Working Capital Management Concepts

Working Capital Management Concepts

Shawn Blakeley

MBA 550 – Working Capital Management

University of Phoenix

June 11, 2008

Working Capital Management Concepts Worksheet

Concept Application of Concept in Scenario Reference to Concept in Reading

Describe the firm's cash conversion cycle.

In the scenario, Lawrence Sports considered two of the four main categories of cash outflow on a week-to-week basis. 1. Payments on accounts payable was constantly analyzed and negotiated to both Gartner Products and Murry Leather Works. 2. Labor, administrative, and other expenses were represented as operating expenses. These two categories were fairly easily and quickly adjusted to achieve the desired short-term result. The other categories: 3. Capital expenditures and 4. Taxes/interest/dividend payments were not adjusted on a week-to-week basis. However, these categories certainly play a vital role in achieving yearly or long-term outcomes. Since these categories are not easily or quickly adjusted, they were not considered in the scenario. Four main categories of cash outflow:

“1. Payments on accounts payable. You have to pay your bills for raw materials, parts, electricity, etc. The cash-flow forecast assumes all these bills are paid on time, although Dynamic could probably delay payment to some extent.

Delayed payment is sometimes called stretching your payables. Stretching is one source of short-term financing, but for most firms it is an expensive source, because by stretching they lose discounts given to firms that pay promptly.

2. Labor, administrative, and other expenses. This category includes all other regular business expenses.

3. Capital expenditures. Note that Dynamic Mattress plans a major capital outlay in the first quarter.

4. Taxes, interest, and dividend payments. This includes interest on presently outstanding long-term debt but does not include interest on any additional borrowing to meet cash requirements in 2005” (Brealey, Myers & Allen, 2005b, p.850).

Examine the effects of credit policy on cash conversion cycle and revenue.

In the scenario, the interest rate for the bank loan was an example of how the credit policy effected the cash conversion cycle for Lawrence Sports. As the total amount of money loaned increased, so did the interest rate. As the interest rate increased, Lawrence Sports had to account for this added expense. The utilization of the bank loan would have undoubtedly decreased as the interest rate became more prohibitive, forcing Lawrence Sports to consider less costly methods. “Interest rates are used as a benchmark for pricing many types of short-term loans in the United States and in other countries. For example, a corporation in the United States may issue a floating-rate note with interest payments tied to dollar LIBOR” (Brealey, Myers & Allen, 2005a, p.828).

Examine the effects of account payable terms on cash conversion cycle and cost of goods.

In the scenario, the collection policy and practices were vital in managing the working capital for Lawrence Sports. Constantly, decisions were made on how much to collect from Mayo. Balancing client satisfaction with Lawrence Sports’ cash inflow/cash outflow was challenging. In the scenario, the collection policy was perpetually negotiated. Lawrence Sports did not employ some of the traditional techniques such as demand letters, phone calls, and collections agency. “Collection policy… The final step in credit management is to collect payment. When a customer is in

arrears, the usual procedure is to send a statement of account and to follow this at intervals with increasingly insistent letters or telephone calls. If none of these has

any effect,