FIN 370 Week 4 Individual Assignment Reeds Clothier Case Study and Questions
FIN 370 Week 4 Individual Assignment Reeds Clothier Case Study and Questions fin571
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Date Created: 11/11/15
Q Brie y summarize the case In order to increase sales Reeds Clothier concentrated on increasing inventory They were afraid that lower inventory level will harm sales Company renovated the stores and tripled the inventory But sale did not increase as they expected While they tripled the inventory sales doubled only This resulted in excess inventory Money was stuck up in inventory Instead of analyzing the problem and addressing the root cause company considered it as cash problem and tried to solve the problem by having progressively larger line of credit But increasing the line of credit could not solve the problem When banks demanded payment severity of the issue came to the attention of the owners of Reeds Clothier Now they are trying to analyzing financial problem and finding solution Q Calculate a few ratios and compare Reed39s results with industry averages Some industry averages are shown in Exhibit 4 What do these ratios indicate Answer Formulae Current Ratio current assetscurrent liabilities Quick Ratio current assetsinventorycurrent liabilities Gross Profit Margin EBIDTA sales Net Profit Margin PATSales Ratio Reeds Industry Current Ratio 20 27 Quick Ratio 094 16 Gross Profit Margin 298 33 Net Profit Percentage 42 78 Reed s has current ratio lower than the industry average which indicates that company may be experiencing liquidity problem Low current ratio means company may find it difficult to meet short term debt requirements In the same line quick ratio of Reeds is significantly lower than the industry average Quick ratio does not consider inventory which is considered in current ratio Very low quick ratio as compared to current ratio means company is having more than enough inventory Reeds must work on cutting down inventory level Even Gross profit margin and Net profit margin of Reeds is significantly lower than the industry average Based on the ratios of Reeds company does not seem to be doing well It is having poor financial health Company is having inventory piled up and company is not selling enough That is causing lower profit margin also Q Why does Holmes want Reed39s to have an inventory reduction sale and what does he think will be accomplished by it Reeds has very low quick ratio as compared to industry Quick ratio current assetsinventorycurrent liabilities This quick ratio can be increased by reducing inventory Holmes wants Reed to unload excess inventory because it will restore the relative value of Reed39s quick ratio and so improve liquidity Result will be short term cash ows will improve and the carrying costs associated with the acquisition of the excess inventory will be reduced or eliminated It will increase Reed39s ability to repay short term debt Q 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 effect his sales High working capital means high current asset High current asset means more account receivable It indicates that more product is sold on credit If working capital policy is tightened it will reduce sales But Reeds can manage to keep profitable sales high at the cost of unprofitable sales and improve its bottom line Q Assuming that Reed39s can improve its operations to be in line with the industry averages construct a 1995 pro forma income statement Assume that net sales will be reduced 5 percent to 1938000 but that depreciation and amortization will not change but remain at 32000 Pro Forma Income Statement Figures is 000 Sales 1938 COGS 1360 GP 578 General Admin 356 DampA 32 Interest 60 Earnings before tax 130 Income Tax 50 Net Income 80 Q What type of inventory control system would you suggest to Jim Reed Reed39s first priority should be to reduce inventory and increase sales An inventory control system which regularly evaluates the demand as a ratio of sales should be preferred The system should set a limit of demandtosales ratio for each item below which item should be sold even at discounted price Practically ABC inventory control system is the system Reed should use In ABC inventory control system items are segregated based on its value Class A items contributes most to the profit of the company Class B items are moderate value and class C items are low value items So even if class C items are not available it will not affect the profitability of the company much but shortage of class A item will affect the company most Thus company should concentrate more on class A items than class B or C item Q What type of accounts receivable control would you suggest to Jim Reed Reed should try to place as many as possible customers on COD If payment is not being received at time business is not profitable At the same time company can not put all customers on COD So for regular customers Reed should use Ageing schedule Ageing schedule control will help teh company in identifying customers who39s payment is over due Company can put effort to collect past due from customers which will definitely improve the status of account receivables of the company Q Is the increase in sales related to the increase in inventory The increase in sales and increase in inventory show a similar upward trend But these increases are disproportional There is no clear evidence which can say that sales increase as a result of increase in inventory We see that between 1991 and 1992 inventory increased 87 while sales increased only 41 Also between 1992 and 1993 inventory increased by 10 while sales increased by 36 only So increase in inventory is directly linked with the increase in sales Q What is Reed39s cost of not taking the supplier Payment term is 3 10 net 60 cost of not taking the suppliers discounts discount 365 100 discountPayment days discount period Cost of not taking the discount discount100 discount X 365Payment days discount period 3365100360 10 2257 In terms of dollar we can calculate cost of not taking supplier39s discount as follows 80 of the goods are bought on terms of 310 net 60 So goods purchased on this term 1428000 80 1142400 If discount is availed discount Will be 3 of 1142400 1142400 3 34272 In my opinion cost of not taking discount in terms of should be taken All text books use only
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