WEEK FOUR ESSAY (Ray’s Bonefish Paradise)
Ray Hetchka, a retired English professor, recently launched a new business in Miami called Ray’s Bonefish Paradise (RBP). Ray decided at age 62 that he wasn’t quite ready to retire early and lounge around at home living the life of leisure. Ray’s passion is fishing, and he always dreamed of opening a saltwater fly fishing specialty company. Since Ray’s educational background was in literature and not in business, he hired you, as a noted business finance expert, to help him with the company’s cash management and credit policies.
Regarding his company’s credit policy, Ray also needs your help to determine if changes are needed. One of his summer interns from the local community college, who will soon graduate with a finance major, recommended that the credit terms be changed from 2/10, net 30 to 3/20, net 45 and that both the credit standards and the collection policy be relaxed. According to the intern, this change would cause sales to increase from $3.6 million to $4.0 million.
Currently, 62.5% of RBP’s customers pay on Day 10 of the billing cycle and take the discount, 32% pay on Day 30, and 5.5% pay (on average) on Day 60. If the new credit policy is adopted, Ray estimated that 72.5% of customers would take the discount, 10% would pay on Day 45, and 17.5% would pay late, on Day 90. Bad debt losses for both policies are expected to be trivial. Variable operating costs are currently 75% of sales, the cost of funds used to carry receivables is 10%, and the marginal tax rate is 40%. None of these factors would change as a result of a credit policy change.
Ray is very eager to learn, so he asked you to perform a detailed analysis and report to help him understand cash management and credit policies. Make sure your report includes details and examples that can help Ray better understand the following key decision points:
a. What is the goal of cash management and why do firms hold cash?
b. What is meant by the terms precautionary and speculative balances?
c. What are some specific advantages for a firm holding adequate cash balances?
d. How can a firm synchronize its cash flows, and what good would this do?
e. You have been going through the company’s checkbook and bank balances. In the process, you discovered that RBP, on average, writes checks in the amount of $10,000 each day and that it takes about five days for these checks to clear. Also, the firm receives checks in the amount of $10,000 daily, but loses four days while they are being deposited and cleared. What is the firm’s disbursement float, collections float, and net float?
f. How could Ray’s firm speed up collections and slow down disbursements? Why would this be important?
g. Should RBP make the credit policy change? Assume that operating and credit costs are paid on the day of the sale.