Clarkson Lumber Company Case Study

1.          When looking at Clarkson Lumber Company’s income statement and balance sheet, it is evident that the company is generating more revenue year after year. While looking at Exhibit 1, Clarkson’s net profits had increased from $60,000 in 1993, to $77,000 in 1995. Due to this, this displays concerns of liquidity and cash on hand. First, the companies accounts receivable, accounts payable, and inventory classes are growing in each of the 3 years. But, the company has not been receiving cash from its customers because its cash has not been growing at a rapid rate. In addition to this, the company’s accounts payable have shown that it is taking longer for the company to pay off its short term liabilities, thus making them less likely to take advantage of the 2% discount.

The faster increase in accounts receivable relative to accounts payable indicates that they are paying their suppliers faster than they are receiving cash from their customers. In addition, the company has been holding on to its inventory on its shelf for a long duration of time. The conversion cycle notes that it is taking 72 days to convert its working capital to cash (F-1). Moreover, when looking into the companies liquidity it is important to note the exponential decrease in their quick ratio from 1.3 to 0.6 (F-2). This is showing that they are not keeping nearly enough short term assets excluding inventory for the amount of short term debt they are carrying. 

The growth in sales for the company has been 54% which is a great sign. But, when looking at the debt to equity ratio, it is important to note that it has increased from 0.8 to 2.6 in just three years. This indicates that the main source of funding for operations is in the loans and debt that Clarkson is able to take in. The inability to cover its current liabilities because of longer receiving periods in accounts receivables dictates an ongoing concern. It is not organically growing, rather it is relying on loan agencies to increase its operations, and this action could lead to disastrous results if short term funding in the future is a problem. In addition, Mr. Clarkson still has to pay off an additional $100,000 to Mr. Holtz which is an expense which has to be accounted for. The company is staying afloat, however when one looks at exhibit 3, it is evident that in the case of an economic slump, where people are not making repairs, which is the main source of income, the company can go under. In exhibit 3, if they become one of the low-profit outlets on their return on assets, return on equity, and return on assets will all be negative.

2. Trade discounts are always enticing as well as an incentive for the borrower to pay faster but pay less. [2/10, n30] The invoice term signals that the borrow is expected to pay within 30 days and if they pay with 10 days, they can have the 2% discount. However, the days that Clarkson usually pays its invoices from suppliers is from 35 days to 47 days, although the accounts payable are due in 30 days, let us assume the days to be 50. That being said, on a purchase of $ 1000, he either pays $ 980 in 10 days or $1,000 in 50 days. He thus pays $20 for the use of $980 for 40 days, then the interest rate is about 2.04 % for 40 days, or 18.6 % annual. We have to know that the 18.6% was simply a rough estimation because Mr. Clarkson may take some of the advantages of the discount and he may also pay his suppliers even longer than 50 days.

Based on his previous purchases from 1993-1995, if Mr. Clarkson decides to utilize the trade discount he would be saving $84,680. This is a very enticing offer in order to utilize the trade discount. However, in order for him to utilize the trade discount he needs to have the funds available to pay in the designated term of his creditors.

3.        The company’s inability to receive payments from customers in a timely manner has been a major reason for its lack of cash. Given the firm’s income statement, it is obvious that the company is actually not profitable enough to support its operations. The company’s costs have increased at a faster rate than its revenue. The Net income is growing at a slower rate as compared to the operating expenses.The loan is needed in order to keep their growth. It can be seen that Mr. Clarkson is very diligent with paying his creditors on time even if it does mean taking on additional debt. There are no delinquencies. Mr. Clarkson has been unable to take full advantage of the trade discount during the last two years due to a shortage of funds arising from his purchase of Mr. Holtz’s interest in the business and the additional investments in working capital associated with the company’s increasing sales volume.He should pay off Mr. Holz in order to gain full ownership of the company.
        This is a great example of a company that is reaching higher growths than it can account for from the business internally. With that being said, its cash on hand has remained low for the past years and short term loans were needed to suffice the rapid increases in sales. The company in the past has taken part loans from Suburban National Bank. With its high growth rate in the past years and with an expectation to increase almost 24% in 1996, there is a need of financing. As we look at the company's balance sheet for 1996, the $5.5 million in sales shows that the company expects to grow, but will not be able to unless they look to finance their operations elsewhere. To equalize the total assets to the stockholders equity and liabilities company would need more than the $750,000 line of credit. This is almost $1 million in notes payable from the bank to couple the expectation of the sales growth. For the company to keep on increasing its growth the necessary line of credit this year is necessary, and in perpetuity will be necessary until the Lumber Company can stabilize its cash with the working capital needed. If it plans to grow as fast as it did in 1996, then additional lines of credit will be needed aside from the $750,000.