The Clarkson Lumber Company is a family-owned business that has been in operation for over 50 years. The company sells lumber and building materials to contractors and homebuilders in the Greater Los Angeles area.
In recent years, the company has experienced a decline in sales and profitability. As a result, the owners are considering selling the business. The Balance Sheet and Income Statement for Clarkson Lumber Company are attached.
Financial ratios are one way to measure a company’s financial health. The following table shows some key financial ratios for Clarkson Lumber Company:
– Current Ratio: The current ratio is a measure of a company’s ability to pay its short-term obligations with its current assets. Clarkson Lumber’s current ratio is 1.5, which means that the company has enough assets to cover its liabilities.
– Debt-to-Equity Ratio: The debt-to-equity ratio is a measure of a company’s financial leverage. Clarkson Lumber’s debt-to-equity ratio is 0.4, which means that the company has more equity than debt.
– Profit Margin: The profit margin is a measure of a company’s profitability. Clarkson Lumber’s profit margin is 5%, which means that the company makes a profit of $0.05 for every $1 in sales.
The following table shows some key financial ratios for the lumber industry:
– Current Ratio: The average current ratio for the lumber industry is 2.0.
– Debt-to-Equity Ratio: The average debt-to-equity ratio for the lumber industry is 0.5.
– Profit Margin: The average profit margin for the lumber industry is 5%.
Mr. Clarkson, the owner of Clarkson Lumber Company, has been its only operator for 49 years now. He’s always lived a frugal lifestyle and as such doesn’t have much personal debt. The company he owns is very efficient due to low staff and operating expenses – this is all thanks to Mr. Clarkson himself who manages everything expertly.
The company has been profitable every year since it was founded. For several years, the company has experienced significant growth in both sales and earnings. Clarkson Lumber Company is currently the largest lumber supplier in the Northwest. As a result of this success, Mr. Clarkson is now considering expansion into new markets. Before making any decisions, he wants to take a close look at the company’s financial situation.
To get started, Mr. Clarkson pulls out the balance sheet from the most recent year-end (December 31) and begins to examine it carefully. He first looks at the total assets and notes that they have increased significantly from the previous year. This is mainly due to an increase in inventory, which has gone up from $600,000 to $1,200,000. Mr. Clarkson is pleased to see that the company has been able to maintain a healthy level of cash on hand, which currently stands at $300,000.
Next, Mr. Clarkson turns his attention to the liabilities and equity side of the balance sheet. He notes that total liabilities have also increased over the past year, but not by as much as assets. The largest increase is in accounts payable, which has gone up from $200,000 to $400,000. Mr. Clarkson knows that this is due to the fact that the company has been buying more inventory on credit lately in order to keep up with demand. Overall, he is not too concerned about the increase in liability levels, as the company is still in a very strong financial position.
Looking at the equity side of the balance sheet, Mr. Clarkson sees that total equity has increased from $1,000,000 to $1,500,000. This is mainly due to retained earnings, which have grown from $800,000 to $1,200,000. Mr. Clarkson is pleased to see that the company’s profits are being reinvested back into the business and fueling further growth.
After reviewing the balance sheet, Mr. Clarkson begins to look at some key financial ratios. He starts with the current ratio, which measures a company’s ability to pay its short-term obligations with its current assets. The current ratio for Clarkson Lumber Company is 2.5, which Mr. Clarkson knows is very strong. This means that the company has more than enough assets on hand to cover its short-term liabilities.
Next, Mr. Clarkson looks at the acid-test ratio, which is a more stringent measure of a company’s liquidity. The acid-test ratio for Clarkson Lumber Company is 1.8, which is still very strong. This indicates that the company has enough liquid assets (assets that can be quickly converted to cash) to cover its short-term liabilities even if it had to do so immediately.
Finally, Mr. Clarkson calculates the debt-to-equity ratio, which measures a company’s financial leverage. The debt-to-equity ratio for Clarkson Lumber Company is 0.4, which Mr. Clarkson knows is very low. This means that the company has very little debt and is financed mostly by equity. Overall, Mr. Clarkson is very pleased with the company’s financial position and decides to move forward with his expansion plans.
The company’s original owner, Keith Clarkson, bought out his partner’s interest for $200,000 in 1994. His business partner at the time, Henry Holtz, accepted a note instead of cash that was repayable in semi-annual installments of $50 000 with an 11% interest rate beginning on June 30th 1995. The reason Mr. Clarkson took this route was to buy himself some time to arrange the necessary financing.
The company has experienced rapid growth in recent years. The sales in 1995 were $3,750,000 and increased to $5,250,000 in 1996. The accounts receivable at December 31, 1995 were $325,000 and increased to $425,000 by December 31, 1996. The inventory at December 31st was also up from the previous year’s levels; $475,000 in 1995 to $575,000 in 1996. Clarkson paid off the note to Holtz in full on June 30th of this year with proceeds from a new loan.
