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Lecture Fundamentals of financial management (13/e) - Chapter 10: Accounts receivable and inventory management

This chapter will reveal the key variables involved in managing receivables effi- ciently, and it will show how these variables can be changed to obtain the optimal investment. We consider first the credit and collection policies of the firm as a whole, and then discuss credit and collection procedures for the individual account. The last part of the chapter investigates techniques for efficiently managing the final major current asset account for the typical firm – inventories. | Chapter 10 Accounts Receivable and Inventory Management © 2001 Prentice-Hall, Inc. Fundamentals of Financial Management, 11/e Created by: Gregory A. Kuhlemeyer, Ph.D. Carroll College, Waukesha, WI Accounts Receivable and Inventory Management Credit and Collection Policies Analyzing the Credit Applicant Inventory Management and Control Credit and Collection Policies of the Firm (1) Average Collection Period (2) Bad-debt Losses Quality of Trade Account Length of Credit Period Possible Cash Discount Firm Collection Program Credit Standards The financial manager should continually lower the firm’s credit standards as long as profitability from the change exceeds the extra costs generated by the additional receivables. Credit Standards -- The minimum quality of credit worthiness of a credit applicant that is acceptable to the firm. Why lower the firm’s credit standards? Credit Standards A larger credit department Additional clerical work Servicing additional accounts Bad-debt losses Opportunity costs Costs arising from relaxing credit standards Example of Relaxing Credit Standards Basket Wonders is not operating at full capacity and wants to determine if a relaxation of their credit standards will enhance profitability. The firm is currently producing a single product with variable costs of $20 and selling price of $25. Relaxing credit standards is not expected to affect current customer payment habits. Example of Relaxing Credit Standards Additional annual credit sales of $120,000 and an average collection period for new accounts of 3 months is expected. The before-tax opportunity cost for each dollar of funds “tied-up” in additional receivables is 20%. Ignoring any additional bad-debt losses that may arise, should Basket Wonders relax their credit standards? Example of Relaxing Credit Standards Profitability of ($5 contribution) x (4,800 units) = additional sales $24,000 Additional ($120,000 sales) / (4 Turns) = receivables $30,000 Investment in ($20/$25) x ($30,000) | Chapter 10 Accounts Receivable and Inventory Management © 2001 Prentice-Hall, Inc. Fundamentals of Financial Management, 11/e Created by: Gregory A. Kuhlemeyer, Ph.D. Carroll College, Waukesha, WI Accounts Receivable and Inventory Management Credit and Collection Policies Analyzing the Credit Applicant Inventory Management and Control Credit and Collection Policies of the Firm (1) Average Collection Period (2) Bad-debt Losses Quality of Trade Account Length of Credit Period Possible Cash Discount Firm Collection Program Credit Standards The financial manager should continually lower the firm’s credit standards as long as profitability from the change exceeds the extra costs generated by the additional receivables. Credit Standards -- The minimum quality of credit worthiness of a credit applicant that is acceptable to the firm. Why lower the firm’s credit standards? Credit Standards A larger credit department Additional clerical work Servicing additional accounts Bad-debt losses .