198 ◾ Introduction to Working Capital Cases

CASE: WIDGET MANUFACTURING

It was beautiful and sunny just before the Memorial Day holiday when Arnold
Parks left a difficult meeting with his banker, Uriah R. (U. R.) Clueless of Second
National Bank of Chicago. Arnold and his father, Arnold Sr., who had estab-
lished Widget Manufacturing, have banked with Second Chicago for almost
30 years. U. R. had just informed Arnold that the bank will not extend its line
of credit beyond the current amount.
In addition, the overdue portion of notes payable must be paid within three
months, by Labor Day. Although Arnold was irritated by the lender’s demand,
the note was over 30 days past due, and Arnold did not see how any more than
a token payment could be made during the next 60 days.

Company History
Arnold’s father founded Widget Manufacturing in 1946 shortly after he had com-
pleted his military service in World War II. The company originally focused on
radio components and eventually branched out into various types of consumer
electronics products. Shortly after 1950, the first salesmen were hired to call on
stores in the Midwest. During the next decade, the business continued to grow, and
by 1976, when Arnold took over as president, annual sales had risen to $75 million.
The current product line supplements nationally advertised merchandise
in many stores using the retailer’s own private brand. The private brands offer
a cheaper price to consumers than such name brands as Hewlett‐Packard (HP)
and Samsung. For stores that do not have a private brand, the Widget brand
name—Diode Circuitry—is used.

The Cash Cycle

Although some stray checks are received in the Chicago headquarters (about
10 percent of the total billed), Widget’s manufacturing facilities are individu-
ally responsible for their own billing and collections activities. Customers are
instructed to mail their remittances to the address of the plant responsible for
the merchandise; the plants are located in the following cities:

Televisions and radios St. Louis, MO

Wireless telephones and related equipment Decatur, IL
Laptop computers and related equipment South Haven, MI

The mail is delivered by U.S. Postal System local route mail carriers to each of
the plants between 11:00 a.m. and 2:00 p.m. daily.
 Case: Widget Manufacturingâ•… ◾ 199

On the first business day of the month, the plant manager at each location
reviews the prior month’s ending balance at the local bank and determines if
cash is above or below the target balance level. He or she deposits excess cash
to the principal bank (Second National) by mailing a check drawn on the local
bank, or draws down cash to cover shortfalls by depositing a Second National
Bank check at the local bank. The plant managers also prepare forecasts of cash
requirements for the current month. They fax their month‐end cash positions,
transfers by check, and cash forecasts to the corporate treasurer, Ernie Paydoff,
by the second business day of the month.
Ernie gets daily balance reports on his computer from Second National,
which has a target balance of $1 million in the master account, and estimates
his cash position by 1:00 p.m. When there is excess cash, it is invested in over-
night repos in increments of $50,000. Shortfalls are covered by borrowing
against a revolving line of credit at the bank for which the company is cur-
rently charged prime +3 percent (although this is likely to increase the next
time credit is negotiated).

Bank Relationships
A monthly cash forecast is compiled, and Ernie reviews the balances and trans-
fers cash to or from Second National to maintain the local account target bal-
ances that he has established. Ernie does not monitor the local bank balances
because they are usually stable during the month once all the plant managers
have made their deposits and withdrawals.
If one of the business units requires an emergency infusion of cash during
the month, the plant manager calls Ernie to report that he or she is writing a
check against the principal account. As long as there is an adequate amount in
that account, Ernie does not worry about funding it until the normal month‐end
cycle.
Widget maintains relationships with several banks around the coun-
try, primarily because of the decentralized nature of the organization, the
autonomy granted to plant managers, and the concern for access to borrow-
ing should Second National pull its credit line. Though none of the business
units negotiate individual credit facilities with its banks, each maintains its
own noncredit services.
The plants and the home office maintain a general operating account at
a local bank. This account is used for deposit of all remittances and payment
of all expenses except payroll. Payroll accounts are maintained at separate
banks, primarily because each of the plant managers wants to deal with more
than one local bank.
200 ◾ Introduction to Working Capital Cases

EXHIBIT 12.1 Significant Industry Ratios

Industry
Current ratio 2.75
Quick ratio 1.63
Receivables turnover 7.72
Average collection period (in days) 47.48
Asset turnover 1.96
Inventory turnover 7.02
Return on equity (%) 25.95

I.M. Cash Is Promoted

In the past, Arnold had only dealt with his high school friend, golfing buddy,
and banker Ira M. (I. M.) Cash, and after talking about their favorite rounds of
golf and their twelfth‐grade antics, an increase in the line of credit had always
been granted without I. M. even looking at the financial results. However, three
months ago, I. M. had been promoted to senior vice president in the bank, and
Arnold’s fi rst meeting with U. R. Clueless had been depressing.
U. R. had asked to see an up‐to‐date set of financial statements at their first
meeting. After reviewing these reports (see Exhibits 12.1 through 12.3), U. R.
had talked about cash problems and even noted the possibility of a financial
emergency. There had been no backslapping, no reminiscing about the time
they tied the vice principal to the flagpole, and no golf stories.

EXHIBIT 12.2 Income Statement (in $ millions)

Widget $ Widget %
Net sales $931.6 100.0
Cost of goods 683.9 73.4
Gross profit 247.7 26.6
General and administrative expenses 179.1 19.2
Depreciation expense 16.8 1.8
Interest expense 30.2 3.2
Earnings before taxes 21.6 2.3
Income taxes 7.3 0.8
Net income $14.3 1.5
 Case: Widget Manufacturing ◾ 201

EXHIBIT 12.3 Balance Sheet ($ millions) (% to total

assets and to total liabilities and equity)

Widget $ Widget %
Cash $ 8.0 0.97
Inventories 285.2 34.14
Accounts receivable 217.8 26.07
Total current assets $ 511.0 61.18
Net fixed assets 324.3 38.82
Total assets $ 835.3 100.00
Accounts payable $ 98.2 11.76
Notes payable 112.1 13.42
Other current liabilities 8.6 1.03
Total current liabilities $ 218.9 26.21
Long‐term debt 289.3 34.63
Total liabilities $508.2 60.84
Stockholders’ equity 327.1 39.16
Total liabilities and equity $835.3 100.00

Questions
1. Calculate the most important financial ratios and compare Widget’s re-
sults with industry averages. What do these ratios indicate?
2. What changes do you recommend to the cash cycle of the Widget Company?

Arnold’s Reaction
Arnold could not believe that U. R. had the gall to tell him he needed to drasti-
cally reduce the company’s receivables and to strongly suggest a clearance sale
to reduce inventory. Since the founding of Widget Manufacturing (previously
described), no inventory sales had ever been held, although there was a period
during the late 1970s recession when the price of televisions had to be reduced
to move merchandise.
The growth of the business is causing Arnold to consider opening a fourth
production site, with both Texas and Tennessee under consideration. How-
ever, ongoing cash problems have put this idea on hold. There are 10,000 total
employees, 5,000 in St. Louis and 2,000 each in Decatur and South Haven,
and 1,000 in the home office in Chicago. Each site maintains local vendors and