Week 4 FIN370 Reeds Clothier Paper Bell

8/8/2019 Week 4 FIN370 Reeds Clothier Paper Bell

http://slidepdf.com/reader/full/week-4-fin370-reeds-clothier-paper-bell 1/7

W4_Reed’s Clothier Paper_Bell

Reed’s Clothier Case Study / Questions

Gary Bell

Finance for Business

FIN370

GA09BSB10

Doug Nelson

December 2, 2010




Reed’s Clothier Case Study Analysis

Jim Reed, II is the owner of Reed’s Clothier, a men’s clothing store which is facing

financial difficulties. Established in 1934, by Jim Reed senior, the clothier was started to cater to

the high volume of Virginia Military Institute (VMI) graduates. Initially the business

experienced struggles for several years until 1976 when the business annual sales grew to

$800,000. It was at this time that Reed decided to retire and hand over the operations to his son.

In 1981, Reed’s son decided to expand the store floor space and acquired an $880,000

long-term mortgage debt. At the same time, Reed’s Clothier increased inventories with the idea

that higher inventories would lead to higher sales. By 1994, the business had grown to more than

$2 million in annual sales. Although the store has seen a dramatic rise in sales, the increased

inventories, in addition to the acquisition of mortgage payments, have seriously affected Reed’s

positive cash flow.

During the last year, Reed had incrementally increased his line of credit and failed to

maximize discounts offered by his suppliers. As a result, several of Reed’s accounts are nearly

40 days past due, and his suppliers are beginning to demand payment. In order to further extend

his line of credit by an additional $100,000, Jim decided to visit his bank and spoke to Harold

Holmes of Fist Virginia National Bank where he was informed that the bank would not extend

their line of credit, and that Reed must repay an overdue note of $13,000 within 30 days.

After Jim spoke with Holmes, he finally realized that the business was in serious state of

financial trouble. Although the store is rich in inventory, it is short in cash, and Reed must

liquidate inventory immediately to meet his financial obligations.




Question 1

Reed's Industry

Liquidity Ratios

Current ratio 2.0 2.7

Quick ratio 0.9 1.6

Receivables turnover 4.9 7.7

Average collection period 74.1 47.4

Efficiency Ratios

Total asset turnover 1.3 1.9

Inventory turnover 2.9 7.0

Payable turnover 7.0 15.1

Profitability Ratios

Gross profit margin 29.8 33.0

Net profit margin 4.2 7.8

Return on common equity 16.0 25.9

The above ratios show that Reed’s is poor in comparison to the industry average on all

fronts. Their current and quick ratios are less than the industry average; which shows Reed’s

liquidity to be poor. The low current ratio indicates that the company will likely experience

trouble in meeting short-term debts. Also, Reed’s quick ratio is also much lower than the rest of

the industry; and a low quick ratio in comparison to current ration indicates a high inventory.

With too much inventory, Reed’s is not selling off enough, which is causing a lower profit

margin, i.e., Reed’s appears to be in poor financial health.

Question 2

Holmes wants Reed’s to hold an inventory reduction sale to restore the relative value of

Reed’s quick ration and improve liquidity. By having an inventory reduction sale, Reed’s will

quickly generate cash to help repay the bank note. Ideally they will generate enough cash to

repay the note of $130,000 improving their Short-term cash flows .




Question 3

Jim Reed implemented a very loose working capital policy which caused higher current

assets than industry averages. By tightening the working capital to align with industry averages,

Reed’s will move towards restoring their financial stability. The change shouldn’t have effect

sales as long as Reed’s doesn’t dramatically reduce inventory. By doing this Reed’s will be

passing savings to customers in the form of price reductions, discounts, and sales will help boost

sales.

Question 4

Assuming that Reed’s can improve its operations to be in line with the industry averages,

results in the following 1995 pro forma income statement:

1994 1995 Industry

Net Sales2,035,00

01,938,00

0

Cost of goods1,428,00

01,298,46

0 67.0%

Gross profit 607,000 639,540 33.0%General & administrative

expenses 374,000 352,716 18.2%Depreciation & amortization 32,000 32,000

Interest expense 63,000 23,256 1.2%

Earnings before taxes 138,000 246,126 12.7%

Income taxes 53,000 94,962 4.9%

Net income 85,000 151,164 7.8%

Question 5

Jim Reed certainly needs to adjust the current inventory control. Obviously, Reed’s

would greatly benefit from an inventory system that would reduce inventories and increase

efficiency. “The just-in-time inventory control system is more than just an inventory control

system; it is a production and management system. Not only is inventory cut down to a




minimum, but the time and physical distance between the various production operations are also

reduced” (Keown et al., 2005, p. 722).

Question 6

Reed should attempt to place as many customers as possible on COD. Of course, not

every account can be placed on COD; therefore, Reed should use an ageing account schedule. In

addition, Reed should specify the terms of sale

Question 7

Year Inventories Net Sales

Change in

Inventory

Change in

Sales

Inventoryas % of

Sales1991 378 1,812

1992 411 1,886 8.73% 4.08% 21.79%

1993 452 1,954 9.98% 3.61% 23.13%

1994 491 2,035 8.63% 4.15% 24.13%

There is a connection between the amount of inventory and the net sales, both posting an

upward trend. Net sales appear to increase in conjunction with inventory; however, since the

change in inventory is much higher than the change in sales, there is no direct link to prove that

sales increase as inventory increases. Carrying high inventory, being careless in collecting

accounts receivables, and carrying high debts have led Reed’s into financial ruin.

Question 8

The cost of not taking the suppliers’ discounts can be calculated as follows:




Reed’s cost of not taking suppliers’ discounts is 22.27%, or in terms of dollar amount:

Reed’s purchased 80 percent of its purchases on terms 3/10, net 60; therefore, $1,428,000*80% =

$1,142.400. Had Reed’s taken the discount of 3%, Reed’s would have saved $34,272.00.




Reference

Keown, A. J., Martin, J. D., Petty, J. W., & Scott, D. F. (2005). Financial Management:

Principles and Applications (10th ed.). Upper Saddle River, NJ: Pearson Education, Inc.

Documents

Week 4 FIN370 Reeds Clothier Paper Bell