lt international business school| Clarkson Lumber Company| | | Adeeb Valiulla| 1/3/2011| | Summary Experiencing rapid growth in business and generating fairly good profits, Mr. Keith Clarkson the sole owner and president of The Clarkson Lumber Company still faced a shortage of cash and found it necessary to increase his borrowings, he was therefore on a look-out to start off a new banking relationship where he could not only borrow a larger loan amount but also one that did not require a personal guarantee attached. Suburban National Bank, Mr.
Clarkson’s current bank was willing to offer him a loan amount to an extent of $ 400,000 which also called for a personal guarantee. Northrup National Bank, on the other hand, was offering a loan amount of $ 750,000 with no personal guarantee, after considering detailed inquiries about Mr. Clarkson. Therefore, the above the situation leaves Mr. Clarkson in a position whether to continue his current relationship with Suburban National Bank or consider the loan offer made by Northrup National Bank, keeping in mind that once the Mr.
Clarkson enters into a loan agreement with the new bank he would have to sever his relationship with his current bank. Analysis: Following are the problems which Clarkson Lumber Company is facing. 1) Clarkson Lumber Company is already facing shortage of cash. Along with this problem he also has to pay his brother in law, Henry Holtz, for buying his stake in the company. Calculations show that current ratio of the company is not so good which tells us that company is not solvent enough to pay its short term obligations. 2) | FY – 1993| FY 1994| FY 1995| FY 1996| Accounts Payable| $ 213,000| $ 262,000| $ 376,000| $ 364,000|
Accounts Payable for Clarkson Lumber has been increasing over the past few years. Accounts payable are debts that must be paid off within a given period of time in order to avoid default. | FY – 1993| FY 1994| FY 1995| FY – 1996| Accounts Receivable| $ 306,000| $ 411,000| $ 606,000| $ 583,000| 3) Accounts Receivables on the other hand is also increasing over the past years, this means that it has made a sale but yet to collect the money from the purchaser. 4) If the company fails to generate enough profits from the amount borrowed, Mr. Clarkson’s personal belongings would be at risk.
He might jeopardize his personal savings which includes his house, life insurance. Recommendation: Thus in order to enhance Company’s performance and increase future cash flows, he should consider taking a loan from Northrup National Bank. Now, the question arises as to how much loan amount Mr. Clarkson should consider taking from Northrup National Bank. There are two options available, either he takes entire amount of $ 750,000 or he take a part of it from the bank. Exhibit 2 of the case shows that the company has already taken $ 399,000 from suburban bank in the first quarter.
So taking a full amount of $ 750,000 from Northrup would not be a good idea for the company, because it will increase their notes payable by a substantial amount. Along with that, Net worth (shareholders’ equity) reduces to a very low number (i. e. $ 68,000). Thus, Mr. Clarkson should consider taking loan from Northrup National Bank; but out of the $ 750,000 which the bank has to offer, he should only take $ 364,000 as the loan amount. They have an accounts payable of $364,000. Thus, if the company borrows the same amount as the accounts payable, they can get rid of it and can use $ 399,000 to generate profits out of it.
Hence, considering loan amount of $ 364,000 the balance sheet and income statement of 1996 year would be as follows. (All amounts are in thousands of dollars) Balance Sheet| FY – 1996| Cash| $ 53| Receivables| $ 583| Inventories| $ 607| Total Current Assets| $ 1,243| PP&E| $ 384| Total Assets| $ 1,627| Current Portion of debt| $ 642| Accounts Payable| $ -| Other Current Liabilities| $ 67| Total Current Liabilities| $ 1,073| Long term debt| $ 464| Income tax Payable| $ -| Total Liabilities| $ 1,173| Net Worth| $ 454| Total Liability & Net Worth| $ 1,627| Income Statement| FY – 1996|
Sales (Net)| $ 5,500| COGS| $ 4,160| Gross Profit| $ 1,340| Operating Expense| $ 1,149. 80| EBIT| $ 190. 20| Interest Expense| $ 53. 04| EBT| $ 137. 16| Provision for Income Taxes| $ 22. 25| Net Income before tax| $ 114. 91| Net income| $ 114. 91| * Accounts Payable = 364 – 364 = 0 * Long Term debt = 100 + 364 = 464 * Predicted Sales = $ 5. 5 million * COGS = 5,500 * 75. 64% (75. 64% is the average % calculated on the basis of last 3 years) * Interest Expense = 13 + (364 * 11%) = 53. 04 * Income Tax calculated based on “c” given in Exhibit 2 (= 22. 25) Statistics of Lumber Outlets
Percent of Sales| High Profit Outlets| Calculated Ratios| COGS| 75. 1%| 75. 64%| Operating expense| 20. 6%| 20. 91%| Cash| 1. 1| 0. 96| AR| 12. 4| 10. 60| Inventory| 11. 6| 11. 04| Fixed assets, net| 9. 2| 6. 98| Total Assets| 34. 3| 30. 0| | | | Percent of Total Assets| | | Current Liabilities| 29. 2%| 43. 58%| Long Term Liabilities| 16. 0| 28. 52%| Equity| 54. 8| 27. 90%| | | | Current Ratio| 2. 52| 1. 16| Return on Sales| 4. 3%| 3. 46%| Return on Assets| 12. 2%| 10. 21%| Return on Equity| 22. 1%| 25. 31%| | Loan Amount – $ 364, 000| Loan Amount – $ 750,000|
Net worth| $ 454,000| $ 68,000| Comparing the above table with Exhibit 3 of the case, Clarkson Lumber Company falls on the High-Profit Outlets side. In addition to that, the company is able to generate Net Worth of $ 454,000 which is better than the first option of considering loan amount of $ 750,000 from Northrup National Bank. | FY – 1993| FY 1994| FY 1995| FY 1996| ROE| 13. 70%| 16. 57%| 17. 05%| 25. 31%| Last but not the least, with this option the forecasted ROE increases to a substantial amount over the last few years, which is a good sign for the Company.
DuPont Analysis also tells us that Clarkson Lumber has been generating 40% of its return from its core/sustaining operations and as per the analyst, the Company’s future is bright and will help increase ROE in the coming years. Overall, Clarkson Lumber Company has now a total loan of $ 763,000, i. e. $ 399,000 from Suburban and $ 364,000 from Northrup National Bank. Interest Payment for the previous year would add up to the coming years and the Company has to have enough cash to service the loan.
It has to reduce its Accounts receivables by a substantial amount because this is one of the major reasons why the company is facing shortage of cash and has difficulties in paying its short term obligations. I would like to conclude by stating that overcoming the above mentioned i. e. investing the loan amount into Company’s core activities, reducing Accounts receivables, Clarkson Lumber Company can increase the future cash flows and generate high profits which would eventually help the Company to pay off its short and long term debts.