Analysis of the Reed’s Clothier case Essay

Analysis of the Reed’s Clothier case

1)      Some of the ratios of Reeds Clotheir Company are indicated below ;

(a)Liquidity ratios

                                                   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

(b)Efficiency ratios

                           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

                            (c)Profitability ratios

                            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

                                                                      Amount ($000)

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

                                                                                         Amount ($000)

Opening stock                                                                     452

Purchases                                                                            1467

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

References

Bull, R. (2008). Financial ratios: how to use financial ratios to maximise value and

success for your business. New York: Elsevier Science & Technology