Cases_in_Financial_Mangement

Cases in Financial Management Dallas Stoneburner, FIN/370 January 8, 2012 Regina Powers 1. Calculate a few ratios and compare Reed’s results with industry averages. What do these ratios indicate' Reed's Clothiers Selected Ratios | | | | | | | Liquidity Ratios | | | | Reed's | Industry | Period | Current Ratio | | 2.02 | 2.7 | times | Quick Ratio | | 0.94 | 1.6 | times | Receivables turnover | | 4.93 | 7.7 | times/year | Average Collection period | | 74.08 | 47.4 | days | | | | | | Efficiency Ratios | | Total asset turnover | | 1.28 | 1.9 | times | Inventory turnover | | 2.91 | 7 | times/year | Payable turnover | | 6.97 | 15.1 | times/year | | | | | | Profitabilty Ratios | | Gross profit margin | | 29.83% | 33.00% | | Net profit margin | | 4.18% | 7.80% | | Return on common equity | | 16.04% | 25.90% | | At first look, Reed’s Receivables turnover is 4.93 which are 2.77 times/year lower than the Industry. A low ratio implies that he should re-assess his credit policies in order to ensure a timely collection in order to increase his earning interest for his company. His average collection period is 74.8 days, which are 26.68 more than the industry. In order to have enough cash to pay off expenses he needs to lower his collection period to turn his receivables into cash. Finally, his return on common equity is 9% lower than the industry which represents the amount of net income returned as a percentage of shareholders equity. In order to keep the shareholders he must increase his return on common equity. 2. Why does Holmes want Reed’s to have an inventory reduction sale, and what does he think will be accomplished by it' Holmes wants Reed to have an inventory reduction sale because his inventory turnover, which is 2.91 times per year, is less than half of the industry average at 7 times per year. A low turnover implies poor sales relative to inventory levels. In Reed’s case his sales have doubled over the past decade but he has tripled his inventory in the same time and needs to liquidate some of the inventory in order to meet his current liabilities. If he has an inventory reduction sale he can increase his current ratio, quick ratio, and payable turnover ratio. Reed believes that a high inventory pleases his customers, but if he doesn’t focus on pleasing his suppliers, he won’t be able to continue serving his customers for long. The suppliers have threatened to cease deliveries unless he makes a payment which is currently 40 days past due. 3. Jim Reed has adopted a very loose working capital policy with higher current assets than industry averages. If he merely tightens his working capital policy to the averages, should this affect his sales' Working Capital = Current Assets – Current Liabilities. The higher the working capital turnover, the better because it means that the company is generating a lot of sales compared to the money it uses to fund the sales. 4. Assuming that Reed’s can improve its operations to be in line with the industry averages, construct a 1995 pro forma income statement. Assume that net sales will be reduced 5 percent to $1,938,000 but that depreciation and amortization will not change but remain at $32,000. Income Statement | | | Reed's | Industry | | | | | Net Sales | $1,938 | 100.0% | 100.0% | Cost of Goods | $1,298 | 67.0% | 67.0% | Gross Profit | $640 | 33.0% | 33.0% | General & administrative expenses | $353 | 18.2% | 18.2% | Depreciation & amortization | $32 | 1.7% | 0.9% | Interest Expense | $23 | 1.2% | 1.2% | Earnings before taxes | $232 | 11.9% | 12.7% | Income Taxes | $89 | 4.6% | 4.9% | Net Income | $143 | 7.4% | 7.8% | 5. What type of inventory control system would you suggest to Jim Reed' I would suggest that Jim Reed use the Barcode inventory management system. Using the barcode technology would increase his accuracy and efficiency of his inventories. Using the barcode allows him to maintain usage statistics, which can be used to make buying decisions based on current sales and existing inventory on hand. 6. What type of accounts receivable control would you suggest to Jim Reed' Although Jim is afraid that if he aggressively attempts to collect on his past due accounts he might lose his customers, he needs to make his invoicing quick and professional, write customized personal dunning letters, offer incentives for quick payments, and get in contact with the late paying customers. Currently he has 24.7% accounts that are currently over 90 days past due. He is currently 6% higher than the industry average in his accounts receivable and he is almost 3% higher in his accounts payable. If he simply collects on his past due accounts, he will drastically reduce his total liabilities. 7. Is the increase in sales related to the increase in inventory' An increase in inventory to sales ratio indicates that Reed’s investment in inventory is growing more rapidly than sales, his sales are dropping, and it signals that he has an oncoming cash flow problem. Inventory to sales Ratio = Inventory/Sales of the Year. Reeds Inventories vs Sales | | | | | Year | Inventories | Net Sales | Percentage | 1991 | $378 | $1,812 | 20.9% | 1992 | $411 | $1,886 | 21.8% | 1993 | $452 | $1,954 | 23.1% | 1994 | $491 | $2,035 | 24.1% | 8. What is Reed’s cost of not taking the suppliers’ discounts' Reed purchased about 80 percent of his purchases on terms of 3/10, net 60. 3/10, net 60 states that if he pays off his inventory within 10 days he will receive a 3% discount on the sale. The remainder of the sales term, “net 60” means the bill is due within 60 days. Reed’s inventories are currently $491,000. If he purchased 80% of his purchase on 3/10, net 60 then he purchased $392,800 on credit. Had he paid off his inventory within the discounted 10 day period, he would have saved $11,784.