Management of Inventories and Accounts Receivables

1
Management of Inventories and Accounts Receivables

• By
• Prof. Augustin Amaladas

2
Aspects of Receivables Management

• 1. credit policy variables
• 2. Credit evaluation
• 3. Credit granting decision
• 4. Control of receivables
• 5. Management of trade credit in India.

3
Credit policy variables

• A) Credit standards
• B) Credit period
• C) Cash discount
• D) Collection effort

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A) Credit standards

• Liberal Vs Stiff credit standards
• Optimum Credit policy
• 1.Trade off between cost of lost contribution and
  credit administration costs and bad debts losses
  is minimum.
• 2.The value of firm maximised when the
  incremental rate of return of an investment is
  equal to the incremental cost of funds

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• 3. Marginal rate of return should be more than
  marginal cost of capital
• Important terms- 3/10 net 30 means customer can
  pay within 10 days to get discount of 3
  otherwise, the customer has to pay within 30 days.

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Steps in evaluation of accounts Receivables

• 1. Estimation of incremental operating profit(
  Additional contribution or loss of contribution)
• 2.Estimation of incremental investment in
  Accounts Receivables
• a) total cost variable costFixed cost
  debtors period/12
• Calculate with old policy and new policy

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Calculation

• 3.Find the difference between the investment in
  Debtors
• 4.Calculate incremental costs in receivables
• 5. Net increase in operating profitIncremental
  operating profit after tax-interest on
  incremental investment in A/C receivable.
• See page 422, 434 illustration,-increase in
  receivables, and 423-discount to be given or not.
• See 433-reduction of receivables

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Example-1

• S. Ltd currently provides 30 days of credit
  present sales of Rs.50 lakhs. Cost of capital is
  10.Variable cost to sales is 85.
• New proposal 1. Extent credit period to 60 days
• 2. Increase in sales by 5 lakhs
• 3.Bad debts loss in additional sales is 8
• Whether worth extending credit period?

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Answer

• 1. Incremental benefitsAdditional
  salescontribution ratio
• 5,00,000.15
• 75,000
• 2. Incremental costs-
• A) bad debts loss .085,00,00040,000
• B) incremental existing Accounts receivables
• 
  50,00,000(60-30)/3604,16,667
• New Accounts receivables.85605,00,000/360
• 
  70,833
• Interest on costs involved in Accounts
  receivables
• 4,87,5001048,750
• Incremental Benefit- Incremental cost
• 75,000-40,000-48,750
• (13,750)

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Similar pattern

• Page-434 prob-2,Page-440 prob.1
• Page-435 prob-3, page-440 prob.3
• Page-433 ill 14.6, page-441 prob.5

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Page-383 prob.1

• Current Assets
• Raw material 8000
• Finished goods 5000
• Debtors( inland) 3120006/52 36,000
• Export 78,0001.5/52
  2,250
• Paid in advance 8,000/4
  2,000
• Gross current assets 53,250
  ( A)
• Current Liabilities
• Delay in wages 2,60,0001.5/52
  7,500
• Stores 480001.5/12 6,000
• Rent, royalties 10,0006/12
  5,000
• Staff salary 62400.5/12
  2,604
• Manager salary 4800.5/12
  200
• Misc.expenses 48,0001.5/12
  6,000
• Total 27,304
  (B)
• Working capital
  25946 (A-B)

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Exercise-2

Present Future sales
40 lakhs 5
lakhs Average collection period 20 days
40 days Variable cost 0.80
Cost of
capital 12 Bad debts ratio
0.05
0.06 Calculate should company relax the
collection effort?

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Answer

• Contribution 5,00,000.2
  1,00,000
• Interest on additional Capital on B/R
• 0.12(40,00,000(40-20)/360 ) -(5,00,000400.80/36
  0)
• 0.122,22,222-44,444
• 0.121,77,777 ( 21,333)
• Bad debt loss0.0645,00,000-0.0540,00,000
• 2,70,000-2,00,000 (70,000)
• Net Benefit
  8,667

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3.Effective cost if discount is not accepted
from creditors

• 
  Discount360
• (1- discount )(Actual payment
  period-Discount period)
• A corporation buys its raw material in terms on
  3/10, net 60, but it can delay by paying in 90
  days if it elects not to avail discounts.
• What is the effective cost of the non free trade
  credit?
• .03360 10.8 13.91
• (1-.03)(90-10) 77.6
• If 3/10 net 30?

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If 3/10 net 30?

• .03360/.97(30-10) 60

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4.Working Capital Cycle

• The following information is available for M Ltd.
• Average stock of raw material and stores 300
  lakhs
• Average stock of Work in progress 400 lakhs
• Average stock of Finished goods 250 lakhs
• Average Accounts receivable 400 lakhs
• Average Accounts payable 200 lakhs
• Average per day
  cost per unit
• Raw Material and stores 12 60
• Work in progress 14
• Cost of goods sold 17
• Sales 20 100
• Processing cost per unit 20
• Selling and distribution cost per unit 10
• 1.Calculate the duration of operating cycle
• 2 Calculate total working capital requirement if
  cash balance requirement is 15 lakhs.

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Answer

• 1. Duration Drm300/1225 days
• Dwip400/1428.6 days
• Dfh250/1714.7 days
• Dar400/2020 days
• Dap200/1217.67 days
• Duration of operating cycle2528.614.720-17.67
• 71 days.

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• Working capital requirementSales per
  dayDuration of working capital Cash balance
• 207115 lakhs
• 1435 lakhs

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Various committees recommendations-page 365

• 1.Dahejis committee
• 2. Tandon committee
• 3.Chhore Committee
• 4.Marathe committee
• 5.Nayak committee
• 6. Vaz committee
• 7. Kannan committee

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(No Transcript)
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Bank facilities

• Fund Based-Term loans,
• Working Capital finance
• -Cash credit Hypothecation, Pledge
• Overdrafts Clean, Secured
• Bill finance-Clean-Purchase of drafts, cheques
• Documentary-Bill purchase, Bill discount,
  Overdrafts against bills sent for collection
• Export finance-pre shipment, post shipment
• Working capital Demand loan

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Working capital loan criteria by IDBI

• Eligibility criteria-financially sound companies
• Net worth- Not less than Rs.15 Cr.
• Debt/Equity ratio-31
• Current ratio1.251
• Interest Coverage ratio21
• Extent of AsistanceUpto 80 of Working capital
  gap. Min. Rs.2 Crore or US .50mn
• Rupee loan Interest-Minimum term lending rate
  plus Risk Spread

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Tandons committee

• Method of lending
• The Borrower should bring 25 of net working
  capital from its long term liabilities and its
  owned funds
• The borrower should finance 25 of all current
  assets from owned funds and long term liabilities
  and the balance be financed by the bank
• The hard core current assets i.e. the by the
  current assets which are permanently required by
  the unit for its functioning must be exclusively
  financed by the borrower.the borrower should
  provide 25 of the remaining current assets and
  only the balance will be financed by the bank.

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Example-1

• Current liabilities
• Creditors for purchase 200
• Other current liabi-80
• Bank borrowing-400

• Current Assets
• Raw materials-300
• Stock in progress-100
• Finished goods-150
• Receivables-100
• Other current assets-50

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answer

• Total current assets 700
• Less other current liabilities 280
• (excluding borrowing)
• Working capital gap 420
• 25of working capital margin 105
• Maximum permissible bank finance(MPBF)-315
• Excess borrowings-85
• NO WORKING CAPITAL FINANCE PERMISSABLE

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METHOD-II

• Total current assets 700
• Less25 of above as margin
• From long term source 175
• Eligible current assets 525
• Lessother current liabilities 280
• MPBF 155
• (Maximum Permissible Bank Finance)

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• II method ensures a minimum current ratio of
  1.331
• Chore committee recommends the II method of
  lending.
• Repayment of loan can not be more than 5 years.

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Chore Committee

• Cash credit system

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Maratha committee

• Prior permission required from RBI before
  availing credit for I crore or more
• Now it is increased to 5 crore.

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Kannan committee

• 1997
• Sole discretion of the bank to determine
  borrowing limits of corporates
• Corporate borrowers are allowed to issue short
  term debentures(12-18 months) maturity. Banks may
  subscribe such debentures
• WC over 20 crores can be granted by way of demand
  loan.
• Bench markratio of current ratio is 1.33. and D/E
  ratio is at the discretion of the banker.

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Nayak committee

• 1991
• Institutional credit to SSI
• Based on projected turn over limited to 20of
  such turn over.
• New person it should be based on existing
  entrepreneurs
• Upto 2 crores-turn over method for other than SSI
• SSI-upto 5 crores
• WC above 10 crores- 80 demand-payablein 6
  instalments 20 cash credit

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• END of Debtors management

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Thank You
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Inventory Managementunit-15 page-445-476
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Inventory Management-Unit-15

• Techniques of inventory Management

1. Economic Ordering Quantity 2. Fixation of
inventory levels 3. Inventory Turnover 4. ABC
Analysis 5. Bill of Materials 6. Perpetual
Inventory system
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1.Economic ordering Quantity(448)

• EOQRoot of (2AO/C)
• Where Aannual demand in units
• O Cost of placing order (cost from
  the time we order till we receive goods)
• C Carrying cost per unit per year
  (measured in terms of percentage on cost per
  unit)
• Assumptions normally on an average ½ of the
  units are in the store all the time.

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EOQ Formula by differentiation

• Total cost(AMCPU)(A/Q)O(Q/2)C
• do/dQ 0AO/(-1/Q2)C/20
• or
• Q (2AO)/C
• A(MCPU)-Material purchase cost which does not
  change (Fixed)-almost fixed.
• Q Order quantity
• A Annual requirement in units
• OCost of placing an order
• CCost of carrying one unit per year.

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Exercise-1

• Annual demand 600 units
• Ordering costRs.400
• Holding cost40
• Cost per unit of raw materialRs.15
• 1)Calculate EOQ
• 2. If 10 discount on material cost if we buy
  500units at a time.

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Answer-Exercise-1

• EOQRoot of (2AO/C)
• Root of(2600400/(4015)
• Root of 80000
• 282.845 units
• Total cost of inventory annually(60015)(3400)
  (1/22824015)90001200846
• Rs.11,046.

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• Answer-Exercise-1continues
• If 10 discount is given cost per unit15-(10of
  15)13.5
• Total cost(60013.5)(2400)(1/25004013.5)
• 81008001350
• Rs.10,250
• Advise Purchase 500 units as annual cost of
  inventory is cheaper.
• If safety stock is required at any point of time
  in order to calculate holding cost we add the
  safety stock with the ½ of EOQ stock.
• Holding cost includes storage and interest on
  locked up capital

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If 10 discount is given

• If 10 discount is given cost per unit15-(10of
  15)13.5
• Total cost(60013.5)(2400)(1/25004013.5)
• 81008001350
• Rs.10,250
• Advise Purchase 500 units as annual cost of
  inventory is cheaper.
• If safety stock is required at any point of time
  in order to calculate holding cost we add the
  safety stock with the ½ of EOQ stock.
• Holding cost includes storage and interest on
  locked up capital, handling, insurance of godown

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2. Fixation of inventory level(458)

• Re-order levelMaximum leadtime
  Maximum usage
• Minimum level Reorder level-(Normal usageNormal
  lead time)
• Maximum levelRe-order level Re-order
  qty-(Minimum usageMinimum Lead time
• Average level(Maximum level Minimum level)/2
• Danger levelNormal usageLead time for emergency
  purchases

Note Re-order quantityEOQ
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• EOQ is calculated in order to find Re- order
  quantity
• Re-order quantity is different from Re-order
  level
• Sometimes minimum stocksafety stock

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3. Inventory (Stock) turnover ratio

• It explains operating efficiency of the
  organisation.
• How quickly raw material are converted into
  finished goods and also gives number of days of
  conversion.
• It explains number of times in a year raw
  material are converted into finished goods

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3.Stock turnover ratio
Page-461

• Value of materials consumed in a year
• Average stock
• Average stock (Opening stock Closing Stock)/2

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ABC analysis
Always Better Control
Control Always Better
Better Control Always

• Classify the various inventories according to
  their importance(70 of the value)
• A-High cost per unit but less quantity (70 of
  the value)-large investment-effective control on
  supply
• B- Moderate price per unit but moderate quantity
  (20 in value)
• C-less cost per unit but large quantity(10 in
  value)-control on availability of material

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5. Bill of materials

• Bill of materials is a list of materials required
  for a job.. It also indicates quantity required
  for each item.
• It helps in cost computation, material to be
  purchased by purchase department, that the order
  to be executed indicator.

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6.Perpetual inventory control system(page-465)(Uni
t number 15)

• Stocks are recorded as soon as placed in the
  godown and also recorded immediately as soon as
  stock is taken out.
• They are recorded in Bin card and stores ledger.
• It helps if insurance claim initiated and also
  fixing various level of stock, adjusted for
  discrepancies and periodical profits are
  estimated.

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Problems-clarification

• Problem number-03,06,7,8,9 and 10 from
  exercise-page 474-476-EOQ
• Page-474 and 475- prob.4 and 5 in
• unit-15.-Level of stock

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Prob.1-page 473

• EOQRoot of(220,000100)/(204)
• 2225(Approximate)
• Number of times20,000/2225
• 8.98 times

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Prob.3-page-474

• Root of (224004.00)/(122.40)
• 818 units
• Carrying cost includes interest cost

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Prob.6 page 475

• 2. Re-order level Safety stock (Normal
  usagenormal lead time)
• 100(3210)
• 420
• 1. EOQ Root of(2800012.5)/(201)
• 2,00,000/0.2
• 1000units
• 3.Holding cost(Safety stock order
  size/2)Carrying cost per unit per year
• (1001000/2)(201)
• Rs.120

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Prob.9-answer

• EOQ100 units
• Total Ordering costRs8000
• Total storage costRs.8000

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Thank You