Abstract
In order to stimulate demand of their product, firms generally give credit period to their customers. However, selling on credit exposes the firms to the additional dimension of bad debts expense (i.e., customer’s default). Moreover, credit period through its influence on demand becomes a determinant of inventory decisions and inventory sold on credit gets converted to accounts receivable indicating the interaction between the two. Since inventory and credit decisions are interrelated, inventory decisions must be determined jointly with credit decisions. Consequently, in this paper, a mathematical model is developed to determine inventory and credit decisions jointly. The demand rate is assumed to be a logistic function of credit period. The accounts receivable carrying cost along with an explicit consideration of bad debt expense which have been often ignored in previous models are incorporated in the present model. The discounted cash flow approach (DCF) is used to develop the model and the objective is to maximize the present value of the firm’s net profit per unit time. Finally, numerical example and sensitivity analysis have been done to illustrate the effectiveness of the proposed model.
Highlights
The basic purpose of a firm is maximization of its present value and in order to achieve this goal proper inventory management is an important aspect
Trade credit is used by the firms as a marketing strategy to stimulate demand by attracting the customers who consider it to be a type of price reduction
Teng [1] illustrated two benefits of trade credit policy to the supplier: (1) it should attract new customers who consider it to be a type of price reduction; (2) it should cause a reduction in the sales outstanding, since some established customers will pay more promptly in order to take advantage of permissible delay more frequently
Summary
The basic purpose of a firm is maximization of its present value and in order to achieve this goal proper inventory management is an important aspect. Since the matching principle of accrual accounting requires the recognition of bad debts expense at the same time as the related revenue; in order to record and measure the accounts uncollectible, the firm usually uses allowance method for bad debt losses as it confirms the matching principle of accrual accounting In this method, the firm makes an estimate of the portion of credit sales that will be uncollectible from as yet unidentified customers. Jaggi et al [6] expanded on this theme and developed an EOQ model with trade credit linked demand under the two stage trade credit financing In these models the credit period is assumed to be given and only ordering decisions were determined. In this paper, a mathematical model is developed within the discounted cash flow approach to determine optimal inventory and credit period decisions jointly for a firm. A hypothetical numerical example, sensitivity analysis, and observations are presented to illustrate the effectiveness of the proposed model
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