Reed Clothier Case Study

Reed's Clothier Case Study

The company Reed's Clothier was established in 1934 by Jim Reed. Mr. Reed decided to open the company after retiring from the military. By 1976, the company had grown with a net profit of over $800,000.00. After great success Jim Reed made the decision to retire and he gave the family owned company to Jim Reed II, his son. Upon receiving the company, Jim Reed II then decided to purchase a property in downtown Lexington which was considered a prime location. The purchase of that property created $880,000.00 in mortgage debt for the company. Reed's Clothier began to grow, as did their inventory. As a result of speedy progression of the company's inventory, liabilities and debt increased as well. When the debt got higher the company began to have delinquent accounts, thus causing Jim Reed II to turn to his personal banker Harold Holmes, who expressed to him that he had more delinquent accounts and debt than cash flow and he also told him that he was over extended in his credit. Harold Holmes recommended that Jim hire a consultant that will review his finances, as well as assist with the management of Reed's Clothier's inventory and accounts receivable systems so that he could reduce the amount of inventory to the average inventory of the clothing industry. After hearing this news, Jim Reed II realized the severity of Reed's Clothiers financial distress.

Question 1

Calculate a few ratios and compare Reed's results with industry averages. (Some industry

averages are shown in Exhibit 16.4.) What do these ratios indicate?

Exhibit 16.4.

Reed's Clothiers Selected Ratios*

Liquidity Ratios Industry

Current ratio 2.7 2.02

Quick ratio 1.6 0.94

Receivables turnover 7.7 4.93

Average collection period 47.4 74.08

Efficiency Ratios

Total asset turnover 1.9 0.90

Inventory turnover 7.0 2.91

Payable turnover 15.1 6.97

Profitability Ratios

Gross profit margin 33.0 29.83%

Net profit margin 7.8 4.18%

Return on common equity 25.9 16.04%

These ratios indicate that there is more inventory than there are sales which possible causes the payable turnover to be low as it takes longer to pay the creditors. These ratios also indicate that the efficiency of assets is low and they have low gross and net margin. Lastly They are below the industry average on the return of equity.

Question 2

Why does Holmes want Reed's to have an inventory reduction sale, and what does he think will be accomplished by it?

Harold Holmes suggests that Reed has an inventory reduction sale so that cash can be generated. There is an upcoming mortgage payment of $130,000.00 that will be due and Reed has a total inventory of $491,000.00, if Reed has the sale, he could possibly have enough money to pay it.

Question 3

Jim Reed had adopted a very