Be an Entrepreneur

Chap 11

The Entrepreneur

The Business Plan

The Enterprise•Epilogue

Be an Entrepreneur

MANAGE DAY-TO-DAY OPERATIONS

Chapter 11

Chapter 11 overview

The previous chapters gave guidance on setting up the business. In Chapter 11, we focus on the day-to-day running of the business.

Chapter 11 overview

Daily operations may look boring or routine but if they are left unattended, all sorts of problems crop up.

These include: damaged reputation, out-of-stock situations, bad debts, and lost opportunities.

Chapter 11 overview

We show how to avoid such problems in Chapter 11.

More to the point, we show how to maximize profits by effectively managing the resources used in operations.

Coverage of the chapter

• The Operating or Cash Cycle:• Investing in the Operating Cycle• Cost-Benefit Analysis

• Payables • Inventory• Receivables

Activities

IcebreakerGlossary. Video.

Story: Roger Laney

Define Operating Cycle

Story: using technology to

manage inventory

Manage Payables

Cost-benefit approach

Story: automating the

purchasing

Story: Managing Receivables

Summary. Case analysis:

Mcdonalds.

Learning Objectives

• Define the operating cycle and identify its components

• Describe the cost-benefit approach to managing the operating cycle components

• Describe the role of payment period and discounts for early payment in managing payables

Learning Objectives

• Explain why the focus of inventory management is on costs

• Identify the different costs in managing inventory and describe the relationship between the volume ordered and these costs

Learning Objectives

• Identify the variables you can manage in relation to receivables and describe their effects on the costs and benefits of extending credit

Story from Real Life

• Roger Laney was an accountant for 30 years and owned his own accounting firm for more than 20 years.

• He recently came across an intriguing side business: ice houses (selling ice cubes.)

Story from Real Life

• Yes, ice. When someone asked him to lease property to a 20-foot-by-40-foot self-serve ice kiosk, Laney's initial response was "What? That's crazy."

Story from Real Life

• Fourteen months later, he and his partners now run Alamo Ice Company. They own five ice houses in San Antonio, Texas--the closest non-saturated area to their home base of Chipley, Florida.

• They also sell the machines in 12 counties they have bought licensing rights for.

Story from Real Life

• While Laney still works full-time at his firm, the icehouse partners take turns traveling to Texas once a month.

• Laney has spent many nights and weekends building the business.

Story from Real Life

• But he says that, once the machines are up and running, it's “hands off.”

• "That's the beauty of the ice machine business," says Laney.

Story from Real Life

• Laney says adds that two of the biggest headaches small-business owners have are employees and collecting money.

• The ice machines have neither issue as they're managed and maintained by a contract company in Texas.

Story from Real Life

• The partners plan to invest in 80 machines total in Bear County, Texas, and continue selling machines in their 11 other territories.

• At $130,000 each for full installation, it's a big investment. Laney says the investment breaks even in 30 months.

Story from Real Life

• "I anticipate keeping both businesses for an extended period of time," he says. "Once we get the machines installed, and operating, they are easy to manage.”

• (Lucky for him, it is easy to manage the day-to-day operations of his business.)

Operating Cycle or Cash Cycle

Cash Cycle

Glossary

Operating cycle: The set of everyday business activities

that convert cash back into cash again. Thus, it is also called the cash cycle.

Glossary

Activities of Operating cycle. The activities may include:

paying cash for raw materials, moving materials into production, storing finished products, selling the products, and collecting from customers.

Glossary

Payables: Obligations that arise when purchases

are made on credit; that is, the buyer is allowed a short period after goods are delivered before payment is due.

Glossary

Inventory: Things a business buys or makes, with

the intention of selling them to customers.

Glossary

Receivables: Claims on customers that arise when

sales are made on credit; that is, when a seller allows a short period before collecting payment.

Glossary

Ordering costs: Costs related to the purchase or

ordering of inventory. They are generally fixed in nature.

Glossary

Holding or carrying costs: Costs related to storing, keeping,

controlling the inventory after delivery.

They are generally variable in nature.

Glossary

Trade-OffA trade-off between quantities occurs

when an improvement in one quantity means a worsening in the other quantity.

In such cases there is usually an ideal value for each quantity.

Points to Remember

• The operating cycle is the set of routine business activities that turn cash into something and then back into cash again.

• For this reason, the operating cycle is also called the “cash cycle.“

Buying and paying for raw

materials

The production process

Storing finished products

Selling products on credit card.

Accounts Receivable

Collecting cash from customers

Points to Remember

A typical operating cycle consists of • paying cash to buy raw materials, • moving the materials into production, • storing finished products, • selling the items on credit, and finally • collecting cash from customers.

Points to Remember

Managing day-to-day operations involves managing the components of the operating cycle: • payables, • inventory, and • receivables.

Points to Remember

• The investment your business makes in the operating cycle is significant and permanent, which motivates us to examine it closely and manage it effectively.

Points to Remember

• The approach we use to guide us in managing the operating cycle is the cost-benefit approach.

• In this approach, total expected costs are compared against total expected benefits.

• The investment is made when benefits exceed the costs.

Points to Remember

• We applied the cost-benefit approach to the components of the operating cycle and the particulars are shown in this table: (next slide)

Costs and benefitsOperating cycle component

Benefits Costs Management variables

Payables Readily available financingFree and flexible financing

Cost of moneyDamaged reputation

Payment periodDiscounts for early payment

Inventory Profits from sales (but this cannot be managed)

Cost of inventory (but this cannot be managed)Ordering costsHolding costsLost profits when out-of-stock

Order quantity (number of units per orderSafety stock

Receivables Profits from increased sales

Cost of moneyBad debts

Quality of customersPayment periodDiscounts for early payment

Points to Remember

• You change the level of investment in the operating cycle components by managing the variables within your control.

• You will manage these variables such that benefits always exceed the costs.

Points to Remember

• Credit terms define when payment is due, and may include an incentive for early payment.

• Sellers may themselves stretch the payment period during the low season to encourage sales.

• Buyers also use all sorts of tactics to pay as late as possible.

Points to Remember

• There is an opportunity loss if discounts are not taken.

• Payables may be stretched but doing so beyond an acceptable period damages the reputation of your business.

Points to Remember

• Inventory management: The focus in managing inventories is not on benefits but on costs. This is because the benefit derived from inventories – the profit made from sales --is either already known or determined elsewhere.

• The manager focuses on lowering the costs in buying and keeping inventory.

Points to Remember

The costs you can manage are the other costs surrounding the inventory process. They may be grouped into: • Ordering costs• Holding or carrying costs• The lost opportunity to sell, when you are out of

stock.

Points to Remember

The variables you can manipulate in managing receivables are:• Quality of customers: • Are your customers both willing and able to pay? The

higher the quality of your customers, the lower the bad debts. • But limiting credit to high-quality customers also

limits sales.• (Continued)

Points to Remember

The variables you can manipulate in managing receivables are: (continued)

• Payment period: • Longer payment periods encourage more profits as it

allows customers who may be tight on cash to buy your products. • But the longer time frame increases both the cost of

money and bad debts.• (Continued)

Points to Remember

The variables you can manipulate in managing receivables are: (continued)

• Discounts for early payment: • Giving customers an incentive for paying early lowers

the cost of money as you receive the funds earlier. • It also lowers bad debts. • But as the price is effectively lowered by the discount,

your profits are likewise lower.

Ask Yourself

• Are there people who owe me money? Did I collect from them?

• Can I apply cost-benefit analysis to other aspects of my life? Sports, gadgets, etc.

Ask Yourself

• Do I have any items that I have to pay for, but I have not yet fully paid for them?

• Have I ever taken advantage of a discount for cash payments?

Ask Yourself

• Do I use technology to manage my data, papers, items in storage? Do I know where to find all the files and data that I have stored?

Ask Yourself

• Have I ever tried to buy something from a store or restaurant, an item which was out of stock?

• Was it a total disappointment? • Did I learn something valuable from the

experience?

Ask Yourself

• Did I ever sell goods to people, and did I collect the payment?

Review Questions

What is an operating cycle? What would be the activities in an operating cycle of a manufacturing company?

Why is it important to look into what the business invests in the operating cycle?

Review Questions

Briefly describe the cost-benefit approach to managing the operating cycle components.

What is the trade-off between the payment period and the discount for early payment in managing payables?

Review Questions

Why should the focus on inventory management be on costs?

What are the costs that need to be managed in managing inventories?

Review Questions

What is the relationship between ordering costs, holding costs, and the volume ordered?

What variables (things you as business owner can control or change) can you manage in relation to receivables?

Review Questions

What are the effects on receivables of managing quality of customers, payment period, and discounts for early payment?

Case Study questions

• What do you think are the benefits to McDonald's in employing just-in-time inventory?

• Do you think it is worth investing in technology to achieve the benefits of JIT?

Case Study questions

• IF a fast-food restaurant does not cook until an order is placed, there is the danger of having a large number of customers come in at one time and having to wait longer.

• How do you think they should handle situations like these? (long lines forming…)

NEXT CHAPTER: 12

MONITOR AND CONTROL

Chapter 12 overview

In chapter 11, we focused on managing everyday business activities. But business is much more than routine

transactions. It is about achieving goals. Are you achieving your goals?

Chapter 12 overview

Specific questions: Are things going as planned? Are you getting the results you expect? Can you spot problems early on? How do you make sense of everything

that is happening?

Chapter 12 overview

Chapter 12 attempts to answer those questions by showing you ways to control and monitor the health and performance of your business.