1) Overall, the performance of Pearson Air Conditioning & Service has been satisfactory despite of the issues of inadequate working capital. The company has shown the highest profits in 2009 ever since its purchase in 2002. The firm has the policy of keeping cash balance to minimum $15,000 but it has cash in excess which amounts to $28,000. The accounts receivable and inventory of Pearson Air Conditioning & Services possess some weaknesses but the company has never really suffered from bad debts. The company, however, fails to provide monthly and quarterly income statements necessary for proper functioning of the business because it lacks standardized systems.
2) At Pearson Air Conditioning & Service, the accounts receivables are not recorded as they should be due to which the overdue amount is sometimes not known. It is not possible for the firm to receive payment immediately after the service is provided. On the positive side, the firm has satisfactory record of accounts receivables. On new projects, partial amount is received which is able to cover up the tied receivables. The firm allows 30 days for receiving payments and after that one percent is charged.
No cash discount is offered so as to obtain loyal customers. The firm always has assumed that it has excess of inventory but due to the absence of a standardized system, there is no knowledge of actual inventory available. Profit determination has become difficult because inventory is used annually which means that the income statement is available on annual basis only. The good part is that the company is realizing that it needs to switch to a perpetual inventory system. However, maintenance of the software would be costly. 3) The firm must try to reduce its bank borrowings because in the long run, the bank could set up borrowing limits or even force the firm to reduce its borrowings to zero.
If the current bank officer is replaced by someone else who doesn’t have the same attitude towards Scott, the firm could suffer in the long run. So it is better to plan for uncertain events that could occur in future. 4) Payables make important part of Person Air Conditioning & Service’s working capital.
The company does not accept discounts from suppliers because it believes in building and retaining strong relationships. The payments are made at maximum within 30 to 45 days as per their policy. However, different suppliers have different methods for obtaining payments. For instance, payment is made to Carrier when the sale is made. General Electric requires immediate payment. Pearson had to borrow from bank when the payment is large. On the other hand, York provides 30 days for making payments after which it charges interest at 18%. 5) Obaidullah Jan explains that Cash Conversion Cycle is the time required by any firm to convert its inputs into cash.
The smaller the time is, the more quickly the company is able to generate cash for making payments. The formula for cash conversion cycle is: Cash Conversion Cycle (CCC) =Days Sales Outstanding (DSO) +Days Inventory Outstanding (DIO) - Days Payable Outstanding (DPO) Calculation: DSO=365/receivables turnover ratio=365/12.82=28.47 days DIO=365/inventory turnover ratio=365/5.20=70.19 days DPO=365/payables turnover ratio=365/12.09= 30.19 days Cash Conversion Cycle =28.47+ 70.19 -30.19 = 68.47 days The cash conversion cycle reveals that the time required to generate cash by Pearson Air Conditioning & Service is 68.47 days which is quite a lot.
This means that the firm will be generating cash for making payments in 68.47 days which signifies that the working capital of the firm requires a lot of improvement. 6) Pearson could improve its working capital situation by increasing its collectibles and recording them on time. It could even consider giving cash discounts to make the process of collection faster. The inventory must be kept at low by the use of proper inventory management software so that only necessary items are available and the costs spent on purchase of unimportant inventory items could be minimized.
Negotiations must be made with the suppliers who ask for immediate payments so that bank borrowings could be minimized. Reference Obaidullah Jan. (n. d.). Cash Conversion Cycle. Available: http: //accountingexplained. com/financial/ratios/cash-conversion-cycle. Last accessed 28th March 2014.