CHP 15: Assets: Inventory and Operations Management
arm's-length transaction
A business deal where the parties have a prior relation or affiliation, but where the business is conducted as if they were unrelated. This approach is done to help guard against potential conflicts of interest.
capital assets
Assets that are expected to provide economic benefits for periods of time greater than one year.
1. the rate of sales 2. the time required to receive new stock
Deciding when to place an order is determined by
1. that the asset has a fixed, determinable period of utility 2. the asset has a fixed, determinable value that will exist when the depreciation process is complete 3. the value of the asset will decline in a continuous and predictable manner over the period of utility
Depreciation is based on three assumptions
point-of-sale (POS) system
Hardware and software combinations that integrate inventory management directly into accounting software.
simplicity easy comparison of alternatives
Main advantage of using the payback period analysis
1. minimize the time that passes btwn when a credit sale is made and when the cash is received 2. Keep the number of bad accounts as low as possible
Manage your accounts receivable for benefit to your business
1. informational feedback 2. corrective feedback 3. reinforcing feedback
Operations control depends on three types of feedback
1. Giving credit increases sales bc people who buy on credit tend to buy more 2. Giving credit increases repeat purchases 3. Providing credit reduces the cost of selling bc it is much more expensive to obtain repeat business than it is to get new customers 4. Even though giving credit raises some costs, the increased sales result in increased profit.
Pros of Offering credit to customers
1. requires little or no cash investment 2. renting usually does not require an extensive application process as does borrowing money 3. renting usually protects you from unexpected costs of repairs 4. Renting capital equipment provides an easy method to avoid ongoing costs if business conditions change
Rent advantages
1. The exact amount of timing of cash outflows is specified in the rental contract 2. renting provides a fall back position should your projections prove to be incorrect
Renting provides two advantages over buying
to improve the quality of decisions about how to best use the scarce resources of the business
The goal of capital budgeting
objectives
The inputs of a business are determined by its
capital budgeting
The process of deciding among various investment opportunities to create a specific spending plan.
replacement cost
The total cost of replacing an asset with an essentially identical asset.
1. Payback period 2. Return on investment (ROI)
The two most commonly used financial ratios for comparing investment alternatives are
utility in other words, your assets are worth the sum of the future benefits that the assets will produce
The value of operating assets is a function of their
1. the amount of profit you recognize 2. the value of your business
The value that you assign to inventory sold and on hand affects
1. short term (inventory and accounts receivable) 2. Operating or capital assets
There are two fundamental kinds of assets in a business
1. periodic inventory 2. perpetual inventory 3. bar coding
Three approaches to maintaining records of inventory that are very common in small businesses
intangibility inseparability perishability
Three characteristics of services
operations management
concerned primarily with directing and controlling
informational feedback
information about the processes of yourbusiness
equipment
machinery, tools, or materials used in the performance of the work of the business
accounts receivable
money owed to your business by customers who purchased your product on credit
periodic inventory
process of physically counting business assets on a set schedule
reinforcing feedback
rewards efficient processes and desired employee behaviors
work instructions
specific guidance for completing steps in a process
process
the business activities necessary to convert inputs into desired outputs
time value of money
the principle that a dollar received today is worth more than a dollar received in the future
production management
to ensure that the factors of production are used efficiently to produce your business's product or service
Return on Investment (ROI)
A capital budgeting equation used to measure the relationship between initial investment and the profits that are expected to be received from making the investment.
physical inventory
A count of all the inventory being held for sale at a specific point in time.
capital lease
A lease in which at the end of the lease period the asset becomes the property of the lessee, possibly with an additional payment.
operating lease
A long-term rental in which ownership of the asset never passes to the person paying for the lease.
Economic Order Quantity (EOQ)
A statistical technique that determines the quantity of inventory that a business must hold to minimize total inventory cost.
pull-through system
A term for just-in-time inventory systems in which product is ordered and placed into production only after a sale has been completed.
best practices
Activities identified by authoritative bodies as examples of optimal ways to get things done in a particular industry, profession, or trade
1. The cost of acquiring the asset 2. The cost of owning the asset 3. The cost of operating the asset 4. The cost of disposing of the asset
All capital assets cause you to incur four costs over time
straight line for a useful life of 10 years
Depreciation is computed using a straight line method over 10 years, so an asset would lose 10% of its value each year.
1. You do not have ownership position 2. Rental requires regular, timely payments 3. The number of dollars paid in rent usually exceeds the number of dollars you would spend to own the asset
Disadvantages of renting
bar coding
Obtaining a Universal Product Code number and scan-ready visual tag, and printing it on the product or its packaging. Bar codes can then be scanned and recognized by others.
1. Delays the receipt of cash 2. You must somehow replace the missing cash 3. If you give credit to customers, sooner or later one of them will not pay
The Cons of Offering credit to customers
optimum stocking level
The amount of inventory that results in the minimum cost, when considering the cost of lost sales resulting from running out of stock, the number of units sold per day, and the number of days required to receive inventory Also known as the reorder point
payback period
The amount of time it takes a business to earn back the funds it paid out to obtain a capital asset.
replacement value
The cost incurred to replace one asset with an identical asset.
cost of operating
The direct cost incurred in using an asset for the purpose for which it was intended.
1. book value 2. disposal value 3. replacement value 4. fair market value
The four accounting methods to value capital assets are
disposal value
The net amount realized after subtracting the costs of getting rid of an asset from its selling price.
just-in-time inventory
The practice of purchasing and accepting delivery of inventory only after it has been sold to the final customer.
fair market value
The price at which goods and services are bought and sold between willing sellers and buyers in an arm's-length transaction.
1. disregards the time value of money 2. it disregards all cash flows that occur after the payback period
The primary disadvantages of the payback method are that
microinventory
The purchase of inventory only after a sale is made; very typical with Internet firms.
1. The cost of processing an order 2. The cost of keeping merchandise in inventory 3. The cost of lost sales if you run out 4. the time it takes to receive inventory after its ordered
The right amount of inventory to keep on hand and the right amount of inventory to order at one time is determined by
whole of life costs
The sum of all costs of capital assets, including acquisition, ownership, operation, and disposal
-the cost to buy the inventory -the cost to store, protect and maintain inventory -the cost of making an order to purchase inventory
The total cost of keeping inventory is the sum of:
1. know yourself 2. Keep strategy decisions in house 3. Fully specify tasks that are to be outsourced 4. Know with whom you are contracting
To get the greatest benefit from outsourcing, you need to
1. method to create bar codes 2. a means to print the codes on the items you wish to track 3. a scanner that can read the codes 4. a computer software program that can interpret the codes and update a database of info associated with each code
To use bar codes effectively
1. accept only those alternatives for which the time required to recoup the original investment is equal to or less than a maximum allowable time determined by management 2. accept the alternative with the shortest payback period among those that meet the first criterion
Two decision rules are applied in choosing from among alternative investments in a payback period
1. accept only those alternatives for which the return on investment is equal to or greater than the business's weighted average cost of capital 2. accept the alternative with higher ROI among those that meet the first criterion
Two decision rules to choose from alternatives with ROI
property
a general term for real estate, but it can also be applied as a legal term for anything owned or possessed
plant
a general term for the facilities of a business
quality
a product or service's fitness for use, measured as durability, reliability, serviceability, style, ease of use, and dependability
lease
a rental agreement that specifies a minimum period of time for which you must make rental payments
fractional ownership
a small business may buy only that share that it can reasonably sue during the course of business
safety stock
an amount of inventory carried to ensure that you will not run out of inventory bc of fluctuating levels of sales
outsourcing
contracting with people or companies outside your business to do work for your business
costs of owning
cost incurred in financing, insuring, taxing, or tracking an asset
cost of disposition
cost incurred in the activities necessary to get rid of an asset
inventory valuation
determination of the amount of assets held by the firm for sale or production
corrective feedback
evalative and judgemental, It comprises a value judgement about processes and behaviors
outflow
funds being paid to others by the firm
pledging receivables
giving a third party legal rights to debts owed your business in order to provide assurance that borrowed money will be repaid
inventory
products that are held for sale to customers
factoring
selling the rights to collect accounts receivable to an entity outside your business
joint ventures
simply a formalized partnership btwn two or more businesses for some specific purpose
efficiency
the comparison of productivity ratios to see the extent that an org has generated more outputs with fewer inputs
inputs
the materials, labor, and energy put into the production of a good or service
feedback
the process of communicating within or to the organization about how the outputs worked or were received
operations
the processing of transforming materials, labor, and energy into goods or services
productivity
the ratio measure of how well a firm does in using its inputs to create outputs. Literally, productivity is outputs divided by inputs
procedure
the series of steps and activities required to complete a process
outputs
the services or products that are produced for sale
average annual profits x average investment
ROI =
1. easy to calculate 2. relies on accounting info with which business owners, lenders, and investors are comfortable
ROI analysis has two advantages
1. profits are not the same as cash 2. the method ignores the time value of money
ROI disadvantages
1. Pledge your receivables as collateral for a commercial loan 2. sell your receivables to a finance co
You can use receivables in two ways to quickly get cash
perpetual inventory
a system of recording the receipt and sale of each item as it occurs
supply chain
a way to think about the line of distribution of a product from its start as materials outside the target firm, to its handling in the target firm, to its handing by sellers, with placement into the hands of customers
book value
the difference between the original cost of an asset and the total amount of depreciation expense that has been recognized to date
acquisition cost
the total cost of acquiring an asset, including such costs as purchase price, transportation, installation, testing, and calibrating in order to ready it for its first productive use