Discussed in this paper is the need for change to place Lawrence Sports in a more financially strong position. Lawrence Sports will notice by making some changes to the way they currently do business
Running head: LAWRENCE SPORTS WORKING CAPITAL POLICY
Lawrence Sports Working Capital Policy Paper
Nicole Hamblin
University of Phoenix
Lawrence Sports Working Capital Policy Paper
Discussed in this paper is the need for change to place Lawrence Sports in a more financially strong position. Lawrence Sports will notice by making some changes to the way they currently do business they can have more cash assets to grow the company to the desired level. In addition Lawrence Sports can reverse some of the negative issues identified in their present policy by making these changes to their cash revenue balance, renegotiation of the strategies used with their customers, credit policies and terms of payment, and changing the way that they look at short term financing.
Working Capital Policy
Cash budgeting is defined as the ending cash balance remaining after all cash has been collected and all expenses have been paid after evaluating the cash disbursements and cash receipts to attain this information. The purpose of a cash budget is to determine the minimum amount of cash that a company needs on hand as excess cash aside from the disbursements and expenses that are to be paid. In order for the Lawrence Sports organization to have adequate cash reserves, there needs to be the establishment of a cash budget. This cash budget will allow the financial managers to forecast the uses of cash for the company for cash needed for one month, three months, six months, and one year. This will give adequate levels of forecasting to establish the company with the needed cash during these intervals.
Lawrence Sports had many weaknesses defined in the simulation. Those weaknesses include the following:
1. Having low cash available
2. Being unable to meet the interest payments on long and short term debt
3. Contracts that are losing money.
4. Decrease in the needed production caused by company cutbacks.
When credit is granted to a customer as with Lawrence Sports credit with Mayo and Gardner they are investing in a customer. The investment, as described in Chapter 28 of Short Term Finance, is an investment tied to the sale of a product or service. The decision to grant credit and how much credit to grant and the stipulations in relations to the granting of the credit has a major impact on the revenue and assets on all companies involved. One thing that is noted with Lawrence Sports is their credit management practices currently. They see their goods and services and have a certain percentage that is paid initially in cash and the remaining revenue is paid after a certain time established with their customers. This extension of credit to customers is a great means of developing and gathering new business for the organization but it can also be a hindrance financially for the organization. In order for the company to be considered a reputable company to extend credit to, Lawrence Sports should do a thorough evaluation of how they pay their bills prior to establishing a certain line of credit with an organization. In addition, it is important that an organization has adequate financial revenue and can afford to extend credit to an organization and wait for the accounts receivables to come in. If not, like Lawrence Sports this can place the organization in a financial predicament that affects the business production. Extending credit to an organization can be done but in the case of Lawrence Sports as with many other organizations, there should be a higher amount of immediate cash paid and a lesser amount actually paid for through a line of credit until the organization has a substantial amount of excess revenue to not be affected so dramatically by the waiting period of the extended credit payments.
When the credit is granted, an account receivable for the company to which the credit is granted is created. Accounts receivables for an organization require an investment from the company. For example, when the company has paid for raw materials, supplies, and the hours for salaries of employees to provide the labor needed to provide the goods and services needed to sell to the customers. This investment has already occurred prior to the company recouping any revenue from their customers. If an organization cannot afford to put this revenue, out and still conduct business as usual while waiting ...
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When the credit is granted, an account receivable for the company to which the credit is granted is created. Accounts receivables for an organization require an investment from the company. For example, when the company has paid for raw materials, supplies, and the hours for salaries of employees to provide the labor needed to provide the goods and services needed to sell to the customers. This investment has already occurred prior to the company recouping any revenue from their customers. If an organization cannot afford to put this revenue, out and still conduct business as usual while waiting on the receivables. To be able to conduct business as usual, the company must have substantial revenue to continue business as usual. Otherwise, they are not able to as an organization to continue to purchase raw materials and supplies, pay employee hours to continue to produce the products and services that are needed for the company to continue to receive revenue. Therefore, in other words, without substantial revenue, the company cannot provide the continual supply chain needed to provide the needed goods and services to pay for the company's continual production of the needed goods and services. A continual process requires the needed amount of revenue in the needed amount of time to be able to be considered profitable. The investment into accounts receivable for any firm, as with Lawrence Sports, depends on the amount of credit sales and the average collection period. For example, if a firm's credit sales per day equal $1000 and its average collection period is 30 days, its accounts receivables will be equal to $30,000. The investment into the area of accounts receivable depends on factors influencing credit sales and collections as mentioned above. These factors are all dependent on a firm's credit policy set forth to their customers.
The components of a credit policy include the following:
o Terms of the sale. This is the information that includes the conditions set forth by the firm offering the credit. The terms can specify the period for the credit being extended, the amount of cash discount offered if any, and the type of credit instrument offered.
o Credit analysis. This is the step when the firm decides between customers that will pay versus customers that will not pay. There are various devices and procedures used to determine the customers' probability to pay.
o Collection policy. When a firm has evaluated potential customers to extend credit to, they must then establish the policy and manner in which they will collect the cash when it becomes due.
Since Lawrence Sports has generally low cash balances each month, their credit policy is detrimental to the financial health of the organization, the negotiation strategies that are used for their suppliers for payment terms of the balances owed to lend to the cash balances, and the credit line that is established by Lawrence Sports with their short term financing has also caused financial issues with the high cost of meeting the obligations of repaying the credit line Lawrence Sports needs a strong working capital policy.
The cash budget that is established for Lawrence Sports includes the development of all of the uses of cash that are utilized by the organization each month. Since the primary source of cash for Lawrence Sports is the collection of accounts receivables, this needs to be revamped in this policy. The cash budget included for Lawrence Sports is the actual cash received from cash collections from credit sales inclusive of whatever the previous month's cash balance was prior to the collection of these debts. The combination of these two defines the total cash that is available for Lawrence Sports per month minus the cash disbursements that are required each month. Lawrence Sports has the disbursements of cash for the purchase of the supplies needed to make the goods that are sold. They have the disbursements needed to pay the wages, taxes, and expenses of running a warehouse with staff and the salaries, taxes, and costs for overhead within a facility. Lawrence Sports also has a monthly payment that is the interest for the short term debt that is used to keep their cash balance at the needed numbers to function every month. There was also the cost of equipment that was needed to produce the goods that the company sells. The difference between the beginning cash balance and the total of all cash collected from cash sales minus the cash disbursements paid out each month is the total that will be remaining each month as the ending cash balance. Lawrence Sports needs to change the policy that they use for terms of payment until they have built enough cash revenue to have the substantial remaining each month. This could be done by increasing the amount of initial cash payment required for providing the services and offering an increase in the cost of the products but offering a prompt pay discount for the payment of the products in a lesser timeframe that would be substantial enough so that the company would chose not to pay on the due date and allow the money to grow interest in an interest bearing account but would be slightly higher discount allowing the company to have an incentive to pay promptly therefore allowing Lawrence Sports to have a higher cash balance available each month by collecting on credit in a more timely fashion. In addition, another avenue that Lawrence Sports should take is the marketing and sales approach of their products to increase the sale of the sporting products. This will also increase the cash revenue for the company by having an increase in customers. This I feel would address the cash balance requirements and increase the cash reserves needed to function and grow the organization.
Lawrence Sports credit policy can be improved by changes the percentages of the initial cash receipt versus the amount that is allowed to be extended over a greater period. After the initiation of new customers and the reevaluation of their existing customers, Lawrence Sports should look at the following three factors:
o The probability that the customer will not pay. Lawrence Sports needs to evaluate the companies they are looking to offer credit to and if the customer is determined to be high risk, Lawrence Sports might consider offering the customer restrictive credit terms.
o The size of the account also should be evaluated in deciding the credit period offered to the customer. For example, if an account is a smaller account they typically have a shorter period to pay the credit. Also when looking at customers to potentially offer credit to Lawrence Sports needs to evaluate the cost difference of providing credit to a smaller company versus a larger company. In addition, because a customer is smaller they are considered less important than a larger company is because they typically place a smaller order and therefore have less of an impact on the company's finances that are extending the credit.
o The extent to which the goods are considered perishable. The more perishable a product is the less time will be granted for credit. If a product cannot be sustained for a long period of time the collateral value is low therefore less credit will be granted.
Although lengthening the credit period would reduce the price paid by the customer and therefore increase sales because they are able to receive more for less, the lengthening of the credit period would cause more financial strain on Lawrence Sports and therefore decrease the amount of cash balances available each month overall.
Another area that needs to be changed for Lawrence Sports is the negotiation of the supplier for terms of payments. This will allow the company to not only receive their payments from customers in a more timely fashion but also to be able to pay their customers in a more timely fashion therefore being able to better take advantage of the discounts offered in prompt payments. The relationship between the suppliers should be looked at again in how both parties can be satisfied and not suffer financially long term. One possible alternative could increase in discounts for customers paying promptly and an alternative could be a certain percentage discount for the customer ordering a certain pre-established larger quantities of product. The customer could be offered a 10% discount if they order a one and half times the amount of product they typically order and are able to pay the credit terms of 50% initial cash and the remaining amount in 25% in 14 days and the remaining 25% in 45 days from the initial delivery of the product. These terms can be renegotiated and looked into by each new customer account established. Also from the perspective of Lawrence Sports being the customer, they should look into renegotiating their payment terms for those that they need to make accounts payables. For example, Lawrence Sports should look into establishing certain discounts based on the payments being paid in a timely fashion. Lawrence Sports should look into decrease in interest rates when payment terms are renegotiated and discounts for loyal relationships and discounts for increase in quantities in certain needed supplies because they have increased the amount ordered if the payment is made within certain specified terms.
Lawrence Sports has a high bank loan that should be considered a short term loan but because there is not substantial cash balances at the end of the month and the current accounts receivables is not allowing for stability in a cash revenue the amount that is being paid each month is primarily only interest and the company is therefore getting into a tighter financial situation and the real use of the short term financing is not being utilized since the company is not sustaining adequate cash revenue to accommodate the funds needed for the loan. Lawrence Sports should look into decreasing the amount borrowed each period and increase the amount being paid back by cutting back on areas that can be minimized within the process. Once these areas are cut back and the company has revamped the negotiation process, the credit analysis process, and changed processes to increase the cash balances then the can eventually decrease the balance in the short-term loan and hopefully alleviate the need for bankruptcy to stay afloat. Another final potential option for the change of policy would be to establish another lower interest rate line of credit for long term financing. This line of credit will provide the company with the needed finances to pay the current bills while growing a larger amount of cash in an interest bearing account to have the substantial revenue needed to not just stay afloat but to actually grow and flourish. Lastly, the company should be able to increase the cash balance by increasing sales, place the cash into an interest bearing account over short term, and allow the money to gain interest therefore increasing the cash balance while holding to pay monthly disbursements needed.
The metrics that will be used to monitor the success or failure of this policy would include the financial forecasting set up by the financial managers and the metrics would include close monitoring of the company's receipts and disbursements in addition to the close monitoring of the growth within the interest bearing accounts and movement to different accounts as warranted. The metrics would be closely monitored in a cash flow worksheet that would calculate all balances received and owed and cash needed to continue operations in the manner set forth. The key to success in this new policy will be adequate planning.
Ethical Implications
All plans have potential ethical implications and this one is no different. Although Lawrence Sports would benefit from the analyzing of its credit offered to its customers and by changing the payment terms offered to them, the customers might not be too pleased with the new changes being offered by Lawrence Sports. Even though it is beneficial for Lawrence Sports to increase the amount of money that is received initially from customers and change the payment terms to decrease the amount of time the customers have to pay their debt, this can cause a strain on the relationships with the customers therefore potentially driving the customers to other providers of the same products therefore it is imperative that Lawrence Sports consider the ethical implications from their actions. The primary thing that Lawrence Sports needs to do is to continue an excellent working relationship with their customers throughout all potential changes and kept the customers abreast of the changes allowing adaptation periods to adjust to any impending changes. This will keep the customers happier and feel more involved and informed in the changes being made.
A primary ethical implication addressed in the new policy is the increase in the cash revenue for Lawrence Sports while potentially causing unwanted financial strain on their customers. The policy addresses these issues by offering the possibility of discounts to the customers by meeting certain stipulations within the policy. This decrease the ethical implications by allowing all parties involved to win in some fashion.
Conclusion
In conclusion, Lawrence Sports can increase their cash balance by making some specific changes to the way they run their business. They can increase the cash revenue by changing the terms of payment set up with their current customers. This would be done by increasing the amount of cash paid at the time of the sale and decreasing the amount extended via credit. Also by offering shorter credit terms and increasing the discounts for paying in a shorter period, Lawrence Sports will be placed in a better financial position. The changes should allow for the change in status from financially distraught to financially strong.
References
Ross-Westerfield- Jaffe. (2004) Corporate Finance, Seventh Edition. Chapter 26. Short-Term Finance. Retrieved August 8, 2007. pp. 730-745. University of Phoenix Online rEsource.
Ross-Westerfield- Jaffe. (2004) Corporate Finance, Seventh Edition. Chapter 28. Credit Management. Retrieved August 8, 2007. pp. 779-791. University of Phoenix Online rEsource.
Working Capital Policy Paper 1
