1. Managing Short-Term Assets
Chapter 14
Managing Short-Term Assets

2. Credit Management Credit Policy
Credit Policy encompasses of a set of decisions that include a firm’s credit standards, credit terms, methods used to collect credit accounts, and credit monitoring procedures
In general, firms would rather sell for cash than on credit, but competitive pressures force most firms to offer credit. Firms prefer to delay their payments, especially if there are no additional costs associated with the delay.

3. Factors determining the Credit Policy
Credit Standards
Standards that indicate the minimum financial strength a customer must have to be credit worthy
Terms of Credit
The payment conditions offered to credit customers
Length of credit period and any cash discounts offered
Collection Policy
The procedures followed by a firm to collect its accounts receivables

4. Receivables Monitoring
Credit Management
Receivables Monitoring
The process of evaluating the credit policy and payment patterns to determine whether a shift in the customers’ payment pattern occurs or whether the credit policy needs modifications

5. Methods for monitoring receivables
The days sales outstanding (DSO) represents the average length of time required to collect accounts receivable.
The DSO is calculated by dividing accounts receivable by daily credit sales.
The DSO can be compared with the industry average and the firm’s own credit terms to get indication of how well customers are adhering to terms prescribed and how customers’ payments, on average, compare with the industry average.
An aging schedule is a breakdown of a firm’s receivables by age of account.
The report divides receivables into specified periods, which provides information about the proportion of receivables that are current and the proportion that are past due for given lengths of time.

6. Monitoring receivables
BEWARE! Things to note!
Both the DSO and aging schedule can be distorted if sales are seasonal or if a firm is growing rapidly. A deterioration in either the DSO or the aging schedule should be taken as a signal to investigate further, but not necessarily as a sign that the firm’s credit policy has weakened.
If a firm generally experiences widely fluctuating sales patterns, some type of modified aging schedule should be used to correctly account for these fluctuations.
If the average collection period or DSO is increasing the firm should consider toughening its credit policy to prevent credit to more customers

7. Analysis of changes in credit policy
Marginal Costs and Benefits (will revenues rise more than costs?)
Analyze change in sales, change in variable operating costs, change in average collection period and change in carrying cost of receivables
Proposed changes should be evaluated the same way as capital budgeting projects would be; changes should be made only if NPV Proposal > 0.
BEWARE: There is quite a bit of uncertainty in credit policy change analysis because the variables are very difficult to estimate. Further, the end result depends on competitors’ reactions. Thus, the final decision is based on the quantitative analysis plus a great deal of informed judgment.

8. Inventory Management Raw Materials Work In-Process Finished Goods
Types of inventory
Raw Materials
Inventories purchased from suppliers that will ultimately be transformed into finished goods
Work In-Process
Inventory in various stages of completion
Finished Goods
Inventories that have completed the production process and are ready for sale

9. Optimal inventory level
Inventory Management
Optimal inventory level
The goal of inventory management is to provide the inventories required to sustain operations at the lowest possible cost. Steps: (a) Identification of costs involved in purchasing and maintaining inventory, (b) Determination at what point those costs are minimized.
There are 3 categories of inventory costs.
Carrying costs are associated with having inventory, such as rent paid where the inventory is stored, and they generally increase in proportion to average amount of inventory carried.
Ordering costs are associated with placing and receiving an order for new inventory, including costs of generating memos etc. The costs of each order are fixed regardless of order size.
Costs associated with running short of inventory (stockouts).

10. Total inventory costs (TIC) Total carrying costs Total ordering costs
Optimal inventory level = +
Total inventory costs (TIC)
Total carrying costs
Total ordering costs
C – carrying cost as a percent O – cost per order
PP – purchase price of inventory T – total demand in units
Q – quantity

11. Optimal inventory level
Economic Order Quantity Model (EOQ)
The optimal quantity that should be ordered
It is the quantity that will minimize the total inventory costs.
The Formula for determining the order quantity that will minimize total inventory costs is the following:

12. Optimal inventory level
Assumptions of the EOQ model
sales are evenly distributed throughout the period examined and sales can be forecasted perfectly,
orders are received when expected
the purchase price, PP, of each item in inventory is the same regardless of the quantity ordered.
The following results occur:
As amount ordered increases, total carrying costs increase but total ordering costs decrease, and vice versa.
If less than the EOQ amount is ordered, then the higher ordering costs more than offset the lower carrying costs.
If greater than the EOQ amount is ordered, the higher carrying costs more than offset the lower ordering cost.

13. Optimal inventory level
But EOQ model should be extended because assumptions for the basic EOQ are unrealistic
If there is a delay between the time inventory is ordered and when it is received, the firm must reorder before it runs out of inventory. So, the reorder point is the level of inventory at which an order should be replaced.
Even if additional inventory is ordered at the appropriate reorder point, unexpected demand might cause it to run out of inventory before the new inventory is delivered. To avoid this, the firm could carry safety stocks.
Suppliers often offer discounts for ordering large quantities; such discounts are called quantity discounts. To evaluate taking or not taking a quantity discount, the savings of the quantity discount are compared against the increased costs of ordering (and holding) a nonoptimal amount.
For most firms, it is unrealistic to assume that demand for an inventory item is uniform throughout the year. Thus, the EOQ model cannot be used on an annual basis.

14. So, how to determine a successful inventory management?
A successful inventory management is a multi-management process that requires interaction with departments, such as sales and production, but also knowledge of the economy and the business cycles are important to be able to evaluate, for instance, unexpected demand.

15. Inventory Control Systems
Introduction
The EOQ model can be used to help establish the proper inventory level, but inventory management also involves the establishment of an inventory control system. These systems vary from the extremely simple to the very complex.

16. Inventory Control Systems
Control procedures
Red-Line Method
An inventory control procedure in which a red line is drawn around the inside of an inventory-stocked bin to indicate the reorder point level
Computerized Inventory Control System
A system of inventory control in which a computer is used to determine reorder points and to adjust inventory balances

17. Inventory Control Systems
Control procedures
Just-In-Time System
A system of inventory control in which a manufacturer coordinates production with suppliers so that raw materials or components arrive just as they are needed in the production process
OutSourcing
The practice of purchasing components rather than making them in-house

18. ST-3 change in credit policy (page 610)
Proposed problem
ST-3 change in credit policy (page 610)