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The methods of Capital Management carry with it a certain level of risk regardless of what course of action is decided. This paper will describe and analyze the various options that lay before the management team in the case of Lawrence Sports. The first option to be considered is the Maturity-Matching approach which can be used for both long and short-term situations. Second is the conservative approach, which takes an exclusively long-term view and plans accordingly. Third is the aggressive approach that emphasizes the short-term planning cycle. After examining both the benefits and costs of each approach, the approach chosen will be indicated through the process of selecting performance parameters as well as the plan of implementation. The approach agreed upon should result in maximum profitability for Lawrence Sports.
The first working capital option for Lawrence is the maturity-matching approach. The maturity-matching approach matches short-term financing to short-term requirements, and long-term financing requirements to long-term debt. The risk associated with this approach is the ability of Lawrence Sports to match the appropriate financing needs to the requirement. If the sporting goods store is not able to sell the seasonal equipment, the short-term loans will need to be shifted to longer term loans to cover the debt.
The Conservative Approach
The contingency plan set in place if the maturity-matching approach is not sufficient is the conservative approach. The conservative approach uses long-term funds to finance a significant portion of the loans used by the organization. This approach protects the company against the volatility of the short-term markets, and guarantees the organization has sufficient capital in place for longer durations of the business cycle. The long-term capital will also protect the store against freezes in the credit markets, as the country experienced in late 2008. Lawrence Sports also has the ability to invest excess capital in safe, short term securities until the time comes when they will need the capital for the business. The excess capital also provides additional layers of protection against unexpected incidents within the company, including the damaged delivery with Gersen Warehousing.
The risk associated with the conservative approach is that Lawrence Sports will not benefit during periods when the short-term lending rates drop which reduces the profit margin of the company. The conservative approach may also create a false sense of security to the company, and may tempt money managers to invest excess capital in investments containing a higher degree of risk.
The Aggressive Approach
The third and final option for the sporting store is the aggressive approach to capital management. The aggressive approach is the opposite structure of the conservative approach, and it uses short-term funds as the primary financing tool. The benefits of the short-term funds are the reduced fees associated with the funds which increase the profitability of the company. An increase in profits solidifies the financial base of the company, protecting employees and opening the potential for future expansion.
The risk associated with the aggressive approach is the volatility of the short-term credit rates, and the ability of Lawrence Sports to obtain funding during extended periods of stringent credit markets. A recent Barons article describes the difficulty which continues to plague small business owners during these difficult economic times. ???Blue-chip corporations such as Cisco Systems can raise billions on advantageous terms, mostly because it has $35 billion in cash and equivalents on its balance sheet. For small businesses that have limited cash on hand and need loans to remain open, the credit spigot remains largely shut.??? (Forsyth, 2009)
To manage the working capital, measurements must continuously be done to ensure that the capital is working most efficiently. Cash, inventories, receivables, marketable securities, and both long-term and short-term debt all contribute to what is considered working capital. Measurements of inventory and receivables can be used to determine the effectiveness of giving more credit to customers and keeping high inventories. Do they increase sales or do they produce higher costs to the company Measurements of Liquidity between cash and marketable securities determine if the company can liquidate what it needs to cover its liabilities quickly (Emery, Finnerty, & Stowe, 2007). Can assets be liquidated into cash quickly to cover debts Measurements are made in the relationships with its customers and suppliers through keeping track of inventories, receivable, debt payment to name a few. Are customers receiving quality and availability of the company??™s products Are suppliers receiving their payment to their satisfaction
To measure the success of the approach using Maturity-matching, a careful eye must be kept on short-term requirements with short ??“term debt. To determine the right amount of short-term debt that can be successfully incurred, a measurement of the highest amount of temporary assets (inventory), the company purchase so the sufficient short-term debt can be incurred to cover the price of the short term assets, should they not get sold (Emery, Finnerty, & Stowe, 2007).
For example, Lawrence Sporting must carefully ensure that its inventory sold matches its short-term debt to cover the debt. If the sold inventory is less than the short term, a measurement must be made that determines how much inventory remains to be covered by long-long debt. Measurements of what the prior year??™s inventory versus how much of the inventory sold will determine a guide line for how much inventory for short-term debt is need in the future.
A more conservative approach is to use long- term- debt instead of short-term debt to cover some of the short-term requirements. For this approach, the measurements of temporary assets are included in part to be covered by some long-term debt.
For example, Lawrence Sporting can measure its inventory to determine how much inventory it needs to keep on hand. From this measurement, the company can allocate its projected sales to pay a portion in short-term debt with the excess of inventory to be covered by long-term debt.
Team A recommends the maturity-matching approach. The maturity-matching approach matches short-term financing to short-term requirements, and long-term financing requirements to long-term debt.
Implementing the new trade credit policy and cash management process will happen according to the following guidelines. After deciding on agreeable terms of sale with Mayo, management will outline the next profitable horizon. Future retailers will be bound by a policy contract that includes the terms of sale, credit analysis and a collection policy. The credit team should have the new policy terms established within one week. Lawrence Sports need to negotiate with Mayo, considering the need of immediate action. Value creation depends on cash flows. New cash positioning need to be evaluated for Lawrence Sports when receipts and disbursements create positive net working capital, supported by a sustainable infrastructure of processes. Following the new cash yielding trade off decisions, the company should start experiencing growth opportunities.
A credit policy that is too liberal will continue to cause damage to Lawrence Sports. Currently both receivables and payables are unsynchronized at Lawrence Sports, which is putting undue financial distress on the firm, as well threatening supplier relationships. Considering the dominant sales role that Mayo plays in the supply chain, Lawrence need to be very careful in pressuring the payment of receivables
When the trade credit guidelines are set, the finance team will be able to calculate the targeted cash balance, which should be assessed every two weeks. From this, the capital management outlay will be created. After the policy and cash flow plan is established, management can then begin investigating alternative retailers and suppliers. Instead of the present unpredictable receivables turnover, the new credit policy will allow the basis to calculate a minimum cash balance to increase liquidity.
Evaluation of Results
Part of project implementation is guaranteeing a way to measure results. Unfortunately, Lawrence must design a new policy immediately. ???Change occurs, as it must, but it does so in an atmosphere of crisis and confusion. Substantial loss may result before the needed design is complete??? (Pyzdek, 2003). Therefore, management will be advised to enroll in online Six Sigma courses, as well instructed to immediately update techniques for financial/operational analysis.
The evaluation schedule is as follows. Credit policy reviews will happen once a month, supplier payables correspondence on a weekly basis, operations will be assessed daily, financial investments analysis reports will occur and retailer analysis memos will be delivered bi-weekly.
The Maturity-Matching approach that was agreed upon appears to be the most advantageous to this particular company in the current phase of business development. The aggressive policies that apply to a short-term outlook are not needed for a company of this size and capability. In addition, the more conservative approach for a long-term strategy is not viable at this stage of development. The preference for the Maturity-Matching approach was scrutinized and deemed to meet the needs of the company in order to achieve optimum level of management. The use of both long-term and short-term debt requirements has the advantage of flexibility that is necessary to meet the ever changing needs of Lawrence Sports.
Emery, D. R., Finnerty, J.D., Stowe, J.D. (2007). Corporate Financial Management (3rd ed.). New Jersey: Pearson-Prentice Hall. Retrieved November 21, 2009, from University of Phoenix rEsource, Corporate Finance FIN/571 course Web site.
Forsyth, R., (Nov, 2009) A Tale of Two Credit Markets, Barons, Retrieved December 5, 2009 from the ABI/Inform Global database.
Pyzdek, T. (2003). The Six Sigma Handbook. Publisher: McGraw-Hill