MBA 622
Brief Accounts Receivable and
Inventory Management
Portions from Emery and Finnerty: Corporate Financial
Management – Edited by Del Hawley
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Effective Use of Trade Credit
 Advantages:
 Readily available
 Informal
 Flexible
 Stretching payments
 Disadvantages
 High cost of discounts foregone
 Excessive stretching of payments
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Trade Credit Terms
Common credit terms:
Net 30
2/10 Net 30
Meaning:
(Disc%)/(Days to get discount) (Date Due)
2/10 Net 30  2% discount if paid within 10
days; otherwise pay within 30 days
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Cost of Trade Credit
Discount Music Stores buys its inventory on
“1/10, net 30” terms. What is the cost of not
taking the discount?
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Cost of Trade Credit
 Let d = the amount of the discount (= 1%)
 Let DP = the discount period (= 10 days)
 Let TP = the total payment period (= 30
days)
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Cost of Trade Credit
d
365
APR 

1  d TP  DP
.01
365
.1843 

1  .01 30  10
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Cost of Trade Credit
Pay on Day 40  12.29%
Pay on Day 60  7.37%
So, there is an incentive to pay late that the
seller must counter.
The cost of foregoing the discount must be
higher that cost of short-term borrowing or
the buyer will use the trade credit as a loan.
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Pursuing Delinquent Accounts
 Letters
 Telephone calls
 Personal visits
 Collection agencies
 Legal proceedings
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Inventory Management
 Types of inventories:
 Raw materials
 Work-in-process
 Finished goods
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Economic Order Quantity (EOQ) Model
 Let
 S = constant usage rate of the inventory
 F = fixed cost of ordering inventory
 C = carrying cost per unit of inventory for the
period.
 Q = units of inventory ordered.
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Inventory Levels for the EOQ Model
Inventory Level
Q
Q/2
0
Time
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Economic Order Quantity (EOQ) Model
Total cost = Ordering cost + Carrying cost
S
Q
F C
Q
2
2FS
EOQ 
C
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Economic Order Quantity (EOQ) Model
Annual Cost
Total Cost
Minimum
Cost
Carrying Cost
Ordering Cost
Q*
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Order Quantity (Q)
EOQ Model
The Acer Co. sells 10,000 units per year. The
cost of placing one order is $45 and it costs $4
per year to carry one unit of inventory.
What is Acer’s EOQ?
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EOQ Model
2FS
EOQ 
C
a fa
f
2 $45 10,000

 475 units
$4
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EOQ Model
 Average inventory = Q/2 = 475/2 = 237.5
units.
 Number of orders per year = S/Q =
10,000/475 = 21.
 Time between orders = Q/S = (475/21)(365)
= 17.34 days.
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EOQ Model
 Annual ordering cost = F(S/Q) =
$45(10,000/475) = $947 per year.
 Annual holding cost = C(Q/2) = $4(475/2) =
$950 per year.
 Total annual cost = $947 + $950 = $1,897
per year.
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Just-In-Time (JIT) Inventory Systems
 Materials should arrive exactly as they are
needed in the production process.
 Reduces inventory holding costs
 Important factors determining success of JIT
systems:
 Planning requirements
 Supplier relations
 Setup costs
 Other cost factors
 Impact on credit terms
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