The document discusses the purpose and preparation of a fund flow statement. It defines key terms like fund, flow, and working capital. It explains that a fund flow statement shows the sources and uses of funds in a business over a period of time. It overcomes limitations of traditional financial statements by showing where funds came from and how they were used. The document provides an example of a fund flow statement with sources of funds including profit and sale of assets, and uses of funds such as purchase of assets and payment of dividends. It also includes an example schedule of changes in working capital.
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Chapter 3 – Why we prepare fund flow
statement?
The balance sheet and income statement are the traditional basic financial
statement of a business enterprise. A serious limitation of these statements is
that they do not provide information regarding changes in the firm’s
financial position during a particular period of time. They fail to answer
following question
What funds were available during the accounting period and for what purpose
these funds were utilized?
Have long term sources been adequate to finance fixed asset purchase?
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Chapter 3 – Why we prepare fund flow
statement?
Permanent and Temporary Working Capital
Maturity Matching Principle
Financing Net working Capital
Short-Term vs. Long-Term Financing
Working Capital Policy
Does the firm possess adequate working capital?
How much funds have been generated from operations?
Why did the firm not pay dividend in spite of adequate
profit?
The balance sheet is merely a static statement. It is
statement of asset and liabilities of the business as on
particular date.
The fund flow statement overcomes these limitations
of basic financial statement. Fund flow statement will
provide us information about different sources of fund and
their various uses in particular time.
4. The term fund has a variety of meaning such as cash fund, capital fund and
working capital fund.
1.Cash fund –In a narrow sense, fund means only cash. ‘Cash flow statement’
portrays net effect of the various business transactions on cash into
account receipts & disbursement of cash.
This concept of preparing fund flow statement is not accepted, as there are
many such transactions which do not affect cash but represent the flow of
fund .
for example: purchase of furniture on credit does not affect cash but there is
flow of fund.
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Meaning Of Fund
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Meaning Of Fund Continued……
2. Capital fund –Here fund means all financial resources used in the
business, whether in the form of men, money, material, machine &
others.
3.Net working capital -Net working capital means difference between
current asset and current liabilities .funds generally refers to cash or
cash equivalent or to working capital.
6. Meaning Of Flow
The term ‘flow’ refers to changes or transfer and therefore the ‘flow
of funds’ means transfer of economic values from one asset to
another, from one liability to another, from one asset to liabilities or
vice-versa or a combination of these. So flow of fund refers to
increase or decrease in net working capital.
The increase or decrease in net working capital will take place only
when one account, out of two accounts to be affected in a transaction
,is a current account i.e. current asset or current liabilities and the
other account is non current account i.e. fixed asset or long term
liability or capital.
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Meaning Of Flow (Continued)…………
When a change in non current account is followed by a change in
another non current account, it does not amount to flow of fund. It is
because, in such case, neither the working capital increase nor
decrease
For example
Machinery a/c Dr
To share capital a/c
(Machinery purchase in consideration of share)
In the above transaction both accounts are non current accounts
which do not at all affect current asset and current liability. Therefore
working capital will remain unaffected i.e. there will be no flow of
fund.
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Meaning Of Flow (Continued)…………
When changes in one current account results in a
changes in other current account ,it also does not
affect working capital i.e. there is no flow of funds.
For example
Cash a/c Dr
To debtor a/c
(Cash received from debtor)
It represents an increase of cash –a current asset account and decrease
of debtor again a current asset account .thus there will be no net
changes in the amount of working capital, although the composition of
working capital will be affected .
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Meaning Of Flow (Continued)…………
In the above figure the dotted line displays there will be no flow of
fund & the dark line displays the flow of fund.
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Preparation of Fund Flow Statement
The changes which occurred in the current accounts as a result
flow of fund are reflected in a statement known as
‘schedule of changes in working capital’ .
The similar changes in non current accounts are shown in
‘Fund Flow Statement’.
Therefore, following two statements under this techniques
.
1. Statement or Schedule of Changes in Working Capital.
2. Statement of Sources and Uses of Funds or Funds Flow
Statement.
11. Preparation of Fund Flow Statement
Schedule of Changes in Working Capital
It discloses the changes in individual item of current asset & current
liabilities between two period & there effect on working capital.
Working capital will increase when there is an increase in current
asset and decrease in current liabilities, whereas, working capital will
decrease when there is a decrease in current asset & increase in
current liabilities.
Net increase in working capital is treated as use of funds & the net
decrease in working capital is treated as source of funds.
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•
Statement or Schedule of Changes in Working Capital
Item
(A) Current Assets
Cash at bank
Cash in hand
Stock in trade
Debtors
Bills receivable
Advance payment
Short term investment
Prepaid expense
Accrued income
Total (A)
(B) Current Liabilities
(1) Short term loans
(2) Bank overdraft
(3) Creditors
(4) Bills payable
(5) Outstanding expenses
(6) Unclaim dividend
Total (B)
Net Working Capital (A-B)
Incraese / Decrease in Working Capital
Total
Previous Year Current Year Effect on
Incraese Rs.
Working
captial
Decrease Rs.
13. This statement reveals resources from which funds were
obtain by the firm and the specific uses to which such
funds were applied. The effectiveness of financial
management in procuring funds from various sources &
using them effectively for generating income without
sacrificing the financial position of the firm is reflected in
fund flow statement .
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Meaning of fund flow statement :
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Definitions of fund flow statement:
In the words of Foulke, R.A., “a statement of source and
application of fund is a technical device design to analysis the
changes in the financial condition of business enterprises between
two dates”.
According to : Almond Coleman, “ The fund flow statement
summarizing the significant financial changes which were occurred
between the beginning & the end of a company’s accounting
periods”.
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Definitions of fund flow statement:……..
This fund flow statement has two parts :
1. Sources of fund
2. Application of fund
The difference between these two parts that is sources & uses of
funds represents net changes in working capital.
The excess of sources of funds over uses of fund is the net increase
in working capital & excess of uses over sources of fund is net
decrease in working capital.
The amount of net increase or decrease as shown in fund flow
statement should be equal to the amount shown by schedule of
working capital changes.
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The Fund Flow Statement
Sources of Fund Amount
Fund from operation
Issue of share
Issue of debenture
long term loans
Sale of fixed assets /
Investment
Non trading receipts
Decrease in working
capital
(if any)
Uses Of Funds Amount
Loss from operation
Redemption of
preference shares
Redemption of
debentures
Repayment of
long term loans
Purchase of fixed assets
/ Investments
Payment of dividend & taxes
Increase in working capital
(if any)
17. Fund from operations :
The profit made by a firm through normal operations is a major source
of funds. The amount of sales as shown in the P&L A/c is a source of
funds by way of increase in cash , debtor and B/R.
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18. Profit & loss Adjustment ac
•
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Particular Amount
Depreciation
Loss on sale of fixed assets
Under writing commissions
Discount on issue of shares &
debentures
Preliminary expense written off
Deferred revenue expenses
Goodwill written off
Patent or trademark
Provision for taxes
(If treated non current)
Particular Amount
Profit or gain on sale of
fixed asset
Dividend received
Interest received of
investment
Profit on revaluation
of asset
Fund from operation
19. Q-Comparative Balance sheet of Z Ltd. As
on year 2000 and 2001 were as follow
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Liabilities 2000 2001 Assets 2000 2001
Account payable
Notes payable
Loan on Mortgage
Capital
Sinking fund
Retained Earning
Provision for DD
Accumulated
Depreciation-
Building
furniture
15000
10000
40000
50000
16000
13950
1350
12000
3200
161500
18000
75000
40000
45000
12000
16275
1425
9000
2400
151600
Cash
Account
receivable
Stock
Sinking fund
investment
Land
Building
Furniture
11200
21300
35000
16000
10000
60000
8000
161500
8500
23500
30600
12000
10000
60000
7000
151600
20. Following information is given further
• Net profit for the year 2001 amounted 6675.
• Dividend amounted to Rs.5000 was paid during the year.
• Prepare a statement of sources and uses of fund.
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Schedule of Changes in Working Capital
Items
CURRENR ASSETS:-
Cash
Account receivable
Stock
TOTAL of CA (A)
CUURENT LIABILITIES:-
Account payable
Note payable
Provision for D D
TOTAL of CL (B)
Difference b/w (A-B)
Decrease in W C
2000
Amount
11200
21300
35000
67500
15000
10000
1350
26350
41150
41150
2001
Amount
8500
23500
30600
62600
18000
7500
1425
26925
35675
5475
41150
Change in
Increase
2200
2500
5475
10175
Working
capital
Decrease
2700
4400
3000
75
10175
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Fund flow statement
Sources of fund
Sale of sinking
fund investment
Fund from
operation
Decrease in
working capital
Amount
4000
525
5475
10000
Application of
fund
Redemption of
share capital
Dividend paid
Amount
5000
5000
10000
23. Difference between permanent &
temporary working capital-2
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Variable Working Capital
•
•Amount
•of
•Working
•Capital
• Permanent Working Capital
•
• Time
•
24. Financing needs over time
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•Fixed Assets
•Permanent Current Assets
•Total Assets
•Fluctuating Current Assets
•Time
•$
25. Matching approach to asset financing
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•Fixed Assets
•Permanent Current Assets
•Total Assets
•Fluctuating Current Assets
•Time
•$
•Short-term
•Debt
•Long-term
•Debt +
•Equity
•Capital
26. Conservative approach to asset financing
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•Fixed Assets
•Permanent Current Assets
•Total Assets
•Fluctuating Current Assets
•Time
•$
•Short-term
•Debt
•Long-term
•Debt +
•Equity
• capital
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•Fixed Assets
•Permanent Current Assets
•Total Assets
•Fluctuating Current Assets
•Time
•$
•Short-term
•Debt
•Long-term
•Debt +
•Equity
• capital
Aggressive approach to asset financing
28. FACTORS DETERMINING WORKING CAPITAL
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1. Nature of the Industry
2. Demand of Industry
3. Cash requirements
4. Nature of the Business
5. Manufacturing time
6. Volume of Sales
7. Terms of Purchase and Sales
8. Inventory Turnover
9. Business Turnover
10. Business Cycle
11. Current Assets requirements
12. Production Cycle
•13. Credit control
14. Inflation or Price level changes
15. Profit planning and control
16. Repayment ability
17. Cash reserves
18. Operation efficiency
19. Change in Technology
20. Firm’s finance and dividend policy
21. Attitude towards Risk
29. EXCESS OR INADEQUATE WORKING CAPITAL
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Every business concern should have adequate working capital to run
its business operations. It should have neither redundant or excess
working capital nor inadequate or shortage of working capital.
Both excess as well as shortage of working capital situations are bad
for any business. However, out of the two, inadequacy or shortage of
working capital is more dangerous from the point of view of the
firm.
30. Disadvantages of Redundant or Excess
Working Capital
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Idle funds, non-profitable for business, poor ROI
Unnecessary purchasing & accumulation of inventories
over required level
Excessive debtors and defective credit policy, higher
incidence of B/D.
Overall inefficiency in the organization.
When there is excessive working capital, Credit worthiness
suffers
Due to low rate of return on investments, the market value
of shares may fall
31. Disadvantages of Inadequate Working
Capital
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Can’t pay off its short-term liabilities in time.
Economies of scale are not possible.
Difficult for the firm to exploit favourable market situations
Day-to-day liquidity worsens
Improper utilization the fixed assets and ROA/ROI falls sharply
32. Management Of Working Capital ( WCM )
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Management of working capital is concerned with the problems
that arise in attempting to manage the current assets, the current
liabilities and the inter-relationship that exists between them. In
other words, it refers to all aspects of administration of CA and
CL.
Working Capital Management Policies of a firm have a great
effect on its profitability, liquidity and structural health of the
organization.
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3D Nature of Working Capital Management
•Dimension I
•Profitability,
•Risk, & Liquidity
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Principles Of Working Capital
Management
•PRINCIPLES OF
WORKING CAPITAL
MANAGEMENT
•Principle
of Risk
Variation
•Principle
of Cost of
Capital
•Principle
of Equity
Position
•Principle of
Maturity of
Payment
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Maturity Matching Principle
• Maturity (due date) of financing should roughly
match duration (life) of asset being financed
Then financing /asset combination becomes self-
liquidating
• Cash inflows from asset can be used to pay off loan
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Financing Net Working Capital
• According to maturity matching principle
Temporary (seasonal) should be financed with short-
term borrowing
Permanent working capital should be financed with
long-term sources, such as long-term debt and/or equity
• In practice, firms may use more or less short-term
funds to finance working capital
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Figure 3.7(a):
Working Capital Financing Policies
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Figure 3.7(b):
Working Capital Financing Policies
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Short-Term vs. Long-Term Financing
• The mix of short- or long-term working capital
financing is a matter of policy
Use of long-term funds is a conservative policy
Use of short-term funds is an aggressive policy
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Short-Term vs. Long-Term Financing
• Short-term financing
Cheap but risky
• Cheap—short-term rates generally lower than long-term rates
• Risky—because you are continually entering marketplace to
borrow
• Borrower will face changing conditions (ex; higher interest rates and
tight money)
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Short-Term vs. Long-Term Financing
• Long-term financing
Safe but expensive
• Safe—you can secure the required capital
• Expensive—long-term rates generally higher than short-term
rates
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Working Capital Policy
• Firm must set policy on following issues:
How much working capital is used
Extent to which working capital is supported by short-
vs. long-term financing
How each component of working capital is managed
The nature/source of any short-term financing used
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Cash Management
• Cash management—determining:
Optimal size of firm’s liquid asset balance
Appropriate types and amounts of
short-term investments
Most efficient methods of controlling
collection and disbursement of cash
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Cash Management
• Why have cash on hand?
Transactions demand: need money to pay bills
(employees, suppliers, utility/phone, etc.)
Precautionary demand: to handle emergencies
(unforeseen expenses)
Speculative demand: to take advantage of
unexpected opportunities (purchase of raw materials
that are on sale)
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Objectives of Cash Management
• Cash doesn’t earn a return
• Want to maintain liquidity
Take cash discounts
Maintain firm’s credit rating
Minimize interest costs
Avoid insolvency
• Good cash management implies maintaining
adequate liquidity with minimum cash in bank
Can place portion of cash balance into marketable
securities (AKA: near cash or cash equivalents)
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Marketable Securities
• Liquid investments that can be held
instead of cash and earn a modest return
Examples include Treasury bills,
commercial paper, bankers’ acceptances
Many are bought and sold at a discount in
money market
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Examples of Marketable Securities
• Treasury Bills
Short-term government notes issued at a
discount with principal repaid at maturity
• Commercial Paper
Short-term unsecured promissory notes
issued by corporations with good credit
• Bankers’ Acceptances
Short-term promissory notes issued by a firm
and accepted (or guaranteed) by a bank
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Yield on a Discounted Money Market
Security
• Annualized yield
100 – P 365
P d
where P = Discounted price as a
percentage of maturity value
d = Number of days to maturity
r = Annualized yield
×r =
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Components of Float
• Mail Float
delay between when cheque is sent to a payee and
is received by payee
• Processing Float
time between receipt of payment by a payee and the
deposit of the payment in the payee’s account
• Clearing Float
time between depositing a cheque and having
available spendable funds
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Cheque Disbursement and the
Cheque Clearing Process
• When you pay a bill,
You write cheque and mail to payee (2-3
days of mail float)
Payee receives cheque and performs internal
processing (1 day of processing float)
Payee deposits cheque in its own bank (1 day
of processing float)
Payee’s bank sends cheque into interbank
clearing system which processes cheque (2
days of clearing float)
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Figure 4.5: The Cheque-Clearing
Process
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Accelerating Cash Receipts
• Lock-box systems
Post office box(es) located near customers in
order to shorten mail and processing float
• Local bank empties the box, deposits payments
into firm’s account, and reports payments to firm
May involve significant fees
More cost-effective if small number of larger
deposits
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Figure 4.6: A Lock Box System in
the Cheque-Clearing Process
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Accelerating Cash Receipts
• Concentration Banking
Customers send cheques sent to firm’s local
collection centres, where they are deposited
Local deposits are transferred electronically
into one central concentration account
Reduces mail float
Funds available for paying loans or investing
in marketable securities
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Electronic Funds Transfer
• Electronic funds transfer mechanisms
are reducing the importance of float
management techniques for many
companies
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Electronic Funds Transfer
• Wire Transfers
Transferring money electronically
• Preauthorized Cheques
Customer gives payee signed cheque-like
documents in advance
When payee ships product, it deposits
preauthorized cheque in its bank account
• Eliminates mail float
• Payee must trust payer
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Managing Cash Outflow
• Zero balance accounts (ZBAs)
Decentralization of cash payments can lead to large
number of cash balances around the country
Divisions write cheques on ZBAs—funded from
central account only when cheques are cleared
Solves problem of idle cash in decentralized bank
accounts
• Remote disbursing
Using bank in remote location for disbursement
chequing account
• Increases mail float
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Evaluating Cash Management
Services
• Evaluation involves comparison of costs
versus benefits of faster collection
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Example 4.1: Evaluating Cash
Management Services
Q: Kelso Systems Inc. has customers in British Columbia that remit
about 500 cheques a year. The average cheque is for $10,000.
West coast cheques currently take an average of eight days
from the time they are mailed to clear into Kelso’s east coast
account.
A British Columbia bank has offered Kelso a lock box system for
$1,000 a year plus $0.20 per cheque. The system can be
expected to reduce the clearing time to six days.
Is the bank’s proposal a good deal for Kelso if it borrows at 8%?
Example
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Example 4.1: Evaluating Cash
Management Services
A: The cheques represent revenue of: 500 × $10,000 =
$5,000,000 per year.
The average amount tied up in the cheque clearing process is:
8/365 x $5,000,000 = $109,589.
The proposed lockbox system will reduce this to: 6/365 x
$5,000,000 = $82,192, thus freeing up $27,397 of cash.
Kelso will be able to borrow $27,397 less, thus saving: $27,397
x 0.08 = $2,192 in interest
The system is expected to cost: $1,000 + ($0.20 x 500) =
$1,100.
The net saving is: $2,192 - $1,100 = $1,092
The bank’s proposal should be accepted
Example
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Managing Accounts Receivable
• Generally firms like as little money as possible
tied up in receivables
Reduces costs (firm has to borrow to support the
receivable level)
Minimizes bad debt exposure
• But, having good relationships with customers
is important
Increases sales
• Firm needs to strike a balance on these issues
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Trade-offs in Receivable
Management
Liberal Management
More sales and gross
margin, but
More bad debts
Higher collection costs
More discount
expenses
Higher receivables
Longer collections
More interest expense
Strict Management
Less sales and gross
margin, but
Less bad debts
Lower collection costs
Less discount
expenses
Lower receivables
Shorter collections
Less interest expense
Trade-offs in Managing Accounts
Receivable
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Managing Accounts Receivable
• Policy Decisions Influencing Accounts
Receivable
Credit Policy
• Criteria used to screen credit applications
• Controls quality of accounts to which credit is extended
Terms of Sale
• Terms and conditions under which credit extended must be
repaid
Collections Policy
• Methods employed to collect payment on past due accounts
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Credit Policy
• Must examine creditworthiness of potential
credit customers
Credit report
Customer’s financial statements
Bank references
Customer’s reputation among other vendors
• Conflicts often arise between sales and credit
departments
Sales department’s job to generate sales
Credit department may refuse credit to high risk
accounts
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Terms of Sale
• Credit sales are made according to
specified terms of sale
Example: 2/10, net 30 means customer
receives 2% discount if payment is made
within 10 days, otherwise entire amount is
due by 30 days
Customers pay quickly to save money
Firm’s terms of sale generally follow
industry practice
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Collections Policy
• Firm’s collection policy—manner and aggressiveness
with which firm pursues payment from delinquent
customers
Being overly aggressive can damage customer relations
• Function of collections department— to follow up on
overdue receivables (called dunning)
Mail polite letter
Follow up with additional dunning letters
Phone calls
Collection agency
Lawsuit
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Inventory Management
• Inventory management— establishes a balance
between carrying enough inventory to meet
sales or production requirements while
minimizing inventory costs
• Inventory usually managed by manufacturing
or operations
However, finance department has an oversight
responsibility
• Monitor level of lost or obsolete inventory
• Supervise periodic physical inventories
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Benefits and Costs of Carrying
Adequate Inventory
• Benefits
Reduces stockouts and backorders
Makes operations run more smoothly, improves customer
relations and increases sales
• Carrying Costs
Interest on funds used to acquire inventory
Storage and security
Insurance
Taxes
Shrinkage
Spoilage
Breakage
Obsolescence
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Inventory Ordering Costs
• Inventory ordering costs
Expenses of placing orders with suppliers,
receiving shipments, and processing
materials into inventory
• Excludes vendor charges
Relate to the number of orders placed
rather than to the amount of inventory held
Tend to vary inversely with carrying costs
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Economic Order Quantity (EOQ)
Model
• EOQ model recognizes trade-offs between
carrying costs and ordering costs
Carrying costs increase with amount of inventory
held ( from larger orders)
Ordering costs increase with the number of orders
placed (from more orders)
• EOQ minimizes total of sum of ordering and
carrying costs
72. Khursheed Ahmad Bhat, HOD. Department of Hospital Administration TMU
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Inventory Costs and the EOQ
Q (Order Size)
Cost
($)
Total
Cost
EOQ
Carrying
Cost
Ordering
Cost
73. Khursheed Ahmad Bhat, HOD. Department of Hospital Administration TMU
73
Economic Order Quantity (EOQ)
Model
• EOQ model is:
where
Q= order size in units
D= annual quantity used in units
F= cost of placing one order
C= annual cost of carrying one unit in stock
½ denotes square root
c
2FD
Q
½
74. Khursheed Ahmad Bhat, HOD. Department of Hospital Administration TMU
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Figure 4.7: Inventory on Hand for a
Steadily Used Item
75. Khursheed Ahmad Bhat, HOD. Department of Hospital Administration TMU
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Economic Order Quantity (EOQ)
Model
• Other Inventory Formulas
Average Inventory =
Total Carrying Cost: =
Number of Orders =
Total Ordering Cost = FN =
Total Ordering and Carrying Cost =
2
Q
Q
c
2
D
N =
Q
D
F
Q
Q D
TC = c +F
2 Q
76. Khursheed Ahmad Bhat, HOD. Department of Hospital Administration TMU
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Example 4.3: Economic Order
Quantity
Example
Q: The Galbraith Corp. buys a part that costs $5. The carrying
cost of inventory is approximately 20% of the part’s dollar value
per year. It costs $50 to place, process and receive an order.
The firm uses 900 of the $5 parts per year.
What ordering quantity minimizes inventory costs?
How many orders will be placed each year if that order quantity
is used?
What inventory costs are incurred for the part with this ordering
quantity?
77. Khursheed Ahmad Bhat, HOD. Department of Hospital Administration TMU
77
Example 4.3: Economic Order
Quantity
Example
A: Annual carrying cost per unit is 20% x $5 = $1
EOQ = 300 units
The annual number of reorders is 900 300 = 3
Ordering costs are $50 x 3 = $150 per year
Average inventory is 300 2 = 150 units
Carrying costs are 150 x $1 = $150 a year
Total inventory cost of the part is $300
1
900502
Q
½
78. Khursheed Ahmad Bhat, HOD. Department of Hospital Administration TMU
78
Safety Stocks, Reorder Points and
Lead Times
• Safety stock provides insurance against
unexpectedly rapid use or delayed
delivery
Additional supply of inventory that is carried
at all times to be used when normal working
stocks run out
Rarely advisable to carry so much safety
stock that stockouts never happen
• Carrying costs would be excessive
79. Khursheed Ahmad Bhat, HOD. Department of Hospital Administration TMU
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Safety Stocks, Reorder Points and
Lead Times
• Ordering lead time—advance notice
needed so that an order placed will arrive
when required
Usually estimated by item’s supplier
• Reorder point—level of inventory at
which order is placed
80. Khursheed Ahmad Bhat, HOD. Department of Hospital Administration TMU
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Figure 4.9: Inventory on Hand
Including Safety Stock
81. Khursheed Ahmad Bhat, HOD. Department of Hospital Administration TMU
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Economic Order Quantity (EOQ)
Model
• Other Inventory Formulas (with Safety
Stock)
• Average Inventory =
• Total Carrying Cost: =
• Total Ordering and Carrying Cost =
StockSafety
2
Q
Q
c Safety Stock
2
Q D
TC = c SafetyStock +F
2 Q
82. Khursheed Ahmad Bhat, HOD. Department of Hospital Administration TMU
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Tracking Inventories—The ABC
System
• Some inventory items (A items) require great
deal of attention
Very expensive
Critical to firm’s processes or to those of customers
• Some inventory items do not require great deal
of attention (C items)
Commonplace, easy to obtain
• B items fall between items A & C
• ABC system segregates items by value and
places tighter control on higher cost (value)
pieces
83. Khursheed Ahmad Bhat, HOD. Department of Hospital Administration TMU
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Just In Time (JIT) Inventory
System
• Inventory supplied
At exactly the right time
In exactly the right quantities
• Theoretically eliminates the need for factory inventory
Shortens operating cycle
Reduces costs
Eliminate wasteful procedures
But: late delivery can stop factory’s entire production line
• Works best with large manufacturers who are powerful
with respect to supplier
Supplier is willing to do almost anything to keep the
manufacturer’s business