Question

Limo Ltd is a small family owned company that has been suffering from the credit crunch and has very limited borrowing power. The company gets it finance mainly from bank overdraft which has been tightened up and the interest rate has been increasing. One of the main problems is that the company suffers from the late payment of their debtors and even default. Limo offers credit to all of its customers and most of them pay after the due dates. The board of directors decided to look into their cash flow situation and new proposal were put forward for consideration. 1. Delaying payment to creditors: at the moment Limo pays its creditors on 30 days from invoice. Often the invoice is received before the good arrived. The credit manager proposed delaying payment to creditors till customers pay. 2. Offering discount for prompt payment to debtors. At the moment the debtor payment system is as follow: · 0nly 20% of customers pay within one month · 15% pay after two month · As many as 50% pay after three month and · 13% pay take four months to pay The board of director consider this patter unacceptable and wants to bring payment forward. A marketing research conducted last month showed that if a two-part-term is introduced for payment within 1 month at 2.5% discount then the patter will improve as follows: · As many as 70% will take the discount and pay within one month · Only 5% will pay within two month · 10% will pay within three month and · And the payment after four month increases by 1% to 14% 3. The company may try to negotiate a five year loan backed up by one of the marketable assets. The company’s cost of capital is 15% and the annual turnover is £12m. You are required to: a) Discuss the different options and make some recommendations. b) Evaluate the discount for prompt payment to see whether or not such a scheme is worth introducing (it is necessary to compute the expected costs and benefits of the discounts). c) Discuss other additional benefits of introducing a prompt payment sch

Answer 1

A) There are many ways to maintain cash flow

1. Payment to creditors : generally our credit period is 30 days instead of paying with in one month we can request or ask vendors to give more credit period like 60 days it will give more cash flow to the company and in the mean time we will provide discount to debtors to get the money immediately and that will more cash flow and cash in hand this recommendation only useful for short time for this company need to bear some expenditure

Long term they need to control costs and as well as need to maintain stock based on the current demand this will helpful to maintain the cash flow without any cost of discount and any other expenditure and company can negotiate five year loan it will give more cash flow into the company with low cost rate without spending any additional amount.

2. Calculating the discount portion

2.5% allowing discount it good option to generate the cash immediately and it will also benefit to the customers and company can attract new customers and company also benefited for cash flow this is best option and company only bearing the EUR 210000 per year

3 As per above recommendation company can continue to allow prompt payment scheme to customers