This Is A Team Assignment I Am Only Covering One Bullet For

This Is A Team Assignement I Am Only Covering 1 Bullet For the Below

This is a team assignment. I am only covering one bullet related to the case study provided. Please review and let me know if you have any questions. I am focusing on bullet D, questions 1-5, which involves analyzing Casa de Diseñо’s cash management practices, operating cycle, and potential cost savings by optimizing credit terms and receivables management.

Paper For Above instruction

Introduction

Effective cash management is essential for manufacturing firms like Casa de Diseñо, which operate complex short-term financial cycles involving inventory, receivables, and payables. The company's strategic decisions on credit policies, inventory control, and payment terms directly influence its operational efficiency and profitability. This paper evaluates Casa de Diseñо's current cash conversion cycle and investigates potential improvements to reduce resource investment requirements, costs, and enhance overall financial performance, particularly focusing on the insights presented in bullet D questions 1-5.

Analysis of Current Operating Cycle and Resource Investment (Question 1)

Casa de Diseñо's existing operating cycle comprises the time it takes to convert raw materials into finished goods, sell, and collect receivables. The calculation starts with the Inventory Period, Accounts Receivable Period, and Accounts Payable Period. The current data indicates an inventory age of 110 days against an industry standard of 83 days, suggesting excess inventory holding. The collection period for receivables, given the net-60 credit terms, is 75 days, aligning with industry norms. The average payable period is 30 days, slightly shorter than the industry average of 39 days. The operating cycle (OC) is thus:

OC = Inventory Period + Receivables Period - Payables Period = 110 + 75 - 30 = 155 days.

The cash conversion cycle (CCC) is:

CCC = OC - Payables Period = 155 - 30 = 125 days.

The resource investment needed for this cycle can be approximated by the annual operating-cycle investments, which are about $26.5 million, considering the average inventory age and receivables.

Potential Industry Standard Optimization (Question 2)

Assuming Casa de Diseñо adapts to industry standards, the inventory age would decrease from 110 to 83 days, and the receivables period would align with the industry average of 75 days. The payables period would remain at 39 days, based on industry standards and confirmed by regional data. The optimized operating cycle thus becomes:

OC = 83 + 75 - 39 = 119 days.

Consequently, the optimized cash conversion cycle is:

CCC = 119 - 39 = 80 days.

This shorter cycle would significantly reduce the firm's working capital requirements and associated resource investments, lowering the annual investment need proportionally to the decrease in cycle length.

Cost of Operational Inefficiency (Question 3)

The difference between current and optimized resource investments reflects the inefficiency cost. The current investment level is approximately $26.5 million, and the optimized investment needs would be proportional to the reduced cycle length:

Cost of inefficiency = Current investment - Optimized investment.

Given that the resource investment is proportional to the cycle length, the avoided investment is roughly:

($26.5 million) * (155 - 119) / 155 ≈ $6.3 million.

This indicates substantial potential savings through better inventory and receivables management, emphasizing the importance of optimizing credit and inventory policies.

Additional Savings from Shortened Cash Conversion Cycle (Question 4)

By offering a 3/10 net 60 credit term, the firm can reduce the average collection period by 40%. If the original collection period is 75 days, a 40% reduction equates to:

Reduction = 75 * 0.40 = 30 days, leading to a new collection period of 45 days.

This change would further shorten the cash conversion cycle, reducing the investment in receivables and cycle costs. The additional investment savings would be approximately:

($40 million sales) (30 / 365) 0.80 (variable cost ratio) = approximately $2.62 million annually.

Furthermore, offering early payment discounts influences the firm's income and receivable balance. Assuming 45% of customers take the 3/10 net 60 discount, the firm would experience revenue reductions and altered bad debt expenses, which must be weighed against the cost savings.

Impact on Revenue and Accounts Receivable (Question 4 parts 2-4)

Offering the 3% discount to 45% of customers on $40 million sales would decrease revenues by:

$40 million 0.45 0.03 = $540,000 annually.

The reduction in average accounts receivable, considering a variable cost structure and sales volume, is approximately:

Accounts receivable = Sales Average collection period / 365 days (1 - discount uptake rate),

which translates to a decrease of roughly $4.4 million, resulting in further savings in working capital.

Regarding bad debts, reducing expenses from 2% to 1.5% of sales would save $600,000 annually, positively impacting profit margins and cash flows.

Financial Justification for Offering Discounts (Question 4 parts 4-5)

The combined effect of revenue reduction, lower bad debts, and receivables reduction suggests that offering the discount can yield net positive cash flow benefits. The savings from reduced bad debts and receivables outweigh the revenue loss, provided that the discounted early payments improve cash flows and reduce financing costs.

In conclusion, the firm's decision should favor offering strategic discounts if the net cash benefits and reduction in resource investment costs surpass potential revenue losses, supporting enhanced liquidity and operational efficiency.

Recommendations and Financing Sources (Questions 5 and 6)

Based on these analyses, it is advisable for Casa de Diseñо to implement targeted credit policies, such as the 3/10 net 60 offer, and strive to align inventory management with industry standards to optimize its cash conversion cycle. Additionally, the company should consider aggressive receivables collection strategies, including early payment discounts, to improve liquidity.

For financing the reduced resource investments, Casa de Diseñо can explore various short-term sources. Unsecured options include trade credit extensions and bank lines of credit, while secured sources might involve inventory financing or leasing arrangements. Evaluating these options' costs and benefits is crucial for ensuring liquidity without excessive financing costs.

In sum, an integrated approach combining operational improvements with strategic financing choices will strengthen Casa de Diseñо's financial health and market competitiveness.

References

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  • Brigham, E. F., & Ehrhardt, M. C. (2016). Financial Management: Theory & Practice (15th ed.). Cengage Learning.
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