American Apparel, Inc.

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assets were only 28% percent of their current liabilities. However, considering that the cash conversion cycle has increased between 2009 and 2013, short-term liquidity really is not the issue for American Apparel.

The issue for the company, as mentioned above, is their continuous and unsustainable borrowing. In 2009, the company’s debt ratio was a respectable 52%. By 2013, this number skyrocketed to 123%, meaning the company has 23% more liabilities than they do assets, and almost all of these liabilities are long-term. In 2009, the company had no long-term debt, resulting in a long-term debt to total capitalization ratio of 0%. However, by 2013, long-term debt was 157% of the company’s total capitalization. In 2009, the company was making more than enough operating profit to cover their interest expense, but by 2013 their times interest earned ratio dropped to -0.75. See Exhibit 3 in the Appendix for several financial ratios for American Apparel.

Conclusions

This analysis has shown that American Apparel has gotten themselves into a hole that will be hard to climb out of, primarily because of their debt. This is not to say that debt is a bad thing. Debt can be a good inflow of funds that can help businesses expand operations or improve the efficiency of those operations. However, too much debt is a very bad thing, and this is a classic case of how too much debt can lead to the downfall of a company. A long-term debt to total capitalization ratio of 157% is simply not a sustainable capital structure. Also, the CEO Dov Charney getting fired is not a good thing for this company at this time. His vision of growth, although it was not a bad vision, is what led to this debt, and he should be the one to help them get rid of it. Furthermore, one of the covenants of their main loan is that the loan can be taken away at any time due to a change in management, and this would leave the company with absolutely nothing. As mentioned though, when a company hits rock bottom, the only direction to go is up, and this means that there is room for improvement in the financial performance of American Apparel. The first thing they can do to improve is advertise their emphasis on fair wages and using sustainable resources. Their target market would respond well to these advertisements and this could increase sales. Secondly, the company needs to focus on fine tuning their newly implemented inventory management system and distribution center. This can increase productivity, logistics, and operations. Thirdly, the company needs to implement a strict debt management system that focuses a lot of employee’s efforts on how to strategically pay off their debt. And finally, the company needs to figure out a way to cut cost of sales, selling expenses, and general and administrative expenses. Although it would hurt their good response time to fashion trends, cutting these costs could be done easily by outsourcing with firms that specialize in these types of activities. If these changes were to be implemented, although they would cost in the short-run, they would help the company’s operating performance, increase sales, cut costs, and reduce debt as quickly as possible.