Lawrence_Sports_Simulation

Lawrence Sports Simulation Lawrence Sports manufactures and distributes equipment and protective gear for a variety of sports. They currently have $20 million in revenue but are facing working capital and cash flow issues. The firm is seeking to create an alternative policy that will reduce future difficulties with working capital and cash flow issues. The Simulation gives an insight into what it is like to handle the day- to-day cash inflow and outflow through good and hard times to develop a suitable recommendation that will optimize their working capital and create a sustainable growth. Review of the Cash Conversion Cycle The cash conversion cycle is used to manage the effectiveness of management’s ability to use short-term assets and liabilities to generate cash. It is calculated using several activity ratios that measure the length of time between the payment of accounts payable and the receipt of cash from accounts receivable (Emery, Finnerty, & Stowe, Chapter 22, Liquidity Management, 2007). In the Lawrence Sports stimulation receivables and payables have a direct impact on the bottom line of the company. Each scenario consisted of negotiation with Mayo, Gartner, and Murray for better collection and payment schedules. Each decision had an impact on both Lawrence and their vendor’s cash flow. The current collection and payment arrangements for Lawrence Sports are as followed: • Mayo: 20% collection on sales, the remaining 80% in the following week. • Gartner: 40% payment on purchase, the remaining 60% in the next week. • Murray: 15% payment on purchase, the remaining 85% in the next week. The account receivables and account payables are unorganized causing financial stress on the company. Mayo is the principle customer of Lawrence and has placed them in a difficult situation by defaulting on payments, which causes them to have to use their line of credit or negotiate with Gartner and Murray their suppliers to defer payments. The success of the company is critical to the management of the cash conversion cycle and working capital system. A recommendation of how the company can approve on these are outlined below. Conservative Approach Risks The conservative approach has very minimal risks. This approach focuses on long-term financing and is used to finance long-term, permanent current and temporary current assets. In the Lawrence Sports Simulation the company was presented with instances in which its customer could not pay. In the beginning of the simulation Lawrence’s main customer Mayo began to default in some of its payments. This put the company in a situation with its other customers and making payments in a timely manner. Gartner was delayed in receiving funds from Lawrence Sports, which resulted in a loan and interest burden (University of Phoenix, 2012). Because of these outstanding issues the conservative approach was implemented. Although this approach is conservative, there are still risks associated with this approach. Risks of this approach occur when the costs of these funds are higher than short-term financing. These types of risks can limit profitability with a company if a more aggressive approach is not considered. Since interest rates can be a juggle in capital markets, forecasting and planning should be implemented for contingency reasons. This is especially the case if the Conservative Approach is taken and interest rates begin to fall. Should this happen Lawrence is presented with the problem of having to refinance the loan or pay a higher interest rate. Either of these actions results in a loss to the company’s profitability (Prentice-Hall, 2007). Contingencies for the Recommendation The first step in the contingency plan of a company is hiring the right people to handle a job. A great manager understands the importance of this concept. It would be an impact to the company should the wrong person be hired for a position. Example a person who is not qualified to give financial advice should not be hired for a Chief Financial Officer position. Therefore, the first step in the contingency plan is using the Principle of Comparative Advantage. This principle simply means hire the right person for the job. Since Lawrence Sports is a sports company, it would not be beneficial to seek out someone in the company and put them in a position to make financial decisions with no experience in this area. So the first step is to make sure that the company has the right people making financial decisions for the company. In the simulation there are three managers that are being asked for financial advice. So managers would begin with making sure they are qualified to give this advice. The Conservative Approach can be considered safe in comparison to the other approaches. However, the next step in the contingency process should be to make sure this is the better approach to take. This is especially the case, since the company has been presented with customers not being able to make payments on time. Management should have the financial manager’s outline why this approach should be taken and the pros and cons of this approach. After this has been outlined a contingency plan should implemented for these types of situations. To ensure that payments are made to their other client’s, Lawrence Sports must have a contingency plan when all money is tied up. The Conservative Approach has a built in contingency plan that borrows money when there is a need for short term financing. This is the safer option if the company is not wishing to use its saved cash and the interest rates are not high (Prentice-Hall, 2007). Performance measures for conservative Approach The conservative approach uses long-term funding for all long-term monies, permanent recent assets, and some of its provisional assets. The performance measures used to determine if the conservative approach is successful are current interest rates and if asset needs are high or low. The conservative approach is deemed to be performing well when financing can be locked in at a fixed interest rate. If asset needs are low, surplus monies can be used by the company to invest. Additionally, if access to financing becomes scarce or non-existent the conservative approach benefits the company. However, if interest rates decrease dramatically it can be detrimental to the company because they may be trapped with higher interest rates and/or the financial burden of having to refinance. Clearly the rate at which financing is attained and whether asset needs are high or low are the two most important determinants of success with the conservative approach (Emery, Finnerty, Stowe, 2007). Implementation Short-term financing is used in cases when asset needs are high whereas, long term financing should be used in all other cases. Seasonal changes in asset needs financed on a long-term basis act as a built in safety measure because the interest rates are fixed over a longer period of time and not subject to fluctuation of interest rates. The method of implementing the conservative approach is represented graphically below. References Emery, D. R., Finnerty, J. D., & Stowe, J. D. (2007). Corporate Financial Management (3rd ed.). Retrieved from The University of Phoenix eBook Collection database. Prentice-Hall. (2007). Working capital management. (Part VI ed.). Person Education University of Phoenix. (2012). Working capital management. Retrieved from https://ecampus.phoenix.edu/secure/AAPD/vendors/tata/sims/finance/working_capital/finance_working_capital_frame.html