Clarkson Lumber Company

Mr. George Dodge, Clarkson Lumber Company is doing well but there is the issue of whether or not there is too high a risk in granting the request for the $750,000 line of credit. There are many supporting strong points but it also has some problems to work out. This is a company that has many good characteristics and looks promising but needs the extra money to pay off loans, inventory, and supplies. I recommend this company to receive the line of credit.

Looking at the individual ratios seen in exhibit 1 and comparing it to the industry average shown in exhibit 2 gives a sense of where this company stands. Current ratio and quick ratio are really low and have been decreasing. For 1995, the current ratio is 1.15:1, which is less than the industry average of 1.60:1, however to give a better sense of where this stands in the industry, as seen in exhibit 3, it is actually less than the average of the bottom 25% of the industry. The quick ratio is 0.61 is less than the industry is 0.90. Both these ratios serve to point out the lack of cash in this company. The cash flow has been decreasing because, it takes longer to get the money from customers, but the company still needs to pay for its purchases. Also, the company couldn’t go over the $400,000 loan limit, so they were forced to stretch their cash.

Return on sales is decreasing and is below the industry average, but the goods news is that sales and profits have been increasing each year. However, costs of goods are increasing and more inventory is left over each year causing the return on sales to decrease. For 1995, it was 1.7% which is less than the average of 2.44% but is a lot higher than the bottom 25% of companies as seen in exhibit 3, which actually have negative sales return of 0.7%. Return on equity is increasing each year and at a higher rate than industry average. In 1995, it was 20.7%, greater than the average of 18.25% and close to the highest companies in exhibit 3, of 22.1% showing that the return in investment in the company is increasing, which is good for the owner.

Return on assets is also decreasing and less than industry average. For example, in 1995 it was 4.7%, less than the average of 6.3%. However, this also has a positive side. This means that the company has a lot of inventory, which is good on a selling standpoint, because it means there is a larger selection base available for the customers. This could bring in more customers because they can be more confident that the company has on hand what they need. The debt to equity ratio could be a problem. The debt to equity ratio is increasing and is more than double the industry average. In 1995, it was 265% compared to the average of 170%. The company has a lot of debt to deal with including paying the partner what is owed to him. However, there has never been a problem with paying the bills. All the references show that he is a good business man and is reliable. For the bank, as long as the loan is being paid the bank is happy and it appears that this company can handle paying the loan.

Inventory turnover is also decreasing and less than the average, but as stated previously, it is because the company has more inventory on hand to give their customers plenty of selection. For instance, in 1995, it was 5.83 times vs. the industry average of 8.1 times, but this gives them an advantage and gives customers a reason to come to them instead of other companies. Since, lumber is a commodity the company has to find a new way to compete. One way is to have a larger selection for the customers. As for accounts receivable turnover, it is also decreasing and less than the average but also signifies another area in which the company is trying to compete in the industry. For instance, in 1995, it was 7.46 and the industry average was 10.7 times. Therefore, Clarkson doesn’t get paid right away but it does make the customers more comfortable since they don’t have to worry about paying the lumber back to Clarkson. Also, since most customers are probably contractors, it would make them happier to be able to use the wood and get paid first, so they can pay Clarkson.

The average collection period of accounts receivable is increasing. Customers, as stated before, are given the opportunity to pay later. Instead of paying every 34.1 days like the average, Clarkson customers have been able to pay back in about 49 days. As for the average payment period, Clarkson has been testing its boundaries and bargaining power to see how many days he could take to pay back his purchases. For instance, he took 35 days in 1993, 45 days in 1994, and 38 days in 1995. It seems that he tried to take longer but then the suppliers may have talked to him because he improved to 38 days, however, it is still an extra 8 days from the typical 30 day invoice. The problem with this is that he isn’t taking advantage of the 2% discount which is evident that many companies do since the industry average is only 16.3 days. However, at this point it doesn’t seem very possible since the loan limit and lack of cash make it hard to take advantage of this situation.

Based on the pro forma sheets there is an additional $251,000 needed to attain the goal of $5.5 million in sales. Also, since part of the agreement is to break off from Suburban National Bank, the line of credit has to cover the 399,000 covered by the loan. Therefore, the amount needed is $650,000 as seen in Exhibit 6. The credit line would also help to pay for inventory instead of having to go on trade and the notes payable for Mr. Holtz which is supposed to be paid by the end of 1996 and is paid in installments of $50,000 at a time.

The company doesn’t supply a very high risk to the bank. The company has its problems but they all seem to stem from the fact that the company has a loan limit and lack of cash since customers take longer to pay. The company doesn’t have a very big risk because this problem would be solved with the equity line. It would fill in the time gap from paying for inventory and from being paid by the customers. The company has a good strategy to compete by having more inventory on hand and allowing customers more time to pay for the lumber. Clarkson has good references which show that in the past he has been a good businessman to deal with. With an economic downturn but the company is protected in new housing construction because of the relatively high proportion of its repair business. Sales, net income, and return on equity are increasing and show the company has a lot of potential. Another plus is that the assistant knows how to do everything that Clarkson does, so if anything were to happen to him, there is a replacement. Also, if Clarkson weren’t able to pay back the loan and the bank takes the company it should be able to make money selling it since it has a lot of potential.