A Review of the Cash Conversion Cycle
At Lawrence Sports, the management of their cash conversion cycle, and working capital system, is critical to their continued success. It appears that a review of this process is needed in order to fully understand what they are currently doing, where they can improve, and how much of an impact those options will have on the company. According to Emery, et. al., in their work Corporate Financial Management, “The cash conversion cycle is the length of time between when a firm pays its accounts payable and when it collects on its accounts receivable. The cash conversion cycle is equal to the inventory conversion period plus the receivables collection period minus the payables deferral period” (Emery, et. al., 2007, pg. 659). Looking in detail at Lawrence Sports current payment arrangements, the follow agreements are in place: ·
Revenue - Mayo Stores – 20% collection on sales, 80% payable the following week ·
Costs – Gartner – 40% collection on sales – 60% payable the following week ·
Costs – Murray – 15% collection on sales – 85% payable the following week
(UOP, 2010, pg.1)
With common credit terms of net 30 and net 45, Lawrence is operating under a very difficult system by which it must pay in full all of its credit obligations to its vendors within 10 days. This leaves the cash conversion cycle, for all parties involved, at 14 days. Lawrence Sports needs to negotiate with their suppliers a minimum of net 30 payment terms, extending its deferral period and buying time to sell their finished products, and collect from Mayo Stores in full, prior to paying their vendors. This will greatly reduce the need for using the existing line of credit and associated interest fees.
Emery et. al. (2007) Corporate Financial Management. Prentiss Hall, Pearson
Education, Upper Saddle River, New Jersey.
UOP (2010) Finance for Managerial Decision Making, Working Capital
Management. University of...
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