I.

Introduction
Short term financing refers to financing needs for a small period normally less than a year. In
businesses, it is also known as working capital financing. This type of financing is normally
needed because of uneven flow of cash into the business, the seasonal pattern of business, etc. In
most cases, it is used to finance all types of inventory, accounts receivables etc. There are
various types and sources of short-term financing for a business and each type has different
characteristics and can be used in different situations. It includes Trade Credit, Short Term
Loans, Business Line of Credit, Invoice Discounting, and Factoring. One of the most common
source of Short Term financing is the Accounts Payable which can be delayed to pay in the
suppliers.

II. Statement of the Problem

In January 2012, Teresa Leal was named treasurer of Casa de Diseño. She decided that she
could best orient herself by systematically examining each area of the company’s financial
operation. She began by studying the firm’s short-term financial activities.

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. Next,
Leal studied the production cycle and inventory policies. Her concern was whether the firm’s
cash management was as efficient as it could be. For the reason, she was concerned about the
financing cost resulting from any inefficiency in the management of Casa de Diseño’s cash
conversion cycle.
 III. Objectives of the Study

To identify Casa de Diseño’s existing operating cycle (OC), cash conversion cycle
(CCC), and resource investment need. Assuming a constant rate for purchases,
production, and sales throughout the year and if Leal can optimize c operations
according on industry standards.

To determine the cost of Casa de Diseño’s operational inefficiency in terms of resource

investment requirements

To know the additional savings in terms of resource investment costs will result from
the shortened cash conversion cycle, assuming the level of sales remained constant.

To present the firm’s reduction of annual revenue as a result of the discount if the firm’s
sales (all on credits are $40,000,000 and 45% of the customers are expected to take the
cash discount.)

To determine the reduction in the average investment in accounts receivable and the
annual savings that will result from this reduced investment, assuming that the firm’s
variable cost of the $40,000,000 in sales as 50%, and sales remain constant.

To determine the annual savings if the firm’s bad debts expenses decline from 2% to
1.5% of sales assuming that sales remain constant.

To explain whether adhering the cash discount can be justified financially or not.

To identify the key source of short –terms financing both unsecured and secured
sources., other than accounts payable, that may consider for financing Casa de Diseño’s
resource investment need.

IV. Areas of Consideration

Casa de Diseño purchases all of its raw materials and production supplies on open
account. The company is operating at production levels that prelude volume discounts. Most
suppliers do not offer cash discounts, and Casa de Diseño usually receives credit terms of net 30.
An analysis of Casa de Diseño’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
peiod was also 39 days.
 Next, Leal studied the production cycle and inventory policies. Casa de Diseño 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 Diseño 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 firms were given. Where cash discounts
were offered, the collection period was significantly shortened. Leal believed that if Casa de
Diseño were to offer credit terms of 3/10 net 60, the average collection period could be reduced
by 40 percent.

Casa de Diseño was spending an estimated $26,500.00 per year on operating cycle
investments. Leal considered the 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 the reason, she was concerned about the financing cost resulting from any
inefficiency in the management of Casa de Diseño’s cash conversion cycle. (Note: Assume a
365-day year and that the operating-cycle investment per dollar payables, inventories, and
receivables is the same.)

V. Alternative Courses of Action

1. Use formulas to solve the operating cycle, cash conversion cycle, resource
investment need and the likes in line industry or the assumed rate.
2. Solve for the operating cycle, cash conversion cycle, resource investment and
additional savings both with or without cash discount.
3. At the end of the computations in each requirement, present possible sources of
short –terms financing both unsecured and secured sources other than accounts
payable, that may consider for financing Casa de Diseño’s resource investment
need.
4. Use table or charts to illustrate the result of the findings on Casa de Desiños
current operations.
 VI. Analysis

a. Assuming a constant rate for purchases, production, and sales throughout the year, what
are Casa de Diseño’s existing operating cycle (OC), cash conversion cycle (CCC), and
resource investment need?

Operating Cycle = Average Age of Inventory + Average Collection Period

= 110 days +75 day

= 185 days

Cash Conversion Cycle = Operating Cycle – Average Payment Period

= 185 days−30 days
= 155 days
Total Outlays
Resources Investment Need = x Cash Conversion Cycle
365 days
$ 26,500,000
= x 155 days
365 days
= $11,253,425
Explanation: Assuming a constant rate for purchases, production, and sales throughout
the year, Casa de Diseño has an existing operating cycle (OC) of 185 days,
given 30 days as the average payment the cash conversion cycle (CCC)
will be 155 days, and resource investment need amounting to $11,235,425
is affected with the result of CCC as to the total amount needed by the
entity during the 155 days.
b. If Leal can optimize Casa de Diseño’s operations according on industry standards, what
will Casa de Diseño’s operating cycle (OC), cash conversion cycle (CCC), and resource
investment need to be under these more efficient conclusion?

Operating Cycle = Average Age of Inventory + Average Collection Period

= 83 days +75 day

= 158 days

Cash Conversion Cycle = Operating Cycle – Average Payment Period

= 158 days−39 days
= 119 days
Total Outlays
Resources Investment Need = x Cash Conversion Cycle
365 days
$ 26,500,000
= x 119 days
365 days
= $8,639,726
Explanation: This computation is based on industry standards wherein Leal can optimize its
operations. Hence, resulted Casa de Diseño’s operating cycle (OC) to decrease,
 cash conversion cycle (CCC) also decline by 39 days, and for that changes the
resource investment need also decrease which concludes that is more efficient to
go with the standard than use the former data.

c. In terms of resource investment requirements, what is the cost of Casa de Diseño’s

operational inefficiency?

Cost of Operational Inefficiency = (Negotiated Financing-Industry Resources Needed) x 15%

= (11, 253,425 – 8,639,726) x 15%
= $392,055
Explanation: Casa de Diseño has $392,055 cost operational inefficiency. Cost operational
inefficiency Search about this.
d. (1)-If in addition to achieving industry standards for payables and inventory, the firm
can reduce the average collection period by offering credit term of 3/10 net 60, what
additional savings in resource investment costs will result from the shortened cash
conversion cycle, assuming the level of sales remained constant?

Reduction in collection period = 75 days – 30 days = 45 days

Operating Cycle = Average Age of Inventory + Average Collection Period

= 83 days +45 days

= 128 days

Cash Conversion Cycle = Operating Cycle – Average Payment Period

= 128 days−39 days
= 89 days
Total Outlays
Resources Investment Need = x Cash Conversion Cycle
365 days
$ 26,500,000
= x 89 days
365 days
= $6,461,644
Additional Savings = (Industry Resources Needed - Negotiated Financing) x 15%
= (8,639,726 - 6,464,644) x 15%
= $326,712
Explanation: Assuming the level of sales remained constant the additional savings in resource
investment ($6,461,644) costs is $326,712 as a result of the shortened cash conversion cycle (89
days). The firm’s reduction of the average collection period by offering credit term of 3/10 net
60 which is intended to achieving industry standards for payables and inventory are the main
reason to come up with that amount of additional savings. Take note that the negotiated
financing is the same with the resource investment need in this case of offering the said credit
terms which is different with the industry resources needed. The 15% of the difference of the
industry need and negotiate financing is now the additional savings.

d. (2) If the firm’s sales (all on credits are $40,000,000 and 45% 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?
 Reduction in Sales = (Sales x cash discount) x percentage of customer to take cash discount
= (40,000,000 x 0.03 x 0.45)
= $540,000
Explanation: By $540,000 the firm’s annual revenues be reduced as a result of discount.
Given that the firm’s sales (all on credits are $40,000,000 and 45% of the customers are
expected to take the cash discount) aside from the 3% discount on the credit terms is one
factor to consider the amount of reduction in sales.

d. (3) If the firm’s variable cost of the $40,000,000 in sales as 80%, 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.

With cash discount,

40,000,000 x 0.80
Average Investment in Accounts Receivable = 365
45

= $3,945,205
Without cash discount,
40,000,000 x 0.80
Average Investment in Accounts Receivable = 365
75

= $6,575,342
Reduction in Investment in Accounts Receivable = $6,575,342 - $3,945,205
= $2,630,137
Annual savings= $2,630,137 x 15% = 394,521

Explanation: Assuming that sales remain constant, the reduction of investment in accounts
receivable is $2,630,137. Prior to that the average investment in accounts receivable both with
or with cash discount is vital to know the reduction in account receivable and the annual savings.
The firm’s 80 % variable cost in sales indicates that the 20% is the profit. The annual savings in
this case is somewhat higher than the earlier two. The cash discount also indicates an important
role in the cost of savings as well as the credit terms offered.

d. (4) If the firm’s bad debts expenses decline from 2% to 1.5% of sales, what annual
savings will result, assuming that sales remain constant?
Reduction in Bad Debt Expense = Sales (0.02 x 0.015)
= 40,000,000 (0.02 x 0.015)
= $200,000
Explanation: The reduction Bad Debts expense
d. (5) Use your findings in parts (2) through (4) to access in whether adhering the cash
discount can be justified financially. Explain why or why not?

Answer: Yes. Based on our findings in parts 2 and 4 offering the cash discount as mentioned in
the case could be justified financially for this specific reasons. It would reduce the average
collection period by 30 days which result a lesser days of cash conversion cycle. This implies
that going with the standard is 39 days faster than the assumed constant rate. In this implication
the average investment in accounts receivable would decrease to $2,630,137. Thus, this would
give the company $394,521 annual savings.
List of key sources of short–terms financing

Based on the nature of task (e), it will serve as the conclusion part of the case as well its
recommendations as a whole.

VII. Recommendations and Conclusion

e. On basis of your analysis in parts a trough d, what recommendations would you offer
Terresa Leal?

Recommendations:
 In terms of Cash operating cycle and cash conversion cycle, Ms. Leal should keep an eye
with in the standard as to reduce the resource investment need which can be helpful to the
company.

 Ms. Leal should bring the working capital measures in line with the industry and offer
the proposed cash discount.

 Minimize cost of operational efficiency by resorting to other secured or unsecured

financing.

Conclusion:
By offering a cash discount, the firm would save $394,521 while in offering the said
credit that would reduce the average collection period resulted an additional savings of $326,712.
This amounts were higher than the amount in case the company is not meeting with the industry
standard.
On the other hand, since Casa de Diseños’ s suppliers does not usually offer a cash
discount, the company should keep with availing the cash discount as it reduces cost of resource
investment need. The average payment of accounts payable of the entity is 9 days earlier than
with the industry. Given with the 30 days’ credit terms given by supplier, it seems the company is
closely below with the par of financing its borrowings. However, this is not the point that really
speaks out that the business is having trouble in terms of financing. It is a good implication that
there is an increase of 33.33 % reduction of bad debt expense. This only shows that there is a
good thing happen in accounts receivable, the collection increases as bad debt expense decreases.
The case also requested other secured or unsecured financing to consider and it was enumerated
for an intention of helping Teressa Leal in making alternatives measures and in the entity’s
decision making.
Thus, the company should be advisable to consider the industry standards as to help the
entity in the long run. The company can easily adapt in cases of sudden changes in terms of
financing as provided with this alternative courses of measures and observation.