Float Management

Nathan Daniel is a company that produces and retails designer accessories for young professionals. The company partners Nathan Phillips and Daniel Collins, have been best friends since they started university. Both graduated from Majesty University with a major in accounting and a minor in economics. Both found articling positions in a co-op program during their fourth year at Majesty University. After convocation, Daniel went to work for his father's accounting firm, whereas Nathan worked full-time with the firm where he had articled. After three years, they both passed their national certification exams to become certified accountants.

After two more years of accounting work, the two friends decided to strike out on their own. However, Daniel and Nathan had had enough of spreadsheets, year-end deadlines, and high stress work, and decided to pursue a completely different direction: retail sales of accessories for young, metrosexual professionals. They opened a store in Calgary to sell bags, packs, briefcases, wallets, and other accessories. They also designed some of their own merchandise and sold it under the designer label "Bones." Thanks to a great cover story in Macleans, the Bones brand became an overnight success, and orders started flooding in.

That was five years ago. Today, in addition to servicing their store in Calgary, Nathan Daniel ships merchandise to other retailers, in Alberta, British Columbia, and Ontario. Over the years, 70% of their annual sales of $3,500,000 have shifted to credit sales to other retailers, with 50% in Alberta, 30% in British Columbia, and 20% in Ontario.

As credit sales have increased, managing the cash cycle and float has become important. Most of the credit customers make payments with cheques that are mailed via Canada Post. Cheques from Alberta usually arrive within one business day of posting, whereas cheques from British Columbia take two days, and those from Ontario take about four days to arrive at the Calgary office. When each cheque arrives at the office, Naomi Mitchell, the office manager takes the cheques out of their envelopes, records them, and puts them aside for deposit at the end of business day. It usually takes about three days for the company's bank, Bank of Mount Royal to process and clear the cheques, and deposit the money in the company's account.

In terms of its accounts payable, the company mails its cheques out to its suppliers, all of whom are located in Alberta. The costs of goods sold amounts to approximately 75% of total sales revenue. On average, it takes about one day for suppliers to take their cheques to their banks for deposit, and it takes another three days for their banks to process and clear the cheques.

In the last operating year, the company started the year with payables of $130,000 and ended it with $110,000. Beginning receivables were $175,000, and ending receivables amounted to $145,000; beginning inventory was $80,000, and ending inventory was $120,000; and beginning cash reserves were $20,000, and ending cash reserves were $15,000. Two years ago, Nathan Daniel borrowed $550,000 from the bank at an interest rate of 15% to expand its production and retail facilities. In addition to paying the interest on this loan, they are also repaying 10% of the original principal each year (i.e., it will take another eight years to pay off this loan). At its most recent year-end, the company owned $650,000 in net fixed assets, and Daniel and Nathan had $200,000 in equity in the company. The company uses a line of credit (up to a maximum of $200,000) with its bank to cover shortfalls in its cash-on-hand. The interest on this line of credit is 2% per month.

The manager of the Bank of Mount Royal just phoned Daniel and offered the company same-day deposit for their cheques; this will reduce their availability float to one business day. The fee for this service will be $3,000 per year.

Nathan and Daniel must decide whether this is a good deal or not. At the end of the business week, the partners ordered a large pizza and went to Nathan's place to hash out their decision. They came up with the following list of questions:

1.What are the company's inventory period, receivables period, and payables period? (Round all periods to the nearest integer.)

2.What are the company's operating and cash cycles?

3.How do the company's operating and cash cycles compare to the industry average of 30 and 20 days, respectively?

4.If the company's customers' average cash cycle and operating cycle are 30 and 40 days, respectively, what can we say about the company's credit management policy of net 30?

5.What is the company's average daily collection float? What is its average daily disbursement float? (Use the average mail float to calculate the collection delay, use the average daily cost of goods sold to calculate the average daily disbursement float, and use the average daily credit sales to calculate the average daily collection float.

6.What is the company's net float?

7.What is the effective annual interest rate on the company's line of credit? What is the annual short-term interest expense based on this effective annual rate? Assume that the ending short-term borrowing amount is the average short-term borrowing amount. This average amount can then be multiplied with the effective annual interest rate to obtain the short-term interest expense. Note that you will need to construct the Statement of Financial Position to find the ending short-term borrowing amount.

8.What will be the net float if Nathan Daniel takes up the Bank of Mount Royal's offer for same-day deposit of their cheques?

9.How much additional cash will be made available if the company takes up the Bank of Mount Royal's offer for same-day deposit of their cheques? (Assume that on average, sales will remain at $3,500,000 each year.)

10.How much does the company have to borrow from its bank to cover net float if they accept the bank's same-day deposit offer?

11.Should the partners accept the same-day deposit offer from its bank?