Lawrence Sports: Determination of Working Capital Policy

University of Phoenix: Corporate Finance FIN/571
January 27, 2013
Course Facilitator: Troy Mahone

Lawrence Sports is a multi-million dollar company that prides itself on its ability to manufacture and distribute quality sports equipment and protective gear. Their principal Customer, Mayo Corporation, has recently requested a repayment extension on their loan with the company. Mayo would like to pay 80% of the payments due for the weeks of March 17-23 and March 24-30 and no payments would be made prior to April 14-20. To allow this payment arrangement, Lawrence Sports would have a deficit cash position for the weeks of March 31-April 6, where they would have to take an additional loan to cover the $307,000 deficit. Additionally, they would incur an interest payment of $3,150 on the loan. For the week of April 7-13, a loan would have to be made to cover the $411,000 deficit with an additional interest payment of $3,690. Lawrence Corporation has already reached their $1.2 million credit limit level and they would, according to company policy, be unable to make additional loans.
Lawrence Corporation greatly values the business relationship with Mayo Corp, and a decision must be made determining whether to allow a repayment extension based on the terms Mayo has stated, or come up with an acceptable plan, not only for Mayo Corp, but a plan that would be agreeable with all the parties involved. Allowing any extension on repayments from Mayo Corp would affect Lawrence’s ability to make timely payments to other business partners at Gartner Partners and Murray Leather Works.
In the following paragraphs, Team C reviews three working capital plans to determine which plan will reduce risk to Lawrence Corporation. After reviewing each working capital plan, and their contingencies, the team will then determine which plan best resolves each parties’ concerns.
Working Capital Policy 1
The first working capital policy caters to the suppliers while putting off repaying the bank loans as long as possible. This would be the maturity matching approach and it would put a limit on funds that could be available to the business creating a negative working capital position. However, this policy would not work because it leaves negative cash balances and renders Lawrence Sports unable to meet its future financial obligations. Additionally, Lawrence Sports is unable to manage its business proposals. This policy would create a financial burden and strain for the company as well as its business partners, Mayo, Gartner, and Murray. Thus, Lawrence’s working capital position would be hindered.
The key here is to determine the best policy to implement that would not annoy or offend the business partners, but would pay down as much of Lawrence Sport’s existing outstanding debt as possible. We have to strike a balance between satisfactory performance for Lawrence’s working capital and maintaining positive relationships with our business partners.
Working Capital Policy 2 The second working capital policy is not completely catering to the suppliers while paying down the bank loans in a reasonable amount of time. This policy allows Lawrence Sports to handle the day-to-day cash of the company to; balance collections, pay debts, disbursements, future revenues, and borrowing and loan repayment, simultaneously. Good cash management is the backbone of every wel run organization while top management gets the time and peace of mind to concentrate on long term strategic planning. Working capital management is a vital process for running a business. This option allows Lawrence Sports to work with Mayo, their principal customer, and Gartner and Murray, their business partners. They must do what is best for their cash flow and determine what actions work best for all parties involved. Relationships are very important for the future of Lawrence Sports and careful decisions must be made in order to keep everyone somewhat happy. Although not everyone will be completely happy with all the decisions that are made, decisions that everyone can accept and work with is a good balance. Lawrence Sports has to maintain payments from Mayo, 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. The best capital budgeting and financing decisions will help a company that has difficulties in paying its bills. Receivables and payables have direct impact on the bottom line of the company. Improvement of the bottom line is an incremental process that amount to individual managers negotiating with customers and suppliers to optimize the price terms and financing relationships. A positive cash balance position keeps Lawrence Sports prepared for unforeseen emergencies. They need cash to conduct ordinary transactions when cash flows are uneven, to avert default on obligations, and to take advantage of investment opportunities. Bank requirements for compensating balances also contribute to the demand for cash balances.

Working Capital Policy 3 The third working capital policy for Lawrence Sports is to ensure that all bank notes are paid off as soon as possible. This policy will come at the expense of their business partners. Mayo is the organization to which Lawrence Sports sells their goods. They are the business partner where most of the accounts receivable come from. In an effort to shorten the cash conversion cycle as much as possible, demanding immediate payment from Mayo is part of Working Capital Policy 3. Gartner and Murray are the two main suppliers of Lawrence Sports, and in order to minimize the conversion cycle as much as possible, payments to these suppliers should be put off as much as possible. Using this policy, Lawrence was able to attain all their receivables by April 6 and spread their payments to Gartner and Murray over the period from April 1to April 27. This left the company with a cash balance of $50k at the end of the period, while having paid $495 toward the outstanding loans. From April 28-May 25 Lawrence was able to collect from Mayo spread out through the term, spread out their payments to Gartner and Murray as much as possible, and pay off another $529k of their loan. However all of their partners are exceedingly unhappy, and they now having financial difficulties as well. In fact, Murray has been forced to close operations for two months, and all materials will now have to be sourced from Gartner, the more expensive supplier. In addition to this hardship, a shipment to Mayo came in damaged the week of May 5-11. This has cost the company $250k paid to Gersen for closing the contract with them, and it cost the company $100k cash down for the emergency purchase from Gartner. To ensure ends meet from May 12-25, Lawrence will again have to hurt their partners. This minimization of the conversion cycle, at the expense of their partners, has enabled Lawrence to avoid taking any more loans out, and still being able to pay down their loan $294k. While Working Capital policy 3 was able to continue operations while paying down their bank loans, Lawrence Sports’ partners were hurt greatly. One of the suppliers of Lawrence even had to close their doors due to the policy. The other one is about stop supplying the company, and the retailer, Mayo, saw sales decrease the entire period. This working capital policy was able to avoid paying interest on bank loans, but it has cost the business immensely in revenues, and has increased the amount that they will have to pay for materials into the future.
Working Capital Policy Recommendation Lawrence Sports’ main responsibility is to keep their bank loans to a minimum. To do this, they need to focus on their cash conversion cycle. “The cash conversion cycle is the length of time between the payment of accounts payable and the receipt of cash from accounts receivable” (Emery, et al, 2007, pg. 643). The cash conversion cycle is equal to the inventory conversion period, plus receivables collection period, minus payables deferral period. To keep the cash conversion cycle high and to be able to pay back loans to the bank, Lawrence Sports needs to focus on collecting payments from its business partners in a timely manner. To do this, Lawrence Sports may need to renegotiate terms with their business partners in order to insure that payments are being made. If the payments are not being made, Lawrence Sports needs to be forceful in their collection process. Unfortunately, this could hinder relations between the business partners; but payments must be made in order for the company to continue business. To also ensure a positive cash conversion cycle, Lawrence Sports needs to examine their inventory conversion period. The inventory conversion period is based on how long it takes to produce the products along with how long it takes to sell the products. The less time and money spent on production and the faster rate at which it takes to sell the product will be more beneficial for Lawrence Sports and will help to maintain a positive cash conversion cycle. The most important aspect of Lawrence Sports’ cash conversion cycle is when they are able to pay their accounts payable and collect their accounts receivable. They need to ensure that they are making their payments to business partners and the bank at the same rate they are able to collect payments. By doing this, Lawrence Sports can reduce their loans as well as their interest rates.
Conclusion
Allotting an extra week for Mayo to pay the 80% payment for the sales in the weeks of March 10-16, March 17-23, and March 24-30, will allow Mayo some flexibility to accomplish their business goals while Lawrence will continue meeting their financial responsibilities towards Gartner and Murray. Lawrence will be able to maintain a consistent balance of $50,000 or more throughout the period indicated above. There will be no need to take additional loans. They will continue to be able to make some payments to Gartner and Murray, and at the end of the extension period, all business partners will be up to date and they will be able to maintain a satisfactory and prosperous working relationship. Lawrence will continue to receive their raw materials to produce the merchandise for their increased business growth.

Reference
Emery, D. R., Finnerty, J. D., & Stowe, J. D. (2007). Corporate Financial Management (3rd ed.). Upper Saddle River, NJ: Prentice Hall.