Inventory Management-2

MOTIVE FOR HOLDING ENVENTORIES 

It is possible to identify three major movies for holding inventories.

• The transaction motive peoples a business to maintain inventories so that there are no bottlenecks in production and/or sales. It is natural for a business to plan inventory investment commensurate with the level of transactions in the business. The business seeks to ensure that on the shop floor production does not get stalled for want of materials, etc., and sales do not suffer on account of not-availability of finished goods.
• The precautionary motive is also at work. Inventories are held so that there is a cushion against unpredictable events. For instance, there may be a sudden and unforeseen spurt in demand for finished goods or there may occur a sudden and unforeseen slump or delay of raw materials or other components needed for production. An enterprise would surely like to have some cushion to tide over such situations.
• Inventories may also be held so that advantage can be taken of price fluctuations. For instance, if the price of a particular raw material in expected to go up rather steeply, an enterprise may decide to hold a larger than necessary stock of this item (acquired prior to escalation).

INVENTORY MANAGEMENT

NATURE AND IMPORTANCE 

Working capital as net concept, is defined as the difference between current assets and current liabilities. Current assets being those assets that are likely to be converted into liquidity within an year’s time or so and include items like inventories of raw materials, semi-manufactured articles or work-in-process, and finished goods, accounts receivable or dues from customers, hundies or bills receivable, bank balance and cash balance, etc.

 

Current liabilities are in essence short-term liabilities which have to be settles in a year’s time, e.g., accounts payable or amount payable to suppliers of goods and services delivered on credit, bills payable, bank overdraft, etc. Since inventories constitute a major item of current assets, the management of inventories is crucial to successful working capital management. Working capital requirements are influences by inventory holding-the period during which raw materials remain in store, that during which processing takes place and that during which finished goods lie in the warehouse prior to sale. The level of inventory investment affects the total investment in working capital. Thus, operating ratios, such as the ratio of Turnover or sales to Working Capital are affected by it as well.

 

Return on investment can be reviewed as follows:

Return/Investment = (Return/Sales) X (Sales/Investment)

OPTIMIZATION MODELS FOR SHORT TERM INVESTMENTS

A cash management imperative is that idle excess balances represent an opportunity cost to the firm. To ignore investment possibilities, even for one day, is inconsistent with the objective of managing cash as an asset that must return value to the company. Our next logical focus is, therefore, on short-term investment strategies.

 

In most firms, the cash management staff is responsible for short-term investing. One reason for this is that the cash manager has ‘hands-on’ knowledge of the money market and its players. Besides, cash manager is equipped, and psychologically geared, to react to fast-breaking investment opportunities. He and his staff are used to thinking in terms of very short time frames, days and hours. In the investment world, that us when profits are made, and fortunes lost.

 

There are several outlets for short-term investments like inter corporate advances; inter corporate bills financing, stock market operations, treasury bills, commercial papers, etc. The return on such investments is different and depends on money market conditions, amounts to be invested, period of investment, and transaction cost. The risks associated with a certain investment determines its safely, marketability and, hence, its yield. For the most part, the cash manager is primarily concerned with preserving principal. Although he hopes for the best returns on short-term investments, he looks for instruments that are, above all, safe.

SIMULATION APPROACH

Still today we have discussed on cash management and credit analysis. Today we are going to discuss on Simulation Approach. Simulation analysis permits the financial manager to incorporate in his forecasting both likely value of ending cash balances (surplus/deficits) for each of the forecast periods (say, for each month over the next quarter) and the margin of error associated with this estimate. It involves the following steps: First, probability distributions for each of the major uncertain variables are developed. The variables would generally include sales, selling price, proportion of cash and credit sales, collection rates, production costs, and capital expenditures. Some of these variables have the greatest influence upon cash balances.

 

Clearly, more time and effort should be spent in obtaining probability distribution of these variables. Second, values are drawn at random for the variables from their respective probability distributions and using these values each balances are estimated. Third, the process is repeated several times (say, 1000times). Needless to say, such tedious and cumbersome computations are done on computer.

 

In practice, the array of possible hedging strategies is quite a bit more complicated. One is required to consider various alternatives and the associated costs and risks in hedging strategies.

Collection Rate Uncertainty

The firm is also faced with collection rate uncertainty. The firm may historically have collected an average of a certain per cent of its outstanding receivables from a particular period in another particular period, but this average contains considerable variability. Further, changing market and economic conditions may make extrapolation of past historic data into future periods a futile exercise.  

 

There is still another source of uncertainty – production cost uncertainty. The price of materials may change; production problems may arise that lead to increased labor costs; and errors in the sales estimates themselves would necessarily lead to forecasting errors in purchases – hence the volume of payables.  

 

Capital outflow uncertainty is one of the biggest sources of surprises in cash flow forecasting. This is the uncertainty regarding the timing of cash disbursement related to the firm’s major capital expenditure and constructions programmes. For instance, construction firms are notorious for filing late progress reports and then expecting immediate payment. While only a small per cent of the firm’s total bills are from capital construction programmes, the amounts involved are usually very large. One unexpected item of this sort can impair a carefully drawn cash flow forecast.  

 

An efficient way to deal with above uncertainties is to apply simulation analysis of the cash forecast. We will now briefly outline this method.

Source of Uncertainty in Cash Forecasting

Accurate cash flow forecasting hinges on the forecaster’s ability to reduce the amount if observed error between forecast values and actual values that have occurred. Given the short-run nature of the cash forecast, with most things occurring in the near future, one would tent to think that most financial transaction could be forecast very accurately. This is far from true.

 

In practice few firms, if any are able to forecast their inflows and outflows accurately. Sales forecasts are notoriously unreliable, for actual sales depend in part upon factors that lie outside the control of the firm. Changes in the marketing of competitive products, as well as changes in general economic conditions, can lead to large forecasting errors.

 

We may further note that any errors in sales forecasts have multiple impacts on the firm’s cash flows; they impact on receivable levels (and therefore collections) and also on production expenses (and therefore disbursements).

 

Issues and Approaches to Forecasting -3

We are talking Issues and Approaches to Forecasting. An useful forecasting method is to analyze the historical payment patterns to determine the proportion of credit sales that are collected at various times after the date of sale, and then to use this information (along with the estimates of future sales) to project future receipts. We may, however, adopt a better and a more sophisticated approach.

 

In this, all collection rates are estimated simultaneously by regressing past sales figures against past collections. The estimated coefficients of the sales figures in the regression can be interpreted as the collection proportions, and the standard errors of the estimated regression coefficient as the uncertainty inherent in the estimation of these collection proportions.

 

In a situation where the firm is in multiple business lines, the use of overall payment patterns to forecast receipts will be accurate only when the proportions of total sales made in each business lines are constant. This is an unlikely situation, particularly since the different lines usually have different seasonal variations. In such a multiple situation, the most accurate forecasting result is achieved by forecasting receipts for the different units of the firm individually based on their own receipt patterns, then summing these receipts forecasts to obtain total cash receipts for the firm.

 

Issues and Approaches to Forecasting -2

We are talking Issues and Approaches to Forecasting from last two posts. There are four techniques for forecasting financial variables. Diret Method, Proportion of another Account, Compounded Growth, Multiple Dependencies. We talk on all of the above four techniques for forecasting financial variables.

 

Since cash forecast deal mostly with the near future, many of the items on the cash forecast are usually estimated by some variation of the post method. The bases of these spot estimated are usually the firm’s other financial plans. Remaining estimates are mostly on a ‘proportion of another account’ basis, the account often being particular period’s sales. The other two methods are employed less frequently.  

 

It is a common experience that forecast of disbursements is much easier than receipts, because the cash manager can rely on internal information and knowledge of payment knowledge of firm’s other plans (or budgets) and can make use of the forecasting techniques described above. However, a major challenge for him comes in estimating the receipts from the collection of the firm’s receivables. In this regard, an useful forecasting method is to analyze the historical payment patterns to determine the proportion of credit sales that are collected at various times after the date of sale, and then to use this information (along with the estimates of future sales) to project future receipts.

 

Issues and Approaches to Forecasting -1

We are talking issues and approaches to forecasts. The most common approach to short-term cash forecasts is the receipts and disbursement approach. This method minutely traces the movement of cash and is preferred by firms that exercise very close cash control. 

 

After the firm has determined what types of receipts and disbursement are important in its overall cash flow, an important question is how to forecast the future level of these types of inflows and outflows. There are four common techniques of forecasting financial variables (i.e. items/disbursement): 

 

 Direct Method – In using this technique, it is assumed that the variable to be forecast is independent of all other variable, or alternatively, is predetermined. The variable (e.g. lease rental) is forecast by using its excepted or predetermined level.
 

Proportion of Another Account - This technique is used to project financial variables that are expected to vary directly with the level of another variable. For example, if sales volume increases, it is natural that more units will have to be produced to replenish inventory. It is then reasonable to project certain direct costs of production, such as direct materials, as a per cent of sales.
 

ompounded Growth - This method is used when a particular financial variable is expected to grow at a steady growth rate over time.

 

Multiple Dependencies – Under this technique the variable is considered to be influenced by more than one factor. The statistical technique of liner regression is often employed with historical data to determine which explanatory variables are significant in explaining the dependent variable. We will see the application of regression technique after a while. 

 

Since cash forecast deal mostly with the near future, many of the items on the cash forecast are usually estimated by some variation of the post method. The bases of these spot estimated are usually the firm’s other financial plans. Remaining estimates are mostly on a ‘proportion of another account’ basis, the another account often being particular period’s sales. The other two methods are employed less frequently. 

Cash Management -1

Corporate cash management is perhaps the most critical aspect of working capital management as expressed in an old saying. The thing is finest when the need is urgent. Efficient cash management requires proper cash planning, management of receipts and disbursement and an efficient control and review mechanism. In Cash Management we intend to discuss in some details cash forecasting under uncertainty and decision-making models regarding the temporary investment of cash. We will also briefly review current practices of management of cash. Agentswebworld is nice way to handle agents website management.

CASH FORECASTING UNDER UNCERTAINTY

The worst time to raise cash is when you need it most. The company that cannot predict and plan its short-term cash flows simply does not have a handle on reality. Smart cash managers have learned to forecast cash flows for this reason.

The cash forecast is the estimate of the flows in and out of the firm’s cash account over a particular period of time. The cash flow forecast can cover a short time period (e.g. quarter, month, week or day), an annual accounting period or operating cycle or longer period of time. Forecasts for different time spans have different uses. For example, the long-range cash projections may cover periods ranging from three to five years and is useful in planning business growth, investment in projects, and introduction of new products. We will talk more in next post.

 

Ref: agents website, insurance software, insurance crm

 

Short Term Investments

A cash management imperative is that idle excess balances represent an opportunity cost to the firm. To ignore investment possibilities, even for one day, is inconsistent with the objective of managing cash as an asset that must return value to the company. Our next logical focus is, therefore, on short-term investment strategies.

In most firms, the cash management staff is responsible for short-term investing. Life insurance and Annuity is not good investment when business think about short term investing. Financial One helps to manage investment in life insurance. One reason for this is that the cash manager has ‘hands-on’ knowledge of the money market and its players. Besides, cash manager is equipped, and psychologically geared, to react to fast-breaking investment opportunities. He and his staff are used to thinking in terms of very short time frames, days and hours. In the investment world, that us when profits are made, and fortunes lost.

There are several outlets for short-term investments like inter corporate advances; inter corporate bills financing, stock market operations treasury bills, commercial papers, etc. For individual term life insurance or Mortgage life insurance are good way to have term investment. The return on such investments is different and depends on money market conditions, amounts to be invested, period of investment, and transaction cost. The risks associated with a certain investment determines its safely, marketability and, hence, its yield. For the most part, the cash manager is primarily concerned with preserving principal. Although he hopes for the best returns on short-term investments, he looks for instruments that are, above all, safe. In addition, cash managers are responsible for keeping the firm in a liquid position. If an unexpected need for cash should arise, the cash manager may need to investments before maturity. Thus, an important criterion for a short-term investment strategy is instrument’s marketability.

Collection Experience

We talkd about Credit Analysis. we talked the business magazines generally carry the detailed analysis of financial statements and inter-firm comparison of companies in the same industry. This information would be useful in assessing the market conditions of a particular industry. The company can then explore about the credit worthiness of customer through the references provided by him. Additional information may also be obtained by interviewing the customer or visiting his place of work.

In additional to setting the credit standards, credit period, and cash discount policy, it is also important for the company to design the collection policy and procedures so as to speed up the collections as and when become due. What would the company do if the customers do not pay within the set credit period? In this regard the company has to assess the chances of collecting the accounts receivable by putting some effort. If by putting small effort the chance are that the customer will pay his bill are high then the company should go ahead with that much of effort. In situations when the chances of collecting the money are considerably less than the company should explore other ways of collecting the money. Credit Cards or business credit cards collections are easier and require less effort.

The company can use number of methods to speed up the collections. Letters and telephone calls are the easiest one and least expensive. The company may design a policy of sending a letter few days before the payment becomes due. Depending upon the situation the company can call the customers on telephone just before the due date. A visit to customer may prove to be effective when the bills are overdue. Legal action should be treated as the last resort. Before that the company should try to understand the problems of the customer and if the company finds that the integrity of the customer is at doubt, they should resort to legal action. Pre-paid debit cards are better alternative for low interest credit card. On that basis the company can find out whether the particular debt should be treated as doubtful and should be writer off or not.

Credit Analysis -2

Capacity is the ability of the customer to meet the obligations whenever they are due. In this regard it would be important for the company to see that the obligations are met through the funds generated from the operations of the customers. That would reflect the long term ability of the customer to meet the obligations. In case the customer is not in a position to meet his obligation out of operations in some abnormal year, the company should examine the capital base of the company. This would indicate the capability of the company to face the problems in case of some difficulty. The company should examine the net worth of the customer to access the capital base. Credit card debt assistance companies help company to examine net worth of individual customer.

 

The market conditions play an important role when one is doing credit analysis. The expected recessionary trends in the market, growing competition and other market factors should be taken into account when doing credit analysis of the customer. Given a particular set of conditions, the costs associated with extending the credit may some times be high. The cost may get reflected in high bad debt expenses or the default in payments. And finally, the company has to examine the kind of security, debt assistance, collateral in the form of assets, the customer is providing.

 

There will always be a problem in obtaining financial and qualitative information about the customers. This problem arises because there is no systematic source of information particularly about the small sized customers. It may not be possible for most of the companies to administer the collection of information about the customers. Company can take help of company who give assistance with credit cards. The cost in terms of time and money resources involved in such experience would outweigh the benefits. But at the same time the company has to come o conclusion and satisfy itself that the customer to whom it is extending credit is worthy of it and the risks involved commensurate with the return.

Credit Analysis -1

No Company does blindly sell on credit to every customer approaching it. The company has to evaluate the capability of the customer and his strengths to fulfill the promise of paying the bills in time. The companies ignoring adequate analysis of their customer would soon find themselves in a situation not generating sufficient resources for day to day operation of the business. The company must analyze the risk of paying late or risk of default before extending credit. Credit given to Startup jobs employee carrying high risk compare to others.

 

The credit analysis would brodly involve the following three steps. 

• Getting financial and non financial information about the customer.
• Analyzing the credit worthiness of the customer and assessing the risk involved.
• Deciding to grant the credit. 

Analyzing the credit-worthiness of the customer is the most difficult task. The financial and no-financial information may provide some insights into the credit worthiness of the customer. With the help of this information and other insights the company has to access the following six C’s of Credit Worthiness: 

1. Character
2. Capacity
3. Capital
4. Condition
5. Cost
6. Collateral

 The analysis of credit worthiness begins with the assessment of the customer’s willingness to pay the bills of the company. Capacity is the ability of the customer to meet the obligations whenever they are due.  Startup jobs employees are having less credit worthiness. In this regard it would be important for the company to see that the obligations are met through the funds generated from the operations of the customer.

We continue our talk on Credit Analysis in next post.

Cash Discount

A company short of cash resources and facing liquidity problem may consider the use of cash discounts to influence its customers to pay promptly. There are two important of cash discount policy aspects -

• Cash discount rate
• Cash discount period

Giving the cash discount facility is not the same as cutting the prices and there by affecting demand. It is a mechanism through which the company is giving some benefits to customers who opt to pay early. There is a remote possibility that all customers will pay the company their dues within the cash discount period. Only a segment of customers who have sufficient cash resources and good liquidity position will avail cash discount facility. A Student Loan or Private Student Loans can’t consider cash discount. Cash discount will affect customers and sometime loss of revenue too.

The introduction of cash discount as a policy will also affect customers who were paying promptly earlier. Suppose 5 percent of sales were on case basis and rest 95 percent on credit, by introducing cash discounts, the company has to pay cash discount to the 5 percent customers who were paying cash immediately at the time of sale. Some of the customers from the 95 percent segment would avail cash discount but certainly not all.

The cash discount policy would result into loss of revenue to the company. At the same time the company would experience a quick collections resulting in to lower collection period. The reduction in average collection period in turn will affect the investment in accounts receivable. A College Loans for students can’t consider as revenue loss.  Before deciding about the cash discount policy the company has to find out whether the returns on funds released on account of reduction in investment in accounts receivable is more than the loss of revenue. Only if the return completely offsets the loss of revenue the cash discount policy should be introduced.

Credit Standards & Credit Terms

We may take following approach in assessing the effects of lowering down the credit standards:

• Determine find out the profitability of additional sales
• Determine increase in bad debt losses, collection expenses,Credit Repair and any other cost arising from relaxing the standards
• Determine increase slowness of the average collection period and additional amount of investment required in accounts receivable and multiply it by the required rate of return on investment in accounts receivable.

Credit Terms

The other important dimension of accounts receivable management is to decide the terms of credit in advance. Sometimes Credit Repair Service helps to decide credit terms. The decision about the credit terms would involve the decision about the following variables:

1. Credit Period
2. Credit Limit
3. Cash Discount
4. Discount rate and Discount Period

Credit Period

Credit period is the time for which the company is willing to allow their customers not to pay their bills. By the end of the credit period the company expects that the customers would pay their bills. At any point of time there would be customers who may be interested in a longer credit period. If the company liberalizes its credit period the company may be able to attract such customers. But at the same time the extension of credit period means more investment in accounts receivable. Extension of credit sometime gives time forBad Credit Repair.

Credit Standards – II

At any point of time the company would be interested in examining the effect of change in credit standards. This is done by comparing the profitability generated by lowering down the credit standards and the added cost of accounts receivable. So long as the profitability is more than the added cost the company can lower down the credit standards. It is important to determine the costs of lowering down the credit standards and also to find out the impact on profitability of the company. Lowering down of the credit standards would have the following effects. 

• Increase in average collection period
  
• Increase in sales
  
• Increase in account receivable investment
  
• Increase in bad debt losses
  
• Increase in servicing cost of account receivable.

 

The effect of lowering down the credit standards on key variables such as sales and investment in accounts receivable can be quantified and can be used in analyzing the cost vs. benefits of such changes. Lowering down investment in life insurance is not lowering down credit standards. At the same time the costs such as increase in bad debt losses and increase cost of monitoring and servicing the accounts receivable should also be considered. It may be very difficult for the firm to make any distinction between the credit standards for new customers and existing customers. Relaxing the credit standards for the new customers would have certainly some impact on the payment behavior of existing customers. The firm may experience all this in increase in average collection period.

Credit Standards – I

Defining the credit standards is an important component of credit policy of the company. They credit standards do have an important bearing on the sales of the company. The credit standards of the company lay down minimum requirements for the evaluation of credit to its customers. The company may define these requirements in a evaluation of credit to its customers. The company may define these requirements in a very conservative or a strict manner and thus restrain the marginal customers in getting credit.

The marginal customers are those whose financial position are doubtful, may not really be bad. Such a policy would be appropriate for the companies which do not want to take high risk. Or, alternatively the company may follow a very liberal standard and be very aggressive in taking the risks. Lexington homes for sale might not help company to define credit standards.

The company may use some of the following quantitative indicators for establishing credit standards:

• Payment period
• Selected financial ratios
• Rating based on financial ratios

The subject assessment obtained through the market about credit worthiness of the customers may also features as one of the items in the credit standards. These quantitative and subject indicators may provide the basis for establishing and enforcing the credit standards.

We talk more in next post……….

Money Market

Though in term of institutions or players, the demarcation between money market and capital market is very thing, yet money market is said to constitute the pre-dominant source of working capital funds for business and industry. It is, therefore, we talk nature and functions of money market which is the pool or reservoir from which the suppliers of working capital finance to business and industry draw their working finance. scottsdale homes for sale helps business to manage their assets.

 

Nature and Functions of money market:-
 

The money market is a market for short-term financial assets that are close substitutes for money. If facilitates the exchange of money for new financial claims in the primary market as also for financial claims, already issued, in the secondary market. It provides a mechanism for meeting the liquidity needs of the lenders and the short-term requirements of borrowers with minimum transaction cost and delay.
There is strictly no demarcated distinction between the short-term money market and the long-term capital market, and in fact there are integral link between the two markets as the spectrum of instruments in the two markets invariably form a continuum. However, as a matter of practice, money market deals in financial instruments/arrangements which are for a short period not generally exceeding a maturity period of 180 days.

Managing Investment in Current Assets

Working Capital Management we are talking here. for any business as crm software or sfa software require same way working capital management is also required. Insurance Software helps insurance company to deal with it’s day to day business with help of insurance crm software, same way working capital management helps business to plan for their capital management.

Investment in Current Assets:-
Determination of appropriate level of investment in current assets is the first and foremost responsibility of working capital manager.  Although the amount of investment in any current asset ordinary varies from day-to-day, the average amount or level over a period of time can be used in determining the fluctuating and permanent investment in current assets. This distinction is of great import in devising appropriate financing strategies. We shall elaborate this point a little later.   Besides the level of investment, the types of current assets to be held are equally important decision variables. Think of the inventory of a dealer in construction equipment. The dealer must decide how many bulldozers to keep in stocks, as well as whether to stocks bulldozers or dump trucks.

From the viewpoint of the financial manager, all the decisions as to particular items add up to an average level of inventory for a given item, and these averages for all items add up to the total average inventory investment of the firm. Investment in receivables and marketable securities also pose a similar choice. The result is that there are a very large number of alternative levels of investment in each type of current asset.  

Therefore, in principle, current asset investment is a problem of evaluating a large number of mutually exclusive investment opportunities.

Ref: Insurance CRM Software, Insurance Software