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Lawrence Sports is a company involved in manufacturing and distribution of sporting goods. Recently, the company has been facing problems that require careful evaluation. One of the major problems is the cash flow problem. The outstanding interest burden and loans facing the company has increased to unimaginable level. Usually, when faced with a deficit situation, the firm borrows money from banks in order to cover the deficit. This in the long run strains the company’s business partners and stakeholders. In order for Lawrence Sports to survive in this competitive environment it needs a better plan for the management of its cash flow. This plan should provide adequate cash inflow enough to pay the firm’s outstanding debt and ensure adequate working capital to keep the company in operation.
According to Emery, Finnerty and Stowe in their book ‘Corporate Financial Management’, adequate and readily available cash is essential for a company’s survival, therefore, efficient cash management is important to avoid bankruptcy. Lawrence Sports is facing a problem involving its working capital needs (Corporate Financial Management, 2007 p.738). The company’s borrowing capacity has been capped at $1.2 million by its bank. The company has already reached this limit and therefore, it cannot borrow more money from the bank. Another problem leading to the crisis in the company’s working capital is because 80% of its sale revenue comes from a single customer. This makes the company to have little negotiation power with the customer. According to Puxty, Dodds and Wilson in their book ‘Financial Management: Methods and Meaning’ many companies expect customers to pay for goods and services offered on account within the agreed credit terms. However, this is not always the case (Puxty, Dodds & Wilson, 2003 p.112).
A firm’s conversion cycle is the average time lapse between the purchase and receipt of cash from accounts payable (Puxty, Dodds & Wilson, 2003 p.123). Lawrence Sports has a line of credit with its bank. However, the increasing interest rate associated with the line of credit decreases the company’s appeal of using this method as a source of finance. Lawrence Sports mainly uses its working capital to pay its venders and to meet its operating costs. This working capital is highly subsidized by the credit line. In order to curb the shortage of its working capital, the company purchases raw materials from various companies on credit. This enables the company to order products which will be paid for at a later date. Thus, though there is a shortage of working capital, the company continues enjoying an inflow of raw materials .This method of curbing shortages of working capital leads to an increase in debt, therefore, it is important for the company to seek other methods of short-term financing.
Currently, in order for Lawrence Sports to maximize revenue it is using an aggressive Current Asset Financing Policy. In so doing, the company takes short-term debts from a line of credit with its bank. However, this method of financing is sometimes not successful since the short-term debt is not sufficient to meet the company’s finance requirement especially where no revenue is accrued. This puts the company’s line of credit with suppliers in jeopardy.
Though Lawrence Sports has developed into about $20 million Revenues Company, it should find solutions on its unsynchronized problems related to its cash flow. This would help the firm to pay bills and maintain an adequate net working capital. The first step that Lawrence Sports should take is to find ways of balancing their cash flow and consequently creating a net working capital. This can be done by seeking potential suppliers who can accommodate and comply with the firm’s policy needs. The firm should ensure a more conservative policy with Mayo, which is responsible for most sales of Lawrence Sports products.
In order for the firm to achieve an appropriate degree of working capital, it should maintain constant payments from Mayo. Also, in case of a reduction in capital, the firm should reduce payments to vendors. If all this methods are not achievable, the firm should ensure availability of cash by ensuring a careful cash budgeting policy or by liquidation.
Review of the current policy adopted by the Lawrence Sports suggests that a conservative approach of financing would be more successful in comparison to aggressive Current Asset Financing Policy. Conservative financing develops long-term debt and marketable securities and at the same time reducing short term debt. It also leads to a reduction in the cost of short term financing due to a decrease in interest rates.
Also, Lawrence Sports should evaluate how they interact with their supplies as well as how they distribute their products. For instance, due to over reliance of Lawrence Sports on Mayo, the financial difficulties of Mayo impacts on Lawrence Sports’ negatively. In such a situation diversification would be more appropriate.
Lawrence Sports’ should adopt discriminatory policy when giving out credit. The company should consider its financial status before giving out credit. This would help in evaluation of who to give credit and also encourage an aggressive credit collection policy. One of the major risks of adopting discriminatory policy is losing customers. This is because the method may not be appealing to some individuals, though at the long run the firm would benefit by acquiring quality and reliable customers who are able to fulfill their debt requirements.
Implementing the cash management process and trade credit policy will involve laying down agreeable terms among the parties involved. Both Lawrence Sports and Mayo should come up with an agreeable term of sale. Lawrence Sports should come up with appropriate terms of sales, collection policies and credit analysis to be used by retailers.
Evaluation of the above recommendations would be based on the firm’s use of credit, cash, long-term and short-term financing. This would involve analysis of the previous months in terms of the company’s performance. This evaluation can be used in forecasting expected changes in the future. After a long-term development there should be notable changes in the availability of the firm’s working capital.