Working Capital Management Concepts Worksheet
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Working Capital Management Concepts Worksheet
Concept
Application of Concept in the Simulation
Reference to Concept in Reading
Credit policy
Lawrence Sports (LA) current credit policy is not catering to the needs of the company. LAs credit policy is too lenient, and there is no money coming into the company. The companys working capital minimum requirements are not being achieved. In addition, it has a direct effect on the LAs cash conversion cycle because cash is constantly paid for materials but not collected from receivables. LA will need to implement a credit policy that is more stringent than the current one.
A companys credit policy is based on:
How long a customer is given to pay their bills
How to decide the payment terms for each customer
How much credit should be extended to each customer
How to collect the money from the customer
LA is working to maintain a positive relationship with their customers, but the company is hurting as a result. For example, Mayo has defaulted on 80% of their outstanding payment. This will increase LAs cash conversion cycle. In addition, there will be an increase in the time in which they can include this payment as revenue. LA will need to create a solution to streamline the credit policy, communicate the new credit policy to customers, and continue to maintain a positive relationship.
Writing an effective Credit Policy begins with an understanding of the financial exposure that you or your business can endure and the amount of your working capital that you would be willing to risk, or call it invest in your customers” (Grover, 2002).
Optimizing Working Capital
For a company to correctly manage working capital it is required that receivable, inventory, and cash balances be monitored. Working capital can provide a company with liquidity along with an opportunity to be competitive in the market. In order for a company to be successful, the working capital needs to be optimized. Currently LA routinely sells goods on credit. The credit policy allows customers not to pay the debt for weeks or even months. The unpaid debt is tracked in LAs receivables account. The credit policy prevents LA from optimizing their working capital.
Inventory management is another task that may a positive or negative outcome related to working capital. Large quantities of inventory are often expensive to store. Therefore, the advantages of large inventories need to be balanced with the cost required. LA is attempting to balance the inventory versus cost by selling to their customers on credit.
“Short-term, or current, assets and liabilities are collectively known as working capital” (Brealey et al, 2005).
Cash Flow
Cash flow is the total from cash receipts minus payments over a period of time. A companys cash flow important as it helps a company makes decisions related to short-term investments. If, a company has insufficient cash flow the result may be a company failure, even is sales are increasing and the company is making a profit. A company uses cash to pay their bills, not profit. If, there is not enough cash the company could fail. LA need to consider cash pays bills not profit in order to continue to operate. LA should create and implement a new tough credit policy to allow optimization of working capitol. This should ensure LA has a constant cash flow.
In addition, cash flow is important since it indicates the financial performance of a company. A positive cash flow will ensure the company has the required cash to pay bills, employees, and utilizes required for daily operation. The positive cash flow will also allow a company to invest in future opportunities.
Cash flow is important and needed because it helps ensure adequate cash is available to fund day to day commitments, capital expenditures and growth. “You cant pay bills with inventory or with receivables, you must pay with cash” (Brealey et al, 2005).
Short-term Financing
One form of financing used by LA is a short-term option offered as a