Estimating Funds Requirements

Short-Term Sources of Funds

Subject: O.M. Scott & Sons Company

Problem: Should the O.M.Scott company keep with its Trust Receipt Plan in order to maintain 25% growth rate.

Options: 1. Sell receivables to a third party at a discount rate to receive cash.

2. Issue preferred equity to help finance retailers in holding higher Inventory levels 3. Reduce growth rate to a sustainable

Recommendation: In order to maintain the 25% growth, we need to first of all, abandon the trust receipt plan which causes sales growth rate to drop ever since implementation. we need to adopt alternative 1 (selling receivables) in order to reduce …show more content…

This means that Scott will receive 20% instead of the full 25% of the receivables that they sell. However, when taking into consideration the time value of money, as well as the 3% of receivables that Scott is unable to collect, obtaining 95% of the receivables by selling it to the bank seems to be the better option. Also, by selling their receivables, Scott will no longer need to implement methods such as hiring more staff to collect late receivables.

By selling its receivables, Scott will immediately shorten its cash cycle, as accounts receivable period will only be 30 days. This brings the cash cycle to 23.1 days, and the operating cycle to 89.4 days.

Alternative 2

A second alternative is to issue preferred equity in the open market. Preferred equity would be preferable because we assume that the market is not perfectly efficient and does not follow the irrelevance of financing construct according to Modigliani and Miller. Because equity prices are going down, existing shareholder`s benefit more from issuing equity such as preferred shares. Raising equity would help finance the dealers in holding higher levels of inventory, which was the initial problem being targeted by the Trust Receipt Plan. The raised amount of equity could also be used to reduce the high debt level and also reducing the high interest payments. This method would take pressure off the repayment timeline imposed by bank debt. Repayment to shareholders can be done on an