Clarkson Lumbers Company

Case Analysis

GROUP A:
ANA GABRIELA SOTILLO JOHNSON
FABIAN FREIHERR VON ROSEN
IMRE IGNACIO SZAPARY GIL-CASARES
RAYAN SEIF
STEFAN RADISAVLJEVIC
VERENA RIEDHART
YANIS ALEM

IE business School
Section 4
September 2014
Question 1. Evaluate Clarkson Lumbers financial performance. Can
you explain why Clarkson borrowed so much of money during 19931995 despite its positive profitability?

Although, the Income Statement of Clarkson Lumber seems profitable from

1993 to 1995 by generating positive net income of 60k and 77k respectively.
Further it increased both sales and net income by 54% and 28% vs. 1993,
but the company has a problem of a liquidity and a shortage of cash.
One of the biggest indicators of this problem is almost double decrease in
quick ratio in 2 years (Exhibit 1). This means that the company has a
decrement of current assets (not considering inventory) comparing to current
liabilities by 0.66.
Another factor which helps us understand the reason for shortage is Cash
Cycle, which consists of Average Collection days and Average Inventory days
subtracted by Average Payment days. This indicator is increasing
dramatically by almost 11 days in two years, because of increase of
Collection and Inventory days by 16 and minor increase of Payables days by
5 (Exhibit 2 and 3). The change in Working Capital (Exhibit 4) very clearly
presents the greater increase of receivables than payables, which means
that the company pays faster than its customers pays to the company.
Therefore, additional source of financing should be found.
Further, it is worth mentioning that debt-to-equity ratio increased in this
period from 0.82 to 2.65. As a result, it is very easy to understand that the
main source of financing the operations of the company are loans and other
type of debts (Exhibit 5 and 6).
Finally, there is one more factor which should me mentioned, which is the
growth rate. The growth rate of slightly more than 54% from 1993 to 1995 is
the other reason of taking loans. The business doesnt have enough
resources to grow so fast, thus it takes loans from banks.
To sum up, the main reason why company uses debt for financing when the
business is profitable, because it cannot collect all of its receivables faster
than it covers its current liabilities. As a result, shortage of cash.
Question 2. Prepare full set of financial statements (BS, IS, CFS) for
1996 assuming that it will grow with 25% annual rate without
purchase discount (none discount is taken).
Before starting preparation of financial
assumptions which should be clarified.

statements

we

made

some

First of all, the Income statement has an increment by 25%, but interest and
tax calculation assumption is based on the case data. Tax calculation table is
represented in Exhibit 7.
Second, Total Assets and Net worth (Equity) will increase by 25%. There is
not enough information about depreciation therefore the change in PPE was
assumed to be mainly because of increase in Capex. Additionally, not all the
liability items increased by 25%. The lines with the increment are the
following ones: Notes payable, Accounts payable, Accrued expenses.

Accordingly, the calculation of net working capital includes accounts

payables and accrued expenses as operation liabilities since we dont want
to include the loans factor without finding out the final amount of short-term
loan. Balance sheet and Income statement are presented in Exhibit 8 and 9
with the explanation about the assumptions and calculations next to the
items.
Finally, because of lack of information about the depreciation Firm Free Cash
Flow calculation includes the change of net PPE in Capital expenditures.
Apart from this, taking into consideration the fact that our task is to find out
the loan needed for financing the companys operation we didnt include it in
change of net working capital. Debt change of 1996 also doesnt include
short-term loan payable of the bank. Cash Flow Calculations and Cash flow
Statement are presented in Exhibit 10 and Exhibit 11 respectively.
According to our forecast the income statements net sales increased to 5.6
million and Net Income to 101.000 dollars. Further, according to our
calculations of tax rate in Tax table the average tax rate for 1996 is 26.98%,
where final tax is 37.460 dollars. Interest rate is 54.900 dollars which is
calculated based on the average rate of previous years times current loan
and note to the former cofounder: Mr. Holtz. As a result, our Total Assets
equal to 2.046 million with Net worth of 561.000 dollars and Liabilities of 823
million dollars without bank short-term loan. Thus, to cover all expenses we
need additional loan. In addition to this Equity Free Cash Flow is negative
which also indicates the need of additional loan.
Question 3. How much does Clarkson need to borrow in 1996 to
cover his financial needs?
While preparing Balance Sheet and Income Statement it becomes clear that
each account can be estimated except Notes payable, bank. This is the
account there the new loan should be introduced, which is needed first of all
for business operations and to reach a target of 5.6 million sales and second
to cover previous loan of 399.000 and Mr.Holtzs Note of 100.000.
As mentioned above the liabilities of the company for 1996 are 1.485 million
dollars which include 662.500 dollars of bank credit needed to cover the
previous loan, Mr. Holtzs note and business operation expenses to reach a
forecasted sales target of 1996.
Recommendation
Taking the loan from the new bank can mean a huge amount of control by
the third party on the business for the amount that exceeds our needs. Thus,
the amount of 750.000 dollars note is not required and will just incur
additional interest rates, which will cause additional expenses and control
from third party. Our recommendation is to negotiate for less credit line than
offered by the bank and try to reduce the control. Getting a loan solves this
liquidity problem on the short term. However the long-term problem, which
still exists can be solved by decreasing receivable days and inventory days.

Additionally, Cost of Goods Sold is 75% of Sales, which is relatively high and
our recommendation is minimize a cost of the products without decreasing
the quality of them or to increase the price to the reasonable level.

Quick ratio chart: Exhibit 1

Working capital table: Exhibit 2

Cash

Cycle

Chart: Exhibit 3

Working Capital Chart: Exhibit 4

Debt-to-Equity ratio chart: Exhibit 5

Additional ratios table: Exhibit 6

Tax calculation table: Exhibit 7

Income Statement: Exhibit 8
Balance Sheet: Exhibit 9

Free Cash Flow Table: Exhibit 10

Cash Flow Statement: Exhibit 11