Accounting Business Reporting for Decision Making

CHAPTER 13 Financing the business 541

for a long period. For JB Hi-Fi Ltd, we must remember that the business specialises in a range of

products from cheaper items such as CDs to more expensive items such as computers. A reduction

in days could result from an increase in cost of sales or a decrease in average inventory. Both would

result in a decrease in the number of days (increase in turnover). Basically, for JB Hi-Fi Ltd to reduce

its turnover in days (increase its turnover in number of times), it needs to sell more or carry less

inventory. Selling more inventory can be achieved by discounting inventory or offering incentives to

customers such as 3 for 2 deals. Reducing inventory levels can be achieved by not carrying as much

floor inventory, particularly carrying less expensive inventory, such as home cinemas. This would also

reduce other costs for JB Hi-Fi Ltd such as storage, inventory loss and insurance costs.

The need to reduce the funds tied up in inventory over long periods of time is especially relevant to

the concept of the ‘just-in-time’ (JIT) philosophy, which was originally developed by the Toyota Motor

Company of Japan in the 1960s. Reduction of inventories provides the benefit of savings in holding

costs. However, reduction of inventories also exposes inefficiencies in management, as the unplanned

changes in inventories no longer mask such problems.

VALUE TO BUSINESS

•   Inventories are held to ensure that production and sales may be carried out without delay and as a

buffer between production and sales.

•   The benefits of holding inventories are:

• sales are made and profits gained


• cross-sales are made and profits increased


• goodwill is built up and no-inventory costs are avoided.
  • The costs of holding inventory include ordering and holding costs.
  • Two techniques are commonly used to manage inventory levels:


• maintaining a minimum level of inventory


• managing the inventory turnover period.

13.5 Sources of short-term finance

LEARNING OBJECTIVE 13.5 Compare the sources of short-term finance.

Remember, in our discussion of the management of working capital, that we looked at the hedging prin-

ciple and noted that temporary assets should be funded with temporary or short-term funds. The most

common sources of short-term finance for entities are:

• accrued wages and taxes


• trade credit


• bank overdrafts


• commercial bills and promissory notes


• factoring or debtor/invoice/trade finance


• inventory loans or floor-plan finance.

Accrued wages and taxes

Accrued wages and pay-as-you-go (PAYG) withholding instalments are examples of spontaneous

sources of finance. An entity such as a private hospital pays a high proportion of its cash expenses as

wages and salaries. Consider such an entity with a $2 million fortnightly wage bill. On average, this

entity effectively owes its employees $1 million all the time. This $1 million of funding is provided

free of charge.