Clarkson Lumber Case Study Analysis

Clarkson Lumber Company

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Mr. George Dodge, Clarkson Lumber Company is doing well but there is the issue of whether or not there is too high a risk in granting the request for the $750,000 line of credit. There are many supporting strong points but it also has some problems to work out. This is a company that has many good characteristics and looks promising but needs the extra money to pay off loans, inventory, and supplies. I recommend this company to receive the line of credit.
Looking at the individual ratios seen in exhibit 1 and comparing it to the industry average shown in exhibit 2 gives a sense of where this company stands. Current ratio and quick ratio are really low and have been decreasing. For 1995, the current ratio is 1.15:1, which is less than the industry average of 1.60:1, however to give a better sense of where this stands in the industry, as seen in exhibit 3, it is actually less than the average of the bottom 25% of the industry. The quick ratio is 0.61 is less than the industry is 0.90. Both these ratios serve to point out the lack of cash in this company. The cash flow has been decreasing because, it takes longer to get the money from customers, but the company still needs to pay for its purchases. Also, the company couldn’t go over the $400,000 loan limit, so they were forced to stretch their cash.
Return on sales is decreasing and is below the industry average, but the goods news is that sales and profits have been increasing each year. However, costs of goods are increasing and more inventory is left over each year causing the return on sales to decrease. For 1995, it was 1.7% which is less than the average of 2.44% but is a lot higher than the bottom 25% of companies as seen in exhibit 3, which actually have negative sales return of 0.7%. Return on equity is increasing each year and at a higher rate than industry average. In 1995, it was 20.7%, greater than the average of 18.25% and close to the highest companies in exhibit 3, of 22.1% showing that the return in investment in the company is increasing, which is good for the owner.
Return on assets is also decreasing and less than industry average. For example, in 1995 it was 4.7%, less than the average of 6.

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3%. However, this also has a positive side. This means that the company has a lot of inventory, which is good on a selling standpoint, because it means there is a larger selection base available for the customers. This could bring in more customers because they can be more confident that the company has on hand what they need. The debt to equity ratio could be a problem. The debt to equity ratio is increasing and is more than double the industry average. In 1995, it was 265% compared to the average of 170%. The company has a lot of debt to deal with including paying the partner what is owed to him. However, there has never been a problem with paying the bills. All the references show that he is a good business man and is reliable. For the bank, as long as the loan is being paid the bank is happy and it appears that this company can handle paying the loan.
Inventory turnover is also decreasing and less than the average, but as stated previously, it is because the company has more inventory on hand to give their customers plenty of selection. For instance, in 1995, it was 5.83 times vs. the industry average of 8.1 times, but this gives them an advantage and gives customers a reason to come to them instead of other companies. Since, lumber is a commodity the company has to find a new way to compete. One way is to have a larger selection for the customers. As for accounts receivable turnover, it is also decreasing and less than the average but also signifies another area in which the company is trying to compete in the industry. For instance, in 1995, it was 7.46 and the industry average was 10.7 times. Therefore, Clarkson doesn’t get paid right away but it does make the customers more comfortable since they don’t have to worry about paying the lumber back to Clarkson. Also, since most customers are probably contractors, it would make them happier to be able to use the wood and get paid first, so they can pay Clarkson.
The average collection period of accounts receivable is increasing. Customers, as stated before, are given the opportunity to pay later. Instead of paying every 34.1 days like the average, Clarkson customers have been able to pay back in about 49 days. As for the average payment period, Clarkson has been testing its boundaries and bargaining power to see how many days he could take to pay back his purchases. For instance, he took 35 days in 1993, 45 days in 1994, and 38 days in 1995. It seems that he tried to take longer but then the suppliers may have talked to him because he improved to 38 days, however, it is still an extra 8 days from the typical 30 day invoice. The problem with this is that he isn’t taking advantage of the 2% discount which is evident that many companies do since the industry average is only 16.3 days. However, at this point it doesn’t seem very possible since the loan limit and lack of cash make it hard to take advantage of this situation.
Based on the pro forma sheets there is an additional $251,000 needed to attain the goal of $5.5 million in sales. Also, since part of the agreement is to break off from Suburban National Bank, the line of credit has to cover the 399,000 covered by the loan. Therefore, the amount needed is $650,000 as seen in Exhibit 6. The credit line would also help to pay for inventory instead of having to go on trade and the notes payable for Mr. Holtz which is supposed to be paid by the end of 1996 and is paid in installments of $50,000 at a time.
The company doesn’t supply a very high risk to the bank. The company has its problems but they all seem to stem from the fact that the company has a loan limit and lack of cash since customers take longer to pay. The company doesn’t have a very big risk because this problem would be solved with the equity line. It would fill in the time gap from paying for inventory and from being paid by the customers. The company has a good strategy to compete by having more inventory on hand and allowing customers more time to pay for the lumber. Clarkson has good references which show that in the past he has been a good businessman to deal with. With an economic downturn but the company is protected in new housing construction because of the relatively high proportion of its repair business. Sales, net income, and return on equity are increasing and show the company has a lot of potential. Another plus is that the assistant knows how to do everything that Clarkson does, so if anything were to happen to him, there is a replacement. Also, if Clarkson weren’t able to pay back the loan and the bank takes the company it should be able to make money selling it since it has a lot of potential.
Exhibit 1:
Financial Ratios (Dollars in thousands):
Ratio Formula 1993 1994 1995
Current Ratio C. Assets/ C. Liabilities 686 / 275 = 2.49:1 895 / 565 = 1.58:1 1249/1088= 1.15:1
Quick Ratio (C. Assets– inv.) / c. liabilities (686-337) / 275= 1.27 (895-432) / 565= 0.82 (1249-587) / 1088= 0.61
Return on Sales Net Income/ Sales 60/2921= 2.1% 68/3477= 2.0% 77/4519= 1.7%
Return on Equity Net Income/ Last year’s equity -------- 68 / 504 = 13.5% 77 / 372 = 20.7%
Return on Assets Net Income/ Total Assets 60 / 919 = 6.5% 68 / 1157 = 5.9% 77 / 1637 = 4.7%
Debt to Equity Total Liabilities/ Equity 415/504= 82.3% 785/372 = 211% 1188/449 = 265%
Inv. Turnover Cost of Sales/ inv. 2202 / 337 = 6.53 2634 / 432 = 6.10 3424 / 587 = 5.83
Accts. Receivable Turnover Sales/ Accts Receivable 2921 / 306 = 9.55 3477 / 411 = 8.46 4519 / 606= 7.46
Age of Accts. Receivable Accts Receivable/ (sales/365 days) 306/ (2921/365) = 38.25 411/ (3477/365) = 43.13 606/ (4519/365) = 48.95
Age of Accts. Payable Accts Payable/ (sales/365 days) 213/ (2209/365) = 35.21 340/ (2729/365) = 45.45 376/ (3579/365) = 38.33
C. = Current

Exhibit 2:

Industry Averages:
Current Ratio 1.60:1
Quick Ratio 0.90:1
Return on Sales 2.44%
Return on Equity 18.25%
Return on Assets 6.3%
Debt to Equity Ratio 170%
Inventory Turnover 8.1 times
Accounts Receivable Turnover 10.7 times
Average Collection Period 34.1 days
Average Payment Period 16.3 days

Exhibit 3:

Statistics on Lumber Outlets
Low Profit Outlets High Profit Outlets
Current Ratio 1.31 2.52
Return on Sales (0.7%) 4.3%
Return on Assets (1.8%) 12.2%
Return on Equity (14.3%) 22.1%

Exhibit 4:

Pro Forma Income Statement
Net Sales: $5,500
- Cost of Goods:
Beginning Inventory 587
Purchases 4345
Ending Inventory 715
Total Cost of Goods Sold 4217
Gross Profit 1283
Operating Expenses 1103
Earnings before int. & taxes 180
Interest Expense 53
Net Income before taxes 127
Provision for inc. taxes 43
Net Income 84

Net Sales: estimated figure (given)

Cost of Goods:
Beginning Inventory: Ending Inventory of previous year.

Purchases: Purchases/Net Sales (previous years)
1993: 2209/2921= 0.756 = 75.6%
1994: 2729/3477= 0.785 = 78.5%
1995: 3579/4519= 0.792 = 79.2%
1996 est.: 79% (rounded average for past two years)
79% of 5500 (sales) = 4345

Ending Inventory: Ending Inventory/ Net Sales (previous years)
1993: 337/2921= 0.115 = 11.5%
1994: 432/3477= 0.124 = 12.4%
1995: 587/4519= 0.130 = 13.0%
1996 est.: 13% (because of increasing trend)
13% of 5500 (sales) = 715

Total Cost of Goods: (Beginning Inventory + Purchases) – Ending Inventory

Gross Profit: Net Sales – Total Cost of Goods Sold

Operating Expenses: Operating Expenses/ Gross Profit (previous years)
1993: 622/719= 0.865 = 86.5%
1994: 717/843= 0.851 = 85.8%
1995: 940/1095= 0.858 = 85.8%
1996 est.: 86% (because of increasing trend)
86% of 1283 (projected gross profit) = 1103

Earnings before interest & income taxes: Gross Profit- Operating Expenses

Interest Expense: Interest Expense/ Total Liabilities (from balance sheet)
1993: 23/415= 0.055 = 5.5%
1994: 42/785= 0.054 = 5.4%
1995: 56/1188= 0.047 = 4.7%
1996 est.: 4.5% (because of decreasing trend)
4.5% of 1173 (Total liabilities from 1st quarter) = 53

Net Income before income taxes: Earnings before interest & taxes – interest expense

Provision for income taxes: If net income before taxes is over $100,000 income taxes is 34%. Net income before taxes is 127 and 34% = 43.

Net Income (bottom line): Net Income before taxes- provision for taxes.

Exhibit 5:

Pro Forma Balance Sheet
Cash 53
Accounts Receivable, net 825
Inventory 917
Current Assets 1795
Property, net 384
Total Assets 2179

Notes Payable 399
Notes Payable to Holtz, current portion 100
Notes Payable, Trade 127
Accounts Payable 573
Accrued Expenses 96
Term Loan, current portion 20
Current Liabilities 1315
Term Loan 80
Note Payable, Mr. Holtz 0
Total Liabilities 1395
Net Worth 533
Additional Financing 251
Total Liabilities and Net Worth 2179

Cash: Taken from 1st quarter of 1996.

Accounts Receivable: (Accounts Receivable/ Sales)
1993: 306/2921 = 10.5%
1994: 411/3477 = 11.8% (increase of 12.4%)
1995: 606/4519 = 13.4% (increase of 13.6%)
1996: increase of about 14.5% on 13.4% = 15%
15% of sales = 825

Inventory: (sales/ inventory turnover)
5500/6 = 917

Current Assets: cash + accounts receivable + inventory

Property: Taken from first quarter of 1996.
Total Assets: current assets + property

Notes Payable: Same as last year since there is the 400,000 limit = 399

Notes Payable to Holtz, current portion: same as last year because it’s the same portion every year = 100

Notes Payable, trade: 127 because same as last year, because already seriously extended and shouldn’t be extended any more

Accounts Payable: Avg. Accounts Payable for 1995 was 38 days
365/38 = 9.6 times a year.
5500/9.6 = 573

Accrued Expenses: previous year + increase in tax expense
75 + (43-22) = 96

Term Loan, current portion: same as previous year, always the same

Current Liabilities: Total of liabilities so far

Term Loan: Previous year – current portion
100 - 20 = 80

Note Payable, Mr. Holtz: Same as previous year

Total Liabilities: current liabilities + term loan

Net Worth: Previous year’s net worth + net income. Previous Year: 372 (1994) + 77(1995) = 449
449 + 84= 533

Additional Financing: Total Assets – Total Liabilities – Net Worth
2179 - 533 – 1395 = 251

Total Liabilities and Net Worth: Total Liabilities + Net Worth + Additional Financing = Total Assets

Exhibit 6:

Total Amount Needed = Notes Payable + Additional Financing = 399 + 251= 650 (Holtz payable of 100 would make it 750)

Clarkson Lumber Company Case Analysis Loan Purpose and Request In the spring of 1996, the Clarkson lumber Company had a shortage of cash to support the increasing working capital associated with a substantial increase in sales volume and to improve profitability by allowing the company to take full advantage of trade discounts. The loan they had in the Suburban National Bank was limited to $400,000 and needed a requirement of a personal guarantee from Mr. Clarkson, the sole owner of the company. In order to solve the problem, the company requested a loan from a much larger bank, the Northrup National Bank. Customer Relationship Mr. Clarkson is the Northrup Bank’s new customer introduced by a friend to George Dodge, an officer in the bank. Mr. Dodge had arranged for the credit department of the Northrup National Bank to investigate Mr. Clarkson and his company including the business management, market, suppliers and so on. They gave particular attention to the debt position and current ratio of the business. If Mr. Clarkson could be extended the line of credit he would build a longer and more stable business relationship with the Northrup Bank including severing his relationship with the Suburban National Bank and transferring deposits and funds to the Northrup National Bank. Business and Strategy Formed in 1981, the Clarkson Lumber Company is a private owned lumber manufacturing factory located in a growing suburb of a large city in the Pacific Northwest. Operations were limited to the retail distribution of lumber products in the local area. The company’s main business was in the repair market as the typical and main products included plywood moldings and sash and door products were used for repair work. The market is ready for the company’s products at all times and Clarkson Lumber Company is projected to expand their business with a further substantial increase of sales volumes. We can also noticed that the company is in the suburb area where most of the houses are built by wood and need to be repaired all the time. The market is stable and sustainable. Although general economic downturn will affect the lumber market, Clarkson’s sale is protected to some degree from fluctuations in new housing construction because their main business in in the repair market. The treat of substitute products in this industry is as low as it has existed for more than 200 years without any major changes. The treat of new entrants, however, is relatively high as the lumber business can be thinly capitalized with limited number of workers. Just as the Clarkson Company, their net worth is only $449,000 in 1995 with $1,637 total assets and $1,188 liabilities. In the early 1996 there are only 16 workers including Mr. Clarkson within which eight worked in

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