Accounting for Managers: Interpreting accounting information for decision-making

(Sean Pound) #1

CONSTRUCTING FINANCIAL STATEMENTS 77


Managing stock........................................


The main measure of how effectively stock is managed is the stock turnover (or
stock turn). Stock turn is:
cost of sales
stock


Using our example, cost of sales is £1.5 million and stock is £200,000. The stock
turn is therefore 7.5 (£1,500,000/£200,000). This means that stock turns over 7.5
times per year, or on average every 49 days (365/7.5).
Sound management of stock requires an accurate and up-to-date stock control
system. Often in stock control thePareto principle(also called the 80/20 rule) applies.
This recognizes that a small proportion (often about 20%) of the number of stock
items accounts for a relatively large proportion (say 80%) of the total value. In stock
control, ABC analysis takes the approach that, rather than attempt to manage all
stock items equally, efforts should be made to prioritize the ‘A’ items that account
for most value, then ‘B’ items and only if time permits the many smaller-value ‘C’
items. Some businesses adoptjust-in-time (JIT)methods to minimize stockholding,
treating any stock as a wasted resource. JIT requires sophisticated production
planning, inventory control and supply chain management so that stock is only
received as it is required for production or sale.
Stock may be written off because of stock losses, obsolescence or damage. For
this reason, firms establish a provision to cover the likelihood of writing off part
of the value of stock.


Managing creditors


Just as it is important to collect debts from customers, it is also essential to
ensure that suppliers are paid within their credit terms. As for debtors, the main
measure of how effectively creditors are managed is the number of days’ purchases
outstanding. Days’ purchases outstanding is:


creditors
average daily purchases

Using the previous example, the firm has cost of sales (usually its main credit pur-
chases, as many expenses – e.g. salaries, rent etc. – are not on credit) of £1.5 million
and creditors of £300,000. Average daily purchases are £4,110 (£1.5 million/365).
There are therefore 73 average days’ purchases outstanding (£300,000/£4,110).
This figure has to be reported in a company’s annual report to shareholders (see
Chapter 7).
The number of days’ purchases outstanding will reflect credit terms offered by
the supplier, any discounts that may be obtained for prompt payment and the
collection action taken by the supplier. Failure to pay creditors may result in the
loss or stoppage of supply, which can then affect the ability of a business to satisfy
its customers’ orders.

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