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Module 4.1 Short-Term Financial Decisions: Inventory Management

The document discusses short-term financial decisions related to inventory management and accounts receivable. It provides details on key concepts like the economic order quantity model, calculating the average investment in accounts receivable, and changing credit terms. Additionally, it discusses ethics and detecting aggressive accounting practices through measures like inventory accumulation and rising accounts receivables. The document also provides information on major credit reporting agencies in New Zealand and relevant privacy regulations.

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18 views2 pages

Module 4.1 Short-Term Financial Decisions: Inventory Management

The document discusses short-term financial decisions related to inventory management and accounts receivable. It provides details on key concepts like the economic order quantity model, calculating the average investment in accounts receivable, and changing credit terms. Additionally, it discusses ethics and detecting aggressive accounting practices through measures like inventory accumulation and rising accounts receivables. The document also provides information on major credit reporting agencies in New Zealand and relevant privacy regulations.

Uploaded by

bobhamilton3489
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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Module 4.

1 Short-Term Financial Decisions


For Chapter 15, you should concentrate on learning the management of inventory (15.3) and
accounts receivable (15.4). The following points should be noted as you read this chapter. The
key areas to focus upon in Section 15.4 are Changing Credit Standards and Managing
International Credit

Inventory Management
The key point to manage inventory is to is to turn over inventory as quickly as possible (or
equivalently, to minimize the average age of inventory) without losing sales from stock outs.
Therefore, financial managers have to closely watch the level of inventory, acting as an advisor
or “watchdog”. In a manufacturing or retail environment, managers may use formal models to
assess the optimal amount of inventory to order. A basic version of the Economic Order
Quantity is presented in Chapter 15, but more advanced textbooks cover more complex
versions of the model.

Economic Order Quantity (EOQ) Model

2∗ ∗
EOQ

EOQ = the order quantity that minimizes the total cost function
S = usage in units per period
O = cost per order
C = carrying cost per unit per period

Cost of the Marginal Investment in Accounts Receivable


The average investment in accounts receivable can be determined using the formula in Zutter
and Smart, or alternatively a more intuitive approach can be followed:

Average Investment Total variable cost of annual sales Average


 
in Accounts Receivable 365 Collection Period

The average daily investment in accounts receivable is recovered when the account receivable
is collected. Note that an advantage of this intuitive approach is that there is no need to
calculate turnover of accounts receivable.

Changing Credit Terms


In New Zealand commercial circles credit terms are commonly the 20th of the month following
the statement date:
e.g. Invoice date: 15th April
Statement date: 30th April
Payment due: 20th May

48
Ethics & Short-Term Financial Decisions
Detecting Aggressive Accounting Practices
Aggressive accounting practices designed to drive higher reported profitability may fool
investors (at least in the short-run). Such practices lead to overstated earnings and therefore
valuation errors. Arnott (2003) 17 argues that simple measures such as looking for rapid
inventory accumulation and rising accounts receivables are excellent proxies for identifying
companies that have these aggressive accounting practices.

Obtaining Credit Information


In New Zealand the major credit-reporting agencies are Centrix, Veda Advantage Ltd and
Dunn & Bradsheet (D&B). Credit data on individuals and companies is available to subscribers
via the Internet.

New Zealand organisations are affected by the Credit Reporting Privacy Code 2004 which
imposes strict control over the collection, retention and use of information about individuals.
Details on the Code are in: http://www.privacy.org.nz/credit-reporting-privacy-code/.

17
Arnott, R.D. (2003) Ethics, Earnings, and Equity Valuation. Journal of Portfolio Management; 29(3), 8-16

49

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