Integrative Case 7
Casa de Diseno
In January 2012, Teresa Leal was named treasurer of casa de Diseflo. she decided that she could best orient herself by systematically examining each area of the company's financial operations. She began by studying the firm's short-term financial activities. Casa de Diseflo is located in Southern California and specializes in a furniture line called "Ligne Moderna." of high quality and contemporary design, the furniture appeals to the customer who wants something unique for his or her home or apartment. Most Ligne Moderna furniture is built by special order because a wide variety of upholstery, accent trimming, and colors is available. The product line is distributed through exclusive dealership arrangemenrs with well-established retail stores' Casa de Diseflo's manufacturing process virtually eliminates the use of wood. Plastic and metal provide the basic framework, and wood is used only for decorarive purposes.
casa de Disefro entered the plastic-furniture market in late 2004. The company markets its plastic-furniture products as indoor-outdoor items under the brand name "Futuro." Fururo plastic furniture emphasizes comfort, durability and practicality and is distributed through wholesalers. The Futuro line has been very successful, accounting for nearly 40 percent of the firm's sales and profits in 2011. Casa de Diseflo anticipates some additions ro the Futuro line and also some limited change of direction in its promotion in an effort to expand the applications of the plastic furniture.
Leal has decided to study the firm's cash management practices. To determine the effects of these practices, she must first determine the current operating and cash conversion cycles. In her vestigations, she found that Casa de Diseflo purchases all of its raw materials and production supplies on open account. The company is operating at production levels that preclude volume discounts. Most suppliers do not offer cash discounts, and Casa de Diseflo usually receives credit terms of net 30. An analysis of casa de Diseflo's accounts payable showed that its average payment period is 30 days. Leal consulted industry data and found that the industry average payment period was 39 days. Investigation of six California furniture manufacturers revealed that their average payment period was also 39 days.
Next, Leal studied the production cycle and inventory policies. casa de Disefro tries not to hold any more inventory than necessary in either raw materials or finished goods. The average inventory age was 110 days. Leal determined that the industry standard, as reported in a survey done by Furniture Age, the trade association journal, was 83 days.
casa de Disefio sells to all of its customers on a net-60 basis, in line with the industry trend to grant such credit terms on specialty furniture. Leal discovered, by aging the accounts receivable, that the average collection period for the firm was 75days. Investigation of the trade association's and California manufacturers' averages showed that the same collection period existed where net-60 credit terms were given. Where cash discounts were offered, the collection period was significantly shorlned. Leal believed that if casa de Diseflo were to offer credit terms of 3/10 net 60, the average collection period could be reduced by 40 percent. Casa de Diseflo was spending an estimated $26,500,000 per year on operatingcycle investments. Leal considered this expenditure level to be the minimum she could expect the firm to disburse during 2012. Her concern was whether the firm's cash management was as efficient as it could be. She knew that the company paid 15 percent annual interest for its resource investment. For this reason, she was concerned about the financing cost resulting from any inefficiencies in the management of Casa de Diseflo's cash conversion cycle. (No/e: Assume a 365-day year and that the operating-cycle investment per dollar of payables, inventory, and receivables is the same.)
a. Assuming a constant rate for purchases, production, and sales throughout the year, what are Casa de Diseflo's existing operating cycle (OC), cash conversion cycle (CCC), and resource investment need?
b. If Leal can optimize Casa de Diseflo's operations according to industry standards, what will Casa de Diseflo's operating cycle (OC), cash conversion cycle (CCC), and resource investment need to be under these more efficient conditions?
c. In terms of resource investment requirements, what is the cost of Casa de Disefro's operational inefficiency?
d. (1 ) If in addition to achieving industry standards for payables and inventorS the firm can reduce the average collection period by offering credit terms of 3110 net 60, what additional savings in resource investment costs will result from the shortened cash conversion cycle, assuming that the level of sales remains constant?
(2) If the firm's sales (all on credit) are $40,000,000 and45"/o of the customers are expected to take the cash discount, by how much will the firm's annual revenues be reduced as a result of the discount?
(3) If the firm's variable cost of the $40,000,000 in sales is 807o, determine the reduction in the average investment in accounts receivable and the annual savings that will result from this reduced investment, assuming that sales remain constant.
(4) If the firm's bad-debts expenses decline from2Y, to-1..5"/o of sales, what annual savings will result, assuming that sales remain constant?
(5) Use your findings in parts (2) through (4) to assess whether offering the cash discount can be justified financially. Explain why or why not.
e. On the basis of your analysis in parts a through d, what recommendations would you offer Teresa Leal?
f. Review for Teresa Leal the key sources of short-term financing, other than accounts payable, that she may consider for financing Casa de Diseflo's resource investment need calculated in part b. Be sure to mention both unsecured and secured sources.
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