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AR & Inventory Management (New plan (Step 2: Cost of marginal…
AR & Inventory Management
Importance of AR management
Represents a large portion of a firm's assets
Affects
Liquidity
Efficient collection = Steady cash inflows = Meet short term payments
Profitability
Money tied up in AR = Cannot invest
Higher risk of bad debts
2 Key Aspects
Credit Policy
Credit Selection
Capital - Financial strength (debt to equity/profitability)
Collateral - Assets as security
Capacity - Ability to pay (liquidity/leverage)
Conditions - Economic/Business climate
Character - Past payment history
Credit Standards
Minimum standard/requirement for extending credit to a customer
Compare customer's credit worthiness to firm's credit standards
Changes will affect
Investment in AR
Relax = increase = profit decrease
Bad debt
Relax = increase = profit decrease
Sales volume
Relax = increase = profit increase
Credit Terms
Cash discount
Cash discount period
Credit period
eg. 2/10 net 30
Collection Policy
Set of procedures for collecting AR
Personal visit
Collection agency
Phone call
Legal action
Reminder letter
New plan
Step 2: Cost of marginal investment in AR
Step 3: Cost of marginal bad debt etc.
Step 1: Changes in profit from sales
3 types of inventory
Raw material
Inputs
Work-in-progress
Currently in production
Finished goods
Produced but not yet sold
Importance of Inventory management
Represents a large portion of a firm's assets
Too low
Stockouts = Lose sales/customers
Production may be shut down = Increased cost/Delays in delivery
Too high
High holding cost (eg. storage cost) and money tied up in inventory
Product may become obsolete
EOQ
Minimise total inventory cost
Carrying and Ordering cost
Larger order = higher carrying cost but lower ordering cost
Assumptions
Constant carrying cost
Constant ordering cost
Constant unit price
Instant delivery
Constant demand
Re-order point
Safety stock - Unexpected demand
Delivery time stock - Non-instant delivery
Re-order point = Safety stock + Delivery time stock