Inventory and Credit Decisions Under Inflationary Conditions With Inflation Induced Bad-Debts

Inventory and Credit Decisions Under Inflationary Conditions With Inflation Induced Bad-Debts

K.K. Aggarwal (Department of Operational Research, Faculty of Mathematical Sciences, University of Delhi, Delhi, India) and Arun Kumar Tyagi (Department of Operational Research, Faculty of Mathematical Sciences, University of Delhi, Delhi, India)
DOI: 10.4018/IJORIS.2018070103

Abstract

This article describes how a credit period, through its influence on demand, becomes a determinant of inventory decisions; therefore, inventory decisions should be determined jointly with credit decisions. Inflation and time value of money affects valuation of investments; hence their effect should not be disregarded in decision-making. Selling on credit exposes a firm to an additional dimension of default risk from customers as a result of inflation. Consequently, this article presents a mathematical model for the joint determination of optimal inventory and credit decisions for a day-terms credit-linked demand by incorporating the effects of inflation and the time value of money. It is assumed that an increase in the rate of inflation leads to an increase in bad-debts. The objective of the model is to maximize the present value of a firm's net profit per unit of time by jointly optimizing the day-terms credit period and order interval. A numerical example, sensitivity analysis, and observations are presented to illustrate the effectiveness of the proposed model.
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1. Introduction

The classical economic ordering (EOQ) model is based on the assumption that demand is an exogenous variable i.e. it cannot be influenced by the decision maker. However, it has been observed that the demand can be influenced by offering credit period to the customers. Teng (2002) also 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. Trade credit reduces the customers’ cost of holding stock and thus motivates them to purchase in large quantities. Credit is used by the firm as a marketing strategy when a new product is launched. It is used as an effective means of price discrimination, product differentiation and product quality guarantee. In fact, many theories (Bougheas, Mateut & Mizen, 2009; Brennan, Maksimovic & Zechner, 1988; Daripa & Nilsen, 2010; Emery, 1984; Lee & Stowe, 1993; Lehar, Song & Yuan, 2012; Metzler, 1960; Schwartz, 1974; Smith, 1987; Vaidya, 2011) have been given for explaining why firms grant credit to their customers; but the one common theme among various theories of trade credit is that it is used to stimulate demand of the product. Peterson & Rajan (1997), Atanasova & Wilson (2003) showed respectively that 70 percent of small U.S firms and 80 percent of firms in U.K provide credit to their customers. Ge & Qiu (2007) found that, on average, 27 percent of total sales in China are based on trade credit. In India, strong evidence exists in support of an inventory management motive for offering trade credit where firms attempt to increase sales and lower finished goods inventory by offering trade credit to their customers (Vaidya, 2011). The two common forms of trade credit are day-terms and date-terms. In day-terms payment has to be done within a fixed time period after the purchase and in date-terms the firm specifies a due date on which payment has to be done (Kingsman, 1983; Carlson & Rousseau, 1989; Robb & Silver, 2006). Thus, in day-terms credit each customer gets same amount of credit period irrespective of its purchase date, while in date-terms credit policy the credit period availed by the customers is the difference between due date (i.e. maximum credit period) and the time at which customer has purchased the goods.

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