Chapter 10 –

Support
Accounts Receivable and
Inventory Management

10b.1 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Remember? Credit and
Collection Policies of the Firm

Quality of Length of
Trade Account Credit Period
(1) Average
Collection Period
(2) Bad-debt
Losses
Firm
Possible Cash Collection
Discount Program

10b.2 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Example of Relaxing
Credit Standards
• The firm is currently producing a single
product with variable costs of $20 and selling
price of $25.
• Relaxing credit standards is not expected to
affect current customer payment habits.
• Additional annual credit sales of $120,000 and
an average collection period for new accounts
of 3 months is expected.
• The before-tax opportunity cost for each dollar
of funds “tied-up” in additional receivables is
20%.
10b.3 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Example of Relaxing
Credit Standards
Review how we can use Excel to analyze this
type of problem (see ‘Relax Standards’ tab)!
The $24,000 gain exceeded the $4,800 cost for a
net benefit of $19,200 so make the change!

Now make some changes using Excel.

Will you make the same decision if an increase of only

3,000 units occurs and it takes 4 months to collect?

10b.4 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Remember? Credit and
Collection Policies of the Firm

Quality of Length of
Trade Account Credit Period
(1) Average
Collection Period
(2) Bad-debt
Losses
Firm
Possible Cash Collection
Discount Program

10b.5 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Example of Relaxing
the Credit Period

Basket Wonders is considering changing its

credit period from “net 30” to “net 60”.
• The firm is currently producing a single product
with variable costs of $20 and a selling price of
$25.
• Additional annual credit sales of $250,000 from
new customers are forecasted, in addition to the
current $2 million in annual credit sales.
• The before-tax opportunity cost for each dollar of
funds “tied-up” in additional receivables is 20%.
10b.6 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Example of Relaxing
Credit Standards
Review how we can use Excel to analyze this
type of problem (See ‘Longer Credit Pd’ tab)!
The $50,000 gain exceeded the $40,00 cost for a
net benefit of $10,000 so make the change!

Now make some changes using Excel.

Will you make the same decision if an increase of

12,000 units occurs because the firm allows
customers to take 75 days to pay (4.8 turns)?
10b.7 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Remember?
How Much to Order?
The optimal quantity to order
depends on:
Forecast usage
Ordering cost
Carrying cost
Let us use Excel to analyze!
Refer to ‘EOQ’ tab.
10b.8 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Total Inventory Costs

Total inventory costs (T) =

C (Q / 2) + O (S / Q)

• O(S/Q): This is the ordering cost portion

• C(Q/2): This is the carry cost portion
• T = O(S/Q) + C(Q/2) or the total cost
• Let us use Excel to look at total costs
depending on our order size (See ‘EOQ’ tab)
10b.9 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Remember? Example of the
Economic Order Quantity
• 10,000 yards of fabric were used at a constant
rate last period.
• Each order represents an ordering cost of $200.
• Carrying costs are $1 per yard over the 100-day
planning period.

What is the total costs per period if the

quantity ordered varies from 200 to 6,000
units per order?
10b.10 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.
 Economic Order Quantity
When we solved the economic order quantity
we found 2,000 units to be optimal – just like
our formula told us.
Observations:
1.We find the optimal minimization that is identical
2.We see that if we are off a small amount, that it is not making a major
difference in total costs
Try these changes and review the impact:
1.Increase the carrying costs to $2 per unit – expect more orders if
holding inventory costs more, which would be a lower Q*.
2.Increase the order costs to $400 per order – expect fewer orders if it is
expensive to place orders, which is a higher Q*. (Return carrying costs
back to $1)
10b.11 Van Horne and Wachowicz, Fundamentals of Financial Management, 13th edition. © Pearson Education Limited 2009. Created by Gregory Kuhlemeyer.