FIN303 CHAPTER 23 REVIEW
FIN303 CHAPTER 23 REVIEW FIN303
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Giulia Dias Roncoletta
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This 5 page Class Notes was uploaded by Giulia Dias Roncoletta on Monday February 15, 2016. The Class Notes belongs to FIN303 at University of Miami taught by Douglas R. Emery in Winter 2016. Since its upload, it has received 42 views. For similar materials see Corporate Finance Management in Finance at University of Miami.
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Date Created: 02/15/16
CHAPTER 23 23.1 ACCOUNTS RECEIVABLE MANAGEMENT 2 Types of Credit: (1) Trade Credit - between ﬁrms, creates accounts receivable for the supplier and account payable for the buying ﬁrms. (2) Consumer Credit: retail credit, ﬁrms sells good or service to a consumer without simultaneous payment. Basic Credit-Granting Decision: Positive NPV Decision: NPV = PV of future CF - Outlay NPV = pR - C (1+r) t - at time zero, we invest C in a credit sale - the sale amount is R - the probability of payment is p - the expected payment is pR - payment is expected at time t - the required return is r Calculate the (zero-NPV) p* - If a credit customer has a payment probability exceeding p* then granting credit has a positive NPV. p* = C (1+r) t R Credit Policy Decisions: - Credit policy affects a company’s revenues and costs. - Include (1) choice of term credit (2) setting evaluation methods and credit standards (3) monitoring receivables and taking actions for slow payments (4) controlling and administering the ﬁrm’s credit functions. Credit Terms: - Credit Terms: are the contract between the supplier and the credit customer specifying how the credit will be repaid. - Credit Period: amount of days the customer has to repay - Discount Period: amount of days customer has to repay with discount - Discount: percentage rate discounted if payment paid during discount period. - Invoice Date: the date the goods are shipped. - Open Account Basis: customers purchase what they want. 23.2 CREDIT STANDARDSAND CREDIT EVALUATION * Low probability of payment, late collection period, or high pv of collection costs, cause NPV to decrease. Source of Credit Information: (a) Internal Sources: 1. credit application with references 2. applicants previous payment history, previously extended credit 3. information from sales rep and other employees (b) External Sources: 1. recent years’ ﬁnancial statements 2. reports from credit rating agencies 3. credit bureau reports 4. industry association credit ﬁles Evaluating credit application: (a) judgmental: uses credit info and knowledge and experience (b) objective: uses numerical cutoffs and scores 5 C’s of Credit: These are ﬁve general factors that credit analysis often consider when making credit granting decisions. (1) Character: the commitment to meet credit obligations. (measured by: payment history) (2) Capacity: the ability to meet credit obligations with current income (measured by: income statement) (3) Capital: the ability to meet credit obligations from existing assets if necessary (measured by: net worth) (4) Collateral: collateral that can be repossessed in case of nonpayment. (5) Conditions: general/industry economic conditions. Credit Scoring Models: Credit Scoring: combines several ﬁnancial variables into a single score that measures creditworthiness. S = w1X1 + w2X2 + w3X3 + w4X4 X1 = net working capital/sales (%) X2 = debt/assets (%) X3 = assets/sales (%) X4 = net proﬁt margin (%) * Positive X1, X3, and X4 mean that the high value results in a higher credit score * Negative X2 means that a higher debt/asset ration reduces the credit score Advantages of Credit Scoring Models: - quickly differentiates a good customer from a bad customer - allow different loan processors - they are objective and avoid bias discrimination Disadvantages of Credit Scoring Models: - it’s as good as the payment records used to construct the model - models have to be updated occasionally - works best in large population of loan applicants 23.3 MONITORING ACCOUNTS RECEIVABLE Aging Schedules: Aging Schedule: is a table showing the total dollar amounts and the percentages of total accounts receivable that fall into several age classiﬁcations. (0-30 days old, 30-60 days old, 60-90 days old, and over 90 days old) Average age of accounts receivable: the average age of all of the ﬁrm’s outstanding invoices. - Calculate by using the percentage of each group in the aging schedule, then get the average date for each group, 0-30 = 15, then multiply the weight by the average date. - changes in credit terms, payment habits, or sales levels can increase or decrease the average date as well as the aging schedule. Collection Fraction and Receivables Balance Fractions: * Measures used to monitor the quality of receivables. (1) Collection Fractions: are the percentages of sales collected during various months. - this checks if collections are faster or slower than expected. (2) Receivables Balance Fractions: are the percentages of a month’s sales that remain uncollected at the end of the month of sale and at the end of the succeeding months. * These are always expressed as a percentage of original sales. * Better measure of quality than aging schedules particularly when sales are increasing/ decreasing. * You learned in class how to compute this. Pursuing Delinquent Credit Customers: Steps for a typical collection process: (1) Letters: a friendly reminder should be sent out (2) Telephone Calls: after ﬁrst couple of letters were ignored, customer is phones (3) Personal Visits: request payment in person (4) Collection Agencies: specialized agencies in collecting past due accounts (5) Legal Proceeding: if bill is large enough, legal action may be used. Changing Credit Policy: Credit Policy can be changed by altering terms, standards, or collection practices. It can affect sales, cost of goods sold, bad debt expenses, carrying costs on accounts receivable and other administrative costs. NVP of credit policy change calculation: - calculate original NVP, then new, then the difference. 23.4 INVENTORY MANAGEMENT The Economic Order Quantity Model: EOQ MODEL: - units are removed from inventory at constant rate S (rate units are sold) - ﬁxed reordering cost F per order - cost to carry a unit in inventory for an entire period is C - assumes constant inventory usage - inventory begins at Q units - Total annual costs = ordering costs + carrying costs Total Cost = F (S/Q) + C (Q/2) * an increase in Q will increase carrying costs but decrease ordering costs. * minimize cost by balancing the two cost components with EOQ EOQ = (2FS/C) .5 Be sure to know how to calculate all this: 1. average inventory = EOQ/2 2. # orders per year = S/EOQ 3. time interval between orders = EOQ/S 4. annual ordering cost = F(S/EOQ) 5. annual carrying cost = C(EOQ/2) 6. Total cost Quantity Discounts: * If discounts exceed the cost of the extra inventory, then you should increase the order size to get the discounts Total Cost = F (S/Q) + C (Q/2) - dS d = dollar price discount per unit * ordering large quantities and getting price discount. Inventory Management with Uncertainty: * EOQ makes a demand assumption: future demand id known with certainty, inventory is used at a constant rate, and delivery is instantaneous. * Firms protect themselves from uncertainties by maintaining safety stocks * stock-outs occur when ﬁrm cannot immediately make a sale due to lack of inventory Reorder Point = (Expected Lead-Time Demand) + (Safety Stock) *total costs with uncertainty. Annual Costs = Ordering Costs + Carrying Costs + Stockout Costs Stockout Costs = probability of a stockout (cost of a stockout) *a larger safety stock increases inventory carrying costs because the average inventory level is equal to EOQ/2 + the safety stock. ABC System of Inventory Control: * This system categorizes inventory into one of three groups: A,B, or C, on a basis of critical need. * Most important are items A - 10% of items, make up for 80% of inventory revenue Materials Requirement Planning (MRP) Systems: * computer based systems that plan backward from the production schedule to make purchases and manage inventory. * no interruptions due to stockouts. Just-In-Time Inventory Systems: * Reduces inventory, materials should arrive exactly when they are needed in the production process. * Success of JIT depends on these factors: (1) Planning Requirements: integrated plan for entire ﬁrm (2) Supplier Relations: must work closely with suppliers (3) Setup Costs: reduce the length of production runs. (4) Other cost factors: opportunity costs is high, better quality and monitoring (5) Impact on Credit Terms: eliminate costs afﬁliated with paper
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