Fin 370 Corporate Finance: Case Study 16 Reed's Clothier (NOT APA format)

Fin 370 Corporate Finance (Finance for Business)
Case Study 16 - Reed’s Clothier

Reed’s Clothier Case Study
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 1994, the business had grown to more than $2 million in sales. The increased inventories, along with the acquired mortgage payments have seriously eroded Reed’s positive cash flow.
During the last year, Reed had slowly increased his line of credit at the bank and failed to take advantage of cash discounts offered by suppliers. Now, many of Reed’s accounts are almost 40 days past due, causing suppliers to demand payment. Jim decided to visit his bank in order to further extend his line of credit by an additional $100,000. Harold Holmes of Fist Virginia National Bank has advised Reed that the bank will not extend their line of credit, and that Reed must repay an overdue note of $13,000 within 30 days.
Holmes suggested the Reed seek assistance from a consultant in order to establish a better inventory system and reduce inventories through an inventory reduction sale. Further, Holmes suggested that Reed reduce accounts receivables by aggressively collecting its past-due accounts. Jim was resistant to Holmes’ suggestions, believing that if he was aggressive in collecting accounts, customers may become angry and take their business elsewhere. In addition, Jim continued to believe that higher inventory resulted in higher sales, and that reducing inventory would reduce sales.
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.

QUESTIONS

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?
2. Why does Holmes want Reed’s to have an inventory reduction sale, and what does he think will be accomplished by it?
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?
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 depreciation and amortization will not change but remain at $32,000.
5. What type of inventory control system would you suggest to Jim Reed?
6. What type of accounts receivable control would you suggest to Jim Reed?
7. Is the increase in sales related to the increase in inventory? (See Exhibit 5.)
8. What is Reed’s cost of not taking the suppliers’ discounts?
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