Financial Position
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If we look at the analysis from 1993 to 1995, we can see that the day sales outstanding is constantly increased from 38 days to 49 days, meaning that the receivables from the sales are taking more time to come into the pockets, creating a void of cash forcing Clarkson to borrow money to for payment to its suppliers. Along with that, if we look at the income statement, we can clearly see that although the sales have increased 54% from 1993 to 1995, the purchases have increased in a higher proportion of 63% from 1993 to 1995, again giving a reason for Clarkson to borrow money. Another reason that can be inferred from the income statement is that although the sales have increased 55%, but looking at the net income, we can calculate that the percentage of net income earned by each $ of sale made has decreased from $.02 in 1993 to 0.017 in 1995, solely blaming to the price competitiveness. Cash Conversion cycle ratio has also increased from 58 days to 72 days giving another reason for borrowing money. Payment deferral period increase has also spelled out for Clarkson to become unable to avail the trade discounts as the case suggests that the suppliers follows a 2/10 net 30 policy, and Clarkson is paying his suppliers in 39 days becoming unavailable to avail trade discounts.
The financial position of the company has definitely weakened considerably if we carefully analyze the financial ratios of the company itself. Debt ratio shows an increasing trend of reliance on debt supposedly to run operation, debt ratio has increased from 0.45 in 1993 to 0.72 in 1995. Along with that if we suppose in case of liquidation, the quick ratio of 1993 of 1.26 to 1995 of 0.66 indicates that the current state of liquidation status for the company has decreased and even in this scenario the company is not in such a strong position that it pays off obligation to creditors in line, although the future projections made by the bank themselves seems to be a good prospect for the company, but the last the trend couple of years has shown declining company allocative efficiency of money. Profit margin has also decreased to 1.7% in 1995, indicating further that the company is earning comparatively less than the previous years; one of the reasons might be the price competitiveness of the current industry. So the current company scenario clearly shows that the companys financial position has weakened during this period as the company is heavily reliant on loans.
To see if the trade discounts are attractive enough we need to calculate how much the company might save in cost if the trade discounts are availed. The formula for calculating the cost is stated below Percentage cost of Accounts Payable=((% ofdiscounts)/(100-% of discounts))x(360/(total days-discount days))
The discount on offer is 2%, and their seems to be a 2/10 net 30 policy so Clarkson is only able to avail trade discounts if he pays up before the 10th day. Clarkson payment deferral period should be taken into account over here as he is paying off dues of supplier on average of 39 days in 1995. So the percentage cost of accounts payable comes out to be
=2/(100-2)*360/(39-10)=25.33%
The percentage comes out to be 25.33%, which in comparison to the interest percent of 11%+2% above prime, seems to be a very good deal and might be helpful in improving the companys financial condition. From the calculated percentage, it can be seen that Clarkson will save around 13% in financial charge, which is a hefty percentage for a company which is deteriorating financially. Hence it is a very attractive deal to avail trade discounts.
To clearly answer this question we need to calculate the working capital for Clarkson Lumber in order to reach to a conclusion. If we look at the forecast of 1996 for $5.5 million, working capital can be calculated by the following formula, that is
Working Capital=Current Assets-Current Liabilities
By the above formula, the working capital is calculated as = $1903000-$1121000=$782000
$782000 is the amount needed by Clarkson to run operations smoothly and also become able to avail the trade discounts of 2%. This amount is higher than the load amount offered