Fin571_Law_Recommendation_for_Lawrence_Sports

Implementation of Recommendation The most appropriate recommendation for Lawrence Sports is to implement the conservative approach. “The conservative approach states that the proportion of current assets to current liabilities should be kept at 2:1. If this proportion is kept, the company would be able to maintain its financial solvency” (“Working Capital Circumstances in the Company”, 2008, p 1). Rarely does a firm maintain the 2:1 ratio; the average ratio for firms employing the conservative approach is 1.4:1. Therefore, Lawrence must maintain 140% of the total outflow in assets. Lawrence’s outflows include operating expenses and payments to Gartner and Murray. Over a seven-week period (from March 10th to April 27th), the total cash outflow is $2,637,000. To successfully implement the conservative approach, Lawrence must secure $3,691,000 in assets to ensure a constant state of solvency. The conservative approach to managing working capital limits the usage of short-term loans and relies on long-term loans. “Long-term financing is used to finance all of the firm’s long-term assets, all of its permanent current assets, and some of its temporary current assets” (Emery, 2007, p.642). Currently, Lawrence only ends the period from March 10th to April 27th with approximately $2,751,000 in assets. Because this level of assets falls short to what is needed to maintain solvency, Lawrence will need to secure a long-term loan to maintain the company’s safety net. In addition to alleviating the crisis of paying vendors when merchants default, such as Mayo’s trouble with making scheduled payments to Lawrence, the conservative method will create opportunity to incur financial gains. If excess assets are not needed in a particular time period, “the firm invests the excess funds in marketable securities. By financing a portion of its seasonal needs for funds on a long-term basis, the firm builds in a margin of safety” (Emery, 2007, p.1). However, because the conservative approach is a low risk approach, the potential rewards are low. Despite this low reward-to-risk, the buffer it creates to maintain healthy brand partnerships outweighs the low financial gains on investment. Contingency Plan A good financial plan includes contingency plans for unlikely outcomes. The planning process can identify potential, if unlikely, conditions that would cause significant problems (Emery, 2007, p.706). For contingency planning to be effective the company must be able to predict when changes are coming that may affect cash flow, inventory flow, and cash on hand. One thing that is not being utilized by the company is a performance indicator (PI) system that allow them to track various parts of the business. By developing PIs that can be used to trend inflow and outflow of inventory, payments made, revenue coming in, and orders the company will be able to identify seasonal changes in orders and cash flow that can be anticipated and planned for. In addition the company needs to develop PIs that track the overall economy both nationally and regionally to allow them to identify when there could be a slowdown that is affecting the product lines they make. This is another method that will allow them to ensure they can plan the inventory flow to compensate for the changes in demand. The company already has one piece of a contingency plan in process even if this was not originally considered as such. The ability to utilize an existing line of credit from Central Bank allows for some limited cash when needed for periods when cash flow is not enough to cover payments that need to be made. The interest on this line of credit scales with the amount that is borrowed. The recommendation to establish a long term loan to allow the Lawrence to establish a 1.4:1 ratio the company must also include the planning for repayment of this loan over time. This must be done while the company continues to build its cash on hand and assets. This larger loan should also be enough to pay off the current loans that are owed Central Bank for the line of credit. Once paid off the company can start by limiting the usage of this account and renegotiating the terms that would significantly reduce costs.