Cash Flow Management in the Lawrence Simulation - Essay Example

Cash Flow Management in the Lawrence Simulation Lawrence Sports is a company that manufacturers and distributes sports and safety equipment for football, basketball, baseball and volleyball with net revenue of $20 million annually. The principal customer of Lawrence is Mayo, the worlds largest retailer. Mayo is the number one retailer in the US and Canada, but is expanding internationally as well. Sales by Lawrence to Mayo represent approximately 95% of Lawrence’s revenues. Mayo has positioned itself in the marketplace as the low cost leader, with the slogan “We Sell For Less.” The two major suppliers of Lawrence are Gartner Products and Murray Leather Works. Gartner is a company with ten times the revenues of Lawrence, with a market share of 37%. Some 70% of Lawrence’s materials and supplies are sourced from Gartner, thus, Lawrence represents less than 0.6% of Gartner’s revenues. In contrast, Murray is only half the size of Lawrence, with $10 million in revenues, and Lawrence represents 75% of Murray’s revenue as their largest single customer. Internally, Robert (Bob) Dent is the account manager with Mayo. For the past five years of his employment with Lawrence, he has demonstrated himself as an aggressive and efficient manager with an impressive record of developing the relationship with Mayo. On the supply side of the house, Ann Wu is head of vendor relationships. She has an excellent relationship with Gartner and Murray. Lawrence has accounts with Central Bank, including a line of credit. The line of credit has a maximum draw-down of $1.2 million with a variable rate of interest depending on the amount of funds are used. Whenever there is a cash deficit, an automatic deposit is made to maintain a minimum balance of $50,000. Repayment is required at month’s end, retaining a minimum balance of $50,000. The variable interest rates are as follows: Amount Borrowed Interest Rate Paid Up to $450,000 10% $450,001 - $650,000 12% $650,001 - $850,000 14% $850,001 - $1,200,000 16% It is in this situation that crisis has struck. Mayo has defaulted on payments for the weeks of 17 through 30 March. Further news is that Mayo will not be paying anything until the week of 14 April. Lawrence must negotiate with Mayo, Gartner and Murray in order to speed up payments from Mayo and possibly further defer payments to Gartner and Murray. Borrowing from the bank is to be managed to minimize the outstanding balance and subsequent interest expense. Analysis: Lawrence faces two problems, a short-term cash-flow problem, and a larger and more significant strategic problem involving an unhealthy dependence on a single customer and lack of diversity amongst suppliers. We are tasked with the short-term cash flow problem at hand. If Mayo is allowed to proceed with delays of payment until the week of 14 April, the company will suffer a cash-flow deficit of up to $411,000 in excess of the $1.2 million line of credit for the period of 31 March through 13 April. Based on the existing payment schedule, there is no savings in interest expense to be gained by forcing Murray to accept delays in payments. If Lawrence chooses not to attempt a negotiation with Gardner for additional time to meet outstanding payments, the interest expense on borrowing will be $3,821 more than if Lawrence attempts to push Gartner to accept further delays in payment, regardless of the terms offered. Is the relationship with Gartner worth $3,821? How much would Lawrence spend to develop a new supplier? The critical issue related to corporate solvency is convincing Mayo to accelerate payment of the defaulted amounts. Mayo must be convinced to accelerate payment of the outstanding receivables from March. At the same time, an emergency search for financing in the amount of $500,000 must be commenced immediately to allow continued operation of the company in the event that Bob Dent is unable to get Mayo to agree with an acceleration on their proposed payment schedule of the defaulted amounts. Gartner and Murray should be left alone and payments for supplies and material should proceed according to schedule. Failure to either negotiate an increase in the line of credit with Central Bank to at least $1.7 million or develop an alternative source of financing cash-flow deficits will place the solvency of Lawrence in the hands of Bob Dent’s ability to push Mayo to accelerate payment on their defaulted amount. His feelings about losing a $150,000 order must be weighed against the threats to the viability of corporate solvency if Mayo is not convinced to accelerate payment. Long-Term Financial Management Issues Murphy’s Law generally states: “That which can go wrong, will go wrong.” (Merriam-Webster) While Bob Dent believes that the defaults on payments are an internal issue with Mayo, there are no guarantees that this behavior will not continue. Senior management must take steps immediately to focus on developing new markets for Lawrence’s products and investigate the possibility of diversification of suppliers. Failing this, an investigation into the possibilities of pursuing a strategy of merger or acquisition is appropriate. In addition, the interest rates charged by Central Bank are usurious, and Board of Directors should authorize Stephanie to initiate negotiations with other financial institutions in order to diversify the sources of capital available to Lawrence and reduce the cost of capital. These decisions are above the pay grade of this level of management and thus we only recommend. However, the finance department can only work with the resources it has been given and we encourage senior management to take this seriously. It is also possible to factor receivables in the event of future defaults, given that the credit-worthiness of Mayo is unquestioned. It is possible that with time we can locate an entity that will offer a better rate of interest based on the receivables as collateral, but we have made no such investigation to date. The most critical need the company faces now is for diversification in the supply of capital for both short-term and long-term capital needs. Our costs of capital is excessive, our supply limited to a single entity and as the default on payments by Mayo has demonstrated, the time to act is now. Work Cited Murphy’s Law. Merriam-Webster Dictionary Online. n.d. Web 24 March 2011 Read More