The goal of this paper is to propose a solution to help Lawrence Sports develop a working capital policy and a cash budget to help optimize working capital.

University Degree Business and Administrative studies

Lawrence Sports Inc.

Running head: PROBLEM SOLUTION: LAWRENCE SPORTS INC.

Problem Solution: Lawrence Sports Inc.

Charles Webb

University of Phoenix

Problem Solution: Lawrence Sports Inc.

According to Brealey et al, “Short-term, or current, assets and liabilities are collectively known as working capital” (2005). Monitoring and managing a company’s accounts receivable, inventory and cash balances are all part of the working capital management process. Working capital provides companies with liquidity and the ability to compete more effectively in the marketplace. In order to be successful, companies have to ensure that this working capital is optimized. Some of the ways to optimize working capital is to develop policies to guide them as well as develop a cash budgeting system for each organization. A manager not only has to deal with the day-to-day cash handling in the organization, but also deals with things like collections, bad debts, disbursements and loan repayments. What a working capital policy does is to target the level of each current asset account and how they would be financed. A successful policy will ensure that a company is able to meet its current obligations. The goal of this paper is to propose a solution to help Lawrence Sports develop a working capital policy and a cash budget to help optimize working capital. This will help the company get to a stage where they would be able to meet their current obligations.

Situation Analysis

Issue and Opportunity Identification

Lawrence Sports are faced with many issues currently facing the working capital for the company. These issues can definitely be resolved and turned into opportunities that will eventually benefit the company. Lawrence Sports’ main customer is defaulting on their payments. Below are some specific issues identified in the scenario.

Mayo has defaulted 80 % outstanding payments for two weeks in March and cannot pay until mid April.
Lawrence is managing by borrowing from the bank. Estimated borrowing from the bank has reached the maximum and Lawrence is still facing a cash deficit. Outstanding loan and interest burden continues to increase.
The number of days in Lawrence Sports’ cash conversion cycle is too long. “The cash cycle begins when cash is paid for materials and ends when cash is collected from receivables” (Ross et al, 2005). Lawrence Sports is using their own money to supply goods to their customers and not receiving payment on time. This is having a huge effect on their working capital since a great deal of money is going out and not much coming in. The current credit policy is not catering to their working capital needs.
The goods that Lawrence Sports sell on credit are shown in the accounts as receivables. It may take weeks or even months before they are paid for these goods. This gives a false sense of security to the company and prevents them from budgeting wisely. Customers are not doing everything within their power to find the resources to pay Lawrence.

One major opportunity for Lawrence Sports is the ability to create and maintain a long-term agreement with its vendors and customers. By implementing policies that will assure their customers pay on time, Lawrence Sports will be eliminating any potential bad relations caused by excessive demand of money. The agreements will also state the result of any breach of the agreement. This will ensure that both parties understand their business relationship. Another opportunity will be the ability to possess liquidity needed to finance their day to day operations and the ability to compete in the marketplace. Lawrence will have the opportunity to pay back some their loans to Central Bank as well as to their vendors, thereby maintaining a good and credit-worthy relationship with them. Lawrence will also have the opportunity to plan for any surprises that might arise. By solving the above issues and putting policies in place, they will be better prepared for situations such as the one they are currently facing with Mayo.

Another opportunity for Lawrence is inventory management. By solving their issues above, Lawrence will be able to better manage their inventory. “To do business, firms need reserves of raw materials, work in process, and finished goods. But these inventories can be expensive to store and they tie up capital” (Brealey et al, 2005). Inventory management involves a trade-off between the advantages of holding large inventories and the costs. Finally, another opportunity for Lawrence is the ability to build a relationship between the credit manager, the cash manager, and the production manager as they work together to solve the working capital problems.

Stakeholder Perspectives/Ethical Dilemmas

The stakeholders in the above scenario are numerous in number. Mayo Stores looked at this scenario as an opportunity for positive change. The management is one of the supporters to change the repayment terms to better fit the expansion of the company. The dilemma comes in when deciding whether to hold the payment to use it in other areas or pay Lawrence for the products purchased. Gartner views the situation as a small setback for Lawrence. Gartner wants to be paid A/R on time every time. Finally, Murray is taking the same stance as Gartner, on time - every time. The customers have to look at how their money is being used to benefit themselves. At the current state the customer is being cheated out of smarter more efficient services and products. The stakeholders invested in Lawrence have some serious ethical dilemmas to examine.

Problem Statement

Lawrence Sports will be able to manage its working capital and reduce its outstanding loan burden by focusing on developing a cash budget system, a stringent cash policy, credit policy and short term financial policy.

End-State Vision

Lawrence Sports will become financially stable and maintain a good working capital if they are able to solve all the above issues and realize their opportunities. The following are the end-state goals they would have accomplished.

In the next 90 days, Lawrence Sports will have a credit policy in place that will answer the following five questions: How long to give customers to pay their bills and whether they are prepared to offer a cash discount for prompt payment; Whether they require some formal IOU from the buyer or just ask them to sign a receipt; How they ...

This is a preview of the whole essay

In the next 90 days, Lawrence Sports will have a credit policy in place that will answer the following five questions: How long to give customers to pay their bills and whether they are prepared to offer a cash discount for prompt payment; Whether they require some formal IOU from the buyer or just ask them to sign a receipt; How they would determine which customers are likely to pay their bills; How much credit they are prepared to extend to each customer, whether they play safe by turning down any doubtful prospects, and whether they accept the risk of a few bad debts as part of the cost of building a large regular clientele; How they collect the money when it becomes due and what to do about reluctant payers or deadbeats. “You need to be resolute with the truly delinquent customers, but you do not want to offend the good ones by writing demanding letters just because their check has been delayed in the mail” (Brealey et al, 2005).
Lawrence Sports will have communicated their credit policy to all their customers and have the implementation in place by the end of 120 days.
Lawrence Sports will conduct a credit analysis of all current and potential customers in order to determine their credit worthiness.
Lawrence Sports will put in place a stringent collection policy. They will also obtain credit insurance in order to protect themselves from bad debts.
Lawrence Sports will maintain a free cash flow that will ensure they are able to fund future short-term projects.
Lawrence Sports will have a cash budgeting system in place that forecast future sources and uses of cash. “These forecasts serve two purposes. First, they provide a standard, or budget, against which subsequent performance can be judged. Second, they alert the manager to future cash-flow needs” (Brealey et al, 2005).

Alternative Solutions

Lawrence Sports has several alternative solutions that will help the company meet the desired end state goals. Below are thee major alternatives identified in the scenario.

Alternative 1 – Implement a Working Capital Policy and Cash Budget to optimize working Capital

Since Lawrence Sports does not seem to have a good budgeting system in place, the first alternative is for Lawrence Sports to prepare an elaborate corporate model cash budget, using a budgeting system. A cash budget ensures that a business has enough cash to fund its activities throughout the current period. Companies might often find themselves strapped for cash even though sales are increasing and they are profitable.

Alternative 2 – Perform a Cash Flow Analysis

Setting a policy that would include performing a consistent cash flow analysis is another alternative for Lawrence Sports. Cash flow analysis is the key method for measuring free cash flow. It provides insights into how a company is obtaining its financing and using its resources, and how the company plans to do so in future endeavors. “Cash flow forecasting--projecting cash flows in the short term (up to one year)--is an important financial management tool” (Ochs & Parkinson , 2006). When it’s determined that free cash flow is needed in a company, one of the ways is to reduce working capital needs through efficiency gains.

Alternative 3- Implement a Stringent Credit Policy

Another alternative for Lawrence Sports is to create and implement a stringent credit policy. According to Grover, (2002),

“Credit is an indispensable catalyst in financing the movement of commerce. Credit helps in production, distribution, selling, consumption and expansion and it increases the immediate buying power of a consumer. However, credit comes with its own negative connotation. Credit could mean a collapse due to overbuying, overexpansion or overselling.”

The most important factor in a successful business is the maintenance of free cash flow. To avoid problems with cash flow, a good manager will administer and manage credit with financial prudence and get paid promptly for goods or services rendered. “Accounts Receivables, which can be broadly defined as uncollected sales, are one of the largest assets of a business, amounting to approximately 15% to 20% of the total assets of a typical manufacturing business. An uncontrolled growth in sales could result in an uncontrolled management of account receivables” (Grover, 2002).

Alternative 4 - Implement a short-term financing policy

Implementing a short-term financing policy is another alternative for Lawrence Sports. The company must be aware that decisions made on assets such as accounts receivable, inventory, cash, and marketable securities will have an effect on their overall financial planning and other assets. “For example, suppose that you decide to give your customers more time to pay for their purchases, it will reduce your future cash balances. Or perhaps you adopt a just-in-time system for ordering from suppliers, it will allow you to get by on smaller inventories and therefore free up cash” (Brealey, 2005). Because a firm’s financial decisions affect its working capital and cash balances, Lawrence Sports must develop short-term financial plans. “Short-term financial planning is concerned with the management of the firm's short-term, or current, assets and liabilities. Often firms arrange a revolving line of credit with a bank that allows them to borrow up to an agreed amount whenever they need financing. This is usually intended to tide the firm over a temporary shortage of cash and is therefore repaid in only a few months” (Brealey et al, 2005).

Analysis of Alternative Solutions

In rating my alternatives between 1 and 5, with 1 being the lowest, the alternative I rated a 5 is the implementation of a cash budget using the Budget Maestro system. I believe this is the most important alternative because it encompasses all others. Without a budget in place, cash, credit, or short-term financial policies will have no meaning. A company needs to have a budget to ensure that they can foresee potential threats to their organization. The budget will allow them to see areas of weaknesses, even within their policies, and address them immediately.

The alternative to implement a credit policy is rated 4. This is because credit has an enormous effect on accounts receivable, a company’s cash flow, cash conversion cycle and revenue. Lawrence Sports has a credit policy with its customers but this policy is not catering to Lawrence’s working capital needs. Revenue is not coming in because it remains on credit and the customer are not doing all they can to make payment. This also has a direct effect on the company’s cash conversion cycle because cash is constantly paid for materials but not collected from receivables. This is why this alternative is very important. My remaining alternatives are rated a 3 as I consider them all as important as one another.

Risk Assessment and Mitigation Techniques

Risks are associated with changes to a company’s working capital policies; Lawrence Sports is no exception. How Lawrence Sports decides to implement the alternative solutions will play a role in the overall success of the company. The goal of the cash budget is to ensure that the company does not run out of cash. According to Brealey et al, a cash budget serves two purposes: “first, they provide a standard, or budget, against which subsequent performance can be judged. Second, they alert the manager to future cash-flow needs” (2005). This cash budget can be prepared by the financial team at Lawrence Sports or an outside company can be hired to assist the company with its preparation.

By implementing a cash flow analysis, Lawrence Sports can solve some problems with their inventory, but generate free cash flow, thereby touching on two aspects of working capital. This will help the company find a method where they can collect payments from their customers and maximize the use of that cash through short-term investments. This will help the company generate some free cash.

Having a credit policy such as this in place will allow Lawrence Sports’ customers and vendors to understand the company’s policy and its universality. They will know when a payment is due and the implications of defaulting. This process will also allow Lawrence Sports to better plan their budget as they will know when to expect payment from their customers and whether or there is customer reliability. According to Grover (2002), “writing an effective Credit Policy begins with an understanding of the financial exposure that you or your business can endure and the amount of your working capital that you would be willing to risk, or call it 'invest' in your customers.” Aside from implementing this credit policy, Lawrence Sports should pay attention to both the successful and the unsuccessful accounts. “Every time a deal goes bad, review the things that were done incorrectly in either setting up of the account, monitoring or collecting it. Measure Days Sales Outstanding (DSO), aging receivables, and bad debts as a percentage of sales. Keep a tab on your liquidity by reviewing liquidity ratios like the current or working capital ratio. Also keep a pulse on your inventory turnover. This will tell you if your efficiency is increasing, decreasing or the same over different time periods” (Grover, 2002).

Lawrence Sports uses a form of short-term financing option. They have a line of credit with Central Bank. When there is a cash deficit or if a short-term loan is needed, Lawrence Sports borrow automatically from the bank to maintain a minimum positive cash balance of $50,000. Under a revolving line of credit agreement, the lender, who in this case is Central Bank, will supply business funds intended to fill temporary shortages. Lawrence Sports should create a policy that will prevent them from borrowing up to the maximum allowable. This will prevent the company from being burdened with the high interest rates. Lawrence Sports should also consider getting a line of credit with another bank in which they can pay back in up to six months. Automatically paying their loans back to Central Bank every month does not give them an opportunity to use the cash. They should either re-negotiate their terms of their contract with Central Bank or find another option.

Optimal Solution

After identifying all the issues, opportunities, alternatives and mitigating circumstances, an optimal solution has been reached. The optimal solution for Lawrence Sports in this scenario is to implement an elaborate cash budgeting system, while developing policies that deal with cash, credit, inventory and short-term financial planning. This combination of solutions will help Lawrence Sports achieve their goal an adequate working capital system. A cash budget will allow them to plan for the future and be prepared for potential threats, while cash, credit and short-term financing policies will allow them to develop an understanding and a relationship with their customers, while meeting their own working capital needs.

Implementation Plan

The first step of the implementation plan is for the senior management team at Lawrence Sports to have a meeting and decide upon which capital budgeting system in which to invest. The responsible party for initiating this part of the plan will be the finance manager, with the approval of the Chief Financial Officer. This should be done immediately. After this decision is made, the budgeting system should be acquired immediately. While it’s in place, finance managers should monitor other financial aspects of the business such as collections. “Most firms keep track of the average time it takes customers to pay their bills. From this they can forecast what proportion of a quarter's sales is likely to be converted into cash in that quarter and what proportion is likely to be carried over to the next quarter as accounts receivable” (Brealey, 2005).

The next step of the implementation is the development of the various policies. Stephanie Sanders should be responsible for coordinating with other leaders on what the company policies should be. The first four weeks should be dedicated to this. After this decision has been made and documented, the CFO should pass it on to the technical writers or communications specialists in the company to accurately document these policies in accordance to any industry and governmental guidelines.

Next, Lawrence should put a system in place for cash flow analysis. This will allow them to consistently monitor their cash flow and be aware of any potential threats. Stephanie Sanders should responsible for assigning a team to this duty. This should be done the following four weeks. A cash flow analysis should be conducted every 60 days for the first year and every quarter for the following years.

Finally, Lawrence needs to put a strategic plan in place that will help them decrease their working capital needs. This plan should be decided upon by the company CEOs and the CFO with the assistance of the finance manager. This should be done by the end of 8 weeks. After implementing these solutions, Lawrence Sports must evaluate the results of this decision to ensure their success.

Evaluation of Results

Lawrence Sports’ desired goal is to successfully maintain a working capital, cash budget and meet their day-to-day operations as well as maintain a good relationship with their customers. To say that the company has been successful, they would have achieved the following:

In the next 90 days, Lawrence Sports will have a credit policy in place that will answer the following five questions: How long to give customers to pay their bills and whether they are prepared to offer a cash discount for prompt payment; Whether they require some formal IOU from the buyer or just ask them to sign a receipt; How they would determine which customers are likely to pay their bills; How much credit they are prepared to extend to each customer, whether they play safe by turning down any doubtful prospects, and whether they accept the risk of a few bad debts as part of the cost of building a large regular clientele; How they collect the money when it becomes due and what to do about reluctant payers or deadbeats. This policy will be communicated to all their customers and agreement will be signed by both parties binding them to the terms of this agreement.
Lawrence Sports will have communicated their credit policy to all their customers and have the implementation in place by the end of 120 days.
Lawrence Sports will conduct a credit analysis of all current and potential customers in order to determine their credit worthiness. They will have an idea of the high risk credit customers as well as the low risk ones.
Lawrence Sports will put in place a stringent collection policy. They will also obtain credit insurance in order to protect themselves from bad debts.
Lawrence Sports will have a strategic inventory management in place.
Lawrence Sports will maintain a free cash flow that will ensure they are able to fund future short-term projects.
Lawrence Sports will have a cash budgeting system in place that forecast future.

Conclusion

As one can see from the scenario, Lawrence Sports needs to create working capital policy that will allow the company the ability to compete ability to compete more effectively in the marketplace. In order to be successful, companies have to ensure that this working capital is optimized. Some of the ways to optimize working capital is to develop policies to guide them as well as develop a cash budgeting system for each organization. Understanding the opportunities that lie in store for the company is the first step toward success. For Lawrence Sports, the opportunities are numerous and have all been identified. Focusing on opportunities instead of issues is a positive way for the company to accomplish its goals. Framing the right problem and developing possible alternatives will lead to the ultimate solution. The optimal solution for Lawrence Sports is to implement an elaborate cash budgeting system, while developing policies that deal with cash, credit, inventory and short-term financial planning. The implementation of the improved cash budgeting system will help Lawrence Sports meet the desired end state goal successfully developing and maintaining a working capital, cash budget, and the ability to meet their day-to-day operations as well as maintain a good relationship with their customers.

References

Brealey R., Myers S. & Allen F. (2005). Principles of Corporate Finance. 8th ed. New York: The McGraw-Hill Companies.

Grover, P. (2000). Managing Credit: Is your Credit Policy Profitable? Retrieved 04 August, 2007, from http://www.creditguru.com/guestarticle44.htm.

Ochs J.& Parkinson K. (2006). Cash flow forecasting: do it better and save. Financial Executive. Vol. 22.1 p64. Retrieved 31 July, 2007, from the University of Phoenix Academic OneFile.

Ross, S., Westerfield, R. & Jaffe, J. (2005). Corporate Finance. New York: The McGraw-Hill Companies.

University of Phoenix. (2007). Scenario 1: Lawrence Sports. Retrieved 31 July, 2007, from University of Phoenix, rEsource, Simulation, MBA550-Resource Optimization website.

Table 1

Issue and Opportunity Identification

Table 2

Stakeholder Perspectives