1) Does the firm need a larger reserve of cash or marketable securities to guard against, say, its customers stretching their payables (thus slowing down collections on accounts receivables)?
2) Does the plan yield satisfactory current and quick ratios?
3) Are there any hidden costs?
4) Does the plan in 2002 leave the firm in good financial shape for 2003?
The first step that each company must take is to understand why the firm needs to invest in net working capital and how this translates to their business cycle. Next, they need to trace the firm's sources and uses of cash and evaluate its need for short-term borrowing. Then each firm can develop a short-term financing plan that meets the firm's need for cash. As you will recall from our previous discussions, a firm needs to focus on profitable sales, rather than just on sales growth. This will allow better use of the available working capital. Next, the firm should arrange for adequate longer-term financing. In addition, closer attention to the credit terms agreed with the customers can have a significant effect on working capital. In the current economy, the problem is that investments are down, and many of the ways businesses generate working capital are reduced. If a firm sells long-term bonds and puts the proceeds in its bank account, these proceeds will increase both cash and net working capital.
The following three figures, as illustrated by Brealey, et al, show different long-term financing strategies. "The 'relaxed strategy' in panel A always implies a short-term cash surplus" (360). This is similar to what Gateway faces with their surplus of cash. This surplus needs to be invested in marketable securities. Dell falls into "the 'restrictive' policy illustrated in panel C" (360). This implies a permanent need for short-term borrowing. Finally, "panel B illustrates an 'intermediate' strategy", HP may fall into this category.
