Key Financial Concepts and Inventory Management
Reorder Point
The reorder point is the inventory level that determines when an order must be placed.
Leverage
Leverage is defined as the company’s use of fixed operational and financial costs. It represents a measure of operational risk and return. It refers to the multiplier effect that fixed costs produce on profits. Combined leverage occurs when a company employs both types of leverage to increase income for the owners.
Financial Leverage
Financial leverage is derived from using debt to finance an investment. This debt creates a financial cost (interest), but if the investment generates an income greater than the interest due, the surplus increases the company’s profit.
Cost-Volume-Profit Analysis
Cost-volume-profit (CVP) analysis seeks to determine the breakeven point or profitability threshold. This determines the level of sales in units and dollars at which the company has no operating income or loss.
Cash Breakeven Point
If the amount of cash available to the company is limited, or the cost of maintaining cash is high, the company is interested in knowing the sales volume needed to cover all cash costs in a period. The financial equilibrium point is a measure of financial risk arising from fixed costs.
Financial Forecasting
The forecasting method consists of estimating expenditures, assets, and liabilities for a future period as a percentage of sales.
Statement of Sources and Uses of Funds
The statement of sources and uses of funds shows us where the funds were obtained and where they were applied. It shows the movement of funds to make investment and financing decisions.
Cash Flow Statement
The cash flow statement is an accounting report aimed at providing relevant information on inflows and outflows of cash for an entity during a given period.
Cash Flow from Operating Activities
Cash flow from operating activities is related to the items of the income statement and the movement of assets.
Investing Activities
Investing activities include the purchase and sale of fixed assets and debt instruments or shares of other companies. It also includes the collection of loans made to a related company.
Financing Activities
Financing activities include share sales, mortgage bonds, commercial papers, and other funds to finance either long-term or short-term debt.
Inventory Management
ABC Analysis
ABC analysis is a tool to visualize this relationship and to determine, simply, what items are of greater value, thus optimizing the resource management of inventory and decision-making by allowing more efficient inventory management.
Types of Inventory
- Raw material inventory: Products that will undergo a transformation.
- Work-in-process inventory: Products that have not yet completed their production process and are therefore not available for sale.
- Finished goods inventory: Products that have completed their production process and are available for sale.
ENTEL Case Study
ENTEL was founded in 1964. After an earthquake seriously damaged the long-distance network, the Chilean government saw the need for a long-distance company to improve telecommunications in the country and build a new network. Currently, the company is part of the telecommunications industry, which is divided into five main segments: basic fixed-line, long-distance (national and international), and wireless or mobile phone.
Example: Inventory Management
A company has significant cash surpluses.
- Cost of borrowing: $1,200 per trip
- Cost of maintaining: $0.02/kg
- Daily demand: 5,000 kg
- Annual demand: 1,825,000 kg
Calculations:
- a) Optimal order size: 467,974 kg
- b) Order frequency: Every 94 days
- c) Annual costs:
- Charter: $4,680
- Storage: $9,359
- Total: $4,680
- f) 30% demand increase, order size: 533,573 kg
Example: Breakeven Point
Rite Walk Shoe Company
- Unit Price: $30
- Variable Costs per Unit: $21
- Fixed Costs: $360,000
- Breakeven Point (units): 40,000
- Breakeven Point (sales): $1,200,000