Reed’s Clothier” Case Study and Questions
Reed’s Clothier Case Study Analysis
Jim Reed, II the owner of Reed’s Clothier, a men’s clothing establishment is facing financial difficulties. Established in 1934, by Jim Reed to cater to the numerous Virginia Military Institute (VMI) graduates, the business struggled for the first several years. By 1976, the business annual sales had grown to $800,000, where Jim Reed decided to retire and hand over the business to his son, Jim Reed II.
In 1981, Jim decided to expand retail floor space and acquired an $880,000 long-term mortgage debt. During this time, Jim increased inventories with the belief that higher inventories led to higher sales. In ...view middle of the document...
After Jim spoke with Holmes, Jim finally realized that the business was in serious financial trouble. Rich in inventory, yet short in cash, Jim Reed must quickly liquidate inventory in order to meet his financial obligations. Through analyzing the various financial ratios, we hope to gain insight into how Reed can restore his family business to a healthy financial position.
Reed’s Clothier Question 1
Calculate a few ratios and compare Reed’s results with industry averages. (Some industry averages are shown in Exhibit 4.) What do these ratios indicate?
Current ratio 2.0 2.7
Quick ratio 0.9 1.6
Receivables turnover 4.9 7.7
Average collection period 74.1 47.4
Total asset turnover 1.3 1.9
Inventory turnover 2.9 7.0
Payable turnover 7.0 15.1
Gross profit margin 29.8 33.0
Net profit margin 4.2 7.8
Return on common equity 16.0 25.9
Examining the above ratios, we find that Reed’s is poor in comparison to the industry average on all parameters. Reed’s current and quick ratios are less than the industry average; therefore, establishing Reed’s liquidity is poor. Reed’s low current ratio indicates that the company may have trouble in meeting short-term debt requirements. Further, Reed’s quick ratio is significantly lower than the industry average; a low quick ratio in comparison to current ration indicates a high inventory. Reed’s has excess inventory, and is not selling enough, causing a lower profit margin. Essentially, Reed’s company appears to be in poor financial health.
Reed’s Clothier Question 2
Why does Holmes want Reed’s to have an inventory reduction sale, and what does he think will be accomplished by it?
Holmes wants Reed’s to have an inventory reduction sale in order to restore the relative value of Reed’s quick ration and improve liquidity. In addition, having an inventory reduction sale will generate cash to repay the bank note coming due. Reed’s can generate enough cash to repay the note of $130,000. Short-term cash flows will improve and the carrying cost associated with the acquisition of the excess inventory will be reduced.
Reed’s Clothier Question 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?
Tightening the working capital to align with industry averages will assist in restoring financial stability. This change should have little effect on sales so long as Reed’s does not reduce inventory so slow that he is unable to meet customer needs. Passing savings to customers in the form of price reductions, discounts, and sales will help boost sales.
Reed’s Clothier Question 4
Assuming that Reed’s 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 $1,938,000 but that...