Inventory Management^255
built models to do this. Smaller companies do not face so much detail and complexity
and find it easier to work with a spreadsheet programme on a personal computer.
In either case the financial manager specifies forecasted cash requirements or surpluses,
interest rates, credit limits, etc. and the model grinds out a plan. The computer also
produces balance sheets, income statements, and whatever special reports the financial
manager may require.
Smaller companies that do not want custom built models can buy general purpose
models offered by accounting companies, management consultants or specialised
computer software companies.
Most of these models are simulation programmes. They simply work out the
consequences of the assumptions and policies specified by the financial manager.
Optimisation models for short term financial planning are also available. These models
are usually linear programming models. They search for the best plan from a range of
alternative policies identified by the financial manager.
Optimisation helps when the company faces complex problems with many interdependent
alternatives and restrictions for which trial and error might never identify the best
combination of alternatives.
Of course the best plan for one set of assumptions may prove disastrous if the assumptions
are wrong. Thus, the financial manager has to explore the implications of alternative
assumptions about future cash flows, interest rates and so on. Linear programming can
help identify good strategies, but even with an optimisation model the financial plan is
still sought by trial and error.
Solved Problems
- The Classic Company offers trade credit to its customers of net 30. Credit sales
average Rs 620,000 per day on which the company earns a contribution margin of
20 percent. The average accounts receivable collection period is 50 days. The
appropriate after-tax discount rate for evaluating accounts receivable policy
changes is 9 percent and the company's marginal tax rate is 40 percent.
a. What is the average balance in accounts receivable? What is the average
investment in accounts receivable? What are the annual financing costs
associated with the investment in receivables?
b. The sales manager believes she can implement a credit policy change that
will reduce the average collection period by four days without affecting the
level of sales. If this policy works as expected, what will be the company's
investment in accounts receivable? What will be the net annual after-tax
advantage to the company of adopting this policy?