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Clarkson Lumber Company stands as a quintessential example of a privately held enterprise that has witnessed rapid sales growth, propelling it to a juncture where the availability of liquid assets is insufficient to sustain the anticipated expansion in the forthcoming years. This predicament is epitomized by the scenario wherein Keith Clarkson, the proprietor, acquired his partner's share in 1994 for $200,000. The subsequent note, assumed by Henry Holtz, bore an 11% interest rate and necessitated semi-annual repayments of $50,000, commencing from June 30, 1995.
Despite Mr. Clarkson's adept management, reflected in the consistent year-over-year sales growth, the company faces a financial crunch with a depleting cash reserve. This becomes particularly critical given the aspiration to achieve a sales target of $5.5 million in 1996. Furthermore, the borrowing threshold set by Suburban Bank has been exhausted, compelling the bank to insist on Mr. Clarkson's personal guarantee for the loan. In response, Mr. Clarkson has initiated talks with Northrup Bank, exploring the possibility of securing a credit line of up to $750,000.
Several factors underpin Mr.
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Clarkson's recourse to borrowing despite commendable profits. While the profits are commendable, their adequacy is questioned due to a net profit margin hovering around 2% since 1993 (Exhibit D). This can be attributed to a disproportionately high cost of goods sold relative to sales, consistently maintaining a level of approximately 75%. Essentially, the costs have outpaced the sales growth, constraining profit margins. Additionally, the Return on Assets stands at around 5% in 1995 (Exhibit D), a figure suppressed by a substantial total assets value.
Notably, the augmented total assets stem from liabilities incurred in the form of trade credits, contributing to a substantial inventory volume, as evidenced by the Inventory Turnover ratio averaging 6%.
The Average Collection Period has extended from 38 to 48 days since 1993 (Exhibit B). Consequently, a considerable portion of the cash inflow is tied up in inventory and loan repayments. Mr. Clarkson's inability to exploit trade discounts in the past two years, due to a financial shortfall arising from the acquisition of Mr. Holtz's interest, has further exacerbated the cash shortage.
Despite utilizing Suburban Bank's credit up to $400,000 to finance increased sales, the imposed ceiling has compelled the company to resort to cash for self-sustenance and loan repayment, as corroborated by both current and quick ratios (see Exhibit D). According to pro forma sheets, an additional $251,000 is imperative to attain the $5.5 million sales target. Moreover, considering the stipulation to sever ties with Suburban National Bank, the line of credit needs to encompass the $399,000 covered by the loan. With $650,000 of the credit line utilized, the residual $100,000 could discharge Mr. Holtz's obligation and facilitate prompt payments to suppliers, realizing the sales goal more cost-effectively.
We strongly advocate Mr. Clarkson's earnest consideration of procuring the proposed line of credit. This strategic move holds the potential to capitalize on trade discounts and settle outstanding debts, thereby mitigating costs. Prioritizing cost reduction becomes imperative, possibly involving a prudent reduction in inventory without compromising service and quality standards. Additionally, Mr. Clarkson should identify and prioritize products or services with high-profit margins, focusing efforts on these lucrative avenues.
The company stands to gain substantially by targeting a reduction in the Average Collection Period to within 30 days, thereby streamlining cash flows. As for Northrup Bank, we recommend extending the line of credit while ensuring vigilance against reaching the ceiling. Initial utilization may be substantial, covering previous loans, Mr. Holtz's interest, and immediate inventory financing. However, with the gradual shedding of existing loans and streamlining of operations, the company is poised to witness a gradual increase in cash reserves.
Mr. Clarkson's impeccable business references and the company's track record of timely bill payments affirm its low-risk profile. Therefore, we strongly advocate the approval of the line of credit by Northrup Bank as a prudent financial maneuver aligning with the company's growth trajectory.
Clarkson Lumber Company, while navigating the challenges posed by its commendable growth, finds itself at a juncture demanding astute financial decisions. The analysis underscores the imperative need for additional financial support to realize the ambitious sales target and alleviate the current cash flow constraints. With strategic utilization of the proposed line of credit, coupled with targeted cost reductions and focused product/service prioritization, the company can position itself for sustained growth and financial resilience.
Financial Analysis and Recommendations for Clarkson Lumber Company. (2016, Dec 29). Retrieved from https://studymoose.com/clarkson-lumber-case-essay
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