Clark’s Plumbing and Supply Company wants to grow
that he won’t have enough cash to make it happen. So he’s hired you as his consultant to help him figure out how much cash he’ll need.
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Get Help Now!You can see where Kent’s cash problem comes from. His minority owners insist that he make a dividend payment every year (per the ratio below), including to himself. He’s got no incentive for customers to pay early. His Payables are high, and he is not able to take advantage of 2%/10 net 30 day payment policies offered by all of his suppliers. In fact, if Payables go any higher, suppliers are likely to require cash payment rather than extending more credit.
In order to grow as planned, Kent will need to hire 2 new associates to assist with sales/customer service, and he’ll need to buy new equipment and shelving for his warehouse. Estimated total additional cost will be $80,000 per year plus $20,000 in one-time investment.
The good news is that Clark customers love this store. Service is great, and they always get what they need when they need it.
You’re a consultant and Clark’s cash is tight. Your billable hours are costly to the company, so don’t tell Kent things he doesn’t need to know. Focus on his problems.
Following is a summary of information derived from the company’s financial statements:
| Sales (2015): | $2.5 million |
| Gross margin | 20% |
| Operating expenses (2015) | $440,000 – includes Kent’s salary |
| Cash | $20,000 |
| Accounts payable | $ 150,000 |
| Notes payable (interest rate of 10%) | $ 300,000 |
| Dividend payout ratio | 50% |
| Inventory turnover ratio (won’t change with growth) | 10.0 |
| DSO (no 2%/10, net 30 day policy – 360 days per year) | 36 Days |
| Tax rate | 40% |
- Construct a 2016 pro forma income statement for Clark, assuming he does not need to borrow further to fund growth.
- Estimate Clark’s additional cash needs. Where do these come from? If you don’t have complete information, make assumption and document them. Don’t forget that if Kent borrows to meet these needs, he’ll have additional interest payments (you can round off).
- Would it help him to borrow more and take advantage of credit terms on his Payables? Be sure to look at both benefit and cost.
- Would it help him to institute a 2%/10, net 30 day credit policy for his customers, assuming 50% would take advantage of this? Be sure to look at both benefit and cost.
- What other actions could Kent Clark take to improve his cash situation?
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