In the early 1990s, Cranston Dispensers, Inc. was quick to realize that concern
ID: 2424669 • Letter: I
Question
In the early 1990s, Cranston Dispensers, Inc. was quick to realize that concern for the environment would cause many consumer product manufacturers to move away from aerosol dispensers to mechanical alternatives that pose no threat to the ozone layer. In the following decades, most countries banned the most popular aerosol propellants, first chlorofluorocarbons and then hydrocholrofluorocarbons. As the leading manufacturer of specialized pump and spray containers for a variety of products in cosmetics, household cleaning supplies, and pharmaceutical industries, Cranston experienced a rapid increase in sales and profitability after it made this strategic move. At that time, the firm focused much of its attention on capturing market share and keeping up with demand.
For most of 20x4 and 20x5, however, Cranston’s share price was falling while shares of other companies in the industry were rising. At the end of fiscal 20x5, the company hired Susan McNulty as the new treasurer, with the expectation that she would diagnose Cranston’s problems and improve the company’s financial performance relative to that of its competitors. She decided to begin the task with a thorough review of the company’s working capital management practices.
While examining the company’s financial statements, she noted that Cranston had a higher percentage of current assets on its balance sheet than other companies in the packaging industry. The high level of current assets caused the company to carry more short-term debt and to have higher interest expense than its competitors. It was also causing the company to lag behind its competitors on some key financial measures, such as return on assets and return on equity.
In an effort to improve Cranston’s overall performance, Susan has decided to conduct a comprehensive review of working capital management policies, including those related to the cash conversion cycle, credit policy, and inventory management. Cranston’s financial statements for the three most recent years follow.
Cranston Dispensers
Income Statement
($ in thousands)
Account
20x5
20x4
20x3
Sales
3,784
3,202
2,760
Cost of Goods Sold
2,568
2,172
1,856
Gross Profit
1,216
1,030
904
Selling & Administrative
550
478
406
Depreciation
247
230
200
Earnings Before Interest and Taxes
419
322
298
Interest Expense
20
25
14
Taxable Income
399
297
284
Taxes
120
89
85
Net Income
279
208
199
Cranston Dispensers
Balance Sheet
($ in thousands)
Account
20x5
20x4
20x3
Current Assets
Cash
341
276
236
Accounts Receivable
722
642
320
Inventory
595
512
388
Total Current Assets
1,658
1,430
944
Net Fixed Assets
1,822
1,691
1,572
Total Assets
3,480
3,121
2,516
Current Liabilities
Accounts Payable
332
288
204
Accrued Expenses
343
335
192
Short-term Notes
503
491
243
Total Current Liabilities
1,178
1,114
639
Long-term Debt
398
324
289
Other Long-term Liabilities
239
154
147
Total Liabilities
1,815
1,592
1,075
Owners’ Equity
Common Equity
1,665
1,529
1,441
Total Liabilities & Equity
3,480
3,121
2,516
Question:
An image-based lockbox system could accelerate Cranston’s cash collections by three days. Cranston can earn an annual rate of 6% on the cash freed by accelerated collections. Using sales for 20x5, determine the most that Cranston should pay per year for the lockbox system.
Account
20x5
20x4
20x3
Sales
3,784
3,202
2,760
Cost of Goods Sold
2,568
2,172
1,856
Gross Profit
1,216
1,030
904
Selling & Administrative
550
478
406
Depreciation
247
230
200
Earnings Before Interest and Taxes
419
322
298
Interest Expense
20
25
14
Taxable Income
399
297
284
Taxes
120
89
85
Net Income
279
208
199
Explanation / Answer
Cranston Dispensers, Inc.
Sales during 2015 = 3,784
Accounts Receivable at the beginning of the Year = 642
Accounts Receivable at the end of the Year = 722
Average Accounts Receivable during the Year = (642 + 722) / 2 = 682
Since the Amount of Credit Sales is not given, it is assumed that all the sales are made on Credit basis.
Therefore Net Credit Sales = 3,784 – 642 + 722 = 3,864
Account Receivable Turnover = 3,864 / 682 = 5.66 Times
Account Receivable Collection period = 360 / 5.66 = 63.60 Days
With the New system the Collection period will be reduced by 3 days.
Therefore Annual Net Credit Sale under new system = 3,864 / (360 / 60.30) = 647
Cash Freed by Accelerated collections = 682 – 647 = 35
Savings on account of Accelerated collections = 35 x 6% = 2.1
Amount that can be spent on the New System can be less than or equal to $2.1 Thousands