Clarkson Lumber Company Case Solution.docx
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Clarkson Lumber Company Case Solution.docx
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ClarksonLumberCompanyCaseSolution
ClarksonLumberCompanyFinancialAnalysis
1.Background
ClarksonLumberCompanyisownedandoperatedbythehardworking,49-year-oldMr.Clarkson.Ithaslowoperatingexpenses,asmallstaff,andstrongmanagement.Theoverallimpressionisoneofaconservative,efficientoperation.Clarksonhimselfleadsafrugallifestylewithlittlepersonaldebt.
Thecompanyhasbeeningrowthduringrecentyearsandanticipatedafurtherincreaseinsales.Despiteofconsistentprofits,thecompanyhassufferedshortageofcashandborrowedfundneededforitsbusinessgrowth.
2.FinancialAnalysis
SeeAppendix
&
.Wefindthatincreasingamountofborrowingdespiteofitsconsistentprofitabilitycamefromfollowingreasons.Firstisthefirm’sfinancialposition.Assaleshaveincreasedby55%from1993-1995,theassetsthatsupportincreaseofsalesincreasedby78%.Theincreaseamountofassetsisovertheamountofnetincome(additiontonetworth).Tomeetfinancialneeds,thecompanyreceivedshort-termloansfrombank,$60in1994and$390in1995.Thenetprofitmarginandoperatingexpensesratiohavebeenstableoverthreeyears,however,interestexpenseshasincreasedalmost1.5times.Thefirm’scurrentratiodeterioratedagainandasaresult,thefirmhasexperiencedtheshortageoffundregardlessofitsconsistentprofitability.SecondistheamountofnotepayableagainstHoltz.Mr.ClarksonboughtoutMr.Holtz’interestfor$200,000paidoffin1995and1996.Becauseofthiscashoutflow,thecompanyneededcashinflowfrombank.Thirdly,thecompany’scollectionperiod(48.95in1995and38.24in1993)andAvgDaysininventory(62.57in1995and55.86in1993)aredeterioratedaswell.
AccordingtothecashflowstatementinAppendix
weknowthatthecompanyhassomemainfinancingchanneltomeettheneedsoffund.Oneisusingthefundofsuppliers,whichincreasedtheamountofA/Pfrom$213,000to$376,000andtheamountofN/Ptradeto$127,000.TheotheroneisbankloanfromSuburbanNational.Buttheceilingof$399,000inborrowingabilityplacedonthecompanybytheSuburbanNationalBankisconsistentlyinsufficienttomeettheirgrowingneeds.
Wetakeleverage,liquidity,cashcycleandprofitabilitymeasurementintoconsiderationtoanalyzethefinancialperformanceoftheClarksonLumber.LookingattheindividualratiosseeninAppendix
andcomparingittotheindustryaveragegivesasenseofwherethiscompanystands.Welearnthatthetimes-interest-earneddecreaseddramatically;onthecontrary,thetotaldebtratiohasbeendeterioratedandgetclosertothoselow-profitoutlets’level.Meanwhile,theliquidityofthecompanydecreasedsignificantly.ButtheprofitabilityseemstobesteadyandtheROEhasrisento0.17.Alltheseratiosservetopointoutthelackofcashinthiscompany.Thecashflowhasbeendecreasingbecause,ittakeslongertogetthemoneyfromcustomers,butthecompanystillneedstopayforitspurchases.
ClarksonLumbercurrentlypurchasesinventoryfromitsvendorsinlargequantities,requiringlargeamountsofcapitaltofundthesepurchases.Supposethecompanytakesadvantageofanadditional2%tradediscountofferedbyitsvendorsforquickpayment,willitsprofitabilitybeincreasedandrectifyitscurrentcashflowsituation?
Withoutprejudicetothecompany'sreputation,theannualrateofA/Ris[2%/(30-10)]*365=36.5%andthepaymentmaybeaslightdelay,theannualratecouldbe24.33%ifthisperiodextendto40days.Sothiscapitalcostismuchhigherthanthecostofbankloan,thetradediscountofferedisattractivetothecompany,butitstilldependsonthelineofcreditofferedbyNorthrupNationalBank.
3.FinancingPlanning
Weproject5.5milliondollars,ormore,insalesforClarksonlumberin1996.AsseenintheProformastatementintheAppendix
.
Webuildproformamostlybasedontheassumptionsasbelow:
1.Withthe2%tradediscount,theCOGSalsoreducedby2%whilethesellingpriceremainthesame.
2.PayoffthenotepayabletoHoltzonschedule.OnlythebankloantoSuburbanNationalBankandNorthrupNationalBankaretheinterest-bearingliabilitiesfor1996
3.A/Ronlyexistsin10daysandN/Ptradereturntozero.
4.Thenewlineofcreditofbankloanhasnoceiling.
5.Mr.Clarksonissuednonewequitiesandpaidnodividendsduringtheforecastedyears.Onlysourceofthechangeinthenetworthisthenetincomeforthesameperiod.
Thenthebankloanwouldexceedtothecreditlineto$1,169,000.Withouttheapprovalofthebank,Mr.Clarksonwouldnotbeabletoexpandhisbusinessatthecurrentgrowthrate.Actually,sincethenewcreditlineisfixedat$750,000,Mr.Clarksonwouldhavetofindotherwaysoffinancingtheoperationsuchasissuingnewequity.
Ifthecompanydon’ttakeadvantageofthetradediscount,then,asshowninAppendix
markedbyyellow.IftheClarksonLumbersells$5.5millionandtheirpercentageofsalesweretostaythesameforthebalancesheetitems,theywouldhaveamorethan$298,000increaseinusesofcash,notincludingthe$399,000thattheyhaveoutstandingontheirpreviouslineofcredit.Ifyousubtractthealmost$300,00thattheywouldgenerateinnewsourcesofcashyoucanseethatthewillalreadyuse$697,000oftheir$750,000.Consequently,iftheygrewatthesamerate,thecompanywouldblowthroughtheirnew$750,000lineofcreditquicklyaccordingtoourproformastatement.
ClarksonLumberisanillustrationofafirmthatisgrowingatarategreaterthanitcansustainwithexistingassetrequirementsandinternalfinancingcapacity.Itisrelativelywellmanaged,butthehugeabsorptionoffundsintofinancinggrowinginventoryandaccountsreceivable,duetotheincreaseinsales,isputtingitintoadifficultsituation.Itsrelianceonbankfinancingisgrowingandtherequestedlineofcreditisinsufficienttopermittakingtheavailabletradediscounts.ThegreaterriskisthatthefirmwillbedramaticallyimpactedshouldthetradelosepatienceanddecidetoputthemonaCODbasis.
4.Recommendation
Asthefinancialadvisor,myrecommendationstotheClarksonLumberare:
1.Thecompanymustreduceliabilitiesanddebtbeforeaccruingmoreandbeingconsumedwithpaymentsandinterestpayments.
2.Setareasonablestockleveltoreduceinventory.
3.Thebusinesscannotsupportthecurrentrateofgrowthmuchlonger.Mr.Clarksonhasnochoicebuttoinfusethebusinesswithoutsidecashrightaway,howeverheneedstoseriouslyconsiderotherformsoffinancingafterthat.
4.Heshouldexplorethepossibilitiesofequityfinancing,inordertobringcashintothebusiness.Suchpossibilitiescouldincluderecommendingtohisbrotherinlawtokeephismoneyinthebusinessandreceivedividends.Anotherequityfinancingoptionwouldbetore-mortgagehishomeandinvesthispersonalcashinthebusiness.
5.Clarksonlumberwouldbetoslowdowngrowthandseekequityfinancing.ClarksonLumberCompanyneedstohavestricterpoliciesonthecustomerstheyallowtopurchasefromthemoncredit.
6.Thecompanyneedstoseriouslythinkaboutincreasingitsinternalfundingthroughgreaterprofitsatthesametimeitreducesitsgrowthratetoamoresustainablelevel.
Frombank’sperspective,theKPIweneedtotakecareistheleverageratioandliquidity,bycontrast,profitabilityisnotmuchimportant,andleverageratioandliquidityofClarksonLumberhavealreadybeenpoor.Ifweprovidethecompanywitha$750,000loan,thoughtheprofitabilitycouldbeimproved,otherKPIswillfurtherdeteriorate.Takingthefeaturesofbankintoaccount,inthepresentcircumstances,theshort-termbankloanmaynotbesuitable.IfwewanttodevelopthemarketandthecapitalstructureofClarksonLumbercanbeimproved,thebankloanisreasonablebutatthesametimetheremustbestricterrestrictions,suchas:
1.Re-mortgagehishomeandinvesthispersonalcashinthebusinessorseekotherequitycapitalstoincreasetheproportionofequityinvestmentwhilereducingClarkson’swageincometoreducetheriskofcreditors.
2.AskingClarksontomakedetailplanstoreduceA/Randinventoryandtheimplementationshouldbesupervisedbythebank.
3.Strictcontroloftheadditionalinvestmentinfixedassetsinthenearfuturetoavoidnewcashoutflow.
Asanoutsideequityinvestor,wewillcomparetheadvantageanddisadvantageofthecompanyandpointouttheopportunitiesandthreatswemymettoseewhetherwearewillingtobuythestocksofthefirm.RegardingClarksonLumberwefindthat:
Strengths
Haveenergeticandpassionateowner-manager.
Wellcontrolofthebusiness;soundbusinessjudgment;workshard.
Favorablesalesprospectswithreadymarketatalltimes;Salesweresomewhathedgedagainstslowdowninnewhomeconstructionbecausemostofthesaleswereforrepairs.
Weaknesses
Negativeoperatingcashflowsandcompetesonprice.
Targetmarketsegmentisheavilydependentonlocaleconomy.
Opportunities
Favorableprospectsforcontinuedgrowthinforeseeablefuture.
Expandtootherproductsandgeographicareas.
Havespacetoimprovefinancialperformance.
Threats
Slowdowningeneraleconomymightdecreasethegrowthrateofsales.
Increaserapidlyinaccountreceivablesandnotespayableinrecentyearswiththefueledexpansion.
Nopurchasediscountsavailedinthelasttwoyearsbecauseofshortageoffunds.
Takeallthesefactsintoaccount,andsincethecompanyissoleownedbyMr.Clarksonandhasnodividendsinpastyears,alsothefreecashflowishardtopredictforthefollowingyears.Wemaysimplyconsiderthenetworthasthesameoffirmvalue.Wearewillingtopaynomorethan$120,000for30%stockofthe
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