Lawrence_Sports_Simulation

Lawrence Sports Simulation In today's business environment, it is imperative that organizations hold fast to the basics of business strategy, which is to continually increase profit for the company and revenue for the stakeholders. In order to be successful in strategizing, each organization must ensure that their working capital is optimized and cash flow is liquidized. Working Capital involves making appropriate investments in cash, marketable securities, receivables, and inventories, as well as the level and mix of short-term financing (Emery, Finnerty, & Stowe, 2007, p. 639). Lawrence Sports is a manufacturer and distributor of sporting good equipment and protective gear for a wide variety of sports. They are a 20 million dollar revenue grossing corporation but are currently facing a number of working capital and cash flow management issues. After carefully analyzing and identifying Lawrence Sport's current issues with their working capital and cash flow management, we will be able to provide a suitable recommendation; one that should improve their ability to liquidize, creating sustainable growth and optimize their working capital. Problem Statement Lawrence Sports is currently enduring a cash positioning problem due to an uncontrollable credit policy. Liquidity also continues to be a challenge due to the current credit policy in place. Lawrence Sports lacks the necessary capital management structure to deal with uncertain future cash flows. The delay of payment from their one of their major customers may end up leaving Lawrence Sports without a vendor and no control of their future supplier payment. Lawrence Sports has a number of issues that also need to be addressed. The most outstanding issue they face is the fact that Mayo, a retailer responsible for approximately 95 percent of their sales, is defaulting on their payments forcing Lawrence to delay on paying their suppliers. The next most important issue is the current credit policies in place do not coincide well with the organization's working capital needs. Some other key issues Lawrence Sports face, predominantly due to the two main issues stated above are: • Lawrence Sports is having to borrow money from the bank • Customers are not finding alternative resources to pay Lawrence • Goods sold on credit are shown in accounts receivables • The number of days in Lawrence Sports' cash conversion cycle is too long Three Alternative Working Capital Policies Working capital management is essential to the success of any business. The strength of any organization is its overall understanding of cash flow and maintaining a balance between outflows and inflows. The main goal of working capital management is shareholder wealth maximization, avoiding negative-NPV decisions and seeking positive-NPV decisions (Emery, Finnerty, & Stowe, 2007, p. 639). There are several working capital policy alternatives that can be implemented to improve and create stability within Lawrence Sports; however within each decision lays a certain level of risk-return trade-off. The first alternative working capital policy Lawrence Sports could implement includes maturity matching. With maturity matching, the firm hedges its risk by matching the maturities of its assets and liabilities (Emery, Finnerty, & Stowe, 2007, p. 639). It finances long-term assets by issuing long-term debt and equity securities. In addition, in most cases there is a permanent component of current assets, however relies on short-term financing for its temporary assets. Inventories and receivables stay at a certain designated minimum level. The downfall of maturity matching is the potential inherent risks involved, which include: costs could rise dramatically or a credit shutoff. The second potential alternative working capital policy that could work well with Lawrence Sports involves taking a more conservative approach, which focuses more on long-term financing rather than short-term. Long-term financing would be 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, Finnerty, & Stowe, 2007, p. 642). Short-term financing is only used when asset needs are elevated. Conversely, when asset needs are low, the organization will actually have more long-term financing than it has assets needed to operate the organization; in which the firm will then invest those excess funds in marketable securities, which helps build a margin of safety (Emery, Finnerty, & Stowe, 2007, p. 642). The third alternative working capital policy Lawrence Sports could implement involves taking an aggressive approach which uses more short-term financing and less long-term. Short-term financing tends to be more cost efficient than long-term financing. The overall goal of taking the aggressive approach is to raise profitability (Emery, Finnerty, & Stowe, 2007, p. 642). By relying on short-term financing, a manager is expecting the interest rates to decline in the near future; on the other hand, if the manager expects the interest rates to rise, long-term financing is the safer bet. Recommendation Based on the current working capital and cash flow issues facing Lawrence Sports and the alternative solutions available to them, the working capital policy that represents the most shareholder wealth maximization possibilities is to focus on the conservative approach of long-term financing. In making this selection, Lawrence Sports could enable themselves to improve their ability to create sustainable growth and maximize their working capital while also reducing the need to rely on short-term financing and limiting the potential impact of such a gamble. In the situation the management team is currently faced with, taking such a risk is highly inadvisable. In addition, considering the business activities with Mayo, Murray and Gartner and the firm’s reliance on them from an operations standpoint, the comparative advantage of making such a selection is amplified, particularly if they are able to lock in at a lower rate, providing lower financing costs. Therefore, because of the possibility that funds might become more expensive or even unavailable, and with limited access to capital markets, Lawrence Sports should proceed conservatively (Emery, Finnerty, & Stowe, 2007, p. 640). Risks. Every decision managers make come with some inherent risk. With Lawrence Sports, there is the concern of dealing with potentially higher interest rates in making this selection, but the risks are considerably lower than those associated with maturity matching or the potentially rising interest rates that could affect the short-term financing approach. With Short-term financing, one is gambling that the interest rates will decrease, while a long-term financer gambles that interest rates will be increase in the future. Contingencies. In the event that long-term financing is simply not an option, maturity matching would be a feasible alternative solution. While the firm could run the risk of dealing with rising costs and potential credit shutoffs, utilizing the Principle of Comparative Advantage could prove to be advantageous (Emery, Finnerty, & Stowe, 2007, p. 642). The Principle of Comparative Advantage refers to an organization's ability to produce their goods or service at a lower opportunity cost than any other party. Performance measures. In order to proceed with this plan, Lawrence Sports must contact their creditor, Central Bank, and their business partners Mayo, Murray and Gartner, and hold candid conversations that explain their approach. Lawrence Sports must implement a policy that ensures payments are made to them in larger sum and more frequently in order to avoid considering credit payments as cash paid and floating those payments to cover their own expenses or borrowing from the bank to cover their shortages. Implementation plan. Once the appropriate policy has been agreed upon, introduced and put into action, Lawrence Sports can ensure they eliminate the issues that are creating cash flow problems, be accountable to their own fiscal responsibilities, and build for future successes. By keeping costs down and identifying means to budget for investing surplus funds the firm can also build for the future in a more confident way. The following is a two week implementation plan based on our recommendation: |Deliverable |Timeline |Who is Responsible | |Decide on Credit Terms |1 week |Credit Team | |Implement Credit Policy |2 weeks |Management | |Determine Target Cash Balance |Bi-weekly |Finance Team | |Outline Capital Management |1 week |Finance Team | |Delegation of Duties |1 week | Management | |Re-assess policies |2 months |Financial Analyst Team | |Investigate Retailer Alternatives |2 weeks |Domestic/International | Review of the Cash Conversion Cycle The cash conversion cycle is the length of time between the payment of accounts payable and the receipt of cash from accounts receivable (Emery, Finnerty, & Stowe, 2007, p.643). For Lawrence Sports, their cash conversion cycle revolves around one principal customer, Mayo Stores, and two vendors, Gartner Products and Murray Leather Works. It is important for Lawrence Sports to borrow as little money as possible because they need to maintain a $50,000 cash balance at all times. It is imperative that their cash conversion cycle continues so they do not have to borrow money from the banks since the bank’s interest rates tend to be high and increases according to the amount borrowed. By managing their short-term financing more effectively they will not need to borrow from the bank at all. In order for Lawrence Sports to keep their cash conversion cycle flowing efficiently, they will need to minimize their inventory conversion period as short as possible. By doing so, Lawrence Sports will have more flexibility in adjusting their inflows and outflows. Along with minimizing inventory, they will need to focus on managing their short-term financing and cash so that their outflow to Gartner Products and Murray Leather Works align with the outflow from Mayo Stores. Currently Lawrence Sports is not effectively managing the inflow and outflow of its cash. In order to be successful in strategizing, each organization must ensure that their working capital is optimized and cash flow is liquidized. By focusing on optimizing their working capital and liquidizing their cash flow, Lawrence Sports should be able to use past uncertainties as a beneficial historical example on the importance of cash flow responsibility. By implementing our suggested adjustments in their business model, Lawrence Sports should be highly competitive for years to come. References Emery, Finnerty, Stowe. (2007). Corporate Financial Management (3rd Ed.). [University of Phoenix Custom Edition e-text]. New Jersey: Pearson-Prentice Hall. Retrieved July 12, 2010, from University of Phoenix, FIN/571 - Corporate Finance Course Web Site.