Fin 370 Case Study Wk 4
Jim Reed and Reed’s Clothier University of Phoenix FIN 370 May 11, 2009 Reed’s Clothier is a clothing store in business since 1934 and is currently being operated by Jim Reed II. Jim has had some gloomy days recently in the store and is in need of some rejuvenation. Reed’s Clothier currently is in some serious cash flow issues stemming from buying the whole entire building years ago and not having a renter in the building now that the law office has left.
Reed’s also has not been taking advantage of the huge discounts offered by their vendors because they need the time to manage the cash flow.In addition, Reed’s has a great deal more inventory on hand than the demand is currently calling for in the market. Reed’s needs to stay ahead of their vendors’ payables by making some quick changes like inventory reduction. Ratios Quite a few ratios are used in the financial market to measure companies against one another in the market, and within the industry. The top liquidity ratios used in business are the current ratio, quick ratio, receivables turnover, and average collection period.
Reed’s current ratio is 2. 02% ($921,000/$457,000). The standard in the industry is 2. %. Compared to other companies, Reed is not as liquid as other companies.
Reed’s quick ratio is 1. 50% [($921,000-$421,000)/$287,000]. The previous two calculations are quite obvious since Jim has not been able to make the companies short term obligations, and has been borrowing money. Reed’s receivables turnover ratio and average collection period show how quickly the company is collecting on the money owed to Reed’s and how quickly they are turning over those accounts. Jim’s receivable turnover ratio is 4. 93 times per year ($2,035,000/$413,000).
The industry standard is 7. 7 times. Reed’s is not maintaining its receivables or accounts with vendors that owe them money. Not collecting on the accounts receivable means Reed’s has money out there they are not able to use to pay on short term and long-term debts. The average collection period for the industry is 47.
4 days and Reed’s is currently sitting at 74 days [$413,000/($2,035,000/365)]. Reed’s is waiting too long to collect money from vendors and this is exactly why they are not able to make their debts. Overall, Reed’s is not too liquid.The industry also has quite a few efficiency ratios like total asset turnover, inventory turnover, and payable turnover. Reed’s total asset turnover is 1. 28 ($2,035,000/$1,591,000) where the industry standard is 1.
9. Reed’s is not too far off on that ratio. It shows that they might be efficient with the maintenance of their assets. Right now, Reed’s is turning over their inventory 2. 91 times ($1,428,000/$491,000), and the standard is 7.
0 times. This particular ratio shows exactly why Reed’s is holding onto too much of the inventory and they should have an inventory reduction sale.Payable turnover is another way to see how efficient the business is operating. Reed’s ratio is 2. 40 ($491,000/$205,000) and the standard is 15.
1. Jim is not being efficient on paying his accounts either. Right now, Reed’s is missing out on quite a few opportunities to catch a break on discounts by paying early. Profitability ratios are also important when investigating exactly where the business is at any given moment. A few of the profitability ratios are gross profit margin, net profit margin, and return on common equity.
Right now, Reed’s is not showing they are profitable in any of the ratios above. The company’s profit margin is below the industry standard. Typically, these profitability ratios explain what is left in the business to invest and what amount of money is available for the stockholders. Reed’s is not meeting any of the standards. Figure 1: Profitability Ratios |Gross Profit Margin= |Gross Profit= | $ 607,000. 00 |29.
80% | | |Sales | $ 2,035,000. 0 | | | | | | | |Net Profit Margin= |Net Profit | $ 85,000. 00 |2. 09% | | |Net Revenues | $ 4,070,000. 00 | | | | | | | |Return on Common Equity= |Net Income | $ 85,000.
0 |16. 00% | | |Common Equity + Paid In Capital+ | $ 530,000. 00 | | | |Retained Earnings | | | Ways for Reed’s To Increase Profitability Jim Reed’s most recent visit to his bank contact, Holmes, resulted in an inventory reduction sale as a suggestion to change the bottom line of the business. Ideally Holmes would like for Reed’s to have the inventory reduction sale to bring the inventory down to normal levels.The store has been bringing in more inventory than is going out. Right now, to meet immediate money obligations, the money from the sale is more important than a bulk of inventory on hand.
Another way that Reed’s can change its outlook immediately is changing its capital policy and decreasing the current assets on hand. Ideally, if Jim was to sale off some assets that would definitely affect the sales. Decreasing inventory will decrease current assets and make more cash available for the business, and collecting on a few of the outstanding accounts receivable will also help with the liquidity of the company.Reduction in Sales Looking into Reed’s income statement, if they only took a reduction in sales, it would result in a negative net income. So in order to become and remain profitable, the company will have to take other measures in addition to a reduction in sales to change the business’ bottom line.
Figure 2: Reed’s Clothier 1995 Pro Forma Income Statement [pic] Controls to Set in Place Reed’s should set some controls in place in order to get a hold of the business. The first type of control should be an inventory control. The ideal inventory control that would work for Reed’s is just in time inventory.The company has so much on hand at the moment, introducing a just in time method would help with inventory reduction and would only keep inventory on hand that is in demand. An accounts receivable control that would help Reed’s is an avid collections policy. Reed’s is not collecting on its money quickly and efficiently and it is affecting the bottom line.
Final Questions and Answers Is the increase in sales related to the increase in inventory? The increase in sales is definitely related to the increase in inventory. When a store has a great deal of inventory available for consumers, it will meet the demands of more people.A company does have a point where it has too much on hand, and Reed’s is currently in this state of business. What is Reed’s cost of not taking the suppliers’ discounts? Every time Jim does not take the discount offered by his vendors, the company loses 3% of a discount. Many of the company’s vendors offer 3/10, net 60.
So if Jim were to pay within 10 days, he would save 3% per vendor. Conclusion Reed’s Clothier has been a very successful business over the past years. Several smart business decisions were made, and will be made again. Once Jim makes the minor adjustments discussed, the company will profit long-term.