Lawrence Sports is a million dollar industry that distributes sports gear as well as protective gear to companies. Over the years the company has grown and built many lasting relationships with its partners. Mayo Stores is the world’s leading retailer and is Lawrence’s principal customer. Lawrence receives all of their materials from Gartner Products and Murray Leather Works. Every relationship has its own set of issues, even in businesses, and Lawrence Sports has started to experience some within their cash flow. To try and resolve the issues they currently have before they get worse, the company must reevaluate the way it operates with their partners. Lawrence Sports will evaluate three alternative routes to reduce future difficulties and recommend the best solution for the corporation.
ALTERNATIVE ONE: CONSERVATIVE APPROACH
The conservative approach to working capital as its name suggests notes that working daily capital is financed through long term financing and that short term financing is not commonly utilized. Emery, Finnerty, & Stowe (2007) states that with the conservative approach, “Long-term financing is used to finance all of the firm’s long-term assets, all of its permanent current assets, and some of its temporary current” (p. 642). A conservative and more flexible working capital policy for a given level of turnover would be associated with maintaining a larger cash balance, perhaps even investing in short-term securities, offering more generous credit-terms to customers holding higher levels of inventory. Such a policy will give rise to a lower risk of financial problems or inventory problems, but at the expense of reducing profitability. Being conservative with business partners, Mayo and Murray, the focus is on maintaining the business relationships in order for Lawrence Sports to maintain a good working capital. This approach may not work with general economic conditions that may deteriorate the company’ capital with increased borrowing cost from the bank.
ALTERNATIVE TWO: AGGRESSIVE APPROACH
Lawrence Sports can implement an aggressive approach as an alternative working capital policy. This policy uses less long term and more short-term financing (Emery, Finnerty & Stowe, 2007). Short -term financing is more cost efficient with comparison to the long term financing. Lawrence Sports would experience a profit increase under this policy. This approach has high risk and often high return, as we know from the principle of Risk-Return Trade-Off that without some sort of market imperfection, higher expected profitability comes only at the expense of greater risk (Emery, Finnerty & Stowe, 2007). The main idea is to collect payments on time, leaving no debtors, invest that amount in the business and pay the creditors as late as possible. With that said, a short term aggressive approach is ideal only if the firm expects decline in interest rates. There are risks associated with this aggressive financing approach include higher interest rates, the potential for accounts receivable default, and credit limitations. Therefore, Lawrence Sports have to be prepared to take different actions that are needed in times of tight periods in the capital cash flow. The company can negotiate with current creditors to stretch the account payable, also, to identify and create a list of potential creditors that would be executed in the event there are issues with the existing creditor relationship. Lawrence Sports’ finance manager should also identify and create a similar list with relevant options for its current short term financing program. The company will use the cash inflow and outflow ratio and the cash balance to measure the aggressive approach policy. The finance manager will monitor a balance ratio of cash flow and will maintain a cash balance minimum of $100,000. The aggressive short term financial policy will be implementing by the finance manager, account manager and head of vendor