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

These are some of "Main source of Finance for the company"

(I) Offer through Prospectus
The most commonly used method for raising funds in primary market is offer through
prospectus. It involves inviting the subscriptions from public by issue of prospectus. A
prospectus is published as advertisements in newspapers, magazines, etc. It provides such

information as the purpose for which the fund is being raised, company's background and
future prospects, its past financial performance, etc. Such information helps the public and the
investors to know about the company as well as the potential risk and the earnings involved.
Such issues need to be listed on one of the stock exchanges and should be in accordance with
the guidelines and rules listed under the Act and regulation disclosure.

(ii) Offer through Sale
Under the offer through sale method, the company does not issue securities directly to the public
rather they are issued through intermediaries such as brokers, issuing houses, etc.

how this flow

Company to intermediaries than intermediaries to Market

(iii) Private Placement
Under this method, the securities are sold only to some selected individuals and big institutional
investors rather than to the public. The companies either allot the securities themselves or they
sell the securities to intermediaries who in turn sell them to selected clients. This method saves
the company from various mandatory or non-mandatory expenses such as cost of manager fees,
commission, underwriter fees, etc. Thus, the companies which cannot afford the huge expenses
related to public issue often go for private placement.
(iv) Rights Issue
This is a privilege given to existing shareholders to subscribe to a new issue of shares according to
the terms and conditions of the company. The shareholders are offered the ‘right’ to buy new
shares in proportion to the number of shares they already possess.

Benefits of prompt payment

1. immediate cash

2. reduce the credit cycle

3. improve profitability

4. avoid the cash crunch

5. less working capital requirement to organisation

6. less chance of baddebts