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Unformatted text preview: CHAPTER 20 Accounts Receivable and Inventory Management CHAPTER ORIENTATION The investment of funds in accounts receivable inventory involves a trade-off between profitability and risk. For accounts receivable, this trade-off occurs as less creditworthy customers with a higher probability of bad debts are taken on to increase sales. With respect to inventory management, a larger investment in inventory leads to more efficient production and speedier delivery, hence, increased sales. However, additional financing to support the increase in inventory and increased handling and carrying costs is required. In addition, the concept of total quality management and single-sourcing have had a major impact on inventory purchasing. CHAPTER OUTLINE I. Accounts receivable A. Typically, accounts receivable account for just over 20 percent of a firm's assets. B. The size of the investment in accounts receivable varies from industry to industry and is affected by several factors including the percentage of credit sales to total sales, the level of sales and the credit and collection policies, more specifically the terms of sale, the quality of customers and collection efforts. C. Although all these factors affect the size of the investment, only the credit and collection policies are decision variables under the control of the financial manager. D. The terms of sale are generally stated in the form a / b net c , indicating that the customer can deduct a percentage if the account is paid within b days; otherwise, the account must be paid within c days. 240 E. If the customer decides to forgo the discount and not pay until the final payment date, the annualized opportunity cost of passing up this a % discount and withholding payment until the c th day is determined as follows: discount the forgoing of cost y opportunit annualized = a 1 a-x b c 360-Example: Given the trade credit terms of 2/10, net 30, what is the annualized opportunity cost of passing up the 2 percent discount and withholding payment until the 30th day? Solution: Substituting the values from the example, we get 36.73% = 02 . 1 02 .-x 10 30 360-F. A second decision variable in determining the size of the investment in accounts receivable in addition to the trade credit terms is the type of customer. 1. The costs associated with extending credit to lower-quality customers include: a. Increased costs of credit investigation b. Increased probability of customer default c. Increased collection costs G. Analyzing the credit application is a major part of accounts receivable management. 1. Several avenues are open to the firm in considering the credit rating of an applicant. Among these are financial statements, independent credit ratings and reports, bank references, information from other companies, and past experiences....
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- Spring '10