Receivable and Inventory Management
Management of Receivable
Accounts receivable typically comprise more than 25 percent of a firm’s assets. The term receivables is described as debt owed to the firm by the customers resulting from the sale of goods or services in the ordinary course of business. There are the funds blocked due to credit sales. Receivables management denotes to the decision a business makes regarding to the overall credit, collection policies and the evaluation of individual credit applicants. Receivables Management is also known as trade credit management. Robert N. Anthony, explained it as “Accounts receivables are amounts owed to the business enterprise, usually by its customers. Sometimes it is broken down into trade accounts receivables; the former refers to amounts owed by customers, and the latter refers to amounts owed by employees and others”.
Receivables are forms of investment in any enterprise manufacturing and selling goods on credit basis, large sums of funds are tied up in trade debtors. When company sells its products, services on credit, and it does not receive cash for it immediately, but would be collected in near future, it is termed as receivables. However, no receivables are created when a firm conducts cash sales as payments are received immediately. A firm conducts credit sales to shield its sales from the rivals and to entice the potential clienteles to buy its products at favourable terms. Generally, the credit sales are made on open account which means that no formal reactions of debt obligations are received from the buyers. This enables business transactions and reduces the paperwork essential in connection with credit sales.
Accounts Receivables Management denotes to make decisions relating to the investment in the current assets as vital part of operating process, the objective being maximization of return on investment in receivables. It can be established that accounts receivables management involves maintenance of receivables of optimal level, the degree of credit sales to be made, and the debtors’ collection.
Receivables are useful for clients as it increases their resources. It is preferred particularly by those customers, who find it expensive and burdensome to borrow from other resources. Thus, not only the present customers but also the Potential creditors are attracted to buy the firm’s product at terms and conditions favourable to them.
Receivables has vial function in quickening distributions. As a middleman would act fast enough in mobilizing his quota of goods from the productions place for distribution without any disturbance of immediate cash payment. As, he can pay the full amount after affecting his sales. Likewise, the customers would panic for purchasing their needful even if they are not in a position to pay cash immediately. It is for these receivables are regarded as a connection for the movement of goods from production to distributions among the ultimate consumer.
Maintenance of receivable
Objectives of receivables management: The objective of Receivables Management is to promote sales and profits until that point is reached where the return on investment in further funding receivables is less than the cost of funds raised to finance that additional credit i.e. cost of capita.
Management of Accounts Receivables is quite expensive. The following are the main costs related with accounts receivables management:
Cost of Management of Accounts Receivables
Advantages of accounts receivable management:
Accounts Receivables Management has numerous benefits. These include:
- Increased Sales: Offering goods or services on credit enhances sales, by holding old customers and attraction potential customers.
- Increased Market Share: When the firm is able to maintain old customers and attract new customers automatically market share will be bigger to the extent new sales.
- Increase in profits: Increase sales, leads to increase in profits, because it need to produce more products with a given fixed cost and sales of products with a given sales network in both cost per unit comes down and the profit will be better.
Management of Inventory
Inventory management is basically related to task of controlling the assets that are produced to be sold in the normal course of the firm’s procedures. In supply chain management, major variable is to effectively manage inventory. The significance of inventory management to the company depends on the extent of its inventory investment.
The objectives of inventory management are of twofold:
- The operational objective is to uphold enough inventory, to meet demand for product by efficiently organizing the firm’s production and sales operations.
- Financial interpretation is to minimize unproductive inventory and reduce inventory, carrying costs.
Effective inventory management is to make good balance between stock availability and the cost of holding inventory.
Components of inventory management: Inventories exist in different forms in a manufacturing company. These include:
- Raw materials: Raw materials are those inputs that are transformed into completed goods throughout manufacturing process. Those form a major input for manufacturing a product. In other words, they are very much needed for uninterrupted production.
- Work-in-process: Work-in-process is a stage of stocks between raw materials and finished goods. Work-in-process inventories are semi-finished products. They signify products that need to undergo some other process to become finished goods.
- Finished products: Finished products are those products which are totally manufactured and company can immediately sell to customers. The stock of finished goods provides a buffer between production and market.
- Stores and spares: It comprises of office and plant cleaning materials like soap, brooms, oil, fuel, light, bulbs and are purchased and stored for the purpose of maintenance of machinery.
Component of inventory
Inventory control encompasses managing the inventory that is previously in the warehouse, stockroom or store. This is to know the type of products are “out there”, how many each item and where it is kept. It means having accurate, complete and timely inventory transactions record and avoiding differences between accounting and real inventory levels. Two tools commonly used to ensure inventory accuracy and control are ABC analysis and cycle counting.
The process of Inventory management consists of determining, how to order products and how much to order as well as identifying the most effective source of supply for each item in each stocking location. Inventory management contains all activities of planning, forecasting and replenishment. The main purpose of inventory management is minimize differences between customers demand and availability of items. These differences have caused by three factors that include customers demand fluctuations, supplier’s delivery time fluctuations and inventory control accuracy.
Types of Inventory
The aim of carrying inventories is to separate the operations of the firm. It means to make each function of the business independent of each other function so that delays or closures in one area do not affect the production and sale of the final product. Because production cessations result in increased costs, and because delays in delivery can lose customers, the management and control of inventory are important duties of the financial manager. There are many types of inventory. The common categories of inventory include raw materials inventory, work-in-process inventory, and finished-goods inventory.
Raw-Materials Inventory: Raw materials inventory include basic materials purchased from other firms to be used in the firm’s production operations. These goods may include steel, lumber, petroleum, or manufactured items such as wire, ball bearings, or tires that the firm does not produce itself. Regardless of the specific form of the raw-materials inventory, all manufacturing firms maintain a raw-materials inventory. The intention is to separate the production function from the purchasing function that is, to make these two functions independent of each other so delays in the delivery of raw materials do not cause production delays. If there is a delay, the firm can satisfy its need for raw materials by liquidating its inventory.
Work-in-Process Inventory: Work-in-process inventory comprises of partly finished goods requiring additional work before they become finished goods. The more difficult and lengthy the production process, the larger the investment in work-in-process inventory. The main aim of work-in-process inventory is to disengage the various operations in the production process so that machine failures and work stoppages in one operation will not affect other operations.
Finished-Goods Inventory: Finished-goods inventory includes goods on which production has been completed but that are not yet sold. The purpose of a finished-goods inventory is to separate the production and sales functions so that it is not required to produce the goods before a sale can occur and sales can be made directly out of inventory.
Motives of inventory management:
Managing inventories involve lack of funds and inventory holding costs.
Maintenance of inventories is luxurious. Still there is motive to retain inventories. There are three general motives:
- The transaction motive: Firm may hold the inventories in order to facilitate the smooth and continuous production and sales operations. It may not be possible for the company to obtain raw material whenever necessary. There may be a time lag between the demand for the material and its supply. Therefore, it is needed to hold the raw material inventory. Similarly, it may not be possible to produce the goods instantly after they are demanded by the customers. Hence, it is needed to hold the finished goods inventory. The need to hold work-in-progress may arise due to production cycle.
- The precautionary motive: Firms also prefer to hold them to protect against the risk of unpredictable changes in demand and supply forces. For example, the supply of raw material may get delayed due to the factors like strike, transport disruption, short supply, lengthy processes involved in import of the raw materials.
- The speculative motive: Firms may like to buy and stock the inventory in the quantity which is more than needed for production and sales purposes. It is done to get the advantages in terms of quantity discounts connected with bulk purchasing or expected price rise.
Merits of Inventory Management
There are several advantages of managing inventory in proper way.
- Inventory management guarantees adequate supply of materials and stores to minimize stock outs and shortages and avoid costly interruption in operations.
- It keeps down investment in inventories, inventory carrying costs, and obsolescence losses to the minimum.
- It eases purchasing economies throughout the measurement of requirements on the basis of recorded experience.
- It removes duplication in ordering stock by centralizing the source from which purchase requisition emanate.
- It allows better utilization of available stock by enabling inter-department transfers within a firm.
- It offers a check against the loss of materials through carelessness or pilferage.
- Perpetual inventory values provide a stable and reliable basis for preparing financial statements a better utilization.
Demerits of Holding Inventory
Besides several benefits, there are some drawbacks of holding inventory.
- Price decline: It is a major disadvantage of inventory holding. Price decline is the result of more supply and less demand. It can be said that it may be due to introduction of competitive product. Generally, prices are not controllable in the short term by the individual firm. Controlling inventory is the only way that a firm can counter act with these risks. On the demand side, a decrease in the general market demand when supply remains the same may also cause price to increase. This is also long-lasting management problem, because reduction in demand may be due to change in customer buying habits, tastes and incomes.
- Product deterioration: It is also serious demerits of inventory holding. Holding of finished completed goods for a long period or shortage under inappropriate conditions of light, heat, humidity and pressures lead to product worsening.
- Product obsolescence: If items are hold for long time, it may become outdated. Product may become outmoded due to improved products, changes in customer choices, particularly in high style merchandise, changes in requirements. Then this is a major risk and it may affect in terms of huge revenue loss. It is costly for the firms whose resources are limited and tied up in slow moving inventories.
In final words, the notion of inventory management has been one of the many analytical characteristics of management. It involves optimization of resources available for holding stock of various materials. If there is shortage of inventory, it leads to stock-outs, causing stoppage of production and a very high inventory will result in increased cost due to cost of carrying inventory.
Managing Current Liabilities
A current liability is an obligation that is payable within one year. The collection of liabilities comprising current liabilities is closely watched, a business must have enough liquidity to guarantee that they can be paid off when due. In accounting area, current liabilities are often understood as all liabilities of the business that are to be settled in cash within the financial year or the operating cycle of a given firm, whichever period is longer.
In exceptional cases where the operating cycle of a business is longer than one year, a current liability is described as being payable within the term of the operating cycle. The operating cycle is the time period required for a business to acquire inventory, sell it, and convert the sale into cash. In most cases, the one-year rule will apply.
Since current liabilities are normally paid by liquidating current assets, the presence of a large amount of current liabilities calls attention to the size and prospective liquidity of the offsetting amount of current assets listed on a company’s balance sheet. Current liabilities may also be settled through their replacement with other liabilities, such as with short-term debt.
The combined amount of current liabilities is major component of several measures of the short-term liquidity of a business. That include:
- Current ratio. This is current assets divided by current liabilities.
- Quick ratio. This is current assets minus inventory, divided by current liabilities.
- Cash ratio. This is cash and cash equivalents, divided by current liabilities.
Common examples of Current Liabilities
Accounts payable: These are the trade payables due to suppliers, usually as evidenced by supplier invoices.
Sales taxes payable: This is the obligation of a business to remit sales taxes to the government that it charged to customers on behalf of the government.
Payroll taxes payable: This is taxes withheld from employee pay, or matching taxes, or additional taxes related to employee compensation.
Income taxes payable: This is income taxes owed to the government but not yet paid.
Interest payable: This is interest owed to lenders but not yet paid.
Bank account overdrafts: These are short-term advances made by the bank to offset any account overdrafts caused by issuing checks in excess of available funding.
Accrued expenses: These are expenses not yet payable to a third party, but already incurred, such as wages payable.
Customer deposits: These are payments made by customers in advance of the completion of their orders for goods or services.
Dividends declared: These are dividends declared by the board of directors, but not yet paid to shareholders.
Short-term loans: This is loans that are due on demand or within the next 12 months.
Current maturities of long-term debt: This is that portion of long-term debt that is due within the next 12 months.
To summarise, financial experts defined current liabilities as “obligations whose liquidation is reasonably expected to require the use of existing resources properly categorized as current assets or the certain of current liabilities.”