FM 5 - Receivable-and-Inventory-Management

RECEIVABLE
MANAGEMENT
LEARNING OUTCOMES
At the end of this topic, students are expected to:

• Understand the need to manage accounts receivable and inventory
• Know the objectives of receivable and inventory management
• Explain the nature of credit policy and elements.
• Explain the functions of inventories
• Identify costs associated with the investment in accounts receivable
and inventories
RECEIVABLES
Accounts Receivable consists of money owed to a firm for

goods and services sold on credit. This type of credit basically
takes two forms:
• Trade or commercial credit – credit which the firm extends
to other firms
• Consumer or retail credit – credit which the firm extends to
its final customers
OBJECTIVE
This is the formulation and administration of plans and policies

related to sales on account and ensuring the maintenance of
receivables at a predetermined level and their collectability as
planned.
Its objective is to have both the optimal amount of receivable

outstanding and the optimal amount of bad debts.
FACTORS IN DETERMINING A/R POLICY
Credit Policy – is a set of guidelines for extending credit to customers. As

a rule, the higher the sales, the larger its profits and the higher the value
of its stock.
This covers the following variables:

• Credit Standards (Character, Capacity, Capital, Conditions)
• Credit Terms
• Collection Policy
• Delinquency and Default
COSTS ASSOCIATED W/ INVESTMENT IN A/R
• Credit analysis, accounting and collection costs

• Capital Cost
• Delinquency Cost
• Default Cost (Bad Debts)
SUMMARY OF TRADE-OFFS IN
CREDIT AND COLLECTION POLICIES
ANALYZING PROPOSED CHANGES
IN CREDIT POLICY
If a business enterprise eases its credit policy either by way of:

• lengthening the credit period,
• relaxing credit standards and collection policy, or
• offering cash discounts,
Then its sales should increase. Cost will also rise because of
increase in production costs. Likewise, additional investment in
account receivable will increase carrying costs and bad debts
and/or discount expenses may also arise.
MARGINAL OR INCREMENTAL ANALYSIS
OF CREDIT POLICIES
Marginal Analysis is performed in terms of systematic comparison of the

incremental returns and the incremental costs resulting from a change in the
firm’s credit policy.
OF CREDIT POLICIES
ILLUSTRATION:
ABC Corporation’s products sells for P10 a unit of which P7 represents
variable costs before taxes including credit department cost. Current annual
credit sales are P2.4 million. The firm is considering a more liberal extension
of credit, which will result in a slowing in the average collection period from
one month to two months.
The relaxation in credit standards is expected to produce a 25% increase in
sales. Assume that the firm’s required rate of return on investment is 20%
before taxes. Bad debt losses will be 5% of incremental sales and collection
expenses will increase by P20,000.
Required: Should the company liberalize its credit policy?

OF CREDIT POLICIES
OF CREDIT POLICIES
Illustration:
• The Roman Shades Company has 12% opportunity cost of capital and currently
sells on terms n/20. It has current annual sales of P10 million, 80% of which are on
credit. Current average collection period is 60 days. It is now considering to offer
terms of 2/10, n/30 in order to reduce the collection period to be reduced to 40
days.
• Required: Should the company change its terms from n/20 to 2/10, n/30?
OF CREDIT POLICIES
WAYS OF ACCELERATING
COLLECTION OF RECEIVABLES
• Shorten credit terms
• Offer special discounts to customers who pay their accounts
within special period
• Speed up the mailing time of payments from customers to
the firm
• Minimize float, that is, reduce the time during which
payments received by the firm remain uncollected funds.
DETERMINANTS OF THE
SIZE OF RECEIVABLES
• Terms of sale
• Paying practices of customers
• Collection policies and practices
• Volume of credit sales
• Credit extension policies and practices
• Cost of capital
AIDS IN ANALYZING RECEIVABLES
• Ratio of receivables to net credit sales

• Receivable turnover
• Average collection period
• Aging of accounts
INVENTORY
MANAGEMENT
OBJECTIVE
• Inventory management is important as it is difficult. The necessity of
forecasting sales before establishing target inventory level makes
inventory management a difficult task. Furthermore, erroneous
establishment of inventory levels could lead to either lost sales or to
excessive carrying costs.
• Objective: To maintain inventory at a level that best balances the

estimates of
• actual savings,
• the cost of carrying additional inventory, and
• the efficiency of inventory control.
FUNCTIONS OF INVENTORIES
INVENTORIES, be they in the form of raw materials, parts and

components, work-in-process, or finished goods, may appropriately be
considered as the life-blood of the production-distribution system. The
functions are:
✓Pipeline or transit inventories
✓Organizational or decoupling inventories
✓Seasonal or anticipation stock
✓Batch or lot-size inventories
✓Safety or buffer stock
COST ASSOCIATED WITH
INVESTMENT IN INVENTORY
ORDERING, SHIPPING, COST OF
CARRYING
AND RECEIVING RUNNING SHORT
•Cost of capital tied up in •Cost of placing orders including •Loss of sales
inventory production and setup costs •Loss of customer
•Storage and handling costs •Shipping and handling costs goodwill
•Insurance •Salaries and wages of employees •Description of
•Property taxes engaged in purchasing, receiving production schedules
•Depreciation and obsolescence and inspecting materials
•Administration costs (e.g. •Communication costs associated
accounting) with ordering, such as telephone,
•Loss due to theft, deterioration, postage and forms of stationary
or obsolescence •Materials in accounting and
•Records and supplies associated record keeping
with the carrying of inventories
COMMONLY USED CONTROL PROCEDURES
▪Order Cycling
▪Min-Max Method
▪Two-bin Method
▪Automatic Order System
▪ABC Plan
INVENTORY MANAGEMENT TECHNIQUES
a. Inventory Planning
b. Inventory Control
c. Modern Inventory Management
INVENTORY PLANNING
Determination of the quality and quantity and location of inventory, as
well as the time of ordering, in order to meet future business
requirements.
A. EOQ Model
• The purchase order which results in the minimum total inventory cost
• Ordering cost and carrying cost must be considered
• Methods to compute EOQ
• Tabular Method
• Formula Method
INVENTORY PLANNING
Determination of the quality and quantity and location of inventory, as
well as the time of ordering, in order to meet future business
requirements.
A. EOQ Model
• The purchase order which results in the minimum total inventory cost
• Ordering cost and carrying cost must be considered
• Methods to compute EOQ (Tabular & Formula Method)
B. Reorder Point
• This is the point at which items should be ordered depending on the
predetermined minimum level by the company
C. Just-in Time
INVENTORY PLANNING
A. EOQ Model
*Tabular Method
Several purchase order quantity alternatives are listed in separate rows.
Total inventory costs showing both carrying and ordering costs. The row
with the lowest total amount of inventory cost will be the EOQ.
INVENTORY PLANNING
INVENTORY PLANNING
• EQQ = 500 units (it has the lowest total ordering and carrying cost)
• Assume that the expected daily usage of an item of material is 100 units and
the anticipated lead time is 4 days.
Order Point = 4 * 100 units = 400 units
Therefore, when the inventory level reaches the OP (Order Point) of 400
units, the company will purchase 500 units which is the ECQ.
INVENTORY PLANNING
A. EOQ Model
*Formula Method
• It is easy to use and it produces exact figures. Formula is:
INVENTORY PLANNING
INVENTORY PLANNING
B. REORDER POINT
• How to compute Reorder Point? The following are the needed data:
• Lead Time – estimated time interval between the placement of an order
and receipt of the material
• Lead Time Quantity – the normal usage during the lead time period
• Normal Usage – the average usage of inventory during a given specific
period of time (e.g. days, weeks)
• Safety Stock – estimated minimum level of inventory needed to protect
against running out of stock
INVENTORY PLANNING
INVENTORY CONTROL
A. Fixed order quantity system – an order for a fixed quantity placed when
the inventory level reaches the reorder point (e.g. Two-bin system)
B. Fixed reorder cycle system (periodic review or replacement system) –
orders are made after a review of inventory levels has been done at regular
intervals. The quantity ordered under this system is variable depending on
usage or demand during the review period.
INVENTORY CONTROL
C. Optional Replacement System. This system represents a combination of
the important control mechanism of the other two systems described above.
Replenishment level is computed by the use of the following equation:
INVENTORY CONTROL
D. ABC Classification System – inventories are classified for selective control:
• A Items – high value items requiring highest possible control

• B Items – medium cost items requiring normal control
• C Items – low cost items requiring the simplest possible control
MODERN INVENTORY MANAGEMENT
Often applied in the context of automated manufacturing
• Material Requirement Planning (MRP) – designed to plan and control raw

materials used in production. The demand for materials, which is assumed
to be dependent on some factors, is programmed into a computer.
• Manufacturing Resource Planning (MRP-II) - a closed loop system that
integrates all facets of a business, including inventories, production, sales,
and cash flows.
• Enterprise Resource Planning (ERP) – integrates the information systems
of the whole enterprise. All organizational operations are connected and the
organization itself is connected with its customers and suppliers.

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RECEIVABLE

At the end of this topic, students are expected to:

Accounts Receivable consists of money owed to a firm for

This is the formulation and administration of plans and policies

Its objective is to have both the optimal amount of receivable

Credit Policy – is a set of guidelines for extending credit to customers. As

This covers the following variables:

• Credit analysis, accounting and collection costs

If a business enterprise eases its credit policy either by way of:

Marginal Analysis is performed in terms of systematic comparison of the

Required: Should the company liberalize its credit policy?

• Ratio of receivables to net credit sales

• Objective: To maintain inventory at a level that best balances the

INVENTORIES, be they in the form of raw materials, parts and

Order Point = 4 * 100 units = 400 units

D. ABC Classification System – inventories are classified for selective control:

• A Items – high value items requiring highest possible control

• Material Requirement Planning (MRP) – designed to plan and control raw

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