1. MANAGEMENT OF RECEIVABLES:
Trade credit arises when a firm sells its products or services on credit and does not receive cash
immediately. It is also an essential marketing tool , acting as a bridge for the movement of goods
through production and distribution stages to customers. A firm grant a trade credit to protect its
sale from the competitors and to attract potential customer to buy its products at favourable
terms. Trade credit creates accounts receivable or trade debtor that the firm is expected to collect
in the near future costs of Maintaining Receivables.
Characteristics of Credit Sale:
1. It involves an element of risk that should be carefully analysed
2. It is based on economic value. To the buyer economic value in goods or services passes
immediately at the time of sale , while the seller expect an economic value to be received
3. It implies futurity. The buyer will make the cash payment of good or services received
by him in future period
Importance Of Receivable Management
In marketing operations receivables management has importance due to following reasons
1. No sale is complete until money is collected from the customer and responsibility for
such collection should generally rest with the concern sales personnel . Substantial delay
or even non collection of receivables invariably results in steady erosion of profit
generated through sales
2. If a large part of the company’s working capital gets blocked up in the receivables
outstanding then it would adversely affect the marketing margin because higher the
interest charges and increase the level of marketing investment thus reducing the ROI
Costs of Maintaining Receivables:
The costs with respect to maintenance of receivables can be identified as follows
2. 1. Capital costs - Maintenance of accounts receivable results in blocking of the firm’s financial
resources in them. This is because there is a time lag between the sale of goods to customers and
the payments by them. The firm has, therefore, to arrange for additional funds to meet its own
obligations, such as payment to employees, suppliers of raw materials, etc., while waiting for
payments from its customers. Additional funds may either be raised from outside or out of profits
retained in the business. In first the case, the firm has to pay interest to the outsider while in the
latter case, there is an opportunity cost to the firm, i.e., the money which the firm could have
earned otherwise by investing the funds elsewhere.
2. Administrative costs - The firm has to incur additional administrative costs for maintaining
accounts receivable in the form of salaries to the staff kept for maintaining accounting records
relating to customers, cost of conducting investigation regarding potential credit customers to
determine their credit worthiness etc.
3. Collection costs - The firm has to incur costs for collecting the payments from its credit
customers. Sometimes, additional steps may have to be taken to recover money from defaulting
4. Defaulting costs - Sometimes after making all serious efforts to collect money from
defaulting customers, the firm may not be able to recover the over dues because of the inability
of the customers. Such debts are treated as bad debts and have to be written off since they cannot
Benefits of Maintaining Receivables
a. Increase in Sales - Except a few monopolistic firms, most of the firms are required to sell
goods on credit, either because of trade customers or other conditions. The sales can further be
increased by liberalizing the credit terms. This will attract more customers to the firm resulting in
higher sales and growth of the firm.
b. Increase in Profits - Increase in sales will help the firm (i) to easily recover the fixed
expenses and attaining the break-even level, and (ii) increase the operating profit of the firm. In a
normal situation, there is a positive relation between the sales volume and the profit.
3. c. Extra Profit - Sometimes, the firms make the credit sales at a price which is higher than the
usual cash selling price. This brings an opportunity to the firm to make extra profit over and
above the normal profit.
Factors Affecting the Size of Receivables
The size of accounts receivable is determined by a number of factors. Some of the important
factors are as follows
1. Level of sales - This is the most important factor in determining the size of accounts
receivable. Generally in the same industry, a firm having a large volume of sales will be having a
larger level of receivables as compared to a firm with a small volume of sales. Sales level can
also be used for forecasting change in accounts receivable. For example, if affirm predicts that
there will be an increase of 20% in its credit sales for the next period, it can be expected that
there will also be a 20% increase in the level of receivables.
2. Credit policies - The term credit policy refers to those decision variables that influence the
amount of trade credit, i.e., the investment in receivables. These variables include the quantity of
trade accounts to be accepted, the length of the credit period to be extended, the cash discount to
be given and any special terms to be offered depending upon particular circumstances of the firm
and the customer. A firm’s credit policy, as a matter of fact, determines the amount of risk the
firm is willing to undertake in its sales activities. If a firm has a lenient or a relatively liberal
credit policy, it will experience higher level of receivables as compared to a firm with a more
rigid or stringent credit policy. This is because of the two reasons:
i. A lenient credit policy encourages even the financially strong customers to make delays in
payment resulting in increasing the size of the accounts receivables.
ii. Lenient credit policy will result in greater defaults in payments by financially weak customers
thus resulting in increasing the size of receivables.
3. Terms of trade - The size of the receivables is also affected by terms of trade (or credit terms)
offered by the firm. The two important components of the credit terms are (i) Credit period and
(ii) Cash discount.
4. Credit Period
The term credit period refers to the time duration for which credit is extended to the customers. It
is generally expressed in terms of ―Net days‖. For example, if a firm’s credit terms are ―Net15‖,
it means the customers are expected to pay within 15 days from the date of credit sale.
Most firms offer cash discount to their customers for encouraging them to pay their dues before
the expiry of the credit period. The terms of cash discount indicate the rate of discounts well as
the period for which the discount has been offered. For example, if the terms of cash discount are
changed from ―Net 30‖ to ―2/10 Net 30‖, it means the credit period is of30 days but in case
customer pays in 10 days, he would get 2% discount on the amount due by him. Of course,
allowing cash discount results in a loss to the firm because of recovery of less amount than what
is due from the customer but it reduces the volume of receivables and puts extra funds at the
disposal of the firm for alternative profitable investment. The amount of loss thus suffered is,
therefore, compensated by the income otherwise earned by the firm.
Why do companies in India grant Credit?
 Competition: Generally higher competition more credit
 Company’s Bargaining Power: Higher bargaining power less credit . Strong bargaining
power in monopoly product , strong brand image, large size
 Buyer’s requirements: ex industrial product , dealers are not able to operate without
 Buyers status: Bulk buyer demands credit
 Relationship with dealers: Companies sometime extend credit to maintain long term
relation with dealers
 Marketing Tools: Particularly in new product launch
 Industry practice: small companies guided by large companies in industry
Components of Credit Policy
5.  Development of credit standards
◦ profile of minimally acceptable credit worthy customer
 Credit terms
◦ credit period
◦ cash discount
 Credit limit
◦ Maximum level of credit balances
 Collection procedures
◦ how long to wait past due date to initiate collection efforts
◦ methods of contact
◦ whether and at what point to refer account to collection agency
Reasons To Write Credit Policy
 There are at least four reasons to have a written credit policy, and they each add to the
productivity of your entire organization.
 First, the responsibility of managing receivables is a serious undertaking. It involves
limiting bad debts and improving cash flow. With outstanding receivables often being a
firm's major asset, it is obvious that a reasoned and structured approach to credit
management is necessary.
 Second, a policy assures a degree of consistency among departments. By writing down
what is expected, the arms of your company (whether marketing, production, or finance)
will realize that they have a common set of goals. Conversely, a written policy can
delineate each department's functions so that duplication of effort and needless friction
 Third, it provides for a consistent approach among customers. Decision making becomes
a logical function based on pre-determined parameters. This simplifies the decision
process and yields a sense of fairness that will only improve customer relations.
 Finally, it can provide some recognition of the credit department as a separate entity, one
which is worthy of providing input into the overall strategy of the firm. This allows the
department to be an important resource to upper management.
Developing a policy is more than a necessity. It is an opportunity to improve the
efficiency of your entire organization.
Sample Company's Credit Policy
The Credit Department is responsible for maintaining a high quality of accounts receivable
6. while selling to all customers that represent prudent credit risks. We will provide flexible
mechanisms to protect our substantial receivable investment.
Our goals are to limit bad debts to ___% of sales, Days Sales Outstanding to ___ days, and
receivable ageings to no more than ___% beyond 60 days. We will visit customers whenever
necessary and strive to resolve all deductions within 90 days.
The Credit Department reports to the office of Treasurer. Functions include the application of
payments, establishing credit limits, and monitoring collection of receivables.
The Credit Manager establishes limits of up to Rs. _______ and may delegate a portion of this to
other department members. Higher limits are approved by the Treasurer or above. If credit
privileges are withdrawn from a customer, it is our policy to consult with marketing personnel in
the decision process. If a consensus cannot be reached, the situation is referred to the President.
When accounts cannot be collected with normal means, the Credit Manager recommends the use
of a Collection Agency or attorney. The Treasurer and Sales Manager approve such requests.
The Credit Department establishes limits for all active customers. Such limits are based on
trade information and financial statements when necessary.
The department reviews larger limits on a periodic basis. All limits are subject to revision, based
on changing levels of credit worthiness. Individual orders are referred to the credit department
when an account is over its limit or 15 days past due, and an effort is made to resolve such
problems. If satisfactory arrangements cannot be made, the order is withheld.
We strive to have a consistent and courteous approach to collection. All customers are called
when they are ____ days past due. If no payments are received after three calls, the sales
representative is asked to contact the customer. If there is still no response, the account is
considered for legal action.
In the case of bankruptcies, the Credit Department files proofs of claim. The department
represents our company with creditor committees and coordinates activities with attorneys.
Terms of Sale:
Terms have been established as Net ___ days. All credit worthy customers are expected to
pay within this period. Any exceptions must be based on competitive practices in accordance
with established procedures.
7. Receivable Maintenance and Service:
The Credit Department initiates the handling of all deductions promptly to assure quality
receivables. Customer inquiries always receive immediate attention.
We are dedicated to behaving in a moral and legal manner. The sharing of business information
and other credit matters will be in compliance with NACM's Canons of Business Credit Ethics.
This policy will be reviewed on an annual basis.
Inventory management is a very important function that determines the health of the supply
chain as well as the impacts the financial health of the balance sheet. Every organization
constantly strives to maintain optimum inventory to be able to meet its requirements and avoid
over or under inventory that can impact the financial figures.
Inventory is always dynamic. Inventory management requires constant and careful evaluation of
external and internal factors and control through planning and review. Most of the organizations
have a separate department or job function called inventory planners who continuously monitor,
8. control and review inventory and interface with production, procurement and finance
Inventory Management Concepts
Inventory management and supply chain management are the backbone of any business
operations. With the development of technology and availability of process driven software
applications, inventory management has undergone revolutionary changes. In the last decade or
so we have seen adaptation of enhanced customer service concept on the part of the
manufacturers agreeing to manage and hold inventories at their customers end and thereby affect
Just In Time deliveries. Though this concept is the same in essence different industries have
named the models differently. Manufacturing companies like computer manufacturing or mobile
phone manufacturers call the model by name VMI - Vendor Managed Industry while
Automobile industry uses the term JIT - Just In Time where as apparel industry calls such a
model by name - ECR - Efficient consumer response. The basic underlying model of inventory
management remains the same.
DELL computer , which has manufacturing facilities all over the world. They follow a concept
of Build to Order where in the manufacturing or assembly of laptop is done only when the
customer places a firm order on the web and confirms payment. Dell buys parts and accessories
from various vendors. DELL has taken the initiative to work with third party service providers to
set up warehouses adjacent to their plants and manage the inventories on behalf of DELL’s
suppliers. The 3PL - third party service provider receives the consignments and holds inventory
of parts on behalf of Dell’s suppliers. The 3PL warehouse houses inventories of all of DELL’s
suppliers, which might number to more than two hundred suppliers. When DELL receives a
confirmed order for a Laptop, the system generates a Bill of material, which is downloaded at the
3PL, processed and materials are arranged in the cage as per assembly process and delivered to
the manufacturing floor directly. At this point of transfer, the recognition of sale happens from
the Vendor to Dell. Until then the supplier himself at his expense holds the inventory.
Benefits of this model for both Dell:
With VMI model, Dell has reduced its inbound supply chain and thereby gets to reduce its
logistics and inventory management costs considerably.
DELL gets to postpone owning inventory until at the time of actual consumption. Thereby with
no inventories DELL has no need for working capital to be invested into holding inventories.
DELL does not have to set up inventory operations and employ teams for operations as well as
management of inventory functions.
Benefits of this model for both Supplier Benefits
9. Supplier gets to establish better relationship and collaboration with DELL with long-term
By agreeing to hold inventories and effect JIT supplies at the door to DELL, supplier will be in a
better position to bargain and get more business from DELL.
With VMI model, supplier gets an opportunity to engage in better value proposition with his
Supplier gets confirmed forecast for the entire year with commitments from DELL for the
quantity off take.
VMI managed is managed by 3PL and supplier does not have to engage himself in having to set
up and manage inventory operations at DELL’s premise.
3PL Managed VMI holds inventories of all suppliers thereby charges each supplier on per pallet
basis or per sq.ft basis. Supplier thereby gets to pay on transaction basis without having to marry
fixed costs of inventory operations.
Today most of the Multi National companies have successfully managed to get their suppliers
and 3PL service providers to setup VMI through out their plants all over the world and this
model has become the order of the day.
Need for Inventory Management - Why do Companies hold Inventories?
Inventory is a necessary evil that every organization would have to maintain for various
purposes. Optimum inventory management is the goal of every inventory planner. Over
inventory or under inventory both cause financial impact and health of the business as well as
effect business opportunities.
Inventory holding is resorted to by organizations as hedge against various external and internal
factors, as precaution, as opportunity, as a need and for speculative purposes.
Reasons why organizations maintain Raw Material Inventory
Most of the organizations have raw material inventory warehouses attached to the production
facilities where raw materials, consumables and packing materials are stored and issue for
production on JIT basis. The reasons for holding inventories can vary from case to case basis.
1. Meet variation in Production Demand
Production plan changes in response to the sales, estimates, orders and stocking patterns.
Accordingly the demand for raw material supply for production varies with the product plan in
terms of specific SKU as well as batch quantities.
10. Holding inventories at a nearby warehouse helps issue the required quantity and item to
production just in time.
2. Cater to Cyclical and Seasonal Demand
Market demand and supplies are seasonal depending upon various factors like seasons; festivals
etc and past sales data help companies to anticipate a huge surge of demand in the market well in
advance. Accordingly they stock up raw materials and hold inventories to be able to increase
production and rush supplies to the market to meet the increased demand.
3. Economies of Scale in Procurement
Buying raw materials in larger lot and holding inventory is found to be cheaper for the company
than buying frequent small lots. In such cases one buys in bulk and holds inventories at the plant
4.Take advantage of Price Increase and Quantity Discounts
If there is a price increase expected few months down the line due to changes in demand and
supply in the national or international market, impact of taxes and budgets etc, the company’s
tend to buy raw materials in advance and hold stocks as a hedge against increased costs.
Companies resort to buying in bulk and holding raw material inventories to take advantage of the
quantity discounts offered by the supplier. In such cases the savings on account of the discount
enjoyed would be substantially higher that of inventory carrying cost.
5.Reduce Transit Cost and Transit Times
In case of raw materials being imported from a foreign country or from a far away vendor within
the country, one can save a lot in terms of transportation cost buy buying in bulk and transporting
as a container load or a full truck load. Part shipments can be costlier.
6.Long Lead and High demand items need to be held in Inventory
Often raw material supplies from vendors have long lead running into several months. Coupled
with this if the particular item is in high demand and short supply one can expect disruption of
supplies. In such cases it is safer to hold inventories and have control.
Holding inventories help the companies remain independent and free from vendor dependencies.
Finished Goods Inventory
All Manufacturing and Marketing Companies hold Finished Goods inventories in various
locations and all through FG Supply Chain. While finished Goods move through the supply
chain from the point of manufacturing until it reaches the end customer, depending upon the
11. sales and delivery model, the inventories may be owned and held by the company or by
intermediaries associated with the sales channels such as traders, trading partners, stockiest,
distributors and dealers, C & F Agents etc.
1.Markets and Supply Chain Design
Organizations carry out detailed analysis of the markets both at national as well as international /
global levels and work out the Supply Chain strategy with the help of SCM strategists as to the
ideal location for setting up production facilities, the network of and number of warehouses
required to reach products to the markets within and outside the country as well as the mode or
transportation, inventory holding plan, transit times and order management lead times etc,
keeping in mind the most important parameter being, to achieve Customer Satisfaction and
2.Production Strategy necessitates Inventory holding
The blue print of the entire Production strategy is dependant upon the marketing strategy.
Accordingly organizations produce based on marketing orders. The production is planned based
on Build to stock or Build to Order strategies.
While Build to Order strategy is manufactured against specific orders and does not warrant
holding of stocks other than in transit stocking, Build to Stock production gets inventoried at
various central and forward locations to be able to cater to the market demands.
Marketing departments of companies frequently run branding and sales promotion campaigns to
increase brand awareness and demand generation. Aggressive market penetration strategy
depends upon ready availability of inventory of all products at nearest warehousing location so
that product can be made available at short notice - in terms of number of hours lead time, at all
sales locations through out the state and city.
Any non-availability of stock at the point of sale counter will lead to dip in market demand and
sales. Hence holding inventories becomes a necessity.
4.Market Size, location and supply design
Supply chain design takes into account the location of market, market size, demand pattern and
the transit lead time required to reach stocks to the market and determine optimum inventory
12. holding locations and network to be able to hold inventories at national, regional and local levels
and achieve two major objectives. The first objective would be to ensure correct product stock is
available to service the market. Secondly stocks are held in places where it is required and avoid
unwanted stock build up.
5.Transportation and Physical Barriers
Market location and the physical terrain of the market coupled with the local trucking and
transportation network often demand inventory holding at nearest locations. Hilly regions for
example may require longer lead-time to service. All kinds of vehicles may not be available and
one may have to hire dedicated containerized vehicles of huge capacities. In such cases the will
have to have an inventory holding plan for such markets.
Far away market locations means longer lead times and transportation delays. Inventory holding
policy will take into account these factors to work out the plan.
6.Local tax and other Govt. Rules
In many countries where GST is not implemented, regional state tax rules apply and vary from
state to state. Accordingly while one state may offer a tax rebate for a particular set of product
category, another state may charge higher local taxes and lower inter state taxes. In such cases
the demand for product from the neighboring state may increase than from the local state.
Accordingly inventory holding would have to be planned to cater to the market fluctuation.
While in case of exports from the country of origin into another market situated in another
country, one needs to take into account the rules regarding import and customs duties to decide
optimum inventories to be held en route or at destination.
7.Production lead times
FG inventory holding becomes necessary in cases where the lead-time for production is long.
Sudden market demand or opportunities in such cases require FG inventories to be built up and
supplies to be effected.
Companies always keep a watch on the economy, annual state budget, financial environment and
international environment and are able to foresee and estimate situations, which can have an
impact on their business and sales.
In cases where they are able to estimate a increase in industry prices, taxes or other levies which
will result in an overall price increase, they tend to buy and hold huge stocks of raw materials at
13. current prices. They also hold up finished stock in warehouses in anticipation of a impending
sale price increase. All such moves cause companies to hold inventories at various stages.
9.Avoid Certain Costs
Finally organizations hold FG inventories to satisfy customer demand, to reduce sales
management and ordering costs, stock out costs and reduce transportation costs and lead times.
Why and When to avoid Holding Inventories
Every business organization that is engaged in manufacturing, trading or dealing with salable
products holds inventories in one form another. Inventory is held in the form of raw materials or
in the form of salable goods. Since every unit of inventoried item has an economic value and is
itemized in the books of account of the company, inventory can be considered to be an asset of
Inventory Management is a critical function performed by planners to balance the inventory
holding so as to ensure that optimum inventory levels are maintained. Any excess inventory will
result in incremental costs of maintaining inventory and affects the financials of the company as
it blocks working capital. Under inventory on the other hand can seriously hamper the market
share. Any customer order that is not fulfilled due to a stock out is not at all a good sign.
Therefore the responsibility of striking a fine balance in holding lean inventory calls for smart
planning and continuous monitoring of the inventory levels coupled with quick decision-making.
Due to the above factors all organizations generally tend to avoid holding inventories except at
Inventory Buildup Can be a Sign of Hidden Problems
It has been noticed that inventory build up in process and manufacturing industries is often a sign
of hidden problems, which lie underneath and are not visible at the surface level. In other words
one can say that to cover up inefficiencies in the internal systems, people build up inventories as
Stock build up can occur as a solution to cover up supplier inefficiencies. If the vendors are not
reliable and the flow of raw materials cannot be ensured, there results a trend to hold buffer
inventories in the form of raw materials or semi manufactured Work in Process inventories.
In other cases inventory build up can happen due to bad quality. The inventory cost increase and
resultant inventory storage cost can be attributed to cost of quality. If the production is not
consistent with quality, the goods produced will get rejected leading to an increase in rejected
inventory. Secondly, to make up for the loss due to quality rejection, one would have to increase
production and hold finished goods inventory.
14. In other cases production delays can lead to build up of inventories too. Production delays can be
attributed to varied reasons such as bad design of the product, production layout inefficiencies,
production stoppage due to breakdowns, Lengthy process times etc. Besides these causes, there
could be many other problems related to people and management resulting in slackness on the
shop floor, which can add to inventory holding at various stages.
Such inventory build-ups not only block the working capital and increase un necessary cost of
maintaining and storing the inventories, but also hide the problems which can cause serious
threat to the business. Management should be watchful to identify any such inventory buildups
and investigate into the root cause and solve such problems.
An inventory build up at the raw material side as well as the finished goods side gives cause for
worry to the finance controllers. Any non moving inventory is a cause for concern because it not
only blocks up the funds of the organization but the incremental cost of holding the inventory
keeps increasing over a period of time and effect the bottom line figures.
More importantly inventory over a period of time is susceptible to loss, theft, pilferage and
shrinkage. It can also become obsolete and deteriorate over a period of time if not used within
the shelf life.
Hence inventory levels are always on the radar of not only finance controllers, but of the top
management as well.
Types of Inventories - Independent and Dependant Demand Inventories
Inventory Management deals essentially with balancing the inventory levels. Inventory is
categorized into two types based on the demand pattern, which creates the need for inventory.
The two types of demand are Independent Demand and Dependant Demand for inventories.
An inventory of an item is said to be falling into the category of independent demand when the
demand for such an item is not dependant upon the demand for another item.
Finished goods Items, which are ordered by External Customers or manufactured for stock and
sale, are called independent demand items.
Independent demands for inventories are based on confirmed Customer orders, forecasts,
estimates and past historical data.
If the demand for inventory of an item is dependant upon another item, such demands are
categorized as dependant demand.
15. Raw materials and component inventories are dependant upon the demand for Finished Goods
and hence can be called as Dependant demand inventories.
Take the example of a Car. The car as finished goods is an held produced and held in inventory
as independent demand item, while the raw materials and components used in the manufacture of
the Finished Goods - Car derives its demand from the demand for the Car and hence is
characterized as dependant demand inventory.
This differentiation is necessary because the inventory management systems and process are
different for both categories.
While Finished Goods inventories which is characterized by Independent demand, are managed
with sales order process and supply chain management processes and are based on sales
forecasts, the dependant demand for raw materials and components to manufacture the finished
goods is managed through MRP -Material Resources Planning or ERP -Enterprise Resource
Planning using models such as Just In Time, Kanban and other concepts. MRP as well as ERP
planning depends upon the sales forecast released for finished goods as the starting point for
Managing Raw Material Inventories is far more complicated than managing Finished Goods
Inventory. This involves analyzing and co-coordinating delivery capacity, lead times and
delivery schedules of all raw material suppliers, coupled with the logistical processes and transit
timelines involved in transportation and warehousing of raw materials before they are ready to be
supplied to the production shop floor. Raw material management also involves periodic review
of the inventory holding, inventory counting and audits, followed by detailed analysis of the
reports leading to financial and management decisions.
Inventory planners who are responsible for planning, managing and controlling Raw Material
inventories have to answer two fundamental questions, which can also be termed as two basic
Inventory planners need to decide how much of Quantity of each Item is to be ordered from Raw
Material Suppliers or from other Production Departments within the Organization.
When should the orders be placed ?
Answering the above two questions will call for a lot of back end work and analysis involving
inventory classifications and EOQ determination coupled with Cost analysis. These decisions are
always taken in co ordination with procurement, logistics and finance departments.
Inventory procurement, storage and management is associated with huge costs associated with
each these functions.
16. Inventory costs are basically categorized into three headings:
Shortage or stock out Cost & Cost of Replenishment
Cost of Loss, pilferage, shrinkage and obsolescence etc.
Cost of Logistics
Sales Discounts, Volume discounts and other related costs.
Cost of procurement and inbound logistics costs form a part of Ordering Cost. Ordering Cost is
dependant and varies based on two factors - The cost of ordering excess and the Cost of ordering
Both these factors move in opposite directions to each other. Ordering excess quantity will result
in carrying cost of inventory. Where as ordering less will result in increase of replenishment cost
and ordering costs.
These two above costs together are called Total Stocking Cost. If you plot the order quantity vs
the TSC, you will see the graph declining gradually until a certain point after which with every
increase in quantity the TSC will proportionately show an increase.
This functional analysis and cost implications form the basis of determining the Inventory
Procurement decision by answering the two basic fundamental questions - How Much to Order
and When to Order.
How much to order is determined by arriving at the Economic Order Quantity or EOQ.
Inventory carrying involves Inventory storage and management either using in house facilities or
external warehouses owned and managed by third party vendors. In both cases, inventory
management and process involves extensive use of Building, Material Handling Equipments, IT
Software applications and Hardware Equipments coupled managed by Operations and
Management Staff resources.
Inventory storage and maintenance involves various types of costs namely:Inventory Storage
Cost &Cost of Capital
Inventory Storage Cost
Inventory storage costs typically include Cost of Building Rental and facility maintenance and
related costs. Cost of Material Handling Equipments, IT Hardware and applications, including
cost of purchase, depreciation or rental or lease as the case may be. Further costs include
operational costs, consumables, communication costs and utilities, besides the cost of human
resources employed in operations as well as management.
Cost of Capital
17. Includes the costs of investments, interest on working capital, taxes on inventory paid, insurance
costs and other costs associate with legal liabilities.
The inventory storage costs as well as cost of capital is dependant upon and varies with the
decision of the management to manage inventory in house or through outsourced vendors and
third party service providers.
Current times, the trend is increasingly in favor of outsourcing the inventory management to
third party service provides. For one thing the organizations find that managing inventory
operations requires certain core competencies, which may not be inline with their business
competencies. They would rather outsource to a supplier who has the required competency than
build them in house.
Secondly in case of large-scale warehouse operations, the scale of investments may be too huge
in terms of cost of building and material handling equipments etc. Besides the project may span
over a longer period of several years, thus blocking capital of the company, which can be utilized
into more important areas such as R & D, Expansion etc. than by staying invested into the
Good Inventory Management Practices
Good inventory Management practices in the company help by adding value in terms of having
control over and maintaining lean inventory. Inventory should not be too much or too less. Both
the situations are bad for the company. However often we see that inventory is not focused upon
by the management and hence lot of inefficiencies build up over a period of time without the
knowledge of the management. It is only when we start a cost reduction drive that the inventory
goof ups and skeletons come out of the cupboard and results in revamping the entire operations.
However those companies, which have always focused on inventory as a principle function and
recognized that the inventory effects their sales, as well as the books of accounts and profits,
have managed to introduce and improve inventory management processes. Many business
models work on lean inventory principle or JIT inventory along with other models like VMI etc.
Inventory management to a large extent is dependant upon the supply chain efficiency as well as
Inventory management is a management cum operations function. It requires operational
processes to be followed and maintained on the floor and in inventory management systems.
Coupled with operations, it entails continuous study; analysis and decision making to control and
manage inventory levels.
18. We have covered below briefly few of the points which when followed, can go a long way in
ensuring that the inventory is lean and clean.
Review Inventory periodically and revise stocking patterns and norms
Inventory is dependant upon the demand as well as the supply chain delivery time. Often
companies follow one stocking policy for all items. For example, all A, B & C categories may be
stocking inventory of 15 days, which may not be the right thing that is required. While some
items may have a longer lead-time thus affecting the inventory holding, the demand pattern and
the hit frequency in terms of past data may show up differently for each of the inventory items.
Therefore one standard norm does not suit all and can lead to over stocking of inventory as well
as in efficiencies in the system.
Get into detailed inventory planning - One size does not fit all
Understand the inventory types and the specific characteristics of the items you are carrying.
Then build the inventory stocking parameters taking into account the unique characteristics of
the particular inventory.
From amongst your inventory list, you will find that all types of materials are not of the same
value. Some might be very expensive and need to be carried in stock for a longer period, while
another item might have a shorter lead-time and may be fast moving. Quite a few items often
have shelf life and hence require separate norms and focus to manage such items.
Getting into the detailed understanding will help you identify the inventory-stocking norm
required to manage these characteristics to ensure optimum efficiency. The solution quite often
may not be to carry stocks, rather it may involve setting up the customer service standard for
such items and specifying a delivery time depending upon the frequency of demand. Quite a few
items often have shelf life and hence require separate norms and focus to manage such items.
Study demand pattern, movement patterns and cycles to build suitable inventory norms for
different categories of inventory
Companies which are into retail segments and dealing with huge inventories in terms of number
of parts as well as value will necessarily need to ensure they practice review of inventory list and
clean up operations on ongoing basis.
Popularly known as catalogue management, inventory norms review should be carried out based
on detailed study of the sales data, demand pattern, sales cycles etc. Understanding of the
business and sales cycles specific to the product category helps one manage inventories better.
For example, in case of retail garments, with every season certain skus become redundant no
matter how their demand was in the previous months. This helps identify those stocks which are
required to be managed at a micro level and identify the high value and fast moving items that
need to be always on the radar to avoid stock outs.
19. It does not help for example to carry standard stocks of all items including low value items as
well as high value items. If the low value items are locally available and the lead-time is less, one
can cut down on the inventory and change the buying pattern. Similarly high value items too can
be managed by cutting down the delivery lead times and in turn reducing inventory.
It helps to periodically study the past data and extrapolate the same to identify slow moving and
obsolete items. The dead stocks should be flushed out and active catalogue items should be made
Techniques of Inventory Control
A. Economic Ordering Quantity (EOQ)
B. Fixing levels (Quantity Control)
C. ABC Analysis for value of items consumed
Inventory Management System
Modern day inventory is managed by sophisticated system applications that are designed to
manage complex inventory plans and to a large extent contain processes that initiate and
streamline the operations and inventory management. In the wake of improvements in the
communication technology, companies are deploying one single ERP system across all factories,
offices, departments and locations, thereby ensuring seamless transactions, visibility and
Need for Enterprise Resource Planning - Why ERP ?
Separate systems were being maintained during 1960/70 for traditional business functions like
Sales & Marketing, Finance, Human Resources, Manufacturing, and Supply Chain Management.
These systems were often incongruent, hosted in different databases and required batch updates.
It was difficult to manage business processes across business functions e.g. procurement to pay
and sales to cash functions. ERP system grew to replace the islands of information by integrating
these traditional business functions.
The successful implementation of an ERP system will have many advantages, as indicated
Business integration and Improved Data Accuracy: ERP system is composed of various
modules/ sub modules where a module represents a particular business component. If data is
entered in one module such as receiving, it automatically updates other related modules such as
accounts payable and inventory. This updating occurs at real time i.e. at the time a transaction
occurs. Since, data needs to be entered only once at the origin of transaction, the need of multiple
entries of the same data is eliminated. Likelihood of duplicate/ erroneous data is, therefore,
minimized. The centralized structure of the data base also enable better administration and
security provisions, which minimizes loss of sensitive data.
20. Planning and MIS: The various decision support tools like planning engines and simulations
functions, form integral part of an ERP system which helps in proper utilization of resources like
materials, human resources and tools. Constrained based planning help in drawing appropriate
production schedules, thereby improving operation of plant and equipment. As a part of MIS, an
ERP system, contains many inbuilt standard reports and also a report writer which produce ad
hoc reports, as and when needed.
Improved Efficiency and Productivity: In addition to provision of improved planning, ERP
system provides a tremendous boost to the efficiency of day to day and routine transactions such
as order fulfillment, on time shipment, vendor performance, quality management, invoice
reconciliation, sales realization, and cash management. Cycle time is reduced for sales to cash
and procurement to pay sequences.
Establishment of Standardized Procedures: ERP system is based on processes of international
best practices, which are adopted by the organizations during implementation. Department silos
are purged and maverick practices are done away with. Because of top down view available to
management, chances of theft, fraud and obsolescence are minimized.
Flexibility and technology: Due to globalized environment, where production units, distribution
centers and corporate offices reside in different countries, organizations need multi currency,
multi language and multi accounting modes, in an integrated manner. These provisions are
available in most of the ERP systems, particularly in products offered by tier 1 and tier 2
vendors. ERP vendors are also quick to adopt latest technologies, from mainframe to client
server to internet. Unlike a bespoke system, Upgrading to latest technology for a running ERP
system is uncomplicated, involving mostly adoption of service packs and patches.
A Marketing Budget
An estimated projection of costs required to promote a business' products or services.
A marketing budget will typically include all promotional costs, including marketing
communications like website development, advertising and
public relations, as well as the
costs of employing marketing staff and utilizing office space.
Marketing budget is a listing of all the expenses planned for marketing
A marketing budget should include expenses for marketing personnel, marketing training,
marketing consultants, market research, market development and promotion.
21. Before making Budget important points to consider
 Who are the customers you’re trying to reach through advertising and marketing?
 What stage of business are you in? Do you need to attract new customers, or create a
strong brand that keeps the old ones coming back? What are your objectives?
 How often do you need to reach your audience?
 What do you think is the most compelling way to reach them? Through what medium?
 How much do you think your competitors are spending on marketing?
 How much have you spent in the past, and did you get results?
 How much can you realistically spend?
Budget Preparation Methods
Percentage of sales—industry averages: compare with own averages
Task method: looks at objectives + costs of tasks (marketing tools) required to succeed
Competitive method: compare your marketing budget to leading competitors’
Zero-base method: no expenditure justified just because it was last year
Steps for Calculation of Marketing Budget
Create a list of the different segments of your marketing efforts. Include research, testing,
creative production, communications and tracking.
Estimate the costs involved in gathering market research. Market research includes efforts such
as developing a customer profile and examining your competitors. Include administering
surveys, buying research studies and hiring a consultant.
Estimate the costs of testing different marketing strategies. Include product giveaways, focus
groups, creating different versions of your product, selling new items in limited locations and
Estimate the costs of a communications campaign. Include the costs of creative design for
packaging, ads, websites and other collateral materials. Calculate the costs for your desired
media buys, such as print ads, website banners and TV and radio commercials. Include expenses
22. for direct mail, trade shows, public relations, contests, promotions and the cost of building and
maintaining a website.
Estimate the costs of tracking and monitoring your communications efforts. This might include
the purchase of a website statistics package, visiting retailers who sell your product or
conducting customer mail or telephone surveys.
Add up the total estimated costs. Determine whether you can afford the total price of your
marketing plan. If not, review each category to see where you can cut back.
Create a spending formula that ties your marketing budget to a percentage of sales. If your
marketing plan is working, then the more you sell with it, the more you should consider spending
on your marketing efforts. If your sales drop, a spending plan tied to sales will put in a place a
brake that will alert you to reexamine each aspect of your marketing plan.
A specified amount of money set aside to promote a business' or organization's
products or beliefs. Promotional budgets are created to anticipate the essential
costs associated with growing a business or maintaining a brand name. The budget
is often set according to a percentage of sales or profits in order to maintain the
intended growth rate.
Advertising and promotion of a business is a cost which most businesses have a tough time
predicting, which is why a percentage method might be used. If new product lines are set to
release in the near future, the budget could be increased. High promotional budgets cut into
profits in the period of use and are intended to increase sales or awareness in the future.
Determinant of Advertising Budget
23.  Market Share & Consumer Base
 Advertising Frequency
 Product Substitutability
 Stage in the PLC
General Steps in Developing and Implementing an Advertising Campaign
1. Setting advertisement Objective:Before deciding on advertising budget, the advertising manager must be clear about advertising
objectives which help him to determine and allocate the ad budget. Main Objectives of
advertisement are:Achieve the level of sales
Enhance the market share by specific %
To increase awareness regarding Products and its uses.
To develop preference for product
To convinces the customer to buy his product.
2. Determining Tasks to be performed to Achieve Advertising Objective:The next step is to determine tasks, activities, strategies, functions to be performed to achieve the
advertising Objectives. This task includes
 Selection of media
 selection of advertising agency
24.  designing of advertising copy
 Deciding frequency o f advertisement
 Designing of advertisement
 Timing of Advertisement
 Quantum of space to be taken in print media
3)Preparing Advertising Budget After identifying various activities to be done to achieve advertising objectives, the next
step is to find out the cost of all such activities. Total cost of all such activities is amount
required for advertising budget. To keep the budget flexible, certain amount in the form
of provision of contingencies is added to the total cost.
 After preparing advertising budget, it is sent to Top-Management through chief of
marketing-department for necessary approval. Top-Management will see if the budget is
affordable and justified it will pass the budget.
5) Allocation of advertising Budget:
 After the budget is approved by the top management, the next step is to allocate it.
Allocation means dividing the budget on different products and activities. Budget should
be flexible to accommodate sudden changes in market, competitors strategies, and change
in another components of market.
6) Monitor and Control:
 After allocation of resource it is essential to have an adequate monitoring and control
over it. In control, actual expenditure is compared with planned expenditure. In case if
expenditure is greater then the planned expenditure then corrective actions are taken
responsibilities are fixed to ensure cost control.
1. Fixed Percentage of Sales method
25. 2. Objective and Task method
3. Competitive Parity method
4. Market Share method
5. Unit Sales method
6. Residual method
1. Fixed percentage of sales
In markets with a stable, predictable sales pattern, some companies set their
advertising spend consistently at a fixed percentage of sales. This policy has the
advantage of avoiding an ―advertising war‖ which could be bad news for profits.
However, there are some disadvantages with this approach. This approach assumes that
sales are directly related to advertising. Clearly this will not entirely be the case, since
other elements of the promotional mix will also affect sales. If the rule is applied when
sales are declining, the result will be a reduction in advertising just when greater sales
promotion is required
2. Same level as competitors
This approach has widespread use when products are well-established with
predictable sales patterns. It is based on the assumption that there is an ―industry
average‖ spend that works well for all major players in a market.
A major problem with this approach is that it encourages businesses to ignore the
effectiveness of their advertising spend – it makes them ―lazy‖. It could also prevent a
business with competitive advantages from increasing market share by spending more
The task approach involves setting marketing objectives based on the ―tasks‖ that
the advertising has to complete.
26. These tasks could be financial in nature (e.g. achieve a certain increase in sales,
profits) or related to the marketing activity that is generated by the campaigns. For
• Numbers of enquiries received quoting the source code on the advertisement
• Increase in customer recognition / awareness of the product or brand (which can be
• Number of viewers, listeners or readers reached by the campaign
This approach, which is perhaps the worst of all, is to base the advertising budget
on what the business can afford – after all other expenditure. There is no attempt to
associate marketing objectives with levels of advertising. In a good year large amounts of
money could be wasted; in a bad year, the low advertising budget could guarantee a
further low year for sales.
Cost of Market research
The cost of market research can vary wide from thousands to many millions spent by
multinationals on major consumer brands. It is relatively easy to assess the cost of market
research and the procedure to follow is:
1. Scope out the activities that you think will be needed (e.g. 1000 telephone calls, 200 face
to face interviews etc.) assess the amount of time input that this requires
2. Identify the daily cost of either your own staff or employing people of the right caliber to
do the work
3. Add in the preparation time for questionnaires and the time to analyse and write up the
Cost benefit Evaluation of market research
Investment in market research is expected to produce additional revenue or reduce cost in
much the same way as a new piece of equipment
There are no widely accepted procedures for evaluating the returns nor is there any
standard set of criteria for economic feasibility of project
A cost benefit analysis finds, quantifies, and adds all the positive factors. These are the
benefits. Then it identifies, quantifies, and subtracts all the negatives, the costs. The
difference between the two indicates whether the planned action is advisable. The real
trick to doing a cost benefit analysis well is making sure you include all the costs and all
the benefits and properly quantify them
Cost Benefit Evaluation Of Market Research
 P.L.Days in his paper ―optimising Marketing research through Cost benefit analysis ―
has outline the main features of such analysis
1. Review objectives that are being sought
2. Establish criteria for the use in evaluating the alternatives
3. Identify relevant alternatives with reference to particular assessment of economic costs
and benefits or gain associated with it
4. Recognise time pattern of benefits and costs
5. Recognise uncertainty. Decide alternative strategy and outcomes .
6. Apply profitability criteria and come to the decision of better strategy
7. Develop a model to suit the analysis with the built in probabilities to take care of
Factors Responsible For Budget Size
 Cost of market research information are acquisition and operating costs while its value is
utility in terms of profitability, market share etc.
1. The selling ability of the marketing research head
2. Amount needed to meet or beat the typical level of expenditure incurred by competitors
3. The amount that the company can afford to spend
4. Budget based on fixed percentage of the total marketing cost budget
28. Research is used most efficiently if its budget is regarded as an investment rather
than an expense
How to Use Discounted Cash Flow (DCF) in Research & Development
When a company's research and development department investigates whether to
pursue a venture, it estimates the investment's total return. This return is the sum of all
future cash flows that the investment produces. Yet the company values current returns
more than future ones due to the chance for reinvestment. The department must
consider this and calculate the investment's discounted cash flows. The venture's total
value is the sum of this cash flow into perpetuity.
Estimate the annual growth rate of the cash flow that the project will generate. For example,
suppose that the returns will increase by 4 percent each year.
Decide on a discount rate to use in your calculation. One frequent source for this rate is the U.S.
Treasury borrowing rate. For example, suppose that this rate is 5 percent.
Subtract the growth rate from the discount rate. With this example, subtract 0.04 from 0.05 to get
Divide the initial cash flow from the product by this value. For example, suppose that the first
year of production brings in a profit of $30,000. Divide $30,000 by 0.01 to get $3 million, the
sum of the product's discounted cash flows. The product's research and development budget must
be lower than this to ensure any profit over the product's lifetime and significantly lower to
produce a significant profit.
29. Meaning of Product Life Cycle
The period of time over which an item is developed, brought to market and eventually removed
from the market. First, the idea for a product undergoes research and development. If the idea is
determined to be feasible and potentially profitable, the product will be produced, marketed and
rolled out. Assuming the product becomes successful, its production will grow until the product
becomes widely available. Eventually, demand for the product will decline and it will become
At the beginning of a product's life, it may have a little to no competition in the market place
until competitors start to emulate it when it shows signs of success. As the product becomes
more successful, it will face increasing numbers of competitors and may lose market share. The
stage of its life cycle the product is currently in will impact the way it is marketed to consumers.
30. For example, a brand-new product will need to be explained to consumers, while a product that
is further along in its life cycle will need to be differentiated from its competitors.
What is Life Cycle Costing?
 Life Cycle Costing (LCC) also called Whole Life Costing is a technique to establish the
total cost of ownership.
 It is a structured approach that addresses all the elements of this cost and can be used to
produce a spend profile of the product or service over its anticipated life-span. The results
of an LCC analysis can be used to assist management in the decision-making process
where there is a choice of options. The accuracy of LCC analysis diminishes as it projects
further into the future, so it is most valuable as a comparative tool when long term
assumptions apply to all the options and consequently have the same impact.
Importance of Life Cycle costing
 Time based analysis: Life cycle costing involves tracing of costs and revenue of each
product over several calendar periods throughout their life cycle. Costs and revenue can
analysed by time periods. The total magnitude of costs for each individual product can be
reported and compared with product revenue generated in various time periods
 Overall cost analysis: Production costs are accounted and recognize by the routine
accounting system . However non production costs like R&D , Design , Marketing ,
Distribution ,customer service etc. are visible on a product by product basis. PLC costing
focuses on recognizing both production and non production costs
 Pre production costs analysis: The development period of R & D is long and costly. A
high percentage of total product costs may be incurred before commercial production
begin . Hence company needs accurate information on such costs for deciding whether to
continue with the R & D or not
 Effective pricing decision: Pricing Decision , in order to be effective should include
market consideration on one hand and cost consideration on the other . PLC Costing and
target costing help analyze both these consideration and arrive at optimal price decisions
31.  Better decision making: Based on a more accurate and realistic assessment of revenue
and costs at least within a particular life cycle stage , better decision can be taken
 Long Run holistic view : PLC Costing can promote long term rewarding in contrast to
short term profitability rewarding . It provides an over all framework for considering total
incremental costs over the entire life span of the product which in turn facilitate analysis
of parts of the whole where the costs effectiveness might be improved.
 Life Cycle Budgeting: Life cycle costing with target costing principles facilitates scope
for the cost reduction at the design stage itself . Since cost are avoided before they are
committed or lock in the company is benefited
 Review: Life cycle costing provides scope for analysis of long term picture of product
line profitability , feedback on the effectiveness of life cycle planning and cost data to
clarify the economic impact of alternatives chosen in the design , engineering phase
Stages of the Expanded Product Life Cycle
1. Research and development
2. Product introduction
3. Development of the market
5. Market maturation
6. Market saturation
7. Market decline
To calculate or measure at what stage of its life cycle a given market is, the following parameters need to be
measured and monitored:
Investment in R&D by year
Number of competitors in the market by year
Number of competitors that entered the market by year
Number of competitors that left the market by year
Market growth rate by year
Market size by year
Industry profitability by year
Investment in marketing (such as advertising, trade shows, and direct sales forces) by year
The measurement of these parameters over time will help you determine what stage a given market is in.
Figure 1 below has been developed to aid you in making this determination:
Figure 1 - Market/Product Age: How to Measure the Stage of the Product Life Cycle
High & Low
Note: All figures are rounded. Source: Frost & Sullivan
During the R&D stage, profits are nonexistent. In certain rare circumstances, profits are made early in the
life cycle. However, generally profits are not made until the development of the market stage. It is usually at
this point that products that have not reached profitability are withdrawn from the market.
Profits reach their zenith during the exploitation stage; the maturation stage and saturation stages are
characterized by steady to declining profits. The declines in profits typical during these stages are attributed
to increased competition. Profits will continue to decline to the point where they no longer exist, and losses
will take hold during the product decline stage.
Thus, the life cycle is vital as a planning tool because the extent of profit changes during each stage of the
life cycle. Forecasting and market planning over the medium term can be performed effectively using the
product life cycle segments as the timing stages. The marketing strategies used will have to be modified as
the product passes through each stage of the cycle.
Criteria for Investment Decisions in New Product
Most important criteria in new product decision are it fit into the company’s mission and
objective , state of competition, profitability etc
Other important criteria are:
Synergy i.e look for positively correlated product Automobile &Petrol
a. Marketing synergy
b. Supplier Synergy
c. Customer synergy
Portfolio effect- negatively correlated product
33. ,Existing verses possible replacement product (fountain pen vs ball point pen),
High margin low volume product verses low margin high volume,
Off the shelf items verses made-to-order item
. Search for SecurityEx TISCO going in for vertical integration , both backward & forward
4. PLC Consideration – investment in product which are in their introductory or growth phase in
their life cycle i.e in upward movement of life cycle
5. Segment movement : If a dairy firm moves from the supply of milk at a cheap price to
supplying butter and other value added milk products to cater to different market segments it
would be instance of segment movement
4. Search for Stability- highly fluctuating to stable product(HMT from machine tools into
Vertical specialization : HMT by moving from general purpose machine to special purpose
machine , the company introduce vertical specialization
 The product-mix of a company is the existence of various products that the company can
produce and sell. However, each product in the mix requires finite amount of limited
resources. Hence it is vital to determine accurately the quantity of each product to be
produced knowing their profit margins and the inputs required for producing them. The
primary objective is to maximize the profits of the firm subject to the limiting factors
within which it has to operate
Application of Linear Programming in product mix
 Linear programming is one of the most useful techniques for effective decision making. It
is an optimization approach with an emphasis on providing the optimal solution for
resource allocation. How best to allocate the scarce organisational or national resources
among different competing and conflicting needs (or uses) forms the core of its working.
The scope for application of linear programming is very wide and it occupies a central
place in many diversified decisional problems. The effective use and application of linear
programming requires the formulation of a realistic model which represents accurately
34. the objectives of the decision making subject to the constraints in which it is required to
 The product-mix of a company is the existence of various products that the company can
produce and sell. However, each product in the mix requires finite amount of limited
resources. Hence it is vital to determine accurately the quantity of each product to be
produced knowing their profit margins and the inputs required for producing them. The
primary objective is to maximize the profits of the firm subject to the limiting factors
within which it has to operate.