small company. Lawrence represents a significant portion of Murray's sales. In addition, Murray's financial condition is tenuous and therefore it is difficult for Lawrence to bring any significant pressure to bear relating to extending payments on the outstanding accounts payable. It is possible that Murray may go out of business if Lawrence does not make payments on a regular basis.
The situation at Lawrence is further complicated by the fact that Lawrence's bank has established a $1.2 million working capital line of credit. However, the interest rate being charged to Lawrence increases dramatically as borrowings approach the $1.2 million maximum. For this reason, Lawrence's financial management team is focused on using other methods to improve the company's working capital position such as accelerating cash inflows from its customers or delaying payments to suppliers. Once the $1.2 million borrowing is exceeded, Lawrence has no alternative but to rely on vendors and customers for its working capital needs. The goal of this paper is to examine how Lawrence can plan its capital budget so that cash flow problems are avoided and so that bank borrowings are minimized.
Any good working capital policy will include a provision for cash reserves which might be needed not simply for day-to-day operations, but in response to long-term opportunities that may arise from time to time. Often, rather than keeping a large sum of cash on hand for such opportunities, companies will negotiate for and obtain a working capital line of credit through a bank. To the extent that the $1.2 million working capital line of credit that Lawrence has with its bank is perceived to be insufficient for the purpose of providing ready cash that can be used as opportunities present themselves, part of Lawrence's working capital policy must be to work with its bank to increase its working capital line of credit or find another bank willing to do so. <...