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Lecture 45 - Business Finance(ACC501 Lesson 45 Review of...

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240 Business Finance (ACC501) Lesson 45 Review of the Previous Lecture • Credits and Receivables • Credit Period • Discount • Instruments • Optimal Credit Policy • Credit Analysis • Collection Policy Topics under Discussion • Inventory Management – Inventory Types and Costs – ABC Approach – Economic Order Quantity (EOQ) Model Inventory Management • We know that firm’s operating cycle is made up of its inventory period and its receivables period. • Both credit policy and inventory policy are used to derive sales, and thus must be coordinated to ensure the process of acquiring & selling inventory and collecting on sale proceeds smoothly. • Inventory Types – Raw Material – starting point in production process – Work-in-Progress – size of this inventory depends on the length of production process – Finished Goods • One company’s raw material can be another’s finished good. – Steel Sheets and Automobile Manufacturing • Various types of inventory can be quite different in terms of their liquidity – Commodity-like or standardized raw materials are easily converted to cash
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241 – Work-in-progress can be quite illiquid • Demand of an inventory item that becomes a part of another item is termed as Derived or Dependant Demand • The firm’s demand for finished goods not derived from demand for other inventory items Inventory Costs Carrying costs include all direct and opportunity costs of keeping inventory on hand Storage and tracking costs • Insurance and taxes Losses due to obsolescence, deterioration, or theft Opportunity cost of capital for the invested amount • Inventory Costs – Shortage costs are associated with having inadequate inventory on hand • Restocking costs – costs of placing an order with suppliers or the cost of setting up a production run • Safety reserve costs – opportunity losses from having inadequate inventory e.g. lost sales and goodwill
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