Clarkson Lumber Company is a classic example of a privately held company that has experienced a rapid growth in sales and has reached a point where it is facing a shortage of cash tosustain the expected growth in sales in the following years. The owner, Keith Clarkson, bought out his partner’s interest in the company in 1994 for $200,000. His partner, Henry Holtz, took a note for the$200,000 with an interest rate of 11% and was repayable in the semi-annual installments of $50,000 beginning June 30, 1995. The note was taken to give Mr. Clarkson time to arrange for the necessaryfinancing. Mr. Clarkson seems to be running the company well, evident by the constant growth in sales year after year. However, the company is running low on cash on hand, and needs some form offinancing to reach the expected sales of 5.5 Million in 1996.Moreover, the borrowing limit set by the Suburban Bank has been reached, prompting the bank to ask Mr. Clarkson to guarantee the loan personally.Mr. Clarkson has been in communication with another bank, Northrup Bank, which might be willing to extend a line of credit of up to $750,000.
There are several reasons for Mr. Clarkson’sneed to rely on borrowing despite good profits. Although the profits are good, they are not good enough in our view. The Net Profit Margin has been close to 2% since 1993 (Exhibit D).The cost of goodsrelative to the sales is high and is keeping the profit margin low. In other words, the costs have increased at a faster rate than sales. The Cost of Goods Sold is consistently around 75% of sales.Secondly, the Return on Assets is roughly 5% in 1995 (Exhibit D). This ratio is kept low due to a high total assets figure. Total assets are also inflated due to the liabilities taken in the form of tradecredits by Mr. Clarkson The company is keeping a high volume of inventory in stock as shown by its Inventory Turnover ratio average of 6%. The Average Collection Period has jumped from 38 days to...
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