1. Current Asset Management & Short-term Financing1 1 1 1 1 1 1 1 1

2. LEARNING OBJECTIVES At the end of the chapter, you should be able to;
Describe the facets of accounts receivable management
Describe inventory management
Calculate the economic order quantity and optimal level of safety inventory
Outline inventory control systems, including just-in-time

3. Inventory Management Inventories consist of:
raw materials,
work in progress, and
finished goods
Inventory levels are influenced by sales and other factors such as the competitive environment and the industry sector
The object of inventory management is to balance a set of costs
Inventory holding costs increase with larger inventory holdings
Inventory ordering costs decrease with larger order sizes

4. Inventory Management What are examples of inventory holding costs?
Warehousing costs – rent & security
Interest on funds invested in inventory
Insurance
Obsolescence
Shrinkage
What are examples of ordering costs?
Transport costs per order
Order initiation costs
Receiving and management costs
Quality control and verification costs
Planning and production management due to smaller orders
Sourcing costs

5. Inventory Management Excessive inventories affect profitability:
they have substantial carrying costs
erode profit margins, and
reduce the asset-turnover ratio
Alternatively: minimal levels of raw material and work-in-progress inventories could disrupt the production process
Adequate inventory levels of finished goods ensures that demand is met rapidly
An accurate information system is important : computerised point-of-sales terminals

6. Inventory Models
The Economic Order Quantity( EOQ) model assumes that two types of costs exist:
The holding cost - increases as order size gets larger
The ordering cost – decreases as order size gets larger
If carrying costs are added to ordering costs, the sum= total ordering and holding costs
The intersection point = minimal total cost which is the EOQ
The main assumptions of EOQ are:
Sales can be forecasted perfectly
Sales are evenly distributed throughout the year
Orders are received with no unexpected delays

7. EOQ Formula

8. EOQ Graph

9. Inventory Control Systems
EOQ model establishes the optimum ordering quantity and the level of inventory
An inventory ordering and control system is essential. Re-order points are determined by demand patterns
Physical methods for re-order points can be used - bin/reserve bin system
Computerised inventory-control systems automatically update inventory records
Bar coding by means of an optical scanner updates inventory records
Management should concentrate on high value items- 10% physical quality = 90% of value

10. Inventory Management Assumption: 50 weeks in a year
Therefore weekly demand = units/50
= 40 units per week

11. Inventory Management
Example: “Keep-fit” books. Selling price is R400 and cost is R200 per book. The ordering cost is R125 per unit and the carrying cost is R50 per unit per year. Annual demand is units per year.
EOQ
Average inventory is 100/2 = 50 units
Total cost at EOQ is:

12. Uncertain Demand and Safety Inventory

13. ABC Inventory System
Items are evaluated on their costs, frequency of usage, seriousness of being out of inventory, order lead time
Category A: expensive, frequently used, long order lead times (monthly)
Category B: less important and less frequently used (adjusted less frequently)
Category C: unimportant and least frequently used (reviewed annually)

14. Just-in-Time (JIT) Inventory Management
Delivery of materials and components from suppliers just as they are required for production
A business using JIT inventory system does not require warehousing and other storage facilities and holding costs are minimised.
Efficiency and quality
A small number of reliable suppliers - to deliver frequently and guarantee quality
The aim of JIT is to reduce the total cycle time from raw material to sale

15. Just-in-Time continued… The Risks
JIT has resulted in improvements in quality and reduction of costs
But there are risks:
the system is fully optimised, interdependencies are compounded and there are higher risks of shutdown
companies should not rely on only one supplier for any component or material
increases in insurance premiums and transportation costs
higher risks of business disruption , increase in insurance risk and higher levels of inventory
volatility of input pricing
Hold inventories of components and materials that are critical, purchased from one supplier, and at a higher risk of disruption of supply.

16. Material Requirements Planning (MRP)
Manufacturing Resource Planning
(MRP II)
Enterprise Resource Planning (ERP)

17. Credit Policy What are the costs associated with selling on credit?
The cost of bad debts
The cost of financing debtors
The administrative costs of managing debtors
In contrast: An optimal credit policy can enhance sales and maximise net profits in relation to relevant risks
Credit sales reduce finished goods inventory and create accounts receivable
Sales are pivotal to greater turnover and increase in profitability
Some controllable factors of sales are: the quality of the product, the pricing and credit policy
The credit policy involves making decisions regarding:
creditworthiness
Collection policy and settlement discounts

18. Creditworthiness
The credit manager, in assessing the creditworthiness of a potential customer needs to consider the customer’s:
Attitude and commitment (Character)
Credit history (Capacity)
Financial position (Capital)
Security offered (Collateral)
The environment in which the customer operates
(Conditions)
The state of the general economy will also impact on the decision. Why?
The creditworthiness of any customer is enhanced when the economy is doing well and the customer’s business is performing well.

19. Setting the Collection Policy
The procedure for collection of overdue accounts could affect :
sales,
collection period,
losses arising from bad debts and
the percentage of customers taking discounts

20. Setting Settlement Cash Discount Policy
The use of settlement discounts encourages early payment
The policy is determined by:
Cost of discount -vs.- benefit of cash flow
The benefits to this system are :
It attracts customers who perceive discounts as price reductions
It reduces the average collection period

21. Analysing the Impact of a Change in Credit Policy on Profitability (net income)
Management is primarily concerned with the balance between risk and return
A change in credit policy would affect the following:
The turnover of the firm and its gross profit
The amount of receivables outstanding
As credit quality has changed, there is likely to be a change in bad debt losses
If there is a change in the discount policy , there will be a change in the cost of discounts

22. Example: Analysis of a Change in Credit Policy
The terms of the formula may be positive or negative
All terms in this formula need not be used in a particular analysis e.g. a change in credit policy may increase the cost of a discount but have no impact on bad debts

23. Analysis of a Change in Credit Policy
Orix Ltd is changing its credit terms from : 3/15 net 30, to 5/10 net 60. All sales are on credit – 70% of customers currently take advantage of the 3% cash discount
Under new credit policy:
60% of customers to take advantage of the cash discount and the average collection period to increase from 20 days to 30 days. Sales are to increase from R240m to R270m. Gross profit margin remains unchanged at 20%. Bad debts losses = 2% of sales. Opportunity cost =10% per annum.
The increase in gross profit will be :
20% x R = R

24. Example 12.1 (continued) Why 0.8? Existing Sales New Sales
Increase in incremental investment–new and existing sales
Expected incremental investment relating to existing sales=Increase in average collection period x existing turnover ÷ no of days in the year. The investment in relation to new sales will be the investment required to cover the cost of sales.
Total = R R = R
Cost of carrying receivables = 10% x = R
Cost of bad debts = R [270m x 0.4 x 2% - 240m x 0.3 x 2% ]
Cost of discounts = R
[(270m x 60% x 5%) – (240m x 70% x 3%) ]
Change in net income = R R R R = + R
Why 0.8?
Existing Sales
New Sales
NB: cost of bad debt applies only to credit sales who do not take the early discount

25. Accounts Receivable Management
Management of accounts receivable starts with the decision to grant credit
This is the responsibility of the credit manager who needs an effective accounts receivable control system
An accounts receivable control system monitors the credit policy application. It helps prevent;
the build up of receivables,
the decline of cash flows, and
increases in bad debts
The total amount of accounts receivable is determined by:
The volume of credit sales
The average length of time between sales and collections
Accounts receivable = credit sales per day x collection period

26. Accounts Receivable Management: Aging Analysis
Comparison of the average collection period to the credit terms
Use Aging schedule to analysis status of debtors