approaches (systems) in US?
- Traditional Materials Requirement Planning (MRP) system
* Just-in-time (JIT) inventory system
Inventory Management: What is Traditional Materials Requirement Planning (MRP) system?
Predominant in US from 1960s to advent of JIT.
- Supply push = goods are produced in anticipation of their sale
- The inventory buffers = inventory is maintained at every level as buffers against unexpected demand
- Production based on long set-up time and long production runs - inflexible system
- Impersonal relationships with suppliers - purchase based on lowest bid
- Quality stds set at an “acceptable” level - allow for certain defects
- Emphasis = job order and processing cost approaches
Inventory Management: What is Just-in-Time inventory (JIT) system?
Originates with Toyota
- Based on obtaining (on the supply side) and delivering (on the sell side) inventory just as and only when needed
- Demand pull = goods are produced only when and as needed by the end user
- Inventory reductions = production and purchasing occur only as needed - inventory reduced or eliminated
- Production in work center (or cells) - workers operate multiple pieces of equipment or robotics are used
- Close working relationships with a limited number of suppliers located physically close to production facilities
- Quality is critical, including inputs to the production process
- Simplified cost accounting with fewer accounts - more items considered direct cost and reducing allocations
Inventory Management: Financial benefits of JIT and related production processes?
- Reduced investment in inventory
- Lower cost of inventory transportation, warehousing, insurance, property taxes and related costs
- Reduced lead time in replenishing production inputs
- Less complex and more relevant accounting and performance measures
Inventory Management: Can JIT be used by every firm?
No
Inventory Management: Regardless of methods, what are 2 elements a firm is concerned?
- The economic order quantity
* The reporter point for its inventory
Inventory Management: The economic order qty: what are the trade off of inventory ordering cost and carrying cost?
Larger the qty ordered, the lower per unit order cost
Larger the qty ordered, the higher the carrying cost
Inventory Management: what is total inventory administrative cost?
Total order costs + Total carrying costs
Inventory Management: what does the economic order qty (EOQ) model determines?
The order size that minimize total inventory administrative costs.
Inventory Management: what is the formula for total order cost? no need to remember
= (Total units / Order size qtry) x Per order cost
= (T/Q) x O
Inventory Management: what is the formula for total carrying cost? no
= (Order size qty / 2) x Per unit carrying cost
= (Q/2) x C
Inventory Management: Formula for total cost? no
TC = [(T/Q) x O] + [(Q/2) x C] or TC = (T x O) / Q + (Qx C) / 2
Inventory Management: Formula for EOQ?
2 TO/C square root.
T = total demand
O = Per order cost
C = Per unit carrying cost
Inventory Management: EOQ EX:
Total demand = 10,000 units, per order cost = $100, Per unit carrying cost = $2.00.
square root of 2 x 10,000 x 100 / 2 = 1,000 units = optimum order qty
Inventory Management: what are assumptions for EOQ?
- Demand is constant during period
- Unit cost and carrying costs are constant during the period
- Delivery is instantaneous
Inventory Management: What is inventory reorder point? Formula?
Determine the inventory qty at which goods should be reordered.
Reorder point = Delivery time stock + Safety stock
Inventory Management: Reorder point ex:
Annual use equally over 50 wks = 300,000 units, delivery time = 2 wks, safety stock = 1,000 units.
[(300,000 / 50) x 2 wks] + 1,000 = 13,000 units = reorder point
Current Liabilities Management: What is the guideline?
- Should be used to finance assets which generate cash in the short-term; the principle of self-liquidating debt.
- Some amount provide a permanent amount of financing
- Normally do not require collateral or impose restrictive covenants
- If requires a compensating balance, the effective cost is greater than the stated cost
- A line of credit, revolving credit and letter of credit provide “stand by” financing
Current Liabilities Management: computing the value of discount ex:
A: 1.5/15, net 30
B: 1/10, net 30
C: 2/10, net 60
A firm must borrow from a bank to take the discount at annual rate of 10%.
Discount% / (100% - discount%) x 360 days / (Total pay period - Discount period).
A: 0.015 / (1 - 0.015) x 360 / (30-15) = 0.3648 - Annual cost of not taking discount. By borrowing from the bank at 10% and taking advantage of the discount, Ruby would benefit by .3653 annual rate saved less .10 annual cost of borrowing = .2653.
