Clarkson Lumber Company

Clarkson Lumber Company

1. Identify the key problem in the case and explaining why it is the key problem.

The key problem in this case is that Clarkson Lumber Company is in short of cash. Clarkson Lumber Company has been expanding rapidly over the years with its net sales increasing 54.71% from 1993 to 1995. Its investment, increase in the property, also increased by 66.52% and Mr. Clarkson had bought out his co-founder Henry Holtz in 1994 with a $200,000 note. This put pressure on Clarkson Lumber to the point that the company had to borrow $399,000 from a bank and forgo the trade discount on accounts payable in order to maintain its expansion. Not being able to take the discount of 2% has a huge impact on the company’s net income which will be explained further in this paper.

1. Why has Clarkson Lumber borrowed increasing amounts despite its consistent profitability?

Even though Clarkson Lumber has been experiencing rapid increase in its sales and consistent increase in profitability, its cash flow has been not so sound. Looking at the accounts receivables, the increase in the percentage is larger than that of net sales. It can be inferred that consequently, it would be more difficult for the company in terms of cash flow. Mr. Clarkson invested in working capital too, which in turn, resulted in higher sales volume. On top of that, the amount of inventory and property increased as well, also affecting the cash flow in the same way as the increase in the accounts receivables do. Mr. Clarkson paid off Mr. Holtz to become the primary and sole owner of Clarkson Lumber. This put Clarkson Lumber’s cash flow in a more difficult situation therefore requiring funds from outside of the company. This combination required external financing for Clarkson Lumber Company.

1. How has Mr. Clarkson met the financing needs of the company during the period 1993 through 1995?  Has the financial strength of Clarkson Lumber improved or deteriorated?

Financing needs of the company has been met through increasing its borrowing of $399,000 from the Suburban National Bank, nearly reaching the limit of $400,000. Clarkson Lumber Company relied heavily on trade credit. From 1993 to 1995, the accounts payable increased by 76.53% and it is also mentioned that suppliers ordinarily did not object if payments lagged somewhat behind the due date of 30 days after the purchase. It suggests, along with increase in the accounts receivable of 98.04%, that Clarkson Lumber Company had been struggling paying the suppliers due to low cash flow. With that said, it is hard to say that the financial strength of Clarkson Lumber improved.

Financial ratios also suggests that Clarkson Lumber’s financial strength is not improving. From 1993 to 1995, current ratio dropped from 2.49 to 1.14, return on sales dropped from 2.05% to 1.70%, return on assets dropped from 6.53% to 4.70% and quick ratio also decreased from 1.27 to 0.61.

1. How attractive is it to take the trade discounts?

It is very attractive to take the trade discounts. With 2/10,n/30 term, Clarkson Lumber could save to $44,000 dollars in purchases which would increase in its net income up to estimated $95,820 with current rate of income taxes. From 1993 to 1995, Clarkson Lumber could have increased its net income by $135,680 if it had taken the trade discounts. This would enable the company to have more cash, leaving the company liquid and in a much better financial state.