Working Capital Management Concepts Worksheet
Application of Concept in the Simulation
Reference to Concept in Reading Credit policy
Lawrence Sports' (LA) current credit policy is not catering to the needs of the company. LA's credit policy is too lenient, and there is no money coming into the company. The company's working capital minimum requirements are not being achieved. In addition, it has a direct effect on the LA's cash conversion cycle because cash is constantly paid for materials but not collected from receivables. LA will need to implement a credit policy that is more stringent than the current one.
A company's credit policy is based on:
How long a customer is given to pay their bills
How to decide the payment terms for each customer
How much credit should be extended to each customer
How to collect the money from the customer
LA is working to maintain a positive relationship with their customers, but the company is hurting as a result. For example, Mayo has defaulted on 80% of their outstanding payment. This will increase LA's cash conversion cycle. In addition, there will be an increase in the time in which they can include this payment as revenue. LA will need to create a solution to streamline the credit policy, communicate the new credit policy to customers, and continue to maintain a positive relationship.
Writing an effective Credit Policy begins with an understanding of the financial exposure that you or your business can endure and the amount of your working capital that you would be willing to risk, or call it 'invest' in your customers" (Grover, 2002). Optimizing Working Capital
For a company to correctly manage working capital it is required that receivable, inventory, and cash balances be monitored. Working capital can provide a company with liquidity along with an opportunity to be competitive in the market. In order for a company to be successful, the working capital needs to be optimized....
References: Brealey R. A., Myers S. C. & Allen F. (2005). Principles of Corporate Finance. 8th ed. New York: The McGraw-Hill Companies.
Grover, P. (2000). Managing Credit: Is your Credit Policy Profitable? Retrieved January 19, 2008, from http://www.creditguru.com/guestarticle44.htm
Ross, S. A., Westerfield, R. W. & Jaffe, J. (2005). Corporate Finance. New York: The McGraw-Hill Companies.
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