1. Identify the key success factors for Earthstone Clays Ltd. and identify how they have changed since the company’s initial operation.

2. What information is required by the president to manage Earthstone Clays successfully?

Reprinted, with permission, from Uniform Final Examination, Paper III, Q#2, 1983, © 1993, The Canadian Institute of Chartered Accountants, Toronto, Canada. Any changes to the original material are
the sole responsibility of the Authors and have not been reviewed or endorsed by the CICA.
Earthstone Clays Ltd. began as a small pottery studio, selling pottery made by the owners and by other local craftspeople. Gradually, other kinds of crafts and supplies were added, until the company became both a retailer of finished crafts and a supplier to the craftspeople. For example, the company sells the raw clay, the glaze materials, and the wheels and kilns used to make pottery, as well as finished pottery.
Over the years, the company has expanded to become a major regional supplier of craft raw materials and equipment. Although the retail business has grown, most of Earthstone’s revenue comes from wholesale sales to craftspeople. The company now has four outlets, each of which has combined wholesale and retail operations. The company mixes most of its clay and glazes and performs other manufacturing and assembly work in a shop attached to its central warehouse.
In the past, essentially all the retail sales and a large portion of the wholesale sales were for cash. Therefore, the company has had low receivables. Recently, however, the company has tried to maintain its sales level by allowing more credit to wholesale customers. Wholesale inventories have always been high in dollar value, particularly for larger pieces of equipment, and have been slow to turn over. Due to the nature of the crafts business, it is necessary to carry a wide variety of inventory items.
Retail merchandise quantities are maintained at a high level. Most of this merchandise is held on consignment, and the remainder consists of items purchased from a few well-established craftspeople or produced in the company’s shop.
Much of the wholesale inventory is imported from the United States and Japan. The company’s margins have been severely squeezed because of recent currency fluctuations and because the recession has prevented recovery of cost increases. Crafts are considered a luxury good, so the company’s retail sales and those to its wholesale customers have been hard-hit. In spite of significant price reductions, sales volume has generally fallen.
Recently, cash flow has been a problem. The company exceeded its credit limit and the bank expressed concern about the company’s financial state and inability to determine its cash requirements. In an effort to alleviate the problem, several cost-cutting measures were implemented and advertising expenditures were increased to try to encourage sales. However, the company’s position continued to
deteriorate. The president then considered the following courses of action: the reduction of inventory levels; the elimination of product lines; the shift of emphasis from wholesale to retail sales; and further price reductions. However, the president was unable to evaluate any of these possibilities since the accounting system did not generate the necessary information.