Running head: Reeds Clothier Case Study

Reeds Clothier Case Study Colleen Mueller FIN/370 August 7, 2011 Christine Gordon

Reeds Clothier Case Study Summary Reeds Clothier opened their doors in 1934 and is a long time family owned business specializing in mens clothing and catering to the military graduates who are the largest portion

of the population in hometown Lexington, Virginia. The business slowly over the next six years showed a steady increase in sales year over year, eventually becoming a successful business and income for Jim Reed. In 1976 after 42 years of running a successful business chose to retire and turn the business over to his some Jim Reed II. Shortly after the turnover Jim Reed II decided that business was grand and updates and expansion would be beneficial to the future of Reed Clothier. With sales soaring Jim felt that the benefits out weighed the risks. The years following the expansion slowly took a toll on the company eroding away at Reeds positive cash flow due to the increase in purchases and interest in principle payments from the $880,000 price tag of the remodeling and expansion. Reeds stubborn pride found him not taking advantage of cash discounts rendering him constantly increasing his line of credit at the bank to finance his purchases. This was never a problem until recently when positions at the bank changed and a gentleman who was not willing to put financial strength on the back burner for friendship. The bank is no longer willing to increase Reeds line of credit and the bank is now demanding payment of their overdue note within 30 days. The bank is also suggesting that Reed reduce his inventory and accounts receivables to the industry averages. The bank suggested that to make these key things happen Reed conduct an inventory reduction sale and aggressively collect on past due accounts receivables. Reeds receivables are trending at almost 27 days higher than the industry standard and are 44 days over their agreed upon credit terms.

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Reed realized that his company was not in a good financial state at all and failure to improve his margins could potentially result in the need to close the long-time family business. Focusing on establishing more stringent credit terms coupled with a useful inventory control program to assist with proper ordering needs could put Reeds Clothier back in the black.

1) Industry Average comparisons Reeds Clothier Liquidity Ratios Current Ratio Quick Ratio Receivables Turnover Average Collection Period Efficiency Ratios Total Asset turnover Inventory Turnover Payable Turnover Profitability Ratios Gross profit margin Net profit margin Return on common equity Current assets/current liabilities Current assets-inventory/current liabilities Sales/Accounts Receivable Accounts receivable/sales per day Sales/Total assets Sales/inventories Sales/accounts payable Gross profit/sales Net profit/sales Net profit after tax/equity 921/457 921-491 457 2035/413 2.01 0.94 4.93 74.08 Industry Average 2.7 1.6 7.7 47.4 1.9 7.0 15.1 33.0 7.8 25.9

2035/1591 1.3 2035/491 4.1 2035/1061 1.9 607/2035 85/2035 85/530 29.8 4.2 16.0

The above ratios show a couple things. First they show that although Reeds is holding too much inventory on a monthly basis which is bringing down his liquidity. They also appear to not be managing their receivables which are taking a toll on their cash flow in the end. Extending 30 day net terms to customers is great if they are paying in those 30 days. Reeds is also drastically below the industry average on their net profit margin and the return on common equity. Not only

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is Reed now seeing the financial distress the company is in, but his shareholders are also likely to begin complaining as well. 2) Why does Holmes want Reeds to have an inventory reduction sale, and what does he think will be accomplished by it? Holmes wants Reeds to have an inventory reduction sale to generate cash. If Reeds were to conduct this sale as a cash and carry sale with inventories of $491,000 even selling half the inventory would allow Reeds to pay the $234,000 overdue note to Holmes. 3) Jim Reed had adopted a very loose working capital policy with higher current assets than industry averages. If he merely tightens his working capital policy to the averages, should this affect his sales? Reducing inventories too much might not be the best idea for Reeds. The potential to lose business when specific items are wanted or needed by a customer could turn them away and potentially lose them for good. Receivables is likely the first thing that Reeds needs to revamp and put a tighter reign on. Current terms Reeds extends to its customers is 30 days, yet their receivables are averaging 74.08 days which is 44 days over their terms and almost 27 days over the industry average. Being more firm on the credit terms and aggressively collecting on past due bills will improve Reeds cash flow.

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4) Assuming that Reeds can improve its operations to be in line with the industry averages, construct a 1995 pro forma income statement. Assume the net sales will be reduced 5 percent to $1,938,000 but that depreciation and amortization will not change but remain at $32,000. Reeds Clothier Income Statement Sales Cost of Goods Sold Gross Profit General and Adimistrative Expenses $1,938,000 $1,298,460 $ 639,540 $ 352,716 32,000 23,256 67% 33% 18.2 1.7% 1.2% 11.9% 4.9% 7.0%

Depreciation & Amortization $ Interest Expense Earnings before taxes Income Taxes Net Income $

$ 231,568 $ 94,962

$ 136,606

5) What type of inventory control system would you suggest to Jim Reed? Since Jim does not seem to have a firm grasp on his inventory verses sales, I would suggest that he invest in inventory control software which would allow him to better manage his inventory based on what he is actually selling. Software such as this would allow for the items to be removed from inventory when they are sold and prepare detailed ordering information for Jim allowing him to not over purchase merchandise. Depending on the specific software Jim can also

Reeds Clothier Case Study utilize the reports within the software to identify what the hottest selling products are as well as

what products are not selling. This feature will also allow Jim to not order those not so hot items which will just be wasted money sitting on the shelves. 6) What type of accounts receivable control would you suggest to Jim Reed? Jim should consider not extending 30 day terms to his customers and changing to a cash sales only model. This puts cash in Jims hands immediately and reduces his exposure. If Jim is concerned he would lose clients by doing this he may consider offering special terms such as an additional 10% or 20% off for paying cash up front. 7) Is the increase in sales related to the increase in inventory. Exhibit 5 Year Inventories Net Sales Change in Inventory Change in sales

1991 $378 1,812 1992 $411 1,886 8.73% 4.08% 1993 $452 1,954 9.98% 3.61% 1994 $491 2,035 8.63% 4.15% The percent change in inventory is significantly higher than the percent change in sales. Based on these calculations we can conclude that the increase in sales is not related to the increase in inventory. 8) What is Reeds cost of not taking the suppliers discounts? Cost of not taking discounts = (% discounts/100-% discount) x 365(payment days discount period) Terms 3/10 net 60 Cost = 3%(100-3%) x 365/(60-10) = 22.6%