Ross et al.: Fundamentals
of Corporate Finance, Sixth
Edition, Alternate EditionVII. Short−Term Financial
Planning and Management- Credit and Inventory
Management
(^760) © The McGraw−Hill
Companies, 2002
maximizing turnover. The approach began in Japan, and it is a fundamental part of
Japanese manufacturing philosophy. As the name suggests, the basic goal of JIT is to
have only enough inventory on hand to meet immediate production needs.
The result of the JIT system is that inventories are reordered and restocked fre-
quently. Making such a system work and avoiding shortages requires a high degree of
cooperation among suppliers. Japanese manufacturers often have a relatively small,
tightly integrated group of suppliers with whom they work closely to achieve the needed
coordination. These suppliers are a part of a large manufacturer’s (such as Toyota’s) in-
dustrial group, or keiretsu.Each large manufacturer tends to have its own keiretsu.It
also helps to have suppliers located nearby, a situation that is common in Japan.
The kanbanis an integral part of a JIT inventory system, and JIT systems are some-
times called kanban systems.The literal meaning of kanbanis “card” or “sign,” but,
broadly speaking, a kanban is a signal to a supplier to send more inventory. For example,
a kanban can literally be a card attached to a bin of parts. When a worker pulls that bin,
the card is detached and routed back to the supplier, who then supplies a replacement bin.
A JIT inventory system is an important part of a larger production planning process.
A full discussion of it would necessarily shift our focus away from finance to produc-
tion and operations management, so we will leave it here.
SUMMARY AND CONCLUSIONS
This chapter has covered the basics of credit and inventory policy. The major topics we
discussed include:
- The components of credit policy. We discussed the terms of sale, credit analysis,
and collection policy. Under the general subject of terms of sale, the credit period,
the cash discount and discount period, and the credit instrument were described. - Credit policy analysis. We developed the cash flows from the decision to grant
credit and showed how the credit decision can be analyzed in an NPV setting. The
NPV of granting credit depends on five factors: revenue effects, cost effects, the
cost of debt, the probability of nonpayment, and the cash discount. - Optimal credit policy. The optimal amount of credit the firm should offer depends
on the competitive conditions under which the firm operates. These conditions will
determine the carrying costs associated with granting credit and the opportunity
costs of the lost sales resulting from refusing to offer credit. The optimal credit
policy minimizes the sum of these two costs. - Credit analysis. We looked at the decision to grant credit to a particular customer.
We saw that two considerations are very important: the cost relative to the selling
price and the possibility of repeat business. - Collection policy. Collection policy determines the method of monitoring the age of
accounts receivable and dealing with past-due accounts. We described how an
aging schedule can be prepared and the procedures a firm might use to collect on
past-due accounts.
CONCEPT QUESTIONS
21.8a What does the EOQ model determine for the firm?
21.8bWhich cost component of the EOQ model does JIT inventory minimize?CHAPTER 21 Credit and Inventory Management 733