Optimal Inventory and Credit Policies under Two Levels of Trade Credit Financing in an Inventory System with Date-Terms Credit Linked Demand

Optimal Inventory and Credit Policies under Two Levels of Trade Credit Financing in an Inventory System with Date-Terms Credit Linked Demand

K.K. Aggarwal (Department of Operational Research, University of Delhi, Delhi, India) and Arun Kumar Tyagi (Department of Operational Research, University of Delhi, Delhi, India)
Copyright: © 2014 |Pages: 28
DOI: 10.4018/ijsds.2014100105
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Abstract

Credit policy through its influence on demand indirectly affects the inventory policy which is designed to meet that demand; therefore inventory policy is interrelated with the credit policy. Consequently, they must be coordinated and should be determined simultaneously in a systems perspective. In this paper, a mathematical model is developed in a discounted cash flow (DCF) framework to jointly determine inventory and credit policies under two levels of trade credit financing in the presence of stimulating as well as disintegrating effect of credit period on demand. The objective of the model is to maximize the present value of firm's net profit per unit time by jointly optimizing the date-terms credit period and replenishment interval. Numerical example and sensitivity analysis are presented to illustrate the effectiveness of the proposed model and results are discussed.
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1. Introduction

Trade credit financing is as old as business and it plays a vital role in the conduct of business operations. However, the classical economic ordering quantity (EOQ) models ignore the presence of trade credit financing in inventory control decisions. They implicitly assumes that the firm must purchase its inventory on cash i.e. cash outflow equivalent to the purchase cost occurs at the time of receiving the items. However, in practice, supplier is generally willing to give credit period for paying the purchase cost of items. Usually, there is no interest charge if the outstanding amount is paid within the permissible delay in period. However, an interest is charged on the outstanding amount if the firm does not settle payment in full by the end of permissible delay period. Therefore, rational firm will delay the payment up to the last moment of credit period. The firm also has an opportunity in the sense that before the end of trade credit period, it can sell the items and accumulate revenue and will earn interest on it.

Owning to these facts, the economic replenishment problem of the firm under supplier’s trade credit financing has been studied by various researchers under variety of assumptions. In the beginning it was Beranek (1967) who brought attention to trade credit financing in making inventory decisions and gave examples where ignoring trade credit terms leads to an infeasible replenishment policy. Haley & Higgins (1973) considered the problem of jointly choosing optimal order quantity and timing of payments to the supplier when inventory is financed through trade credit. Kingsman (1983) pointed out that the two commonly used terms of payment are:(a) payment within a specified period after delivery of the order, e.g. one month; and,(b) payment by some specified time in the month following the month of delivery, e.g. by the 15th day of the month following or the end of the month following. He studied the effect of these payment rules on ordering and stockholding policies for both retail shops and manufacturing companies. Later on, Chapman, et al., (1984), Goyal (1985), Dave (1985), Daellenbach (1986), Chand & Ward (1987) and Chung (1989) developed EOQ models when supplier offers a permissible delay in payments. Carlson & Rousseau (1989) called the Kingsman’s ‘type a’ terms as ‘day- terms’ and ‘type b’ terms as ‘date-terms’ since in the former payment is due a given number of days from a reference date such as the date of invoice, shipment or receipt and in later a future date is specified on which payment is due. They examined EOQ under date-terms supplier credit, making explicit the separate effects on inventory policy of the two components of carrying cost namely, financing cost and other variable holding costs. Kingsman (1991) further extended the theory of EOQ modeling under date- terms supplier credit taking into account the analysis of Carlson & Rousseau (1989). Other articles under permissible delay in payment can be found in Carlson, et al., (1996), Luo & Huang (2002), Robb & Silver (2006), Teng, et al., (2012) and Kumar & Aggarwal (2012), and their references.

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