Group Assignment #2

Clarkson Lumber Company

Financial Management

MIM 2011/12 Section 1 Work Group E

Ana Dominguez Ponce, Anirudh Kanduri, Gabriel Freiha Maria Lourdes Gutirrez Colina, Matthus Ittner, Sofia Kaloeidi

Financial Management Assignment #2

Clarkson Lumber Company

Question 1: Evaluate Clarkson Lumbers financial performance. Can you explain why Clarkson borrowed so much of money during 1993-1995 despite its positive profitability? Although the Clarkson Lumber Company made profits in the last year and is looking forward to even more increasing sales and profits, the company shows some weaknesses.

The first weakness is an increasing ratio of current liabilities. This ratio shows that two third of the company are financed through expensive short-term loans.

Current liabilities
70.00% 60.00% 50.00% 40.00% 30.00% 20.00% 10.00% 0.00% 66.46% 48.83% 29.92%

1993

1994

1995

The next negative sign comes from the quick ratio. It shows from 1993 to 1995 a strongly decreasing tendency from 1.27 to 0.61. Since this ratio shows the proportion of cash and receivables to current liabilities, it becomes clear, that the company cannot cover its current liabilities with easy available money.

Quick ratio
1.40 1.20 1.00 0.80 0.60 0.40 0.20 1993 1994 1995 0.82 0.61 1.27

Work Group E: Ana Dominguez Ponce, Anirudh Kanduri, Gabriel Freiha Maria Lourdes Gutirrez Colina, Matthus Ittner, Sofia Kaloeidi

Financial Management Assignment #2 A lot more ratios, which are shown below, prove that the company, although it is profitable, has some serious problems.

To answer the question, why the company borrows so much money, you should have a look at the accounts of receivables, inventories and payables. The graph below shows that all three accounts are increasing, but accounts receivable and the inventory even more than accounts payable. Hence, Clarkson pays his debts too early and has to wait for the reception of the accounts receivables. Therefore this gap has to be financed with credits and thus the gap should be closed by decreasing the inventory or change the payment policies.
$700.000 $600.000 $500.000 $400.000 $300.000 $200.000 $100.000 $1 2 3 Accounts receivable, net Accounts payable Inventory

Work Group E: Ana Dominguez Ponce, Anirudh Kanduri, Gabriel Freiha Maria Lourdes Gutirrez Colina, Matthus Ittner, Sofia Kaloeidi

Question 2: Prepare full set of financial statements (BS, IS, CFS) for 1996 assuming that it will grow with 25% annual rate without purchase discount (none discount is taken). Following assumptions have been made to forecast the financial statements for 1996. Each description of the assumption is stated next to the forecast, to make it easier to follow them.

Financial Management Assignment #2 After making the assumptions the projections for the year 1996 were possible.

Now it was possible to forecast the cash flow, the income statement and the balance sheet:

Work Group E: Ana Dominguez Ponce, Anirudh Kanduri, Gabriel Freiha Maria Lourdes Gutirrez Colina, Matthus Ittner, Sofia Kaloeidi

Financial Management Assignment #2

Work Group E: Ana Dominguez Ponce, Anirudh Kanduri, Gabriel Freiha Maria Lourdes Gutirrez Colina, Matthus Ittner, Sofia Kaloeidi

Financial Management Assignment #2

Work Group E: Ana Dominguez Ponce, Anirudh Kanduri, Gabriel Freiha Maria Lourdes Gutirrez Colina, Matthus Ittner, Sofia Kaloeidi

Question 3: How much does Clarkson need to borrow in 1996 to cover his financial needs? While preparing the balance sheet and income statement for 1996, it became clear that each account could be forecasted except the account Notes payable, bank. This is the account where we record the new credit, which we have to take to cover the financial needs of Clarkson Lumber. However, we now from the instructions that Clarkson Lumber, before taking the new credit, has to repay the old credit ($399,000) and to cover the note repayments to Holtz ($100,000 for the year 1996). Furthermore the new credit will be useful to repay the last $50,000 notes repayments in 1997.

The asset side of the balance sheet showed a sum of $2,029.25 and the liability/equity side, without recording a bank loan, showed a sum of $1,381.78. According to this information, we can deduct these two amounts and it becomes clear, that the Clarkson Lumber Company has to take up a credit in height of $647.47 in order to repay the old credit, pay the notes to Holtz and fulfill all financial needs to cover the increase in sales.

Question 4: Compare the nature of the financial problems face by SureCut Shears and Clarkson Lumber.

Both companies are faced with increased inventories. However, sales for SureCut Shears are decreasing, while Clarkson Lumber still enjoys rising sales. Thus Clarkson Lumber is able to make profits, while SureCut Shear has negative retained earnings. However, SureCut Shear has, on the longer run, the advantage of a better current ratio, which means that SureCut Shears is able to meet without problems its current liabilities with its own money. Clarkson Lumber has to take a credit to finance its short-term operations. Conclusion: As the comparison shows, making profits doesnt mean to be able to survive in the short-run. Also the current assets are very important for the survival of a company, since your short-term liabilities have to be covered. In conclusion, making profits does NOT imply operating better than a company making losses.