1. Financial Analysis, Planning and Forecasting Theory and Application
Chapter 20
Credit, Cash, Marketable Securities, and Inventory Management By
Cheng F. Lee
Rutgers University, USA
John Lee
Center for PBBEF Research, USA

2. Outline 20.1 Introduction 20.2 Trade credit
20.3 The cost of trade credit
20.4 Financial ratios and credit analysis
20.5 Credit decision and collection policies
20.6 The Baumol and Miller-Orr model
20.7 Cash management systems
20.8 Credit lines and bank relations
20.9 Marketable securities management
Inventory Management
Summary
Appendix 20.A

3. 20.1 Introduction

4. 20.2 Trade credit （20-1） Table 20.1 Aging of Accounts Receivable
January
February
Accounts Receivable
﹪ of Total
0-30 days
＄ 250,000
25.0﹪
22.7﹪
31-60 days
500,000
50.0﹪
525,000
47.8﹪
61-90 days
200,000
20.0﹪
250,000
Over 90 days
50,000
5.0﹪
75,000
6.8﹪
Total accounts receivable
＄1,000,000
100.0﹪
＄1,100,000

5. 20.3 The cost of trade credit
The seller’s perspective
The buyer’s perspective

6. 20.3 The cost of trade credit
= Current sales =＄1 million per year.
S = Incremental sales =＄250,000.
V = Variable costs as a percentage of sales = 70 percent. includes the cost of
administering the credit department and all other costs except bad-debt losses
and financing costs (interest charges) associated with carrying the investment in
receivables. Costs of carrying inventories are included in .
1-V = Contribution margin = 30 percent or equivalently, the percentage of each sales dollar that
goes toward covering overhead and increasing profits.
k = The cost of financing the investment in receivables = 12 percents. k is the
firm’s cost of new capital when the capital is used to finance receivables.
= Average collection period prior to a change in credit policy = 20 days.
= New average collection period after the credit policy change = 30 days. In
this example, we assume that customers pay on time, thus ACP = specified
collection period).

7. 20.3 The cost of trade credit
(20.2)

8. 20.3 The cost of trade credit
（20.3）
（20.4）

9. 20.4 Financial ratios and credit analysis
Financial ratio analysis
Numerical credit scoring
Benefits of credit-scoring models
Outside sources of credit information

10. 20.4 Financial ratios and credit analysis
(20.5)
Table 20.2
Status and Index Values of the Accounts
Account Number
Account Status 7
Bad
.81 10
.89 2
1.30 3
1.45 6
1.64 12
Good
1.77 11
1.83 4
1.96 1
2.25 8
2.50 5
2.61 9
2.80

11. 20.4 Financial ratios and credit analysis
Figure Distributions of Good and Bad Accounts
1.83 12
Discriminate Function Value
Probability of Occurrence
1.64
1.77
1.96
Bad
Good

12. 20.4 Financial ratios and credit analysis
(20.6)
Credit Score
from Scoring Model
Cumulative Frequencies
“Goods”
“Bads”
－.200
0 ﹪
.208 35
.226 2 36
.245 3 40
.356 6 58
.543 16 76
.577 17 82
.596 20 85
.699 34 97
.763 49 99
.898 75
100
1.200

13. 20.4 Financial ratios and credit analysis
Figure 19-2
Key to Dun and Bradstreet Ratings

14. 20.5 Credit decision and collection policies
Collection policy
Factoring and credit insurance

15. 20.6 The Baumol and Miller-Orr model
Baumol’s EOQ model
Miller-Orr model

16. 20.6 The Baumol and Miller-Orr model
（20.7）
Figure 20.3

17. 20.6 The Baumol and Miller-Orr model
Figure 20.4

18. 20.6 The Baumol and Miller-Orr model

19. 20.6 The Baumol and Miller-Orr model
Figure 20.5

20. 20.6 The Baumol and Miller-Orr model
（20.8）
（20.9）
（20.10）
（20.11）

21. 20.6 The Baumol and Miller-Orr model
upper limit = lower limit + spread
= ＄20,000＋＄22,293
= ＄42,293

22. 20.7 Cash management systems
Float
Cash collection and transference systems
Cash transference mechanism and scheduling

23. 20.7 Cash management systems
Figure 20.6

24. 20.7 Cash management systems
Figure 20.7
Source: Stone and Hill, 1980.

25. 20.7 Cash management systems
Figure 20.8
Source: Stone and Hill, 1980.

26. 20.8 Credit lines and bank relations

27. 20.8 Credit lines and bank relations

28. 20.9 Marketable securities management
Investment criteria for surplus cash balances
Types of marketable securities
Hedging considerations

29. 20.9 Marketable securities management

30. 20.9 Marketable securities management
(20.12)

31. 20.10 Inventory Management
Inventory Loans
Economic order quantity

32. 20.10 Inventory Management
（20.13）

33. 20.11 Summary
The subject of Chapter 20 is the management of trade credit for both buyer and seller. For the buyer, the essential issue is to determine the cost of using trade credit as a form of financing, then compare this cost with the cost of alternative sources of capital. While some argue that accounts payable have no cost, we support the arguments against this view. That is, for the buyer, trade credit involves opportunity costs in the form of foregone discounts, implicit bankruptcy costs for taking on too much accounts payable, and costs associated with the timing of taxes and the accounting procedure used.
The grantor of trade credit, the seller, has a large array of decisions to make. The first of these we discussed was determining the cost of granting trade credit. Next, we examined a numerical credit-scoring method via linear discriminant analysis to make the credit-granting decision more effective in terms of risk and related collection and bad-debt costs. Finally, we discussed the other aspects of the firm’s credit policy, including the decision of how much credit to grant, on what terms, and the collection policy procedures to be pursued for delinquent accounts. We noted that the evaluation of various collection policies can be viewed and even carried out in the framework of a capital budgeting problem. Earlier we discussed a number of methods to deal with the capital budgeting problem with uncertainty, including（1）the risk-adjusted discount rate method,（2）the certainty equivalent method,（3）the statistical distribution method, and（4）various simulation methods.

34. Summary
We also discussed the various aspects of cash and marketable security management. Two techniques that can assist in the estimation of an optimal level or range for cash balance were Baumol’s model and the Miller-Orr model.
To make the cash collection system more efficient, the firm can choose from various methods for collecting or transferring cash and deciding when to transfer it. Such cost minimization is ideal for linear programming applications.

35. 20.7 Summary
The credit line offers the firm a means of handling cash variations caused by seasonal effects or unanticipated events. Establishing good bank relations is an important feature for any cash management system. However, bank services do take on a cost, typically in the form of compensating balances. While credit lines can be a good investment for a bank, they can have detrimental effects on the bank’s liquidity that could intensify any maturity gap problems.
Efficient cash management ensures that surplus balances are invested in marketable securities that meet minimum standards for certainty of principal, maturity, liquidity, and yield. In Chapter 20, we considered the hedge decision from the cash manager’s perspective and gave various examples of hedging applications. Optimal inventory management was also briefly discussed.

36. Appendix 20.A. Derivation of Equation 20-1