In order to satisfy the demands of expansion and continue growing top line revenue, an increased amount of borrowing is necessary. This increased borrowing will be In the form of a revolving line of credit with an interest rate of 11%. The following paragraphs will examine this Issue. 1 .
Clarion Lumber Company has seen continued profitability; however, due to perhaps an Increase In scale, the Company takes longer to collect Its accounts achievable.
While revenue grew 19% and 30% from 1993 to 1994 and from 1994 to 1995, respectively, accounts receivable grew at a disproportionately faster rates of 34% and 47%. This leads to Liquidity since the company cannot pay Its suppliers on time to take advantage of trade discounts. This is shown in Payable/Purchases per day increasing from 35. 3 to 47.
1 . In addition, the Company is still paying cash to the previous equity owner after he sold his stake to Mr… Clarion. This is a further use of cash which leads to additional decrease in liquidity.
In order to pay his suppliers on mime and pay his previous partner, Mr…
Clarion took on an additional notes payable from the bank from 1994 to 1995. 2. Due to liquidity and the need to pay Mr.
.. Hot, Mr… Clarion has put additional leverage on the company in the form of larger borrowing from the revolver.
The revolver increased 550% from 1994 to 1995 from $60 to $390. In addition, Mr… Clarion has also taken longer to pay his suppliers, transferring the delay from an increase in accounts receivable to a delay in paying accounts payable, and even taking on trade payable in the form of interest bearing notes. Although this does allow Mr.
Clarion to continue operating his business, prolonging payable is not a long-term financially sound way of operating a company, especially because Mr…
Clarion needs to pay on time in order to take advantage of trade discounts. The Company’s business model is still sound; there is still a demand for the Company’s products; however, due to a drying up of liquidity and a haphazard financial approach to continue operations, the Company Is running the risk of being financially Insolvent. From 1 993 to 1 995, Total Debt/Total Capital Increased from 24% to 62%, Current Ratio decreased from 2. 49 to 1. 15, and quick ratio decreased from 1.
7 to 0. 1. Due to poor financial decisions, the financial strength of the Company has deteriorated. 3. Because the Company runs a low margin, high volume business, It Is of utmost Importance to take advantage of trade discounts.
By taking advantage of these discounts, the Company Is able to make use of Its high volume to lower overall costs and improve margins. Although the Company needs to take on a larger revolver that $67, 400 a year, which is well worth the projected additional $83, 2000 that the company will save on trade discounts. 4. Because the Company needs to pay its suppliers on time, it requires a new revolver n the coming 12 months.
We have projected that the Company will require a new revolver that is at least $613, 000 in size.
We calculate interest expense based upon the past year’s revolver, and assume that income statement line items grow at the same projected 22% increase as Revenue. 5. As Mr… Clarion’s financial advisor, I would suggest that he take advantage with his additional debt financing.
After the debt financing, the Company may take advantage of trade discounts and have the ability for continued expansion. Had the Company been able to take advantage of trade discounts this past year, Net Income would have men $145, 000 instead of $77, 000.
As the banker or lender, I would want at least a first lien on the Company’s assets, in addition to a conditional personal guarantee on Mr… Clarion’s personal assets.
This guarantee will be conditional on the financial health of the Company, which will be determined by the Company’s current ratio and quick ratio. Current Ratio should increase to 1. 5 after 1 year and quick ratio should reach 1. 0 by the end of 1996. If the Company does not meet these requirements by the end of 1996, there shall then be a lien on Mr..
. Clarion’s personal assets until the Company meets these financial targets.