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Managing Accounts Receivable and Inventory: Trade Credit, Costs, and JIT Strategies

This document provides an overview of effective accounts receivable and inventory management, emphasizing trade credit and its implications. It outlines the advantages and disadvantages of trade credit, common credit terms like 2/10, Net 30, and the cost of not utilizing discounts. It also introduces the Economic Order Quantity (EOQ) model for optimizing inventory management, illustrating how to calculate costs and reorder points. Finally, it touches on Just-In-Time (JIT) inventory systems, highlighting key success factors for reducing holding costs.

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Managing Accounts Receivable and Inventory: Trade Credit, Costs, and JIT Strategies

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  1. MBA 622 Brief Accounts Receivable and Inventory Management Portions from Emery and Finnerty: Corporate Financial Management – Edited by Del Hawley

  2. Effective Use of Trade Credit • Advantages: • Readily available • Informal • Flexible • Stretching payments • Disadvantages • High cost of discounts foregone • Excessive stretching of payments

  3. Trade Credit Terms Common credit terms: Net 30 2/10 Net 30 Meaning: (Disc%)/(Days to get discount) (Date Due) 2/10 Net 30  2% discount if paid within 10 days; otherwise pay within 30 days

  4. Cost of Trade Credit Discount Music Stores buys its inventory on “1/10, net 30” terms. What is the cost of not taking the discount?

  5. Cost of Trade Credit • Let d = the amount of the discount (= 1%) • Let DP = the discount period (= 10 days) • Let TP = the total payment period (= 30 days)

  6. Cost of Trade Credit

  7. Cost of Trade Credit Pay on Day 40  12.29% Pay on Day 60  7.37% So, there is an incentive to pay late that the seller must counter. The cost of foregoing the discount must be higher that cost of short-term borrowing or the buyer will use the trade credit as a loan.

  8. Pursuing Delinquent Accounts • Letters • Telephone calls • Personal visits • Collection agencies • Legal proceedings

  9. Inventory Management • Types of inventories: • Raw materials • Work-in-process • Finished goods

  10. Economic Order Quantity (EOQ) Model • Let • S = constant usage rate of the inventory • F = fixed cost of ordering inventory • C = carrying cost per unit of inventory for the period. • Q = units of inventory ordered.

  11. Inventory Levels for the EOQ Model Inventory Level Q Q/2 0 Time

  12. Economic Order Quantity (EOQ) Model

  13. Economic Order Quantity (EOQ) Model Annual Cost Total Cost Minimum Cost Carrying Cost Ordering Cost Q* Order Quantity (Q)

  14. EOQ Model The Acer Co. sells 10,000 units per year. The cost of placing one order is $45 and it costs $4 per year to carry one unit of inventory. What is Acer’s EOQ?

  15. EOQ Model

  16. EOQ Model • Average inventory = Q/2 = 475/2 = 237.5 units. • Number of orders per year = S/Q = 10,000/475 = 21. • Time between orders = Q/S = (475/21)(365) = 17.34 days.

  17. EOQ Model • Annual ordering cost = F(S/Q) = $45(10,000/475) = $947 per year. • Annual holding cost = C(Q/2) = $4(475/2) = $950 per year. • Total annual cost = $947 + $950 = $1,897 per year.

  18. Just-In-Time (JIT) Inventory Systems • Materials should arrive exactly as they are needed in the production process. • Reduces inventory holding costs • Important factors determining success of JIT systems: • Planning requirements • Supplier relations • Setup costs • Other cost factors • Impact on credit terms

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