Back FINANCIAL MANAGEME... could help him establish a better inventory system. In addition, the condition for it line of credit was payment of the overdue note payable 112 of 375 nes also suggested that Jim reduce his inventories and so the industry averages. (See Exhibits 1 and 2 for income statement and balance sheet information for the last full fiscal year. Both state- ments have common-size columns for Reed's and the industry.) Jim had argued that reducing inventory would reduce his sales and make it even harder to become current on his accounts. Holmes had countered this argument by saying that he thought his sales would be reduced less than 5 percent annually, and that by not reducing the inventory through an inventory reduction sale, Reed's would not be able to raise the cash required to meet its financial obligations. Finally, Holmes suggested that accounts receivable be reduced by aggressively collecting its past-due accounts. (See Exhibit 3.) This was a particularly sore point with Jim, for he knew he had allowed his collections efforts to lapse in his efforts to increase sales. Jim was afraid that if he aggressively attempted to collect his past-due accounts, these customers might become angry and take their business elsewhere. Reed's sold about 75 percent of its sales on terms of net 30, which were the same terms offered by all its major competitors. As he slowly walked the two blocks between the bank and his store, Reed finally realized that his store was in serious financial trouble and wondered what he needed to do to regain control. 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 indus- try 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 amor- tization 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?