Working Capital Management: Analysis Project #1
Dr. Echevarria
Spring, 2013
Cameron School of Business
Working Capital Management Project
The WCM project is an exercise using an enhanced cash budget to make changes to operating
parameters in order to observe the impact on the pro forma income and balance sheet statements. The
exercise uses an MS Excel spreadsheet. There are several management strategy options that will be
simulated in order to gauge the results on operating cash flows and profitability. You task will be to
analyze each option and determine which options will improve profitability.
Your analyses will be written using a MS-Word document. Copy and paste from the spread sheet
only the 6 [green] cells containing the Changes in Operating Income, Net Profit Margin, and Net
Income. Label the word document as follows: LASTNAME_WCM.doc and email assignment to
davidpe@charter.net. The assignment is due by midnight (Sunday), February 24, 2013.
Background
The Reliant Electrical Systems, Inc (RES) was started in 1967 to produce standby home power
generators in the 12 to 15 Kilo-Watt peak output range (100 - 125 Amps at 120 volts AC). RES sells
the generators to electrical equipment retailers and to home improvement outlets such as Home Depot
and Lowes. In addition, a number of units are sold to small construction companies as well as state and
federal agencies. The main facility is a 150,000 square foot building located in Richardson, Texas. This
building houses company offices and the production facility. The company has 190 production
employees, 16 production supervisors, and additional 26 workers and supervisors providing quality
control (QC), warehousing (shipping and receiving), and production/inventory control (Factory
Overhead). RES has 10 sales representatives covering the US, Canada, and Mexico. 18 persons work in
the company's administrative and executive offices. The company leases 60,000 square feet of
warehouse space. The leased warehouse is used to store raw material and finished goods inventory.
This lease facility is located in the same industrial park facility.
The generators are sold FOB Richardson, TX at a list price of $2,495. The manufacturer's suggested
retail (MSRP) price is $3195.00. The market for LEC's power generators has been growing at the rate
of 3 to 5% per year. The terms are Net 30 for US customers. Canadian and Mexican shipments are net
60 or 90 days depending on the customer’s credit history. The management of RES is looking to expand
its markets to Africa, Asia, and Europe.
Production Facility and Production Standards
The current facility was built in 1998 to provide sufficient space to support sales, service, and the
administrative staff as well as the production facility. Approximately 90,000 square feet are allocated for
production operations. 70,000 square feet comprise the production area; the remaining area (20,000 sq.
ft.) is allocated for shop-floor control, materials handling, and areas for inspection, packaging, shipping
and receiving. The current layout of the production facility is designed to support a maximum capacity
of 48,000 units per year (4000 per month maximum capacity). The most efficient production rate has
proved to be 3200 units per month. When this production rate is exceeded or reduced, production costs
increase approximately 3% for each 5% increase or decrease in production rate (from the 3200 per
month best rate). See formulas on line 61: Direct Labor Multiplier on the "CashBud" sheet.
1
Project Requirements
The currently scheduled production for the 4th quarter, FY2012 is firm. The company is in its final
planning stages for FY2013. It is now mid-November. Management is concerned about low
profitability; i.e., net profit margins (NPM), return on investment (ROI), and return on equity (ROE).
The current net profit margins are running around 4.0%. RES management would like to increase NPM
to 6 percent or more next year. There are several proposals being suggested. You are part of a
management task team assigned to analyze the following proposals. Using the prepared spreadsheet,
perform an analysis of the following management policy options. Analyze each proposal separately and
make a recommendation as to the proposed course(s) of action. Key to your analysis are the values in
C33 (Change in Operating Income), C35 (Net Profit Margin) and C37 (Change in Net Income). Your
written analysis should include (a) if the change is beneficial (or not) and (b) specific reference to how
OI, NPM and NI change. The final assignment should be no longer than 2 pages. Do not include
printouts or copies of the spreadsheets. Any discussion that sheds additional light on the analysis should
also be included. Finally, don’t forget to remove the changes made before proceeding to the next option.
Recommendations to Management
Your final recommendations to management should include the combined effects of all the options that
improve profitability (the “Stack”). Keep in mind that each recommendation that increases NPM and
Net Income is a positive step. Be careful when combining positive and negative percentages: Example if
one proposal reduces sales 2.5% and another increases sales by 6% - the combined effect is +3.5%.
A1.The sales staff believes RES can increase the FOB price by $125.00 per unit. This increase
in price is expected to decrease sales by 2.5%. [Hint: Increase B3 by $125. Enter -2.5 in cell
B66.]
A2. The ad agency used by RES believes that a $75 decrease in price may increase sales by 5%.
B. The R&D engineers have redesigned the base product to reduce the assembly time from 12.5
hours to 11.0 hours. Implementation of the new design would occur in January 2011. Material
costs for the new design would result in an increase of $20 per unit. (B17, B18)
C. The CFO believes we can run our operations just as smoothly with less cash. She believes
that the firm can operate with .50 times next month's sales level without impacting our supplier
payment schedules. In addition, LEC would reduce the level of borrowing against the firm's
revolving line of credit agreement with First Fleet. The Firm's CEO and COO are somewhat
skeptical and believe this will result in insignificant savings and will increase operating risk.
(B47)
D. The Accounts Receivable Supervisor believes we could improve our bad debt experience by
changing our credit granting and credit collection procedures. For example, a review of our
manufacturer reps reveals that most of the bad debt experience is concentrated in a few reps.
Tightening credit standards should reduce the bad debt experience to 1.25% of sales. This would
come at an increase in administrative costs of $4200 per month for an additional staff member.
No change in total sales is anticipated. (C27)
2
E. The Sales Manager has suggested that we might speed up collections by offering cash
discounts. The Sales manager suggests that terms be changed to 2/10 Net 30. The experience of
other companies in the industry suggests that cash payments will increase to 35 percent in the
month of sale, 25 percent in the month after sale, and 20 percent two months after the sale. The
balance (20 percent) is collected 90 days after the sale (less any residual bad debt experience).
(B8, B9,B10,B11,B12)
F. The Marketing Manager believes that RES can use more advertising and sales promotion
activity. She suggests that RES increase the advertising and sales promotion budget to 4.5%
should result in sales increases of 6%. (B26, B66)
G. The Manufacturing Manager suggested that RES increase the finished goods inventory from
1 to 2 weeks. This should result in lower unit costs. (B58)
Miscellaneous Notes
A. The [forecast] beginning cash balance for FY2013 is $5,505,409.
B. The required level of cash [liquidity] is 0.75 times the forecast sales for the current month.
C. The Negotiated Revolving Line of Credit Agreement interest rate for FY2013 is 6.5%.
However, if the firm can increase its Times Interest Coverage ratio above 5, the bank will reduce
RES’ borrowing rate to 5.50%.
D. The forecast interest rate for the money market account for FY2013 is 0.25%
E. Ending Inventories are valued at the cost for direct materials and labor. Production likes to
have one month's worth of raw materials on hand and approximately one week of finished goods
in the warehouse.
F. Inventory is purchased the month before production and paid for in the month of production.
Terms from our suppliers are typically Net 30.
G. Production labor costs paid twice monthly on the 7th and the 22nd. Pay on the 7th is for the last
two weeks of the previous month. Pay on the 22nd is for the first two weeks of the current month.
H. Factory overhead, selling, and administrative expenses are paid the same month as sales. Pay
scheduled for the 4th Friday of each month.
I. Bad Debt expenses are constructively booked after 120 days from the original sale. For
example, gross sales of $6,237,500 in January, 2013, will have $124,750 (2 %) in uncollectable
accounts booked during the month of April, 2012. Any collections made after that period will be
entered as adjustments at the end of the year.
3