Clarkson Lumber

MEMO RE CLARKSON LUMBER

TO: John Doe

President, Northrup National Bank

FROM: George Dodge

Loans Officer, Northrup National Bank

Clarkson Lumber Company is owned and operated by the hardworking, 49-year-old Mr. Clarkson. It has low operating expenses, a small staff, and strong management. The overall impression is one of a conservative, efficient operation. Clarkson himself leads a frugal lifestyle with little personal debt.

Clarkson Lumber is a company experiencing rapid growth but with a constant cash flow crisis. This is not an unusual confluence, but it does require some financial decision-making. Their current state of under financing makes a number of their ratios look poor.

There are several reasons for the cash flow problems at Clarkson Lumber. One is Mr. Clarkson's decision in 1994 to buy out his partner Mr. Holtz. The note had 4 semi-annual installments of $50,000 beginning June 30, 1995 with an 11% interest rate. Clarkson Lumber is not generating enough profit to pay off this debt in such a short space of time. Basically the debt repayment terms do not match the financial strength of the business. As of today there are 2 remaining payments to be made on this note, June 1996 and December 1996.

The ceiling of $399,000 in borrowing ability placed on the company by the Suburban National Bank is consistently insufficient to meet their growing needs. Sales have increased from $2,921,000 in 1993 to $4,519,000 in 1995. This is an increase of 54%. In addition Clarkson has demonstrated an ability to stay within Suburban's $400,000 limit only by relying heavily on trade credit.

In addition, from their financial statements, it appears that they made substantial property purchases in 1995 ($126,000). These were financed them with their revolving loan. One can assume that this expense was a result of their significant increase in sales, but it is generally not a good cash management strategy to use short-term debt to buy long terms assets.

If we look at a number of key ratios for Clarkson Lumber, some clear issues emerge. Their Debt to Equity ratio is rising as a result of increased debt. In 1993 the Debt to Equity Ratio was .45. In 1994 it was .68 and in 1995 it was .73. This is a trend that Clarkson will have to take into consideration as he refinances his company.

Clarkson Lumber's Current Ratio reveals a struggle with diminishing liquidity. In 1993 their current ratio was 2.5. In 1994 it was 1.58 and in 1995 1.12. Compare this to high and low profit companies in the industry that have Current Ratios of 2.52 and 1.31 respectively. Clarkson cushion of working capital is dropping steadily.

The ROA Ratio is the best indicator of the efficiency of the investment in and use of assts. In Clarkson Lumber's case this ratio is sliding downward. From 1993 to 1995 it has decreased from 6.5% to 5.7%. Compare this to high profit companies in the industry that have ROAs of about 12.2%. Clearly Clarkson Lumber is not effectively utilizing its assets.

Another problem for Clarkson is their decreasing Inventory Turnover Ratio. In 1993 Clarkson Lumber turned their inventory over 7.5 times, but in 1999 they only managed to turn it over 6.3 times. In other works, in 1993 Clarkson Lumber moved their inventory, on average, in 55 days. In 1995 it took them 62 days. This kind