March 21, 2013
Lawrence Sports Simulation
Lawrence Sports is a company with revenues of $20 million. Lawrence manufactures equipment and protective gear for various sports; its business partners include Gartner Products and Murray Leather Works. Gartner sources Lawrence with 70% of its raw materials, and Lawrence contributes to 75% of Murray’s sales. Mayo is the world’s leading retailer and Lawrence Sports’ principal customer (“Lawrence Sports”, 2012). Lawrence Sports entrusted Team A to develop a working capital policy that would benefit Lawrence Sports’ profitability while remaining competitive, and in good standing with its business partners, suppliers, and major customers. Working Capital Policy Approaches
The concept of working capital management involves the management of accounts receivable, current assets, marketable securities, current liabilities, and inventory (Raheman, Qayyum, & Afza, 2011). The effective management of this working capital is of vital importance for the appropriate administration of a company’s financial systems. Policies exist to assist financial managers with the day-to-day operations of the organization. There are three types of working capital policies a company may institute to facilitate maximum profitability for an organization.
The three working capital policies are conservative, maturity matching, and aggressive (Emery, Finnerty, & Stowe, 2007). Team A devised three different working capital policies in an effort to reduce future difficulties for Lawrence Sports. The team reviewed the three alternative policies and determined one of the policies is better suited to meet the needs of the company. Following are the three alternative capital policies formulated for final recommendation. Maturity-Matching Approach
Emery et al. (2007) define Maturity-matching approach to working capital that as the financing firm takes risk by matching the maturities of the business’ assets and liabilities. The firm finances long-term assets by issuing long-term debt and equity securities. Furthermore, the organization finances seasonal variations in current assets with current liabilities of the same maturity. The risk associated with financing maturity-matching is that financing is based on historical data of when the assets mature. The risk is low where short-term borrowing would fall to zero at seasonal low spots. This type of financing approach would not be suitable for small businesses as their assets and working capital have a high turn-around. Conservative Approach
Emery et al. (2007) state 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 assets” (pp. 642). Conservative financing develops long-term debt, marketable securities, and at the same time it reduces short-term debt. The conservative approach can also lead to the reduction in cost of short-term financing because of the decrease in interest rates. Aggressive Approach
The aggressive approach to capital management policy uses more short-term financing compared to more long-term financing. The aggressive policy’s goal is to raise cost-effectiveness and profitability for the company (Emery et al., 2007). Using an aggressive approach to manage capital policy for a firm involves risk. It is important to manage the risk trade-off of aggressive policies. Lawrence achieved good capital performance and the ability to repay 48% of the total borrowing during the month of April. However, this this was accomplished by incurring costs and tense relationships with vendors and suppliers.
When a firm is too aggressive with its capital policy, vendors, customers, and suppliers may suffer the consequences in the future. For example stretching payments on accounts payable may cause a firm to incur implied costs, such as...