Casa de Diseo

In January 2015, Teresa Leal was named treasurer of Casa de Diseo. She decided

that she could best orient herself by systematically examining each area of the

companys financial operations. She began by studying the firms short-term financial

activities.

Casa de Diseo, located in southern California, specializes in a furniture line

called Ligne Moderna. Of high quality and contemporary design, the furniture

appeals to the customer who wants something unique for his or her home or apartment.

Most Ligne Moderna furniture is built by special order because a wide variety

of upholstery, accent trimming, and colors is available. The product line is distributed

through exclusive dealership arrangements with well-established retail stores.

Casa de Diseos manufacturing process virtually eliminates the use of wood. Plastic

and metal provide the basic framework, and wood is used only for decorative

purposes.

Casa de Diseo entered the plastic-furniture market in late 2007. The company

markets its plastic-furniture products as indooroutdoor items under the brand

name Futuro. Futuro plastic furniture emphasizes comfort, durability, and practicality

and is distributed through wholesalers. The Futuro line has been very successful,

accounting for nearly 40 percent of the firms sales and profits in 2014. Casa de

Diseo anticipates some additions to the Futuro line and also some limited change of

direction in its promotion in an effort to expand the applications of the plastic

furniture.

Leal has decided to study the firms cash management practices. To determine

the effects of these practices, she must first determine the current operating and cash

conversion cycles. In her investigations, she found that Casa de Diseo purchases all

its raw materials and production supplies on open account. The company is operating

at production levels that preclude volume discounts. Most suppliers do not offer

cash discounts, and Casa de Diseo usually receives credit terms of net 30. An analysis

of Casa de Diseos 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 period was also 39 days.

Next, Leal studied the production cycle and inventory policies. Casa de Diseo

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 Diseo sells to all 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 firm was 75 days.

Investigation of the trade associations and California manufacturers averages

showed that the same collection period existed where net-60 credit terms were given.

Where cash discounts were offered, the collection period was significantly shortened.

Leal believed that if Casa de Diseo were to offer credit terms of 3/10 net 60, the

average collection period could be reduced by 40 percent.

Casa de Diseo was spending an estimated $26,500,000 per year on operatingcycle

investments. Leal considered this expenditure level to be the minimum she

could expect the firm to disburse during 2015. Her concern was whether the firms

cash management was as efficient as it could be. She knew that the company paid

15 percent annual interest for its resource investment. For this reason, she was concerned

about the financing cost resulting from any inefficiencies in the management

of Casa de Diseos cash conversion cycle. (Note: Assume a 365-day year, and assume

that the operating-cycle investment per dollar of payables, inventory, and

receivables is the same.)

Questions I am having issues with:

1) If in addition to achieving industry standards for payables and inventory the

firm can reduce the average collection period by offering credit terms of 3/10

net 60, what additional savings in resource investment costs will result from

the shortened cash conversion cycle, assuming that the level of sales remains

constant?

2)If the firms variable cost of the $40,000,000 in sales is 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.