Finance

Running Head: Lawrence Sports Simulation Lawrence Sports Simulation University of Phoenix G. Gunderman, D. Lockwood, A. McKeller, E.Green FIN/GM 571 June 7, 2010 Professor Arnold Harvey Lawrence Sports Simulation Lawrence Sports is a company that manufactures sporting equipment for a major retailer and is a $20 million revenue company (University of Phoenix, 2010). Three alternative working capital policies have been created as recommendations in an effort to reduce potential future difficulties. The recommendations suggested by Team A include evaluation of risk, contingencies and a cash conversion cycle as it relates to working capital management (University of Phoenix, 2010). Maturity matching is one way in which Lawrence Sports can minimize risk of rising interest rates and defaults. By matching the maturities of its assets and liabilities in the form of bank loans, risk is minimized (Emery, Finnerty, & Stowe, 2007). The company must negotiate repayment of the loan and eliminate the cash deficit. An option for controlling the outflow of cash is to offer finance seasonal variations in current assets with current liabilities of the same maturity (Emery, Finnerty, & Stowe, 2007). Further, Lawrence Sports could finance long-term assets by issuing long-term debt and equity securities by alternating investments to offset interest rate risk (Emery, Finnerty, & Stowe, 2007). In many cases there is a permanent component of current assets which can be financed with long-term capital, also minimizing risk (Emery, Finnerty, & Stowe, 2007). A financing contingency is common in business, making sales contingent upon a condition for the transaction to take place. Lawrence Sports' working capital management policy is to borrow automatically from the bank to maintain a cash balance of $50,000. The maximum credit limits from the back is $1.2 million with interest rates ranging from 10% to 16%. Lawrence Sports is creating additional working capital management policies concerning the size of cash balances, currency denominations, and where these cash balances are located among the multinational company’s affiliates (University of Phoenix, 2010). Putting these policies into place creates a bit of a safety net, which is a primary purpose of a contingency. To maintain good relationships with business partners and the Lawrence Sports need to maintain a minimum cash balance, the firm will look to adjust credit terms with customers. By offering 2% discounts to customers for payment of invoices within 10 days instead of net 30, Lawrence Sports will be able to decrease the cash conversion cycle. The decreased time in collecting cash will lead to better cash flow for the firm with less borrowing from the bank. Minimum cash balance increase from $50,000 to $75,000 and reduction in parts inventory will also lead to better cash flow. By holding more cash in reserve, the firm will find itself in less need to borrow money. Moving to a just-in-time production model will lower parts inventory which will lower the amount of capital tied up in inventory that can be used to pay for firm debt or additional investments. Commercial paper is a short term way for firms to raise capital by borrowing from investors. Commercial paper is an unsecured form of debt that raises concerns as well as investor risk because the firm may not be able to pay back the debt and interest.  These risks are mitigated because of Lawrence Sports high credit worthiness and are under consideration as an alternative to bank lending due to the lower interest rates. Multinational companies will keep cash in reserve in the foreign currency in which the firm operates. This process will eliminate the conversion rate losses, taxes paid on income, and quicker paying off debt in the foreign country since cash does not need to be converted. The firm will keep track of current and projected currency fluctuation as to take advantages of income gained by converting currency at the most opportune time. In the Lawrence Sports Simulation the cash conversion cycle plays an integral part in determining their working capital management. Lawrence Sports initially has a cash deficit in this simulation, and the finance manager must work with their business partners in an effort to close the deficit. Throughout this simulation, the finance manager must take into consideration relationships with the business partners along with Lawrence’s cash conversion cycle. Initially, Lawrence Sports’ cash conversion cycle was much too long, which is why they found themselves in a deficit in the first place. Shortening the cash conversion cycle can easily be done by requiring payment from Mayo and stretching payments to Gartner and Murray. However, since the relationships with each of these business partners must be taken into consideration, Lawrence must decide how far to stretch payments and how long to float receivables. After all, stretching payments too far could result in Gartner or Murray cutting off supply, which ultimately halts sales to Mayo. Also, allowing Mayo to have too large of a receivables collection period could cause Lawrence to be unable to make payments to Gartner or Murray, which in turn could cause them to halt supply. It is evident that Lawrence’s cash conversion cycle has a significant impact on their working capital management for a multitude of reasons. With this simulation, it is easy to see why having a cash conversion cycle that is too long or too short could have an adverse impact on business partner relationships and working capital management. Without effectively managing Lawrence’s cash conversion cycle, they could significantly decrease their working capital, which could have a significant impact on their ability to operate. Lawrence Sports had a cash flow issue which often found the firm in short supply of working capital. The cash shortfall forced the firm to use short term loans for operational continuity. The loans placed the firm in jeopardy of not being able to pay their bills because of credit limits. The new policy changes used creative methods to improve the cash conversion cycle while also providing Lawrence Sports with the ability to extend credit to maintain business relationships. Changes of raising capital through the use of commercial paper, increase in cash reserve, and monitoring the foreign currency market provide more avenues for Lawrence Sports to obtain cash. Cash flows require a balancing act to ensure that funds are available to pay firm debt, extend credit while the firm waits for cash collections. There are many factors that keep a firm in business such as marketing, sales, and consumer tastes. However, changes to Lawrence Sports cash flows have placed the firm in a possession to continue to operate with a better financial position. With significant techniques such as short term financing such as a line of credit (LOC), increase the business working capital, consider financing larger purchases such as the real estate or equipment and look into federal or local government. Lawrence Sports can adjust to the challenges that are faced. In utilizing short term financing, it allows for emergency purchases to occur without problems arising downstream. In implementing an increase in business working capital allows for a possible return from the excess cash if the stockholders are willing to put up additional capital. The other techniques that Lawrence Sports can consider if applicable is financing larger purchases which will cause an additional deduction in cash flow; however it gives the borrower the opportunity to spread payments over a longer term if possible. Within the area, there could be government stipends that are given for starting the business in a specific community or to bring more business to the city. By implementing cash management techniques, Lawrence Sports can operate on building the business with a maximum return on investment based on what is good for the business. These techniques can be considered and implemented throughout the company or just in areas that need the most attention. References (). Techniques for a better cash flow management. Retrieved from http://www.bdc.ca/en/my_project/Projects/articles/working_capital_cash_flow.htm'c okie%5Ftest=1 Emery, Finnerty, Stowe. (2007). Corporate Financial Management (3rd ed.). New Jersey: Pearson-Prentice Hall. University of Phoenix. (2010). Lawrence Sports Web Link. Retrieved June 6, 2010, from University of Phoenix Week 3, FIN/GM 571-Materials website.