Introduction:
Lawrence Sports (LS) is a $20 million revenue company that manufactures and distributes equipment and protective gear for various sports. Lawrence’s principal customer is Mayo Store, the world’s leading retailer; they comprise 95% of Lawrence Sport’s annual sales. Gartner Products and Murray Leather Works are Lawrence’s two main suppliers. Gartner Products is an industry leader owning 37% of the market with revenues over $200 million. Lawrence does not have very much bargaining power with Gartner even though Lawrence sources about 70% of its raw materials from Gartner. Murray Leather Works is a significantly smaller company than Gartner with annual company revenues at $10 million. Lawrence does enjoy a better bargaining position with Gartner as Lawrence makes up for about 75% of Murray’s sales (Simulation, 2002).
Options to Consider:
Lawrence Sports has several areas that could be discussed, here are three to consider.
1) The current credit policy is ineffective and it forces Lawrence into a dangerous financial situation that will cost the firm thousands in interest when the bank needs to cover expenses. The current policy puts financial stress on Lawrence, chiefly if a customer defaults on a payment.
2) Short-term financing strategy to ensure availability of an adequate line of credit while minimizing the cost of that credit.
3) Negotiate supplier (trade credit) terms for payment that balances LS cost with cash flow requirements. A new credit policy for Lawrence Sports will need to be addressed for credit terms, invoicing, collection policy and discounts.
Working Capital Policy:
Cash budgeting is an important tool toward having an effective capital working policy. Firms need cash for three reasons: to conduct ordinary transactions when cash flows are uneven (the transactional demand), to avert default on obligations (the precautionary demand), and to take advantage of investment opportunities (the speculative demand) (Emery, et al. 2007). A cash budget is a way to monitor a business cash inflow and outflow and in turn, will help in forecasting a company’s ability to pay debt. Cash budget will also pay expenses and help with planning short-term credit. Lawrence Sports has a credit line with high interest rates. Management is concerned about being able to pay off loans without needing to borrow more money. The customers and suppliers have been impacted due to delinquent payments. In turn, Lawrence Sports has delayed payments to their suppliers, resulting in a credit line with high interest rates. Management will need to benchmark and research other companies in their specialty to see if long-term planning can be realized in order to acquire control over finances. The main cash source comes from Mayo Stores. There needs to be an examination of the time lapse between the order of materials for Mayo and the delivery of final payment on the order. Mayo Stores has promised payment on outstanding invoices but have not come through. A cash budget is needed in order to have enough cash on hand in order to pay bills. When a bill comes due before payment is received, this is an indication of needing financing until payment is received. Lawrence Sports has an option of negotiating payment terms with customers and suppliers in order to maintain a balance between inflows and outflows. In turn, Lawrence Sports will rely less on short-term financing in order to pay bills until final payment is received from customers and suppliers.
The main position of a high-quality working capital policy is to free up cash and in turn, the cash will be used in order to grow the business. The capital policy that Lawrence Sports uses is contradicting their vision. The company currently finances all shortages by a line of credit. The credit term Lawrence Sports has with Mayo Stores is 20% collection when ordering and 80% the following week. The credit terms Lawrence Sports has with Gartner is 40% payment upon a purchase and 60% the following week. The credit term Lawrence Sports with Murray is 15% payment upon purchase and 85% the following week. Inventory is kept at a minimal by ordering new parts in order to fill a replacement order. Management has agreements in place that are not being honored by both parties. In two weeks, 100% of the payment is due from Mayo Stores. If Mayo Stores do not pay, Lawrence Sports will not be able to pay the suppliers and in turn, delay in paying their own bills. Lawrence Sports uses a line of credit as a cash reserve along with maintaining a bank balance of $50,000. Management’s operating cost is $100,000 a week and the maximum line of credit of $1.2 million. Lawrence Sports is headed to bankruptcy if Mayo Stores does not send a payment. Lawrence Sports will need to have enough cash in order to finance operating expenses to be paid. If the company does not sell their inventory, the overhead cost must be reduced and a inventory will need to be closely monitored for short term solutions. Firmer credit collection policies can help in reducing the cash conversion cycle.
Contingency Planning:
Associated Risks
Performance Metrics
Conclusion:
The art of working capital management is not as easy at it may seem. It is so much more than just making sure bills are paid on time. A manager handling the day-to-day cash of a company also has to balance many things like collections, bad debts, disbursements, future revenues, borrowing, and loan repayment simultaneously. Keeping loan burdens minimal requires negotiating short-term payment and collection arrangement with business partners while still maintaining good relationships with those partners and still catering to Lawrence’s working capital needs (Simulation, 2002).