– Companies usually find it necessary to hold accounts receivable and inventory stocks.
– Inventories are handled similarly to cash (but with the cost of shortages considered).
– A higher level of receivables promises more credit sales and thus more customers willing to purchase, but also portends to longer waits until the actual receipt of cash from a sale and a higher likelihood of never being paid (bad debt).
– One issue in the investment in receivables is the deterioration in the quality of customer credit accompanying an increase in the amounts owed to the company. Ways of discerning who should receive credit:
- Credit-reporting agencies supply information to a company at a cost.
- A company’s own records of customer payment histories can yield useful information about the likelihood of a customer paying.
- Sophisticated statistical analysis (i.e. discriminant analysis).
– At some point rejecting the marginal customer ceases to be worthwhile. This is the point where incremental expenditure for search and evaluation exceeds the expected gain from discriminating.
- If company accepts everybody – Expected Profit = (# of good customers x profit per customer) + (#of bad customers x loss per customer).
- If company performs a credit analysis – Add (- the cost of the credit analysis).
– Caution: a company who accepts everybody must keep it private or else the ratio of bad to good customers will rise.
– One other approach to the management of receivables is to calculate the NPV associated with a proposed change in credit terms for a company, or; NPV = Change in PV of sales receipts – change in the variable costs – change in working capital management.