DBB2104: Financial Management Manipal University Jaipur (MUJ)

BACHELOR OF BUSINESS
ADMINISTRATION
SEMESTER 3

DBB2104
FINANCIAL MANAGEMENT

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Unit 14
Receivables and Inventory Management
Table of Contents

SL Topic Fig No / Table SAQ / Page No

No / Graph Activity
1 - -
Introduction 3-4
1.1 Learning Objectives - -
2 Receivables Management - -
2.1 Receivables Management – Concept - - 5-6
2.2 Objectives of Receivables Management - -
3 Scope of Receivables Management - 1, I
3.1 Formulation of Credit Policy 1 - 7-13
3.2 Credit evaluation - -
4 Inventory Management - -
13-16
4.1 Inventory Control Techniques - -
5 Conclusion - 2 17
6 Summary - - 18
7 Glossary - - 19
8 Case Study - - 20-21
9 Terminal Questions - -
21-23
9.1 Answers - -
10 Suggested Books and References - - 23

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1. INTRODUCTION
A business firm can sell goods and services on cash as well as on a credit basis. In the case of
cash sales payment is immediately received, but when goods or services are sold on a credit
basis, the payment is deferred for the future. Receivables emerge on account of this facility
extended by the firm to its customers. These receivables constitute a significant portion of
working capital which is an important component of it after inventory. In India, in some
business enterprises, the ratio of receivables to total assets
STUDY NOTE
ranges from 16% to 20% and they form about one-third of
Receivables occupy second
total current assets. Though this asset is not financed important place after
separately capital market like other assets, still, a inventories and thereby
constitute a considerable
substantial portion of the capital remains blocked in portion of current assets in
several firms
receivables in large business enterprises. That is why,
effective and efficient management of receivables is inevitable so that the investment in the
receivables is kept at the optimum level.

Receivables occupy a second important place after inventories and thereby constitute a
considerable portion of current assets in several firms. The capital invested in receivables is
near identical to that of the investment made in cash and inventories. Receivables thus, form
about one-third of current assets in India

The receivables of any company if managed effectively increase the current assets of the
company which leads to an increase in the working capital of company on the other hand if
the company has an excess of receivables it increases the costs by blockage of funds of the
company. Thus, it is important to have proper account receivable by having a reasonable
collection period. Receivables management is a complex process. Prevention, as part of
receivables management, can be considered as the most important phase, which would help
to prevent the emergence of outstanding receivables or bad debts, thereby significantly
reduce costs that relate to the process of recovery.

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1.1 Learning Objectives

After studying this chapter, you will be able to:

❖ Recognize the importance of receivables management for a business firm

❖ Understand the methodology of managing receivables
❖ Explain the meaning of Inventory Control
❖ Find out the various techniques of Inventory Control

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2. RECEIVABLES MANAGEMENT
Receivables arise when goods or services of a firm are sold on a credit basis. Therefore, credit
sales are receivables.

“Receivables are asset accounts representing amount owed to the firm as a result of the sale
of goods and services in the ordinary course of business.”

-Hampton

Thus, receivables are an asset and represent claims of the firm against its customers. These
are shown on the assets side of the balance sheet under titles such as bills receivables, notes
receivables, sundry debtors, trade debtors, book debts, accounts receivables, etc. These
receivables are the result of the extension of credit facilities to the customers. The objective
of such a facility is to allow the customers a reasonable time in which they can pay for the
goods purchased by them.

Receivables have the following characteristics:

• It involves risk – Risk is involved in receivables and it shall be analyzed carefully. This
is because in credit sales cash payment is yet to be received, whereas there is no such
risk involved in cash sales.
• Based on present economic value: In the case of credit sales, the economic value in the
form of goods or services passes immediately to the customers, whereas the seller
expects an equivalent benefit i.e., cash at a later date.
• It implies futurity: The buyer makes the cash payment for goods and services received
by him in the future period.

2.1 Receivables Management - Concept

“Credit is the soul of business” According to this axiom and to survive in a competitive
environment, each and every firm adopts the policy of selling goods on credit. Receivables
are the result of credit sales which ultimately increase the profits earned by the firm. Credit
sales also result in the blocking of more funds in receivables that involve extra cost in terms
of interest. Moreover, an increase in receivables steps up the bad debts. Thus, receivables
involve some costs (interest and bad debts) as well as benefits (increase in profits due to

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credit sales) to the firm. Both the costs and benefits are to be looked at carefully and a trade-
off between them should be attempted. This is known as “Receivables Management”.

In this way, the receivables management consists of matching the cost of increasing sales
(Particularly credit sales) with the benefits arising out of increased sales and the objective
of maximizing the return on investment of the firm. The term “receivables management” may
therefore be defined as the process of making decisions relating to the investment of funds
in this asset as part of the short-term operating process. This will result in maximizing the
overall return on the investment of the firm.

2.2 Objectives of Receivables Management

Maximization of sales is not the purpose of receivables management nor the minimization of
bad debts is its objective. Increased sales could easily be achieved by resorting to heavy
credit sales. Likewise, if minimization of bad debts had been the objective, the firm would
have achieved the same simply by not resorting to credit sales at all. In fact, the objective of
receivables management like other assets is to maximize the return on investment in
receivables or to maximize the sales to the extent the risk involved remains within the
acceptable limits. To accomplish this objective, it is necessary to
• Achieve optimum volume of sales.
• Control and minimize the cost of credit.
• Maintain an optimum level of investment in receivables.

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3. SCOPE OF RECEIVABLES MANAGEMENT

The scope of receivables management is very wide and every business firm requires it. A
business cannot succeed until and unless it is able to manage its receivables in a proper way.
The scope of receivables management covers the following aspects:

Activity 1
Take an example of any organisation and try to find out the various methods,
techniques and precautions used by them for manging receivables.

3.1 Formulation of Credit Policy

A firm makes a significant investment by extending credit to its customers. This requires a
suitable and effective credit policy to control the level of total investment in receivables.
Credit policy refers to the application of those factors which influence the amount of trade
credit, i.e., investment in receivables, general economic condition, competition, industry
norms, and pace of technology changes are the factors that affect the investment in
receivables in an enterprise. But, the firm has almost no control over these factors. The credit
policy of the firm will change as and when any external factor changes. Generally, firms
identify the following two types of credit policy:
a) Liberal Credit Policy – Under this policy, credit sales are made liberally to those
customers whose creditworthiness is doubtful or even is not known at all. In such a
case, the sales are made on liberal terms and favorable incentives are granted to
customers that result in large sales and higher profits. At the same time, it increases
investment in receivables and the cost associated with it. Such a policy will also
increase risk because of lower liquidity
b) Stringent Credit Policy – Here, credit sales are made to only those customers whose
creditworthiness has been tested and is proved good. Firms following such policy are
very selective in granting credit sales. In following such a policy, costs and bad debts
will be minimum and no serious problem of liquidity is posed. But, at the same time,
such a policy adversely affects the sales position and margin of profit, i.e., profitability.

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The above description makes it clear that as the firm makes its credit policy more and more
liberal, its liquidity decreases, whereas profitability increases. On the other hand, if the firm
makes the credit policy more and more stringent, the liquidity may increase but the profita-
bility may go down. A firm therefore should try to frame its credit policy in such a way as to
attain the best possible combination of profitability and liquidity so that the overall return
to the enterprise is maximized. This has been depicted in the figure given below:

Fig 1: Determination of Credit Policy

The basic decision to be made regarding receivables is to decide how much credit be
extended to the customer and on what terms. With this view, credit policy may be defined as
the set of parameters and principles that govern the extension of credit to the customers.
These parameters are also known as components of credit policy are:

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• Credit Standards
While formulating the credit policy of a firm, the finance manager has to be ensured about
the type of customers to whom the firm will extend credit facility. This decision is taken on
the basis of credit standards. Credit standards are the guiding principles set by the credit
control department to screen credit applicants in order to determine the selection of
customers to whom credit can be offered. In nutshell, credit standards are the basic criteria
for the extension of credit to customers. The quantitative basis of establishing credit
standards are factors such as credit ratings, credit references, average payment period,
financial ratios. When the credit standards of a firm are loose, the level of sales and
receivables is likely to be high. The cost of credit administration and bad debts losses will
also increase. As against this, when credit standards are relatively tight, the sales and
receivables are likely to be low. Such standards will result in no bad debts losses and less
cost of credit administration. thus, the choice of optimum credit standards involves a trade-
off between incremental return and incremental costs. The credit standards of a firm are
influenced by factors such as:
a) The customer’s willingness to pay;
b) The customer’s ability to pay;
c) The customer’s financial soundness;
d) The customer’s assets that may be mortgaged; and
e) The conditions that are prevailing presently.
• Credit Terms
After determining the credit standards and capability of the customer, the management has
to determine those terms on which credit will be extended. The credit terms refer to the set
of stipulations or conditions under which the credit is extended to the customers. These
relate to the payment of goods sold. The credit terms specify, how the credit will be offered
including the length of the period, the interest on the credit, and the cost of default. The credit
terms relate to the following:
a) Credit Period: The credit period is the time duration for which the credit is extended to
the customers. The credit period is generally given as a net date. For example, when the
terms of trade credit allowed by a firm indicate “net 30”, it specifies that the payment
is expected to be made by the 30th day from the date of credit sale. There is no hard
and fast rule regarding the credit period and it may differ from one market to another.

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Normally, the credit period is governed by industry norms and customs of the trade,
but individual firms can extend credit for larger durations provided in the industry
norms. The credit period affects the demand of the products, average collection period,
and bad debts losses.

Relaxing Credit Period: Generally, relaxation in the credit period by a firm will result in
increased sales and margin of profit. But, at the same time, administration costs in the form
of supervising additional accounts and servicing increased volume of receivables,
production and selling costs, bad debts losses will increase. When a firm plans to relax or
liberalize its credit period it should try to make a balance between the profits arising due to
increased sales and costs to be incurred on the increased sales caused thereby. The credit
period should be relaxed up to the point where incremental return equals to incremental
costs. In this way, when the additional net profits are more than the expected rate of return,
the credit period should be relaxed.

b) Cash Discount: The second aspect of credit terms is cash discount. Such a discount is
offered by business firms to motivate customers for making early payments of their
bills. The rate of discount and the period for which it is granted is indicated in the terms
of cash discount. In the event of the customer not availing of this opportunity of cash
dis- count, he is required to make the payment by the net date specified as the credit
period. Cash discount also affects the cost of capital, average collection period, and bad
debt losses.

Increase in Discount Rates: Sometimes, the rate of discount is increased with the object to
accelerate the payment of receivables. This results in the reduction of the average col- lection
period and consequently, the investment in receivables is also decreased. It also reduces the
cost of capital. But, on the other hand, cash discount which is itself a loss to the firm, also
increases. Therefore, if the income earned due to accelerated recovery of receivables is more
than the increased cost on account of discount, the increase in the rate of discount will be in
the interest of the firm. Hence, any change in the discount terms is evaluated in terms of the
cost and benefits of such change.

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• Collection Policy
Proper Management of receivables requires an appropriate collection policy of the firm.
Collection policy refers to the procedure adopted by a firm to collect payment due on past
accounts. The basic objective of formulating a collection policy is to ensure the timely
payment of receivables without losing any customer. It helps the finance manager to tight
the credit policy for slow-paying customers. A strict or lenient, both types of collection
policies have adverse effects on business. A strict collection policy can affect the goodwill
and dam- age the growth prospects of sales, while in a lenient collection policy, the customers
with a natural tendency towards slow payments will become even slower to settle their
accounts. Therefore, a collection policy should be such that it may reduce the proportion of
bad debts losses and shorter the average collection period. An important variable in
collection policy is expenditure on collection. The greater the amount spent on collection
efforts, the lower the proportion of bad debts losses and the shorter is the average collection
period. Therefore, an optimum collection policy should be framed by the firm in such a way
that the cost and benefits arising from collections are in equilibrium and it should be pursued
till benefits exceed costs.

SELF ASSESSMENT QUESTIONS – 1

1. Receivables arise when goods or services are sold on basis.

2. Credit is the of business.
3. In policy, credit sales are made only to those customers, whose
credit-worthiness has been tested and is proved good.
4. The credit terms refer to the set of or under
which the credit is extended to the customers.

3.2 Credit Evaluation

Efficient credit management requires that a firm should formulate clear-cut guidelines and
procedures for granting credit to individual customers. In other words, all the custom- ers
should not be treated equally while extending credit facilities to them. So, at the time of
extending credit to the customers, the firm must know the creditworthiness of the customer,
i.e., whether a particular customer is extended any credit or not, and if yes, how much and

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on what conditions. The objective of such evaluation is to select those customers who satisfy
the pre-determined norms of credit. The following steps are involved in this process:
• Collection of Information – credit facilities should be provided to those customers
only who possess the ability to make payments on due dates. This requires the firm to
collect enough credit information from different sources regarding creditworthiness of
each customer. But the collection of credit information involves a cost that should
normally be less than the expected profit s from the transactions. In the case of small
accounts, detailed information may not be collected and the decision regarding
extending credit facility may be taken on the basis of limited available information.
Besides this, the time involved in the collection of credit information also affects the
decision regarding granting credit and such a decision cannot be delayed for long.
Keeping in view, the cost and time factor, information may be collected from any of the
following sources:
a) Financial Statements
b) Credit Rating Institutions
c) Bank References
d) Trade References
e) Firm’s Own Experience
• Credit Analysis: Collection of information in respect of any customer will not serve any
purpose in itself unless it is analyzed to reach some conclusion regarding the
creditworthiness of a customer. Credit Analysis is the evaluation of the borrowing
capacity of the applicant and the promptness and repaying ability of a customer
according to the terms of the contract. To reduce the inherent risk in the loan, the
creditworthiness of the applicant is analysed in detail. The well-known five Cs of credit,
i.e., Character, Capacity, Capital, Collateral, and Conditions provide a framework for the
evaluation of a customer.
• Credit Decision: After determining the creditworthiness of the applicant, it is to be
decided whether or not credit facilities should be provided to him. This requires
matching of the evaluated creditworthiness of the applicant with the established credit
standards of the firm. If the applicant is above or up to the standard, obviously the
credit facilities should be provided, otherwise not. If a decision is taken to extend the
credit facilities to the applicant, the next step is to decide the amount and duration of
the credit.

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4. INVENTORY MANAGEMENT
The term ‘inventory’ originates from the French word ‘Inventaire’ and Latin word
‘Inventariom”, which implies a list of things found. The term ‘inventory’ can be defined as,
The term inventory includes materials like – raw, in-process, finished, packaging, spares, and
others; stocked in order to meet an unexpected demand or distribution in the future
Inventory includes the raw material, spare parts, lubricating oil, etc.

As inventory occupies an important place in the working of the firm, that is why its
management seems to be very much crucial. Inventory Management refers to the process of
ordering, storing, and using a company’s inventory. This includes the management of raw
materials, components, and finished products, as well as the warehousing and processing of
such items.

In the broad sense, inventory management is inventory planning which covers the task of
development and administration of policies, systems, and procedures that minimize total
costs relating to inventory decisions, and related functions such as customer services
requirements, production scheduling, purchasing, and so on.

4.1 Inventory Control Techniques

Inventory control techniques are employed by the inventory control organization within the
framework of any of the basic inventory models, viz., fixed order quantity or fixed order
period. Inventory control techniques represent the operational aspect of inventory
management and help realize the objectives of inventory management and control. Several
techniques of inventory control are in use and it depends on the convenience of the firm to
adopt any of the techniques. The most important is the need to cover all items of inventory
and all stages, i.e. from the stage of receipt from suppliers to the stage of their use. The
techniques most commonly used are the following:

• ABC Analysis: ABC analysis refers to Always Better Control. It is a business term used to
define an inventory categorization technique that is useful in material management. It is also
known as ‘Selective Inventory Control’.

ABC analysis provides a mechanism for identifying items that will have a significant impact
on overall inventory cost, while also providing a mechanism for identifying different

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categories of stock that will require different management and controls. When carrying out
an ABC analysis, inventory items are valued and then ranked. The results are then grouped
typically into three bands. These bands are called ABC codes:-

“A class” inventory will typically contain items that account for 70-80% of the total value, or
5-10% of total items.

“B class” inventory will have around 20-25% of the total value or 20-30% of total items.

“C class” inventory will account for the remaining 5-10% of inventory value, and 60-70% of
total items. ABC analysis is used to segregate the various inventories so that the items
bearing high costs can be given more attention by the management.

• Economic Order Quantity: Economic order quantity is the level of inventory that minimizes
the total inventory holding costs and ordering costs. It is one of the oldest classical pro-
duction scheduling models. The model was developed by F. W. Harris in 1913. But still, R.
H. Wilson, a consultant who applied it extensively, is given credit for his early in-depth
analysis of the model.

In this approach, it is assumed that the demand for a product is constant over the year and
that each new order is delivered in full when the inventory reaches zero. There is a fixed cost
charged for each order placed, regardless of the number of units ordered. There is also a
holding or storage cost for each unit held in storage. An organization is always interested in
determining the optimal number of units of the product to order so that it minimizes the
total cost associated with the purchase, delivery, and storage of the product.

The required parameters to the solution are the total demand for the year, the purchase cost
for each item, the fixed cost to place the order, and the storage cost for each item per year. It
is worth noticing that the number of times an order is placed will also affect the total cost;
however, this number can be determined from the other parameters.

The basic Economic Order Quantity (EOQ) formula is as follows:

2𝐷 ∗ 𝐶𝑂
EOQ = √
𝑆𝐶

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In this Formula, we have three parameters:

1. Demand or consumption (D)
2. Order placement costs (CO) = Transaction costs
3. Stock ownership cost (SC) = Holding costs
• Minimum-Maximum Technique: The minimum-maximum system is often used in
connection with manual inventory control systems. The minimum quantity plus the
optimum lot size. In practice, a requisition is initiated when the inventory reduces below the
minimum level.

The effectiveness of a minimum-maximum system is determined by the method and

precision with which the minimum and maximum parameters are established. If these
parameters are based upon arbitrary judgments with a limited basis, the system will be
limited in its effectiveness. If the minimum is based on an objective rational basis, the system
can be very effective.

a) Maximum Level: It indicates the maximum quantity of an item of inventory that can be
held in-store at any time
Maximum Level = (Reorder Level +Reorder Quantity) – (Minimum Consumption Rate
*Mini- mum Reorder Period)

b) Minimum Level: Minimum level indicates the quantitative balance of an item of

inventory which may be maintained in hand at all times.
Minimum Level =Reorder Level - (Average Consumption Rate*Average Reorder
Period)

c) Reorder Level: Reorder Level is that level where the stock level reaches a stage
indicating the replenishment of the stock as there is always a gap between placing an
order and actually getting the stock.
Reorder Level = Maximum Usage Rate *Maximum Reorder Period

d) Average Stock Level: It simply means an average of stock held as a maximum and
minimum level.

Average Level = Maximum Level + Minimum Level

2

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e) Danger Level: The very Movement of the stock level falls below the minimum stock
level, we are in danger. So, the danger level lies below the minimum level.

• Two-bin Technique: One of the oldest systems of inventory control is the two-bin
systems which are adopted to control ‘C’ group inventories. In the two-bin system, the
stock of each item is separated into two bins. One bin contains stock, just enough to last
from the date a new order is placed until it is received in inventory. The other bin
contains a quantity of stock enough to satisfy probable demand during the period of
replenishment.

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5. CONCLUSION
Hence, from the above discussion, it is clear that receivables and inventory are the current
assets that are very important for the working of a business firm. Along with that, both of
them demand a lot of attention from their management as they play a crucial role in affecting
the profitability and cost of a firm. In case of any negligence, a heavy loss is to be faced.
Therefore, every firm should be particular about the techniques which it wants to adopt to
get the best of results in the long run.

SELF ASSESSMENT QUESTIONS – 2

5. Inventory management is the

a) Management and control of services, inventory, and equipment
b) Management and control of inventory
c) Control of supplies coming into the organization and supplies used
d) Control of materials purchased

6. Carrying costs
a) Are the costs associated with holding an inventory of items
b) Include an ordering cost
c) Are the costs associated with having vendors hold supplies for
organizations
d) Both (a) and (b)

7. Economic order quantity establishes

a) The maximum number of items an organization would want to
purchase at one time
b) The quantity of items an organization should order each time to
minimize costs associated with ordering
c) The number of items an organization can order in bulk to receive a discount
d) The quantity of items an organization would have to order each
time to maximize costs associated with ordering

8. Time as a consideration is unimportant in inventory management.

a) True
b) False

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6. SUMMARY
• Receivables are created when goods or services are sold on credit.
• As receivables involve some costs and benefits, therefore, they are required to be man-
aged, this management is referred to as receivables management.
• A credit policy refers to the application of those factors which influence the amount of
trade credit.
• Credit standards are the basic criteria for the extension of credit to the customers.
• The credit terms refer to the set of stipulations under which the credit is extended to
all the customers.
• The credit period is the time duration for which the credit is extended to the consumers.
• Collection policy refers to the procedure adopted by a firm to collect payments due on
past accounts.
• Receivables should be evaluated properly before extending.
• Inventory is the sum total of the value of raw materials, work-in-progress, and finished
goods.
• Inventory management means efficient control and management of inventories.
• A number of techniques are used for managing inventories.
• Economic order quantity is the size of the order where total inventory cost can be
minimized.

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7. GLOSSARY
Bad Debts: Bad debt is an expense that a business incurs once the repayment of credit
previously extended to a customer is estimated to be uncollectible.

Collateral: The term collateral refers to an asset that a lender accepts as security for a loan.
The collateral acts as a form of protection for the lender. That is, if the borrower defaults on
their loan payments, the lender can seize the collateral and sell it to recoup some or all of its
losses.

Cost of Capital: Cost of Capital is the rate of return the firm expects to earn from its
investment in order to increase the value of the firm in the market place.

Current Asset: A current asset is any asset that can reasonably be expected to be sold,
consumed, or exhausted through the normal operations of a business within the current
fiscal year or an operating cycle, or a financial year.

Economic Value: Economic value is the value that a person places on an economic good
based on the benefit that they derive from the good.

Financial Ratio: A financial ratio is a relative magnitude of two selected numerical values
taken from an enterprise’s financial statements.

Incentives: An incentive is something that motivates or drives one to do something or

behave in a certain way.

Mortgage: A mortgage is a loan that the borrower uses to purchase or maintain a home or
other form of real estate and agrees to pay back over time.

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8. CASE STUDY
Wal-Mart had developed an ability to cater to the individual needs of its stores. Stores could
choose from a number of delivery plans. For instance, there was an accelerated delivery
system by which stores located within a certain distance of a geographical center could
receive replenishment within a day. Wal-Mart invested heavily in IT and communications
systems to effectively track sales and merchandise inventories in stores across the country.
With the rapid expansion of Wal-Mart stores in the US, it was essential to have a good
communication system. Hence, Wal-Mart set up its own satellite communication system in
1983. Explaining the benefits of the system Walton said, “I can walk in the satellite room,
where our technicians sit in front of the computer screens talking on the phone to any stores
that might be having a problem with the system, and just looking over their shoulders for a
minute or two will tell me a lot about how a particular day is going. On the screen, I can see
the total of the day’s bank credit sales adding up as they occur. If we have something really
important or urgent to communicate to the stores and distribution centers, I, or any other
Wal- Mart executive can walk back to our TV studio and get on that satellite transmission
and get it right out there. I can also go every Saturday morning around three, look over these
printouts and know precisely what kind of work we have had.”

Wal-Mart was able to reduce unproductive inventory by allowing stores to manage their own
stocks, reducing pack sizes across many product categories, and timely price markdowns.
Instead of cutting inventory across the board, Wal-Mart made full use of its IT capabilities to
make more inventories available in the case of items that customers wanted most, while
reducing the overall inventory levels. Wal-Mart also networked its suppliers through
computers. The company entered into collaboration with P&G for maintaining the inventory
in its stores and built an automated reorder- ing system, which linked all computers between
P&G and its stores and other distri- bution centers. The computer system at Wal-Mart stores
identified an item which was low in stock and sent a signal to P&G. The system then sent a
re-supply order to the nearest P&G factory through a satellite communication system. P&G
then deliv- ered the item either to the Wal-Mart distribution center or directly to the
concerned stores. This collaboration between Wal-Mart and P&G was a win-win proposition
for both because Wal-Mart could monitor its stock levels in the stores constantly and also

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identify the items that were moving fast. P&G could also lower its costs and pass on some of
the savings to Wal-Mart due to better coordination.

Q1. Conduct SWOT analysis in the above case.

Q2. In the light of above case, explain the techniques of inventory management.

9. TERMINAL QUESTIONS
SHORT ANSWER QUESTIONS
Q1. What do you mean by “Receivables”?
Q2. Define Inventory Management.
Q3. What are Credit Standards?
Q4. Why cash discount is offered by business firms?

LONG ANSWER QUESTIONS

Q1. Explain the two types of Credit Policy.
Q2. Write a short note on “EOQ”.

9.1 ANSWERS
SELF ASSESSMENT QUESTIONS
1. Credit
2. Soul
3. Stringent
4. Stipulations, Conditions
5. A
6. A
7. B
8. B

TERMINAL QUESTIONS
SHORT ANSWER QUESTIONS
Answer 1: Receivables are an asset and represent claims of the firm against its customers .
These are shown on the assets side of the balance sheet under titles such as bills receivables,
notes receivables, sundry debtors, trade debtors, book debts, accounts receivables etc.

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Answer 2: Inventory Management refers to the process of ordering, storing and using a
company’s inventory. This includes the management of raw materials, components and
finished products, as well as warehousing and processing such items.

Answer 3: Credit standards are the guiding principles set by the credit control department
to screen credit applicants in order to determine the selection of customers to whom credit
can be offered.

Answer 4: A cash discount is offered by business firms to motivate customers for making
early payments of their bills.

LONG ANSWER QUESTIONS

Answer 1: Generally, firms identify the following two types of credit policy:
1. Liberal Credit Policy – Under this policy, the credit sales are made liberally to those
customers whose credit-worthiness is doubtful or even is not known at all. In such case,
the sales are made on liberal terms and favourable incentives are granted to customers
that results in large sales and higher profits. At the same time it increases investment in
receivables and cost associated with it. Such a policy will also increase risk because of
lower liquidity
2. Stringent Credit Policy – Here, credit sales are made to only those customers whose
cred- it-worthiness has been tested and is proved good. Firms following such policy are
very selective in granting credit sales. In following such a policy, costs and bad debts
will be minimum and no serious problem of liquidity is posed. But, at the same time,
such a pol- icy adversely affects the sales position and margin of profit,i.e., profitability.

Answer 2: Economic order quantity (EOQ) is the order quantity that minimizes the total
holding costs and ordering costs. It is one of the oldest classical production scheduling
models. The model was developed by Ford W. Harris in 1913, but R. H. Wilson, a consultant
applied it extensively, is given credit for his in-depth analysis. EOQ applies only when
demand for a product is constant over the year and each new order is delivered in full when
inventory reaches zero. There is a fixed cost for each order placed, regardless of the number
of units ordered; an order is assumed to contain only 1 unit. There is also a cost for each unit
held in storage, commonly known as holding cost, sometimes expressed as a percentage of

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DBB2104: Financial Management Manipal University Jaipur (MUJ)

the purchase cost of the item. While the EOQ formulation is straight concept, there are factors
such as transportation rates and quantity discounts to consider in actual application.

10. SUGGESTED BOOKS AND REFERENCES

BOOKS
• Pandey, I.M.; (2018) Financial Management, Pearson Publication.
• Khan, M.Y. and Jain, P.K.; (2018) Financial Management – Text, Problems and Cases,
Mc Graw Hill Publications.
• Srivastava, R.M.; (2005) Financial Management & Policy: Global Perspective, Himalaya
Publishing House.
• Ramchandra, N.; (2012) Financial Accounting for Management, Tata McGraw Hill
Publishers

REFERENCES
• https://www.cbsi-corp.com/wp-content/uploads/2012/02/NA50_05_Receivables_
Mgmt.pdf
• https://epub.uni-regensburg.de/27256/1/ubr13608_ocr.pdf

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