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