Introduction to Corporate Finance

Ross et al.: Fundamentals

of Corporate Finance, Sixth

Edition, Alternate Edition

VII. Short−Term Financial

Planning and Management

21. Credit and Inventory
    Management

© The McGraw−Hill^751

Companies, 2002

sell its receivable. For example, when FoxMeyer Health filed for bankruptcy in August

1996, it owed $20 million to Bristol-Myers Squibb for drug purchases. Once FoxMeyer

filed for bankruptcy, Bristol-Myers tried to sell its receivable at a discount. The purchaser

would then have been the creditor in the bankruptcy proceedings and would have gotten

paid when the bankruptcy was settled. Similar trade claims against FoxMeyer initially

traded as high as 49 cents on the dollar, but settled to about 20 cents less than a month

later. Thus, if Bristol-Myers had cashed out at that price, it would have sold its $20 mil-

lion claim for about $4 million, a hefty discount. Of course, Bristol-Myers would have

gotten its money immediately rather than waiting for an uncertain future amount.

INVENTORY MANAGEMENT

Like receivables, inventories represent a significant investment for many firms. For a

typical manufacturing operation, inventories will often exceed 15 percent of assets. For

a retailer, inventories could represent more than 25 percent of assets. From our discus-

sion in Chapter 19, we know that a firm’s operating cycle is made up of its inventory pe-

riod and its receivables period. This is one reason for considering credit and inventory

policy in the same chapter. Beyond this, both credit policy and inventory policy are used

to drive sales, and the two must be coordinated to ensure that the process of acquiring

inventory, selling it, and collecting on the sale proceeds smoothly. For example, changes

in credit policy designed to stimulate sales must be accompanied by planning for ade-

quate inventory.

The Financial Manager and Inventory Policy

Despite the size of a typical firm’s investment in inventories, the financial manager of a

firm will not normally have primary control over inventory management. Instead, other

functional areas such as purchasing, production, and marketing will usually share

decision-making authority regarding inventory. Inventory management has become an

increasingly important specialty in its own right, and financial management will often

only have input into the decision. For this reason, we will only survey some basics of in-

ventory and inventory policy.

Inventory Types

For a manufacturer, inventory is normally classified into one of three categories. The

first category is raw material.This is whatever the firm uses as a starting point in its

production process. Raw materials might be something as basic as iron ore for a steel

manufacturer or something as sophisticated as disk drives for a computer manufacturer.

The second type of inventory is work-in-progress,which is just what the name sug-

gests—unfinished product. How big this portion of inventory is depends in large part on

the length of the production process. For an airframe manufacturer, for example, work-

in-progress can be substantial. The third and final type of inventory is finished goods,

that is, products ready to ship or sell.

CONCEPT QUESTIONS

21.6a What tools can a manager use to monitor receivables?

21.6bWhat is an aging schedule?

724 PART SEVEN Short-Term Financial Planning and Management

21.7

Visit the Society for
Inventory Benchmarking
Analysis at
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