Lawrence Sport Benchmarling

Working Capital Strategies

Companies should develop working capital strategies in preparation for long-term opportunities. These strategies may include granting credit, credit policies, collection policies, and financing trade credit. “It is useful to think of the decision to grant credit in terms of carrying cost and opportunity costs.” (Ross, et. el., 2005, ch.28, p.10) A firm can either grant or refuse credit depending on which results with the best NPV. “A collection policy is a method of dealing with past-due accounts.” (Ross, et. el., 2005, ch.28, p.17) A company must ensure they have enough cash flow from receivables to pay their bills. “A firm will extend trade credit if it has a comparative advantage in doing so.” (Ross, et. el., 2005, ch.28, p.12) A company determines the level of each of these areas depending on the distinct situation.

There are different approaches when choosing the best strategy to use for a company. When deciding on the best strategy, a company should consider the individual situation, size of the company, and the type of industry. Broward Aviation Services and Roman Jewelers are both small privately owned companies however; they both took a different strategy approach. Roman Jewelers consulted a financial planner to obtain expertise in handling the working capital issues. The financial planner had them increase long-term debt to increase cash flow. Broward Aviation Services worked on the issues internally by factoring, taking advantage of tax benefits, improving credit policies, and adjusting accounts payable.

Purpose of Cash Budgeting

An important aspect of properly managing a business is cash budgeting. “The objective of managing short-term finance and short-term financial planning is to find the optimal trade-off between these two costs.” (Ross, et. al., ch. 26, p.22) The two costs are carrying costs and shortage costs.

“Cash management is more concerned with how to minimize cash balances by collecting and disbursing cash effectively.” (Ross, 2005, p. 754) Managers should be concerned with how to have the minimal amount of cash balances and still be able to pay the operating costs of the firm. Operating costs of a firm are considered cash outflows. (Ross, 2005) There are many different ways to manage the cash balance of a firm; where each different management scheme has its drawbacks and advantages. Having high cash balance will be an inefficient use of a firm’s cash but make the firm resistant to external forces such as late payments. A low cash balance will (using the cash for other investments) would be an efficient use of a firms cash, but make the firm susceptible to external forces such as late payment. NOV and Microsoft both had cash balance issues. They chose very different ways to manage their cash, however. Microsoft chose to minimize their cash; keep high enough cash balance to operate. (McMillann, 2006) NOV chose to keep maximum cash balance. (NOV, 2007) These approaches are both very different, but each firm was able to manage their cash outflow with success.

Perform Cash Flow Analysis

There is important information a company can gain by performing a cash flow analysis. The financial manager uses the cash budget to perform the cash flow analysis. “The financial manager can use the cash budget to identify short-term financial needs. The cash budget tells the manager what borrowing is required or what lending will be possible in the short-run.” (Ross, et. al., ch.26, p.22)

Lawrence Sports is having a difficult time staying ahead of the cash flow game. The company has a line of a credit with a bank to help when cash flow is lean and to maintain a minimum $50,000 daily balance. Accepting Mayo’s negotiation to accept late payments will negatively impact Lawrence’s cash flow. Boeing has a similar situation with a new product. Boeing cannot sell the product as it has issues with vendors, placing the finished product behind schedule. As Boeing has many customers, the company has the cash flow to wait out the schedule to deliver the finished product. LS should benchmark against Boeing to diversify the customer base. This would have a positive impact on LS’ cash flow and allow LS to negotiate better with customers.

Industry Best Practices

How cash is managed differs depending on the size of the company as well, the type of industry involved. “The basic objective in cash management is to keep the investment in cash as low as possible while still operating the firm’s activities efficiently and effectively.” (Ross, et. al., ch.27, p.1)

“Inventory management involves a trade-off between the advantages of holding large inventories and the costs.” (Brealey, et al., 2005) Toyota Motor Corporation employs the cash to cash concept to reduce inventory levels which provides an increase in cash flow for investments. Reducing inventory by reducing the production cycle has proven an effective tool in reducing the cash to cash cycle for Toyota. “Many companies have learned from Toyota’s example. Thirty years ago Ford used to turn over its inventories about 5 times a year; today that figure is over 20 times.” (Brealey, et al., 2005)

Pfizer routinely gave its alliance partners too much time to repay the pharmaceutical company which adversely impacted the company’s balance sheet. Warner-Lambert average collection time on accounts receivables was almost a full month before products were produced which afforded the company the opportunity to grow through a series of acquisitions. “Pfizer’s cash conversion cycle is alarmingly high, and places an unnecessary threat on the company’s financial standing” (Mann, 2000). Clearly, best practices in