Background

CM Clothing Manufacturers recently signed a fulfillment contract for one of the largest sales catalogue companies in the nation. The reputation and customer base of this catalogue wholesaler are impressive and being able to establish a relationship with it guaranteed substantial growth for CM's business.

Given the nature of the catalogue wholesaler's business, this new project was draining CM's cash reserves to the point where paying for day to day operations was becoming a challenge, The catalogue sales company placed orders to CM, which proceeded to deliver a timely basis but the wholesaler only paid for the clothes ordered once these had been shipped out to its retail clients. Part of the sales pitch presented by CM was that it would offer open credit terms. This situation posed a huge challenge for CM because it stretched the company's cash conversion cycle to approxmately 60 days, thus preventing it from using its revenues to pay for monthly raw materials costs. Production at CM was stalling due to the company's inability to repurchase goods. As a result, long term customers were starting to do business with other clothing manufacturers.

In addition to the cash flow challenges, CM's board was worried about the fact that the company's receivables portfolio was mainly comprised of bills to the catalogue wholesaler. This situation posed a risk to CM because if the catalogue merchant defaulted on payments, CM would not be able to withstand the resulting losses.