FIN.3:4 - Solution

1. Identify the mechanism: order quantity and safety stock, customer credit and collection, supplier payment, or a combination. State what can actually change, whose consent is needed and when it takes effect.
2. Recover the relevant volumes, prices, variable resource consumption, holding and shortage consequences, expected credit losses and timed payments. Use an adequate MA account and OPS feasibility result directly.
3. Build the no-change and changed dated cash accounts. Include discounts, financing, collection effort, supplier-price changes, lost contribution, taxes where applicable and the transitional stock or receivable change. Separate recurring operating effects from cash released by reducing a balance.
4. Use cash-conversion measures to explain the mechanism where the business and denominators fit. For a period of N days, inventory days approximate average relevant inventory divided by that period’s cost of goods sold, times N; receivable days use average trade receivables divided by credit sales, times N; payable days use average trade payables divided by credit purchases, times N. Cost of goods sold is a purchases proxy only when its adequacy is established. On consistent period and scope grounds, cash-conversion days equal inventory days plus receivable days minus payable days. Investigate cohort, seasonal or overdue-account differences that an average conceals.
5. Compare feasible alternatives on the same horizon. Preserve service and capacity requirements. A discount offered to a customer is available only when the necessary agreement exists; a supplier extension is not obtained by changing a forecast date.
6. Select a policy or return conditional advice with the operational consequence, cash effect and revisit condition. Use FIN.2 to verify reserves across dates and FIN.15 to perform an authorized action.

For a discount offered in exchange for earlier cash, compare its actual cash cost with the available funding alternative over the same interval. Annualizing a short-period discount can help comparison, but retain its day count, compounding assumption and the actual amount needed; a large annualized percentage alone does not settle the order decision.

Recover the operating cycle before trying to shorten it

Working capital arises because buying, producing, delivering, invoicing and collecting occur at different times. Model the arrangement that creates those times: quantity and price of purchases, stock held before use or sale, credit granted to customers and credit received from suppliers. FIN.4 connects that operating plan to balances and cash. FIN.3 compares changes to the arrangement and their financial consequences.

Begin with the actual cause of the cash tied up. Slow collections may result from a generous credit term, disputed quality, late invoicing or a customer unable to pay. High inventory may be a seasonal build, a supply-protection choice, a production bottleneck or unsalable stock. Those causes call for different actions. Renegotiating payment terms cannot repair an invalid invoice, and writing off obsolete stock does not release the cash spent to acquire it. Inspect sufficiently detailed product, customer and supplier groups before applying an average policy to unlike cases.

The relevant operating alternative must still perform its intended service. Obtain a feasible replenishment or capacity response from operations and its resource/cost consequences from MA. A finance practitioner can compare those responses without inventing an inventory-control or production method. When no alternative operating plan is supplied, report the missing delivery or service condition instead of labeling the lowest stock balance optimal.

Make customer credit a commercial choice

A customer-credit policy includes who can buy on credit, how much exposure can accumulate, the payment term, any early-payment discount, collection action and the response to overdue balances. Establish the actual offer and likely customer response. A longer term can increase sales while requiring earlier production cash and increasing expected nonpayment. A tighter term can reduce exposure while losing a profitable customer. Compare the entire change against the business that would occur without it.

Construct additional receipts from the changed sales volumes, prices, discounts, collection dates and expected losses. Construct the additional cash costs of delivering those sales, credit administration, collection and any capacity step. Use MA.5 for the operating response and FIN.6 for an incremental present-value comparison when dates or recurring effects matter. Revenue growth alone cannot answer whether the credit policy creates value. Do not subtract expected bad debt again if the forecast receipts already allow for noncollection.

Keep the credit limit distinct from the term. The term controls when a particular invoice falls due; the limit constrains the exposure allowed to accumulate. A customer may stay within a limit while paying late, or exceed it through several otherwise current invoices. Consider concentrations and related customers when a common failure can affect several accounts. FDM supplies the relevant parties and claims rather than a name-matching shortcut.

Monitor an aging of actual unpaid invoices, with a stated reference date and whether age is measured from invoice or due date. Reconcile its total to the receivables account and inspect disputes, credit notes and receipts not yet applied. Compare cohorts or stable customer groups when sales mix changes. An aggregate fall in days receivable can be caused by a surge of recent sales; it does not show that old overdue invoices were collected. Return the changed collection forecast to FIN.2.

Factoring or discounting receivables can bring forward cash without changing the customer’s payment. Distinguish the advance, retained reserve, fees, servicing and any recourse if the customer fails. A transfer of the receivable and a loan secured by it have different claim consequences. Use actual FDM terms and FIN.10 to obtain net proceeds and remaining exposure. Do not count both the financier’s advance and the same full customer receipt as unencumbered cash.

Compare inventory policies at the service they provide

For a proposed reduction in stock, distinguish a one-time run-down from a lower steady operating requirement. Selling down existing units without replacing them can release cash during transition, but the lower inventory cannot be released again each year. A recurring improvement may instead reduce spoilage, storage or replenishment costs. Conversely, smaller batches may raise ordering and transport costs or require more supplier responsiveness.

Recover purchase cost, expected realizable proceeds and the payments actually avoided. A fall of 20 in book inventory is not necessarily a receipt of 20: a write-down is noncash, clearance may realize less, and supplier balances may change at a different date. Compare the cash account under both policies through transition and subsequent replenishment. Preserve the continuing stock needed to support the stated sales.

Include lost contribution and recovery costs when stockouts or quality failures are plausible. A service level can be an operating constraint, not a price to be guessed by finance. If operations supplies several feasible service/cost combinations, compare their incremental value and liquidity with explicit uncertainty. Keep resource usage, capacity supplied and expenditure distinct: releasing storage space saves cash only if the space or a related purchase can actually be reduced or redeployed. MA.5 and the actual operating plan supply that distinction.

Price supplier terms on the amounts and dates they change

An agreed longer payment term provides financing until the revised due date. Simply paying late may instead create penalties, stop supply or require cash in advance later. Include those consequences and the supplier’s willingness or contractual right to offer the term. A reduction in purchase price tied to earlier payment is a separate alternative with its own cash need.

For a discount fraction d available on an invoice amount F at an earlier date, the early payment is F(1 − d). Forgoing it retains that amount for the extra days and costs Fd at the later date. The extra-period financing rate is therefore d/(1 − d), not d. For a comparison using an effective annual convention and a year of Y days, the mechanically annualized rate is (1/(1 − d))^(Y/Δdays) − 1, where Δdays is the difference between the two payment dates. State the convention. That number imagines repeated equivalent periods; it is not the currency cost of this one invoice or proof that borrowing is obtainable.

Compare the actual early-payment funding schedule with the later invoice payment. Include the loan’s net proceeds, interest, fees and conditions, then test the dates in FIN.2. If finance is rationed, consuming scarce capacity to earn a discount can displace a better use. The high implied annual rate of a forgone discount is a useful signal, but a short period, small amount or uncertain supply can make currency amounts and operational consequences more decision-relevant.

Use cycle measures to investigate, then calculate the changed cash

The cash-conversion-cycle measures summarize how long operating investment remains tied up on average. Match each numerator to the flow that generates it, use the same period and a representative average balance, and inspect seasonality or rapid growth. Credit sales support receivable days; credit purchases support payable days; cost of sales can only proxy purchases when that approximation is adequate. Do not apply a sales denominator to inventory at cost and then add the result without qualification.

Translate a proposed reduction in days into an initial cash estimate using the corresponding daily flow, then verify it against the actual dates and operating changes. Reducing receivable days by five at stable daily credit sales of 10 suggests a 50 lower receivable balance. It does not create annual profit of 50, prove collection by the threatened payment date or establish how the customers will respond. Growing sales can require more absolute cash even when the cycle becomes shorter.

Compare policies on both value and funding. A valuable policy can have an unaffordable initial cash requirement; an affordable release of cash can destroy more operating value than it frees. Form combinations when terms interact: a customer advance may pay for a supplier discount, while the supplier’s faster delivery may reduce inventory. Count the shared receipt or saving once, retain each party’s required agreement, and recalculate the complete cash account. Return a specific policy, affected customers or goods, implementation timing and the conditions that would reopen the choice.