Question

An arrangement has been made with the local bank that if ToyWorks maintains a minimum balance of $70,000 in their bank account before considering any interest obligation, they will be given a line of credit (ie. ability to borrow from the bank) at a rate of 6 % per annum. All borrowing is considered to happen on the first day of the month, repayments are on the last day of the month. Interest must be paid at the end of each month.

Assume that ToyWorks is unable to obtain the bank financing discussed above and is forecasting a cash deficiency in October 2020. Propose five alternative actions that ToyWorks may consider to avoid this deficiency briefly reflecting your reasoning.

Answer 1

The alternatives are:

1] Offering cash discount to the firm's receivables.

If the firm is not giving cash discount to its customers, it can consider extending cash discount. Cash discounts have to be attractive and hence are more costly than the bank loan, which, is offering funds at 6% APR. This option does not involve any formalities like the bank loan.

2] Factoring the receiables:

This is an off balance sheet option. Though costlier than the bank loan it will help in tiding over the temporary cash crunch.

The factoring arrangement may also help in minimizing collection costs.

3] Stretching the account payables to the maximum extent without affecting credibility. In the process the firm can also forgo any discount offered by the suppiers, eventhough it would be very costly, as trade discounts have higher implied cost.

4] Deferring capital expenditures, dividends etc. These are discretionary items and can be deferred till such time the situation becomes better.

5] Reducing material purchases after reviewing inventory levels. This will reduce dues to suppliers.