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MBA 622

MBA 622. Brief Accounts Receivable and Inventory Management. Portions from Emery and Finnerty: Corporate Financial Management – Edited by Del Hawley. Effective Use of Trade Credit. Advantages: Readily available Informal Flexible Stretching payments Disadvantages

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MBA 622

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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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