FIN 571 Week 4 Managing Working Capital Example

Hops, Cans and Summer Peaks: Shortening Cascade Ridge's Cash Conversion Cycle, Pricing a Can Supplier's Discount and Sizing the Credit Line From a Monthly Cash Budget

[Student Name]

University of Phoenix

FIN/571: Corporate Finance

Week 4 Assignment

[Instructor Name]

[Date]

Cascade Ridge Beverage and all figures are composites written for a model paper; methods and research findings come from the sources listed.

Cascade Ridge Beverage, the composite Bend, Oregon, company planning 15 percent growth, will need about $16 million of outside funding next year, as Week 1 found. Part of that need comes from working capital that the percent-of-sales forecast assumed would grow with revenue. The chief financial officer asked whether that assumption was fair, or whether better management of inventory, payables and cash could reduce the need. Every dollar freed from working capital is a dollar the company does not have to borrow, and in a seasonal business the timing of that dollar matters as much as its size. This paper examines each part of the cycle.

The Cash Conversion Cycle

Inventory of $22 million against cost of goods sold of $108 million represents about 74 days. Receivables of $14 million against revenue of $180 million represent about 28 days. Payables of $13 million against cost of goods sold represent about 44 days. The cash conversion cycle, inventory days plus receivable days minus payable days, is about 58 days (Brigham & Ehrhardt, 2022). For a beverage maker whose finished beer should reach shelves within weeks, inventory days are the obvious target.

Why Inventory Runs High

Three items explain most of the inventory. Hops, bought under multiyear contracts with growers in Washington and Oregon to secure popular varieties, sit in cold storage for up to 18 months; about $5.5 million of hops are on hand. Cans and packaging, stockpiled during the can shortages of 2021 and 2022, still total about $6 million, far above current needs. Finished goods are about $7 million, including slow-moving seasonal beers.

Reducing Inventory Safely

Hops are essential, and contracts protect supply, so Cascade Ridge will keep the contracts but negotiate with its main hop merchant to hold part of the inventory in the merchant's cold storage, delivering monthly, at a storage fee of about 2 percent of value. Cans will be drawn down to six weeks of supply over the next year by suspending new orders for standard sizes. Seasonal releases will be brewed closer to demand, with smaller batches. Together these steps target inventory days of 60 by year end, reducing inventory at next year's cost of goods sold by about $4.9 million compared with keeping 74 days.

Receivables Are Already Short

Many states' alcohol laws require distributors to pay brewers within a short period or on delivery, limiting the credit brewers can extend. Cascade Ridge's 28 days reflect that structure plus a few states with longer allowed terms. Little can be gained here, and pressing distributors harder could cost goodwill in a market where distributor attention drives sales.

The Can Supplier's Discount

Cascade Ridge's can supplier offers terms of 1/10 net 45: a 1 percent discount for paying within 10 days, otherwise payment due in 45. Passing up the discount means paying 1 percent to keep money 35 more days, an annualized cost of about 10.5 percent. The company's revolving line costs about 7.5 percent. Taking the discount, even when funded by the line, saves money. On about $24 million of annual can purchases, the discount is worth about $240,000, less roughly $170,000 of added interest on the extra borrowing, a net gain near $70,000. Paying earlier shortens payable days, adding a little to the cycle, which the savings justify.

A Target Cash Balance

Cascade Ridge holds about $6 million of cash, roughly two weeks of operating expenses. Opler et al. (1999) found that firms with stronger growth opportunities and riskier cash flows hold more cash, and that firms with ready access to credit hold less. Cascade Ridge has a committed revolving line, so it can operate with modest cash. Its target is $5 million at the low point of the year, with the line covering anything beyond.

The Monthly Cash Budget

A monthly budget for next year shows the timing problem. From January through May, Cascade Ridge buys malt, cans and packaging and brews for summer, while shipments run below average. Cash outflows exceed inflows by a cumulative $11 million by the end of May. From June through September, shipments peak and distributors pay quickly, repaying the deficit by September. With the inventory changes, the peak deficit falls to about $8 million, because fewer cans are bought in spring.

Sizing the Revolving Line

The revolving line must cover the peak deficit plus a cushion for a cold, wet spring that delays shipments. Cascade Ridge's current line is $10 million. The finance team recommends raising it to $15 million, covering the $8 million peak, the target cash floor and a margin for weather and for the earlier payments to the can supplier.

Kegs, Deposits and Hidden Capital

Draft beer adds a working capital item most industries lack. Cascade Ridge owns about 38,000 stainless steel kegs, carried as equipment, and charges distributors a deposit on each keg shipped, refunded when it returns. At any time, about a third of the kegs are in the market. Lost kegs, roughly 4 percent a year, must be replaced at about $150 each, and slow returns tie up kegs the brewery needs for summer. The finance team proposed raising the deposit from $30 to $50 and reporting keg turnover by distributor each month. A higher deposit speeds returns and offsets part of the cost of lost kegs, but distributors must agree, so the change will be phased in with the next contract renewals.

Monitoring After the Changes

The improvements must be maintained, not just achieved. The finance team will report monthly to the operating committee on inventory days by category, the can supplier discount captured, keg turnover and the gap between actual and budgeted cash. If inventory days drift back above 66 for two months, purchasing will need the chief financial officer's approval for new can and packaging orders.

Working Capital and Value

Hill et al. (2010) found that firms with greater access to external funds and lower costs of financing tend to hold more net operating working capital, while firms facing financing constraints keep less. As a family-controlled company reluctant to issue shares, Cascade Ridge benefits from keeping working capital lean, preserving borrowing capacity for the canning line.

Effect on the Growth Plan

The inventory reduction of about $4.9 million lowers the external funding need from Week 1 from about $16 million to about $11 million. The seasonal peak still requires the larger line, but the company's term borrowing for growth falls substantially.

Conclusion

Cascade Ridge's 58-day cash conversion cycle is driven by hops held for 18 months, pandemic-era can stocks and slow seasonal beers. Moving hop storage to the merchant, drawing down cans and brewing seasonals closer to demand cut about $4.9 million of inventory. Taking the can discount saves about $70,000 a year. A monthly cash budget shows a spring peak of about $8 million, which a $15 million revolving line covers with margin.

References

Brigham, E. F., & Ehrhardt, M. C. (2022). Financial management: Theory and practice (17th ed.). Cengage.

Hill, M. D., Kelly, G. W., & Highfield, M. J. (2010). Net operating working capital behavior: A first look. Financial Management, 39(2), 783-805. https://doi.org/10.1111/j.1755-053X.2010.01092.x

Opler, T., Pinkowitz, L., Stulz, R., & Williamson, R. (1999). The determinants and implications of corporate cash holdings. Journal of Financial Economics, 52(1), 3-46. https://doi.org/10.1016/S0304-405X(99)00003-3