Clarkson Lumber Case

Case Analysis

Despite a record of high profitability, Clarkson Lumber Company has been facing a cash deficit. To address this issue, the company increased its borrowing amount between 1993 and 1995. The following are the key reasons for the increased borrowing:

• To pay off the note of $200,000 to Mr. Holtz in 1995 and 1996

• To purchase additional inventory for growing sales

• The company requires, on average, 58.88 days of working capital, equivalent to $582,000 (i.e. it takes an average of 58.88 days to convert working capital to revenue).

During prior periods from 1993 to 1995, Mr. Clarkson met the financing needs of the company by increasing the days of payables (Accounts Payable/(COGS/365) from 35.31 days in 1993 to 53.62 days in 1995. Additionally, notes payable increased from $60,000 in 1994 to $390,000 in 1995.

Due to the cash shortage and additional debt requirements of the company, it is necessary to assess its financial strength. The following ratios provide insight into the financial strength of Clarkson Lumber:

1993 1994 1995

Current Ratio 2.49 1.58 1.15

Quick Ratio 1.27 0.82 0.61

L-T debt to assets 0.15 0.19 0.06

The current ratio decreased from 2.49 to 1.15 from 1993 to 1995, and the quick ratio decreased from 1.27 to 0.61 over the same time period both indicative of the increasing leverage of the company. The long term debt-to-asset ratio also decreased from 1993 to 1995. This decrease is not due to the amount of borrowing, but rather to the increased level of inventory, thus affecting total assets. Hence, we can infer that, even though the company’s borrowings are increasing, the company is channelizing the same to improve total assets and quality of earnings.

Another issue to be analyzed is the feasibility of trade discounts. One of the reasons Mr. Clarkson wants to take on additional debt is to take advantage of the trade discounts. The trade discount provides a benefit of $85,000 whereas the interest expense on the debt is $103,000. This is based entirely on the company altering their accounts payable methods with a decrease to 10 days. Thus, the debt required would be $894,000. This shows that even though additional