Fin571

Running head: LAWRENCE SPORTS SIMULATION Lawrence Sports Simulation University of Phoenix May 30, 2010 Lawrence Sports Simulation   Maintaining a positive cash flow is imperative for any business. Lawrence Sports has found itself in a situation in which the company is struggling to pay for a loan, meet customer needs, and maintain a positive vendor relationship. The statement of cash flows is a financial statement indicating the change of position in cash of the period covered by the income statement [ (Emery, Finnerty, & Stowe, 2007) ]. The cash flow breaks down the use of cash throughout the period and shows the flows from operating, investing, and financing activities. This team will attempt to compare the different policies of the cash flow strategies for Lawrence Sports and offer a recommendation of the best strategy that will prove to advance Lawrence Sports' business activities.   Maturity-Matching Approach  A moderate approach to financing working capital entails maturity matching.  In simplest terms, Lawrence Sports can curb their risks by matching the maturities of their assets and liabilities.  Lawrence would be able to finance seasonal variations in current assets with  current liabilities of the same maturity.  Long-term assets are financed through the issuance of long-term debt equity securities.  Long- term capital is also financed with a  permanent component of current assets gained from this policy; whereas inventories and receivables will be able to sustain a minimum level.  In regard to short term borrowing, which is inclusive of bank loan such as the one Lawrence is struggling to pay for, under this policy, the short-term borrowing will be reflective of seasonal swings in current assets.  Short-term borrowing will fall to zero during seasonal low points (Emery, et al., 2007).   It is presumed funds will always be available under a moderate  policy and Lawrence will be dependent on short-term financing for any temporary assets.  The risk of this approach does expose Lawrence to greater risk. Lawrence will be taking a chance on their costs not increasing, sudden or drastic downturns for Lawrence or the economy will result in Lawrence not having the ability to gain access to needed funds or the costs of attaining are at an excessively higher rate.  This approach exposes Lawrence to the risks of a credit shutoff or an increase in costs (Emery, et al., 2007). Conservative Approach   Lawrence Sport can use a conservative working capital policy to “guard against the risks of a credit shutoff or a cost increase (Emery, et al., pg 642, 2007).” This policy uses more long-term and less short-term financing. All long-term assets, permanent current assets, and some temporary assets are financed using long-term financing. Short-term financing is only used when the asset needs are high. Companies can invest excess funds in marketable securities. The advantage of short-term debt versus long-term debt is the ability to acquire funds relatively quickly and repay them without penalty. The disadvantage of short-term debt versus long-term debt is higher risk. Payments are due sooner and Lawrence may have trouble rolling over loans. Lawrence Sports can use this policy to match current assets and liabilities while keeping a safety net in case of uncertainties. The conservative working capital policy would provide the lowest risk for Lawrence Sports, but it also reduces the money needed to increase production.    Aggressive Approach  An aggressive approach to financing working capital is to use less long-term and more short-term financing to raise profitability.  The increase in profits can occur as a result of lower costs.  Costs that can decrease as a result of an aggressive policy include; reduced inventory costs related to carrying lower levels of fast moving inventory, lower collection costs from a more aggressive accounts receivable collection policy, and somewhat lower financing costs from more short-term and less long-term debt (Belt, 1979).    This approach does; however, expose the company to greater risk.   The primary risk involved in an aggressive policy occurs when an organization carries too much short-term financing and cannot meet their debt obligations.  Many small businesses that have followed this policy have found themselves in a bankruptcy situation. Businesses relying on an aggressive approach must maintain good supplier relations.  When increasing the accounts payable payment period the organization is at risk of losing their credit with suppliers if they do not built a solid relationship. A review of the Cash Conversion Cycle To make a better informed recommendation the team must first understand what the cash conversion cycle is for Lawrence Sports. A cash conversion cycle is the measure of time between the payment of accounts payable and the receipt of cash from accounts receivable (Emery, et al, 2007). This type of measurement is valuable as it denotes the speed at which Lawrence Sports can convert its product into cash enabling it to be used elsewhere.   Lawrence Sports purchases a majority of its raw materials from Gartner and Murray and has negotiated the following payment terms.  The agreements are to pay Gartner 40% of the total at the time of the purchased materials and 60% due the following week, with Murray having negotiated a 15% payment and 85% due the following week. Mayo Stores is the main customer for Lawrence Sports and has agreed to pay Lawrence Sports 20% of the sales collected, which results in 80% in accounts receivable due the following week. The cash conversion cycle is shown through the calculation of days in inventory plus days sales outstanding minus days payable outstanding represented by CCC = DIO + DSO - DPO. The CCC represents the company's ability to convert its products and inventory into cash. The shorter the time to the conversion of cash, the less time capital assets are tied up in the business process, therefore the better the company's bottom line [ (Cash Conversion Cycle - CCC, 2010) ]. Lawrence's CCC is representative of its strength and how this company relies on its vendors and customers to convert the company's products and sales to working capital to pay down the loan with the bank, preserving the debt capacity. DIO=InventoryCost of Sales/365 DSO= Accounts receivableSales/365 DPO=Accounts payable+wages,benefits, and taxes payableCosts of sales+Selling, general, and administrative expenses/365 CCC=DIO+DSO-DPO Conclusion   Several arguments can be made that an aggressive approach, which will result in a lower cash conversion cycle to better contribute to company performance.  According to (Jose, Lancaster, & Stevens, Spring 1996) a low cash conversion cycle allows companies to; minimize holdings of unproductive assets such as cash and marketable securities, preserve the debt capacity because less short-term borrowing is required to provide liquidity, and contribute a higher present value of net cash flows from assets. This approach is a gamble for any company in hoping costs will not rise and that the economic conditions will not deteriorate so as to cause a burden on the company. Any company such as Lawrence must maintain its resources, and as a part of those resources, the cash conversion is one of the most important. Although the aggressive approach irritated the vendors and customers, this approach proved to be the most viable for Lawrence. Maintaining a lower loan balance offers Lawrence the ability to make sure that should they need the extra resource it is there for unforeseen problems. Reassuring customers and vendors that once the rough patches in finances have been covered and alleviated they will revert to original negotiations will prove to be crucial in Lawrence’s future. For these reasons, taking a stronger stance on receivables and payables in business can prove to create a stronger and shorter CCC for Lawrence. References Belt, B. (1979). Working capital policy and liquidity in the small business. Journal of Small Business Management (pre-1986) , 17 (000003), 43-51. Cash Conversion Cycle - CCC. (2010). Retrieved May 30, 2010, from Investopedia: http://www.investopedia.com/terms/c/cashconversioncycle.asp Emery, D. R., Finnerty, J. D., & Stowe, J. D. (2007). Corporate Financial Management. In I. Pearson Education (Ed.). Upper Saddle River, NJ, USA: Prentice Hall. Jose, M. L., Lancaster, C., & Stevens, J. L. (Spring 1996). Corporate Returns and Cash Conversion Cycles. Journal of Economics and Finance , 20 (1), p33.