Similar to other articles published to my profile, this article is based on application of class materials to a research paper developed for a college course. Specifically, this paper is written based on the fictitious organization of Lawrence Sports, from the University of Phoenix and applies the concepts including working capital policy. The following information includes industry best practices, ethical implications, evaluation of research, and even expected relationships.
Lawrence Sports Working Capital Policy Paper
Lawrence Sports manufactures sports gear, “protective gear for baseball, football, basketball, and volleyball.” (Working Capital Management, n.d.). “A $20 million revenue company,” distribution of the Lawrence Sports gear is done through Mayo, who is the “world’s leading retailer.” (Working Capital Management, n.d.). Due to the strong relationship between Mayo and Lawrence, their respective success is dependent on each other in a strong way; however, the impact on working capital available to Lawrence Sports also directly influences their suppliers – Gartner Products and Murray Leather Works. Changes in how accounts receivable are collected and how accounts payable are paid, can greatly affect how a company is able to succeed in managing working capital and budgeting. While every company strives to be in a position where emergencies – or unexpected changes – do not drastically influence the company, this is not always the case. Lawrence Sports is unprepared for changes in how Mayo pays for products and the resulting financial situation can cause their business to collapse or reduce the strong relationships the company has with suppliers and Mayo. A solid working capital policy will enable the company to develop finances in a successful way, which reduces redefining policy during times of short-term, unexpected, hardship.
To successfully manage the current issues affecting Lawrence Sports it is important to analyze the working capital, understand cash budgeting, review best practices in working capital, evaluate risks and opportunities, and determine the ethical implications of competing working capital alternatives. Development of a successful Working Capital Policy for Lawrence Sports’ includes:
1. Understanding of the different financial terms and metrics.
2. Reviewing “[c]redit balance requirements including cash reserves needed for long term opportunities that may arise.” (Lawrence Sports’…, n.d.)
3. Developing a “[c]redit policy that balances Lawrence Sports desire to minimize accounts receivable and maximize revenue.” (Lawrence Sports’…, n.d.)
4. Creating a “[s]upplier negotiation strategy for terms of payment that balances the costs to Lawrence Sports and their cash requirements.” (Lawrence Sports’…, n.d.)
5. Negotiating a “[s]hort term financing strategy to ensure availability of an adequate line of credit while minimizing the cost of that credit.” (Lawrence Sports’…, n.d.)
6. Developing quality ‘[m]etrics that will be used to monitor performance against the policy.” (Lawrence Sports’…, n.d.)
Working Capital Policy
Working capital must be carefully managed to maintain a balance between possible income from cash (such as interest gained) and liquidity of assets. Lawrence Sports relies upon bank loans to maintain balances in the working capital; however, use of this credit line also incurs additional costs. In order to become successful with the benefits of working capital, it would be essential for Lawrence Sports to develop investments which are both able to be liquidity quickly if need should arise, and are also able to bring in additional profit when there is no need for the cash. One method to consider would be investment into a high yielding savings account. However, before investment begins it is essential to have a Working Capital Policy in effect that demonstrates the need and desired growth of the company.
Working capital policies include Current Asset Investment Policy – “policies regarding the appropriate level of current assets,” and Current Asset Financing Policy – “policies regarding the use of short-term financing” (Rensselaer, n.d., para. 1). Some examples of these policies include relaxed, restricted, and moderate Current Asset Investment Policies or moderate, aggressive, and conservative Current Asset Financing Policies (Rensselaer, n.d.). Respectively, these policies demonstrate a firm’s strategies in regards to investments or holdings, as well as current asset financing, short-term, or long-term. As both of these types of policies make up working capital policies, it is imperative that the two types of policies are combined to maximize firm wealth and successful company growth. In reviewing cash balance requirements for Lawrence Sports’ it is imperative to include cash reserves needed for long term opportunities; however, at this time there are no policies in place which do this for this company. One major impact on cash is the cash conversion cycle.
The firm’s cash conversion cycle is defined as “time lapse between purchase and income: the average period of time between the purchase of inventory and the receipt of cash from accounts payable.” (Encarta, 2008). The cash conversion cycle is an essential factor/ratio in evaluating how well the “company is managing its working capital.” (Schein, 2004, para. 3). This ratio is defined as CCC = IOD + ARO – APO, which is “Inventory in days (IOD)”, “Accounts Receivable outstanding in days (ARO)”, and “Accounts Payable outstanding in days” (Schein, 2004, para. 3). However, this formula can also be described as CCC = DIO + DSO – DPO, where DIO is the days of inventory outstanding, DSO = days of sales outstanding, and DPO which is the days of payables outstanding (Brealey, Myers, and Allen, 2005).
This ratio can help to determine where money should be applied and how payments should be received or paid out (on accounts). To maintain working capital – which is used to cover expenses – Lawrence Sports has a line of credit with the bank; however, the line of credit comes with an increasing interest rate, which decreases the appeal of using the line of credit. Cash conversion cycles and the cost of goods are effected by the accounts payable. For instance, Lawrence Sports suffered heavy hits to the working capital due to the primary buyer having their own problems with making payment. Collection policy enables companies to predetermine how they will handle a company or client who falls behind in their payments; however, sometimes it is difficult to force a company to pay money if their company is at risk of financial issues, which could cause a closing. Additionally, companies protect themselves from decreases in accounts payable by creating terms of sale that strictly control how payments will be made in purchases.
One way to prepare for unexpected changes in collection of accounts receivable is the development of working capital. Investorwords.com defines working capital as “Current assets minus current liabilities…measures how much in liquid assets a company has available to build its business.” (n.d.) The National Bank of Canada refers to short term financing as “ideal for financing inventory, working capital, and accounts receivable.” (Financing Solutions, 2001, para. 1). The interaction between these two items – working capital and short-term financing is that the financing is often used to provide the working capital. Additionally, working capital is necessary for taking on new projects and effective in demonstrating company stability and effective money management when seeking out long term financing options. Lawrence Sports uses working capital to pay operating costs and vendors; however, their working capital is subsidized by a credit line. In order for Lawrence Sports to maintain a successful degree of working capital, they have to maintain payments from Mayo, at all costs; and try to reduce payments to vendors if capital decreases. In situations where this is not possible, it is important to have other forms of cash available by liquidation and careful cash budgeting policies and systems.
Cash budgeting is essential to successful financial management because it is the primary tool for short term financial planning and enables successful forecasting. Everyone uses cash budgeting; however, how successful the budgeting is depends on tracking cash inflow – sales and other revenue – and cash outflow – accounts payable, labor/operating expenses, capital expenditures, taxes, interest and dividend payments (Brealey, Myers, & Allen, 2005).
Lawrence Sports’ purchased raw materials from companies on a credit policy that enabled the products to be ordered and paid for at a later date. This enabled the company to continue to get raw materials when working capital became short; however, it also enabled the company to continue to build up debt. For instance, Lawrence Sports’ debt to the bank increased each time the working capital did not reach the 50 it needed. In order to better examine how the credit policy should be handled in the future, it would be applicable to examine other methods of short-term financing.
Development of a credit policy that balances Lawrence Sports desire to minimize accounts receivable and maximize revenue is currently an aggressive Current Asset Financing Policy, which uses short-term debt from a line of credit with the bank. (Rensselaer, n.d.). While their short-term debt is funded by a line of credit, it is not sufficient in times where no revenue is accrued and their line of credit with suppliers is then put in jeopardy. Review of these current policies suggests that Lawrence Sports’ would be more successful with a conservative approach with the Current Asset Financing policy as this develops marketable securities and long-term debt while reducing short-term debt typically relied upon during “seasonal fluctuations” and provides for “a low risk approach with low return potential.” (Rensselaer, n.d., para. 9). While low return may seem unappealing, it does ultimately reduce increased costs of short-term financing such as interest rates.
Cash management enables a company to develop money for future projects and expenses. While most companies prefer not to have large amounts of cash “laying about” it is also important that the cash can be used should the need arise. Many companies develop cash in ways, which will produce more cash while awaiting the need for it. Marketable securities are an example of management of cash in ways where the cash can be used to provide an additional source of income while still being available in relatively short-term notice.
Best practices in working capital management can vary between industries. Some industries rely heavily on large amounts of working capital in order to fund rapidly changing technology needs; however, other companies rely more heavily on lines of credit rather than large amounts of working capital. For instance, the media industry has varying needs for working capital and often relies on projects being properly formulated in order to acquire funding for movies or larger projects including completion bonds; however, smaller projects such as ads and commercials may be funded directly from working capital. When larger projects run over budget, the funding may come from the investors, distributors, or additional bank loans, based on the predicted success of the project/movie. Additionally, many media companies run a line of credit with banks to assist in emergency funding of projects that may run over budget will be paid at the completion of the project. Lawrence Sports’ operates based on seasonal changes and is reliant on the changes in both suppliers and distributors. While business may fluctuate in some directions based simply on buying seasons, companies such as Lawrence Sports’ can develop financial situations based solely on the reliability of their sources of revenue as well as the credit issued to those sources.
Successful management of supplier negotiation strategies in terms of payment of balances and costs are reliant on cash requirements and the ability for those to be meet by working capital in Lawrence Sports. Inventory management, credit management, cash, and marketable securities make up working capital metrics, which are essential for developing quality and effective financial management of a company; because these metrics enable careful study of what, is occurring and what must occur to be successful. Of course, the success of supplier negotiations actually begins with careful Inventory Management practices.
Inventory management is literally the management of inventory – from raw goods through finished product. The management of inventory can be complicated due to the storage of the goods, access of product, and maintaining levels of production, which may reduce the cost of inventory to the company; such as is often developed in JIT (Just in Time) operations. Most companies benefit from implementing JIT operations strategies into their company, and while this will probably work great in Lawrence Sports, and should be included in the overall business plans for growth, it would not currently address the issues of cash management. However, credit management would be very beneficial and addresses the issues of accounts payable by addressing the issues of accounts receivable.
Successful metrics enable a firm or company to carefully evaluate the use of cash, credit, short-term and long-term financing. Methods should include a variety of information, which would include asymmetric, geometric, and pecking order methods, which analyze the information from previous months and can be used to forecast upcoming changes in future months. Additionally, a primary metric to evaluate would be the impact on inventory and cash budgeting practices for Lawrence Sports. If long-term development increases availability of working capital the changes should be viewed nearly immediately; however, the changes to debt management and inventory control may take longer to evaluate or to see large changes in. Understanding how other companies manage their working capital or financial needs is essential to success.
Industry Best Practices
Dobson Communications, aka Cellular One, was a rural cell phone service provider who was acquired by AT&T for $2.8 billion in 2007, due to their success in rural markets (Silva, 2007). Dobson Communications faced many challenges over the years through technology changes, acquisitions of other companies, roaming agreements, and manufacturer agreements. Not all companies were able to stand up to industry changes, including SunCom Wireless Holdings Inc. and Centennial Communications Corp. SunCom faced challenges due to problems with accounts which did not pay and were reported as “attracting lower quality subscribers due to lower credit standards”, when unable to collect on accounts outstanding, companies are faced with revenue and working capital decreases (Meyer, 2005, para. 8). Centennial reported that they were answering financial problems by “evaluating a range of possible strategic and financial alternatives” which would address problems with operation costs after realizing a continued 15% decrease in customer growth (Meyer, 2005, para. 2). Some of the changes included the TDMA to GSM conversion that was taking place in frequency to correspond with the FCC eliminating the band to embrace the newer, better, technologies that are forthcoming to the industry. Dobson Communications was able to overcome much of its competitors’ disadvantages by continuing to grow in the rural markets as well as acquiring the brand name Cellular One from Alltell Corp. (Meyer, 2005). Continued growth in customers, along with competitive and productive roaming agreements with T-Mobile and Cingular (now AT&T) enabled the company to stay competitive by offering cheaper packages and better nationwide coverage.
Lawrence Sports can use examples from the wireless industry to evaluate how they distribute their products as well as how they interact with their suppliers. In some situations, it is imperative to diversify distributors, even more so than suppliers. Mayo does not only sell Lawrence Sports products; therefore, the financial difficulties of Lawrence Sports do not affect their company in the same way as the financial difficulties of Mayo impact Lawrence Sports. Additionally, AT&T tends to be aggressive with working capital needs and discriminatory with credit. While this may seem unappealing to many companies who deal with individuals, it enables AT&T to acquire quality customers who are more likely to fulfill debt requirements and less likely to be sent to collections.
While not all companies deal with individuals, they all use credit in one or more aspects of the company – just as Lawrence Sports’ does. Careful consideration of a companies’ financial standing allows Lawrence Sports’ to evaluate who they give credit too and an aggressive collection policy would enable the company to avoid future issues with accounts receivables negatively impacting accounts payable. Credit management is essential to the success of accounts payable and receivable as well as how well a company can acquire additional funds. Companies operate on credit when selling and buying; therefore, careful management on who receives credit and whom credit is opened with will determine how successful a company is in collecting receivables and how successful a company will be in acquiring best rates for their own credit.
Diversity to increase financial stability
Kraft has always endeavored to add quality food products to their line-up to increase value to shareholders. However, increased diversity also increased financial instability due to increased costs to Kraft. Started in 1903 as a cheese company, Kraft became part of a larger line-up owned by Philip Morris Co. and in 1990 Kraft merged with General Foods, in 2000 with Nabisco, and as of April 2nd , 20007, became an independent company separated from Altria (Philip Morris)(About Kraft, n.d.). While Altria was the parent company, Kraft countered “slow internal growth” with acquisitions to increase market share with increased product lines (Arndt, 2007, para. 8). In an effort to increase shareholder value, Kraft determined that inner strategies would need to be developed which would not include acquisitions as a primary source of company growth. The new process included a cash analysis on the productivity of the different branded products carried by Kraft.
Recently Kraft has announced the sale of their cereal brand, Post, to Ralcorp Holdings Inc. (Stainburn, 2008). This sale is a good match because Ralcorp is currently selling “35 knockoff cereals” and will now be able to sell the popular Post brands, which will increase market share and competitive value against companies such as General Mills and Kellogg Co. (Stainburn, 2008, para. 2). Sale of Post has predicted value of 32% revenue for Ralcorp, which still enables Kraft shareholders to increase value because it “will own 54% of the new Ralcorp” (Stainburn, 2008, para. 6). These changes enabled Kraft to restructure working capital and add the Post brands to income as the stock in Ralcorp produces income.
Lawrence Sports does not need to reduce diversity in product and brand availability; rather, they would benefit from performing a cash analysis to determine how money can be more effectively managed to accomplish successful working capital management. Many companies fail to properly organize working capital and develop effective financial planning; therefore, they often operate in the “red” or are not prepared for unexpected changes. Additionally, companies who fail to meet working capital requirements may increase their likelihood for employees to engage in unethical behaviors, or for the company to be placed in a situation where their treatment of other companies or clients could be unethical.
Stakeholders have varying needs and ethical dilemmas. An organization needs to be able to create shareholder value, but in order to be successful in the future; the company has to be able to create value to all stakeholders. Stakeholders have power of a firm in varying ways. Employees are strong stakeholders, if employees are unhappy with a firm, they can bring work to a halt. The government is another stakeholder, which a company must strive to maintain peace with. Laws require a clear communication with the governments that can impact the business atmosphere. There are often many different stakeholders – shareholders, consumers, employees, and government – are the basic stakeholders that nearly every business answers to.
Shareholders and stockholders have a right to increased value in their share of the company. Decreases in working capital or increases in financial debt increases risks to shareholders that the company will go bankrupt. In the case with Microsoft and Yahoo, shareholders may be currently unhappy with Yahoo because the interest for purchase by Microsoft had increased the value of their stocks, and recently their stock is decreasing in value after Microsoft removed their offer (Paradis, 2008). Many shareholders had viewed the possible purchase by Microsoft as a way to increase the value of Yahoo, as years of competition seemed to be taking a negative toll on the company.
Governments have a right to maintain peace between consumers and corporations. Governments regulate organizations to maintain fair play in markets, as well as monitor the interactions with consumers to ensure they are also fair and competitive. One example is the approval for communications companies to merge by the FCC and the Department of Justice. This was the case when AT&T acquired Dobson Communications. They were required to submit forms to both agencies, following a review of the acquisition, both agencies granted approval with stipulations. One stipulation included the ability to maintain competition in each market where the changes would occur – essential to maintain fairness to consumers.
Employees of firms may not want the dynamics of the firm to change, such as changes to operations management, moving to JIT systems, or other company wide changes within their organization. Sometimes organizations ignore the needs of employees as secondary issues; however, just as employees have a personal need to understand their value within the company they cannot be successful as employees if changes affecting them are communicated. Finally, organizations have a personal need to successfully retain employees during times of change to prevent sudden losses of production or mass withdrawal from the company. It is imperative to have a high involvement of the HR Dept. during times of imminent changes.
Lawrence Sports’ will need to establish how they will handle each of these ethical issues early on in the project to prevent both added expenses as well as severely decreased production levels. Maintaining strong communication channels will enable the company to work through problems that often occur early on during these types of projects. If successfully managed, many stakeholders will develop an even stronger loyalty to the company as establishment of good faith is a strong indicator of how well a business can continue growing industry standards.
Ultimately, Lawrence Sports’ has relied heavily on policies that address a permanent solution to financial changes in the company needs; however, it does not address the changing and growing needs. A complete business plan will include development of long-term solutions, which address the growing needs of the company, implementing a JIT system, which focuses on prepared changes in needs as the company seeks out diversification in distribution options. Additionally, growing a strong credit value for the company will increase value to suppliers and encourage ethical behavior.
A successful Current Asset Investment Policy is detrimental to their success – while it should change with the changing company, Lawrence Sports’ would currently benefit from developing a Moderate Current Asset Policy and moving away from the current restricted policy until they are able to find additionally distributors. Additionally, the aggressive approach to Current Asset Financing Policies has increased debt to Lawrence Sports’ and developing a more conservative approach could increase availability of working capital and reduce high risk from unexpected changes in revenue. Last but not least, using productive metrics enables a company to carefully monitor the changes they develop as well as be able to quickly respond if additional changes must occur or if one change has lead them in the wrong direction.
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