Captive Finance Subsidiaries Some firms choose to form a wholly-owned subsidiary—a corporation

Captive Finance Subsidiaries Some firms choose to form a wholly-owned subsidiary—a corporation

owned by the parent firm—to provide the credit granting and collection function of the parent firm. For example, if you buy a General Motors car, you can finance your purchase through General Motors Acceptance Corporation (GMAC), a wholly-owned subsidiary of General Motors.

GMAC is an example of the kind of firm referred to as captive finance subsidiaries. Their sole purpose is to finance the customers’ pur- chase of the parent firm’s products.

These subsidiaries can stimulate sales by providing easy access to loans. For example, Hyundai Motors of America found that customers were having difficulty getting auto loans for their low-priced cars, since loan default rates are typically high for loans on such autos. So Hyundai established their own finance company—Hyundai Motor Finance Co. (HMFC)—to finance customers’ purchases and increase sales.

Another motive is to separate the credit function from the rest of the firm. By operating the credit granting and collection function as a separate profit center, it is easier to evaluate how well accounts receivable are managed.

INVENTORY MANAGEMENT Inventory is the stock of physical goods for eventual sale. Inventory con-

sists of raw material, work-in-process, and finished goods available for sale. There are many factors in a decision of how much inventory to have on hand. As with accounts receivable, there is a tradeoff between the costs of investing in inventory and the costs of insufficient inventory. There’s a cost to too much inventory and there’s a cost of too little inventory.

Reasons for Holding Inventory There are several reasons to hold inventory. The most obvious is that if

you sell a product, you can’t transact business without inventory.

Management of Receivables and Inventory

Another obvious reason is that goods cannot be manufactured instanta- neously. If you manufacture goods, you will likely have some inventory in various stages of production. This is referred to as work-in-process.

You also may want to have some inventory of finished goods in case sales are greater than expected. Or you may want to hold some specula- tive inventory for dealing with events such as a change in the product or

a change in the cost of the raw materials. For example, when Coca-Cola introduced “New Coke” to replace the “old” Coke, many retailers hoarded supplies of the “old” Coke product—since renamed “Classic Coke”—in anticipation of continued customer demand for the original product.

Further, some firms hold inventory to satisfy contractual agree- ments. For example, a retail outlet that is the sole distributor or repre- sentative of a product in a region, may be required to carry a specified inventory of goods for sale.

The decision to invest in inventory involves, ultimately, determining the level of inventory such that the marginal benefit (such as providing for transactions and precautionary needs) equal the marginal cost (such as carrying costs). The level of inventory at which the marginal benefits equal the marginal cost is the owners’ wealth maximizing level.