Financial management is the most important item to be focused on within a corporation. If it is disregarded, the company will ultimately fail. General Electric is no different. General Electric provides a mass variety of products such as: household appliances, plastics, water treatment systems, lighting, medical equipment, nuclear reactors, and aircraft engines and provides commercial financial services as well as investing in different real estate holdings (www. ge. com, 2005).
GE is one of the world’s top three producers of jet engines, supplying Boeing and Lockheed Martin (www. ge. com, 2005). As with any major Fortune 500 company, effective and efficient financial management is essential. Financial management is not only managing the finances of an organization, but also working capital, mergers and acquisitions, and risk management. This paper focuses on these topics as it relates to the three different companies in the class simulations as well General Electric. These topics are the foundation to a successful business.
Working Capital In the current business economy, business entities are highly concerned with maximizing liquidity and ensuring global cash optimization (Keeler, 2005). Good cash management is an integral and imperative activity of every business entity. “Working capital is truly the life blood of any business big or small” (www. advanceme. com, 2005). “Working capital is the cash a business requires for its day-to-day operations, and for financing the conversion of raw materials into finished goods, which the entity sells for payment” (www.
investopedia. com, 2003). An effective and efficient management staff will manage the entity’s bottom line of working capital and realize that in order to improve the bottom line, management has to understand the tradeoff of maintaining good relationships with customers and vendors while protecting profits. Lawrence Sports Company experienced all of the above-stated financial challenges. In March 31 – April 6, Mayo, the entity’s principal customer, defaulted 80% of the outstanding payments for the weeks March 17 – 23 and March 24 – 30.
Mayo then announced that it would not be able to pay until April 14 – 20. As a result, Lawrence Sports had to borrow funds from the bank and defer payment owed to Gartner Products. The failure of one company to pay, directly affected the ability of Lawrence Sports to pay its bills as well. The second challenge occurred when Lawrence Sports had to take out a loan to pay its bills because of the delayed payments and as a result the entity’s cash flow showed a negative balance.
Lawrence Sports had to decide whether to focus on maintaining favorable relationships with its delinquent account holders or to secure positive cash flows within the entity. The third challenge occurred when a consignment article arrived at Mayo with broken equipment. Lawrence Sports, erroneously blamed for poor packing even though it was apparent poor handling during transport caused the damage, was forced to accept responsibility to maintain peace. The entity was forced to pay a contract closure fee of $250,000 and replace the broken equipment at a cost of $100,000.
The unexpected hike in cash outflow poses a new challenge to the entity and Lawrence Sports is faced with either requesting a 30% payment on sales and the remaining 70% in the following week from Mayo or continue the existing arrangement paying 40% on purchases and the remaining 60% in the following week; or finally defer payments to Murray Company. General Electric As with the company in the simulation, General Electric is considered a major player in its industry, due in part to its market share; therefore, managing its working capital is extremely important.
According to an article, former Chief Executive Officer of GE, Jack Welch, controlled cost and cash flow by laying off 10% of his workers per year (http://corpwatch. org/article. php? list=type&type=16, 2005). Jack Welch was noted as also stating, “Every business should be attempting to outsource every job unless management can justify keeping it in-house” (www. polarinstitute. org/corp_profiles/public service gats/corp profile ps ge capital. html 2005).
GE keeps costs down by outsourcing labor costs outside of the United States. Under Welch’s reign, the entity used ruthless methods to maintain positive working capital. Welch cut approximately 100,000 jobs in the 1980s and practiced hastily selling off subsidiaries that did not have number one or two market shares in their specific industry (http://corpwatch. org/article. php? list=type;type=16, 2005). GE’s long-term and total debt to equity ratio is very high, very much like that of Lawrence Sports in the simulation.
As a result of the high ratio, GE borrows large sums of cash exceeding stock sales in order to finance their investment projects (Annual Report, 2004). This places the company in a vulnerable position since it has to rely on lending to finance projects. The company has to borrow money to make money. In 2004, the company’s cash flow from operating activities grew 18% due in part to a 27% expansion in industrial cash flow. The company has improved its financial flexibility by reducing “parent-supported” debt of the financial services businesses by about $14 billion (Annual Report, 2004).
As in the simulation, another significant challenge of maintaining positive working capital is in the adequate reduction of debt. In 2004, GE eliminated $4. 7 billion of debt as a result of the following: retaining 22% of operating earnings, and $1. 6 billion proceeds from the Genworth initial public offering (Annual Report, 2004). GE prides itself on growth, not powered by the building of factories, but through the allocation of capital to maximize returns. GE functions with the concept of reducing working capital and increasing return on equity.