Financial Management Reed\'s Current Ratio

Financial Management

Reed's current ratio is 2.0, compared to the industry average of 2.7; the quick ratio is 0.94 compared with the industry average of 1.6. The receivables turnover is 4.9 compared with the industry average of 7.7. The average collection period is 74 days, compared with the industry average of 47.4 days. The total asset turnover is 0.89 times compared with the industry average of 1.9 times. The inventory turn is 2.9 compared with an industry average of 7.0. The a/p turn is 6.96 times compared with the industry average of 15.1. Reed's gross margin is 29.8% compared with 33% for the industry; the net margin is 4.1% compared with 7.8%. Reed's ROE is 16% compared with the industry average of 16.9%. What these figures indicate is that Reed underperforms the industry on all financial measures. Most of Reed's measures are not poor, but the all lag the industry averages, indicating that Reed is in general a substandard performer.

Holmes wants to have an inventory reduction sale because he feels that the company needs the money to cover the upcoming repayment. Holmes is concerned that the store has too much money tied up in inventory and is going to be unable to make that payment.

3. Reed can tighten his working capital policy without affecting sales. To do so would require him to reduce inventories, but that can be accomplished by improving inventory turnover. This would have a positive impact on sales. Other moves to reduce working capital, such as tightening the receivables turn, would not affect sales at all.

4.

1995 Pro-Forma

Net Sales

1938

COGS

Gross Profit

SGA Exp

Dep

32

Interest

63

EBIT

Tax

65.376

Net Income

5. I would suggest that Reed control his inventory with computerized tracking using SKUs. He should know exactly what is inventory level is at all times. This would allow him to have sales when levels are too high, improving his inventory turnover.

6. Accounts receivable should be controlled with incentives. Jim can provide discounts for early payment that encourage customers to pay more quickly. Currently, payment should be reduced by about one month in order to achieve the industry average, and there is no reason why customers cannot pay within a month. Delinquent customers should be charged interest, as would happen if Reed had a store credit card. This would provide Reed with the ability to earn in interest what he would otherwise earn by reinvesting monies from slow-paying accounts.