How has Mr. Clarkson met the financing needs of the company during the period 1993 though 1995? Has the companys financial strength improved or deteriorated (in your response, include various ratio analyses - such as those ratios used in Exhibit 3 in the case)?

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After rapid growth in its business during recent years, the Clarkson Lumber Company, in the spring of 1996, anticipated a further substantial increase in sales. Despite good profits, the company had experienced a shortage of cash and had found it necessary to increase its borrowing from the County National Bank to $399,000 in the spring of 1996. The maximum loan that County National would make to any one borrower was $400,000, and Clarkson had been able to stay within this limit only by relying very heavily on trade credit. In addition, County National was now asking that Mr. Clarkson guarantee the loan personally. Keith Clarkson, sole owner and president of the Clark- son Lumber Company, was therefore actively looking elsewhere for a new banking relationship in which he would be able to negotiate a larger loan that did not require a personal guarantee. Mr. Clarkson had recently been introduced by a friend to Leonard Jackson, an officer of a much larger bank, the Northwestern National Bank. The two men had tentatively discussed the possibility that Northwestern might extend a line of credit to Clarkson Lumber up to a maximum amount of $750,000. Mr. Clarkson thought that a loan of this size would improve profitability by allowing him to take full advantage of trade discounts. Subsequent to this discussion, Mr. Jackson had arranged for the credit department of the Northwestern National Bank to investigate Mr. Clarkson and his company The Clarkson Lumber Company had been founded in 1981 as a partnership by Mr. Clarkson and his brother-in-law, Harry Holtz. In 1994, Mr. Clarkson bought out Mr. Holtz's interest for $200,000. Mr. Holtz had taken a note for $200,000, to be paid off in 1995 and 1996, in order to give Mr. Clarkson time to arrange for the necessary financing. This note carried an interest rate of 11% and was repayable in semiannual installments of $50,000, beginning June 30, 1995. The business was located in a growing suburb of a large city in the Pacific North- west. The company owned land with access to a railroad siding, and four large storage buildings had been erected on this land. The company's operations were limited to the retail distribution of lumber products in the local area. Typical products included plywood moldings, and sash and door products. Quantity discounts and credit terms of net 30 days on open account were usually offered to customers. Sales volume had been built up largely on the basis of successful price competi- tion, made possible by careful control of operating expenses and by quantity purchases of materials at substantial discounts. Most of the moldings and sash and door products, which constituted significant items of sales, were used for repair work. About 55% of total sales were made in the six months from April through September. Annual sales of $2,921,000 in 1993, $3,477,000 in 1994, and $4,519,000 in 1995 yielded after-tax profits of $60,000 in 1993, $68,000 in 1994, and $77,000 in 1995. Operating state- ments for the years 1993-1995 and for the three months ending March 31, 1996, are given in Exhibit 1. Mr. Clarkson was an energetic man, 49 years of age, who worked long hours on the job. He was helped by an assistant, who in the words of the investigator of the Northwestern National Bank, "has been doing and can do about everything that Mr. Clarkson does in the organization." Other employees numbered 15 in early 1996, 8 of whom worked in the yard and drove trucks, and 7 of whom assisted in the office and in sales, As part of its customary investigation of prospective borrowers, the Northwestern National Bank sent inquiries concerning Mr. Clarkson to a number of firms that had business dealings with him. The manager of one of his large suppliers, the Bennett Company, wrote in answer: The conservative operation of his business appeals to us. He has not wasted his money in disproportionate plant investment. His operating expenses are as low as they could possibly be. He has personal control over every feature of his business, and he possesses sound judgment and a willingness to work harder than anyone I have even known. This, with a good personality, gives him a good turnover; and from my personal experience in watching him work, I know that he keeps close check on his own credits. All the other trade letters received by the bank bore out this opinion. In addition to owning the lumber business, which was his major source of income, Mr. Clarkson held jointly with his wife an equity interest in their home. The house had cost $72,000 to build in 1979 and was mortgaged for $38,000. He also held a $70,000 life insurance policy, payable to Mrs. Clarkson. Mrs. Clarkson owned independently a half interest in another house worth about $85,000. Otherwise, they had no sizable personal investments. The bank gave particular attention to the debt position and current ratio of the business. It noted the ready market for the company's products at all times and the fact that sales prospects were favorable. The bank's investigator reported: "Sales are ex- pected to reach $5.5 million in 1996 and may exceed this level if prices of lumber should rise substantially in the near future." On the other hand, it was recognized that a general economic downturn might slow down the rate of increase in sales. Clarkson Lumber's sales, however, were protected to some degree from fluctuations in new housing construction because of the relatively high proportion of its repair business. Projections beyond 1996 were difficult to make, but the prospects appeared good for continued growth in the volume of Clarkson Lumber's business over the foreseeable future. The bank also noted the rapid increase in Clarkson Lumber's accounts and notes payable in the recent past, especially in 1995 and in the spring of 1996. The usual terms of purchase in the trade provided for a discount of 2% for payments made within 10 days of the invoice date. Accounts were due in 30 days at the invoice price, but suppliers ordinarily did not object if payments lagged somewhat behind the due date. During the last 2 years, Mr. Clarkson had taken very few purchase discounts because of the shortage of funds arising from his purchase of Mr. Holtz's interest in the business and the additional investments in working capital associated with the com- pany's increasing sales volume. Trade credit was seriously extended in the spring of 1996 as Mr. Clarkson strove to hold his bank borrowing within the $400,000 ceiling imposed by the County National Bank, Balance sheets at December 31, 1993-1995, and March 31, 1996, are presented in Exhibit 2. Statistics for a sample of lumber outlets are provided in Exhibit 3. The tentative discussions between Mr. Jackson and Mr. Clarkson had been in terms of a revolving, secured, 90-day note not to exceed $750,000. The specific details of the loan had not been worked out, but Mr. Jackson had explained that the agreement would involve the standard covenants applying to such a loan. He cited as illustrative provisions the requirement that restrictions on additional borrowing would be imposed; that net working capital would have to be maintained at an agreed level; that additional investments in fixed assets could be made only with the prior approval of the bank; and that limitations would be placed on withdrawals of funds from the business by Mr. Clarkson. Interest would be set on a floating-rate basis at 2'h percentage points above the prime rate, Mr. Jackson indicated that the initial rate to be paid would be approxi- mately 11% under conditions in effect in early 1996. Both men also understood that Mr. Clarkson would sever his relationship with the County National Bank if he entered into a loan agreement with the Northwestern National Bank. EXHIBIT 1 Operating Expenses for Years Ending December 31, 19931995, and for First Quarter 1996 (thousands of dollars) 1st Quarter 1996 1993 1994 1995 $2,921 $3,477 $4,519 $1,0269 Net sales. Cost of goods sold Beginning inventory Purchases Ending inventory Total cost of goods sold . Gross profit Operating expenses Earnings before interest and taxes Interest expense.... Net income before income taxes Provision for income taxes Net income 330 2,209 $2,539 337 $2,202 719 622 $ 97 23 $ 74 14 $ 60 337 2,729 $3,066 432 $2,634 843 717 $ 126 42 $ 84 17 $ 67 432 3,579 $4,011 587 $3,424 1,095 940 $ 155 56 $ 99 22 587 819 $1,406 607 $ 799 263 244 $ 19 13 $ 6 1 $ 5 $ 77 a. In the first quarter of 1995, sales were $903,000 and net income was $7,000. b. Operating expenses include a cash salary for Mr. Clarkson of $75,000 in 1993; $80,000 in 1994; $85,000 in 1995; and $22,500 in the first quarter of 1996. c. Clarkson Lumber was required to estimate its income tax liability for the current tax year and pay four quarterly estimated tax installments during that year. The first $50,000 of pre-lax profits were taxed at a 15% rate; the next $25,000 were taxed at a 25% rate; the next $25,000 were taxed at a 34% rate; and profits in excess of $100,000 but less than $335,000 were taxed at a 39% rate. EXHIBIT 2 Balance Sheets at December 31, 1993-1995, and March 31, 1996 (thousands of dollars) 1st Quarter 1993 1994 1995 1996 Cash... Accounts receivable, net Inventory.. Current assets Property, net Total assets $ 43 306 337 $686 233 $919 $ 52 411 432 $ 895 262 $1,157 $ 56 606 587 $1,249 388 $1,637 $ 53 583 607 $1,243 384 $1,627 $ 60 100 Notes payable, bank Note payable to Holtz, current portion Notes payable, trade Accounts payable Accrued expenses Term loan, current portion Current liabilities. Term loan Note payable, Mr. Holtzb Total liabilities. Net worth Total liabilities and net worth 213 42 20 $275 140 340 45 20 $ 565 120 100 $ 785 372 $1,157 $ 390 100 127 376 75 20 $1,088 100 0 $1,188 449 $1,637 $ 399 100 123 364 67 20 $1,073 100 0 $1,173 454 $1,627 $415 504 $919 a. Interest is computed on the average outstandir loan balance at the rate of prime plus 24%. b. Interest is fixed at 11% times the outstanding balance. c. Interest is fixed at 10% times the outstanding balance; the term loan is secured by the fixed assets and is repayable in semiannual installments of $10,000. EXHIBIT 3 Selected Statistics on Lumber Outlets Low-Profit Outlets High-Profit Outlets receivable Percent of sales Cost of goods Operating expense Cash Accounts Inventory Fixed assets, net Total assets Percent of total assets Current liabilities Long-term liabilities 76.9% 22.0 1.3 13.7 12.0 12.1 39.1 75.1% 20.6 1.1 12.4 11.6 9.2 34.3 Equity Current ratio Return on sales Return on assets Return on equity 52.7% 34.8 12.5 1.31 (0.7%) (1.8%) (14.3%) 29.2% 16.0 54.8 2.52 4.3% 12.2% 22.1% a. Defined as the bottom 25% and as the top 25%, respectively, of all surveyed companies, based on return on sales. After rapid growth in its business during recent years, the Clarkson Lumber Company, in the spring of 1996, anticipated a further substantial increase in sales. Despite good profits, the company had experienced a shortage of cash and had found it necessary to increase its borrowing from the County National Bank to $399,000 in the spring of 1996. The maximum loan that County National would make to any one borrower was $400,000, and Clarkson had been able to stay within this limit only by relying very heavily on trade credit. In addition, County National was now asking that Mr. Clarkson guarantee the loan personally. Keith Clarkson, sole owner and president of the Clark- son Lumber Company, was therefore actively looking elsewhere for a new banking relationship in which he would be able to negotiate a larger loan that did not require a personal guarantee. Mr. Clarkson had recently been introduced by a friend to Leonard Jackson, an officer of a much larger bank, the Northwestern National Bank. The two men had tentatively discussed the possibility that Northwestern might extend a line of credit to Clarkson Lumber up to a maximum amount of $750,000. Mr. Clarkson thought that a loan of this size would improve profitability by allowing him to take full advantage of trade discounts. Subsequent to this discussion, Mr. Jackson had arranged for the credit department of the Northwestern National Bank to investigate Mr. Clarkson and his company The Clarkson Lumber Company had been founded in 1981 as a partnership by Mr. Clarkson and his brother-in-law, Harry Holtz. In 1994, Mr. Clarkson bought out Mr. Holtz's interest for $200,000. Mr. Holtz had taken a note for $200,000, to be paid off in 1995 and 1996, in order to give Mr. Clarkson time to arrange for the necessary financing. This note carried an interest rate of 11% and was repayable in semiannual installments of $50,000, beginning June 30, 1995. The business was located in a growing suburb of a large city in the Pacific North- west. The company owned land with access to a railroad siding, and four large storage After rapid growth in its business during recent years, the Clarkson Lumber Company, in the spring of 1996, anticipated a further substantial increase in sales. Despite good profits, the company had experienced a shortage of cash and had found it necessary to increase its borrowing from the County National Bank to $399,000 in the spring of 1996. The maximum loan that County National would make to any one borrower was $400,000, and Clarkson had been able to stay within this limit only by relying very heavily on trade credit. In addition, County National was now asking that Mr. Clarkson guarantee the loan personally. Keith Clarkson, sole owner and president of the Clark- son Lumber Company, was therefore actively looking elsewhere for a new banking relationship in which he would be able to negotiate a larger loan that did not require a personal guarantee. Mr. Clarkson had recently been introduced by a friend to Leonard Jackson, an officer of a much larger bank, the Northwestern National Bank. The two men had tentatively discussed the possibility that Northwestern might extend a line of credit to Clarkson Lumber up to a maximum amount of $750,000. Mr. Clarkson thought that a loan of this size would improve profitability by allowing him to take full advantage of trade discounts. Subsequent to this discussion, Mr. Jackson had arranged for the credit department of the Northwestern National Bank to investigate Mr. Clarkson and his company The Clarkson Lumber Company had been founded in 1981 as a partnership by Mr. Clarkson and his brother-in-law, Harry Holtz. In 1994, Mr. Clarkson bought out Mr. Holtz's interest for $200,000. Mr. Holtz had taken a note for $200,000, to be paid off in 1995 and 1996, in order to give Mr. Clarkson time to arrange for the necessary financing. This note carried an interest rate of 11% and was repayable in semiannual installments of $50,000, beginning June 30, 1995. The business was located in a growing suburb of a large city in the Pacific North- west. The company owned land with access to a railroad siding, and four large storage buildings had been erected on this land. The company's operations were limited to the retail distribution of lumber products in the local area. Typical products included plywood moldings, and sash and door products. Quantity discounts and credit terms of net 30 days on open account were usually offered to customers. Sales volume had been built up largely on the basis of successful price competi- tion, made possible by careful control of operating expenses and by quantity purchases of materials at substantial discounts. Most of the moldings and sash and door products, which constituted significant items of sales, were used for repair work. About 55% of total sales were made in the six months from April through September. Annual sales of $2,921,000 in 1993, $3,477,000 in 1994, and $4,519,000 in 1995 yielded after-tax profits of $60,000 in 1993, $68,000 in 1994, and $77,000 in 1995. Operating state- ments for the years 1993-1995 and for the three months ending March 31, 1996, are given in Exhibit 1. Mr. Clarkson was an energetic man, 49 years of age, who worked long hours on the job. He was helped by an assistant, who in the words of the investigator of the Northwestern National Bank, "has been doing and can do about everything that Mr. Clarkson does in the organization." Other employees numbered 15 in early 1996, 8 of whom worked in the yard and drove trucks, and 7 of whom assisted in the office and in sales, As part of its customary investigation of prospective borrowers, the Northwestern National Bank sent inquiries concerning Mr. Clarkson to a number of firms that had business dealings with him. The manager of one of his large suppliers, the Bennett Company, wrote in answer: The conservative operation of his business appeals to us. He has not wasted his money in disproportionate plant investment. His operating expenses are as low as they could possibly be. He has personal control over every feature of his business, and he possesses sound judgment and a willingness to work harder than anyone I have even known. This, with a good personality, gives him a good turnover; and from my personal experience in watching him work, I know that he keeps close check on his own credits. All the other trade letters received by the bank bore out this opinion. In addition to owning the lumber business, which was his major source of income, Mr. Clarkson held jointly with his wife an equity interest in their home. The house had cost $72,000 to build in 1979 and was mortgaged for $38,000. He also held a $70,000 life insurance policy, payable to Mrs. Clarkson. Mrs. Clarkson owned independently a half interest in another house worth about $85,000. Otherwise, they had no sizable personal investments. The bank gave particular attention to the debt position and current ratio of the business. It noted the ready market for the company's products at all times and the fact that sales prospects were favorable. The bank's investigator reported: "Sales are ex- pected to reach $5.5 million in 1996 and may exceed this level if prices of lumber should rise substantially in the near future." On the other hand, it was recognized that a general economic downturn might slow down the rate of increase in sales. Clarkson Lumber's sales, however, were protected to some degree from fluctuations in new housing construction because of the relatively high proportion of its repair business. Projections beyond 1996 were difficult to make, but the prospects appeared good for continued growth in the volume of Clarkson Lumber's business over the foreseeable future. The bank also noted the rapid increase in Clarkson Lumber's accounts and notes payable in the recent past, especially in 1995 and in the spring of 1996. The usual terms of purchase in the trade provided for a discount of 2% for payments made within 10 days of the invoice date. Accounts were due in 30 days at the invoice price, but suppliers ordinarily did not object if payments lagged somewhat behind the due date. During the last 2 years, Mr. Clarkson had taken very few purchase discounts because of the shortage of funds arising from his purchase of Mr. Holtz's interest in the business and the additional investments in working capital associated with the com- pany's increasing sales volume. Trade credit was seriously extended in the spring of 1996 as Mr. Clarkson strove to hold his bank borrowing within the $400,000 ceiling imposed by the County National Bank, Balance sheets at December 31, 1993-1995, and March 31, 1996, are presented in Exhibit 2. Statistics for a sample of lumber outlets are provided in Exhibit 3. The tentative discussions between Mr. Jackson and Mr. Clarkson had been in terms of a revolving, secured, 90-day note not to exceed $750,000. The specific details of the loan had not been worked out, but Mr. Jackson had explained that the agreement would involve the standard covenants applying to such a loan. He cited as illustrative provisions the requirement that restrictions on additional borrowing would be imposed; that net working capital would have to be maintained at an agreed level; that additional investments in fixed assets could be made only with the prior approval of the bank; and that limitations would be placed on withdrawals of funds from the business by Mr. Clarkson. Interest would be set on a floating-rate basis at 2'h percentage points above the prime rate, Mr. Jackson indicated that the initial rate to be paid would be approxi- mately 11% under conditions in effect in early 1996. Both men also understood that Mr. Clarkson would sever his relationship with the County National Bank if he entered into a loan agreement with the Northwestern National Bank. EXHIBIT 1 Operating Expenses for Years Ending December 31, 19931995, and for First Quarter 1996 (thousands of dollars) 1st Quarter 1996 1993 1994 1995 $2,921 $3,477 $4,519 $1,0269 Net sales. Cost of goods sold Beginning inventory Purchases Ending inventory Total cost of goods sold . Gross profit Operating expenses Earnings before interest and taxes Interest expense.... Net income before income taxes Provision for income taxes Net income 330 2,209 $2,539 337 $2,202 719 622 $ 97 23 $ 74 14 $ 60 337 2,729 $3,066 432 $2,634 843 717 $ 126 42 $ 84 17 $ 67 432 3,579 $4,011 587 $3,424 1,095 940 $ 155 56 $ 99 22 587 819 $1,406 607 $ 799 263 244 $ 19 13 $ 6 1 $ 5 $ 77 a. In the first quarter of 1995, sales were $903,000 and net income was $7,000. b. Operating expenses include a cash salary for Mr. Clarkson of $75,000 in 1993; $80,000 in 1994; $85,000 in 1995; and $22,500 in the first quarter of 1996. c. Clarkson Lumber was required to estimate its income tax liability for the current tax year and pay four quarterly estimated tax installments during that year. The first $50,000 of pre-lax profits were taxed at a 15% rate; the next $25,000 were taxed at a 25% rate; the next $25,000 were taxed at a 34% rate; and profits in excess of $100,000 but less than $335,000 were taxed at a 39% rate. EXHIBIT 2 Balance Sheets at December 31, 1993-1995, and March 31, 1996 (thousands of dollars) 1st Quarter 1993 1994 1995 1996 Cash... Accounts receivable, net Inventory.. Current assets Property, net Total assets $ 43 306 337 $686 233 $919 $ 52 411 432 $ 895 262 $1,157 $ 56 606 587 $1,249 388 $1,637 $ 53 583 607 $1,243 384 $1,627 $ 60 100 Notes payable, bank Note payable to Holtz, current portion Notes payable, trade Accounts payable Accrued expenses Term loan, current portion Current liabilities. Term loan Note payable, Mr. Holtzb Total liabilities. Net worth Total liabilities and net worth 213 42 20 $275 140 340 45 20 $ 565 120 100 $ 785 372 $1,157 $ 390 100 127 376 75 20 $1,088 100 0 $1,188 449 $1,637 $ 399 100 123 364 67 20 $1,073 100 0 $1,173 454 $1,627 $415 504 $919 a. Interest is computed on the average outstandir loan balance at the rate of prime plus 24%. b. Interest is fixed at 11% times the outstanding balance. c. Interest is fixed at 10% times the outstanding balance; the term loan is secured by the fixed assets and is repayable in semiannual installments of $10,000. EXHIBIT 3 Selected Statistics on Lumber Outlets Low-Profit Outlets High-Profit Outlets receivable Percent of sales Cost of goods Operating expense Cash Accounts Inventory Fixed assets, net Total assets Percent of total assets Current liabilities Long-term liabilities 76.9% 22.0 1.3 13.7 12.0 12.1 39.1 75.1% 20.6 1.1 12.4 11.6 9.2 34.3 Equity Current ratio Return on sales Return on assets Return on equity 52.7% 34.8 12.5 1.31 (0.7%) (1.8%) (14.3%) 29.2% 16.0 54.8 2.52 4.3% 12.2% 22.1% a. Defined as the bottom 25% and as the top 25%, respectively, of all surveyed companies, based on return on sales. After rapid growth in its business during recent years, the Clarkson Lumber Company, in the spring of 1996, anticipated a further substantial increase in sales. Despite good profits, the company had experienced a shortage of cash and had found it necessary to increase its borrowing from the County National Bank to $399,000 in the spring of 1996. The maximum loan that County National would make to any one borrower was $400,000, and Clarkson had been able to stay within this limit only by relying very heavily on trade credit. In addition, County National was now asking that Mr. Clarkson guarantee the loan personally. Keith Clarkson, sole owner and president of the Clark- son Lumber Company, was therefore actively looking elsewhere for a new banking relationship in which he would be able to negotiate a larger loan that did not require a personal guarantee. Mr. Clarkson had recently been introduced by a friend to Leonard Jackson, an officer of a much larger bank, the Northwestern National Bank. The two men had tentatively discussed the possibility that Northwestern might extend a line of credit to Clarkson Lumber up to a maximum amount of $750,000. Mr. Clarkson thought that a loan of this size would improve profitability by allowing him to take full advantage of trade discounts. Subsequent to this discussion, Mr. Jackson had arranged for the credit department of the Northwestern National Bank to investigate Mr. Clarkson and his company The Clarkson Lumber Company had been founded in 1981 as a partnership by Mr. Clarkson and his brother-in-law, Harry Holtz. In 1994, Mr. Clarkson bought out Mr. Holtz's interest for $200,000. Mr. Holtz had taken a note for $200,000, to be paid off in 1995 and 1996, in order to give Mr. Clarkson time to arrange for the necessary financing. This note carried an interest rate of 11% and was repayable in semiannual installments of $50,000, beginning June 30, 1995. The business was located in a growing suburb of a large city in the Pacific North- west. The company owned land with access to a railroad siding, and four large storage