Reed's Clothier Case Study

Reed's Clothier Case Study

Jim Reed II is the owner of a clothing store. It is a family business that was passed along to Jim from his father. Both were proud graduates of the famous Virginia Military Institute (VMI). Reed's Clothier is a men's clothing store, which cater to the nearby community and graduates from VMI. The store originally made only a small profit, just enough for the family to survive.

Jim took over the store from his father in 1976 when the company occupied the first floor of a three story building in downtown Lexington. The second floor was office and warehouse and the third floor was rented to a law firm. Jim modernized the store to a new contemporary look and acquired an $880, 00 long-term mortgage debt. Jim slowly increased his inventory assuming many sales were lost because of low inventory when a customer requested it. Sales increased topping $2 million in 1994, which cemented Jim's belief that larger inventory and increase sales are directly related.

Reed's positive cash flow has decreased seriously over the past three years resulting from larger inventories and interest and principle payments on the mortgage. Reed's accounts were past due and suppliers were demanding payment with the threat of ceasing deliveries until payment was made. The store changed from paying on time and sooner usually always taking the cash discounts. The cash crunch caused Jim to visit his banker with the hope of increasing his credit another $100,000.

Jim had only dealt with his classmate from VMI at the Bank. His classmate, Bob Roberts, had been promoted and a new banker, Holmes. Normally Jim would meet with Bob and usually approved what was requested without any financial statements. Holmes requested Jim's up-to- date financial statement. He saw evidence of possible financial distress and made some suggestions to Jim to request the help of a consultant who could assist with a better inventory system. Holmes also told Jim to continue his current line of credit he would need to make due on his overdue note payable within 30 days. Holmes also suggested Jim reduce his inventories and accounts receivables to the industry averages. Jim argued that his inventory was sufficient and decreasing it would decrease sales and hinder his ability to cure the accounts.

Reed's Clothier Ratios Versus Industry Average

Industry Reed's

Liquidity Ratio

Current ratio 2.7 2.0

Quick ratio 1.6 .94

Receivables turnover 7.7 4.93

Average collection period 47.4 74.1

Efficiency Ratios

Total asset turnover 1.9 1.28

Inventory