Analysis of the Reed’s Clothier case
1) Some of the ratios of Reeds Clotheir Company are indicated below ;
Reeds ratio Industry average
Current ratio =$921000/457000 =2.01 2.7
Quick ratio =$921000-491000/457000 =0.94 1.6
Receivable turnover =$2035000/413000 =4.93 7.7
Av. Collection period =365/4.93 = 74.04 47.4
Total asset turnover =$1428000/1591000=0.90 1.9
Inventory turnover =$1428000/491000=2.91 7.0
Payable turnover = $1428000/205000=6.97 15.1
Gross profit margin =607000*100/2035000=29.8 33.0
Net profit margin =85000*100/2035000=4.18 7.8
Return on common equity =85000/530000*100= 16.04
The above ratios indicate the following;
The liquidity ratios indicates that the company is facing some financial crisis, this is indicated by the quick ratio as in that this ratio is less than 1, despite the fact that current ratio is more than 1, this is so because some of the assets like inventory takes a longer time to be converted, also the customers are taking long to repay their debts as is indicated by the average collection period.
The efficiency ratios indicate how well the company is in a position to manage its available assets. The return on common equity indicates the adequate amount of money which used to settle out the dividends and still adequate amount is left for the normal company operations (Bull, 2008).
2) The reason as to why Holmes want Reeds to have an inventory reduction sale is to reduce the account receivables as he would be able convenes customers that stock are not enough to warrant them credit ;this in turn would reduce sales . By doing this cash inflows would increase thus boosting the liquidity position of the company.
3) If Reeds tightens his working capital policy his customers would shift to the competitors hoping that might get better terms thus the sales of Reeds Clotheirs would drastically decline.
4)If sales of Reeds Company declines by 5%, cost of goods and all those expenses that affects sales directly like general and administration expenses would decline by the same rate .Whereas income taxes would be calculated using the percentage or proportion of the original statement ,and it would as follows;
Reeds Proforma Income Statement For the year ended 1994
Net sales 1938
Cost of sales 1357
Gross profit 581
Gen. and admin expense 355
Depreciation and amortization 32
Interest expenses 63
Earnings before taxes 131
Income taxes 50
Net income 81
5) The inventory control system that I would suggest Jim Reed is to use an up to date methods when evaluating the amount of stock to be bought, some of which are Economic Order Quantity (EOQ) or Just in Time (JIT) to ensure that there are optimal inventory.
6) The accounts receivables that I would suggest to Jim Reed is to vet for credible customers who are able to there debts on time, also he can impose penalties for those who would pay as per the agreed date.
7) The increase in sales is not related to the increase in inventory, in that sales has been increasing at a constant rate of 4%, while the increase in inventory had not been constant ,for instant it increase by 5% in the year 1992,by 10% in the year 1993 and 9% in the year 1994.
8) To ascertain Reeds cost of not taking capital, first we have to ascertain purchases for the 1994 and this can done reversing the calculations of gross profit i.e
Reeds income statement for the year ended 1994
Opening stock 452
Cost of goods available for sale 1919
Less: Closing stock 491
Cost of sales 1428
Add: Gross profit 607
Net sales 2035
Therefore the cost of Reeds not taking cash discount would be 80% of 1467=$1174*0.03=$35.20
Bull, R. (2008). Financial ratios: how to use financial ratios to maximise value and
success for your business. New York: Elsevier Science & Technology