Clarkson Lumber Company
Clarkson Lumber is an illustration of a firm that is growing at a rate greater than it can sustain with existing asset requirements and internal financing capacity. It is relatively well managed, but the huge absorption of funds into financing growing inventory and accounts receivable, due to the increase in sales, is putting it into a difficult situation. Its reliance on bank financing is growing and the requested line of credit is insufficient to permit taking the available trade discounts. The greater risk is that the firm will be dramatically impacted should the trade lose patience and decide to put them on a COD basis. Clarkson needs to seriously think about increasing its internal funding through greater profits at the same time it reduces its growth rate to a more sustainable level. In fact, raising prices a bit would accomplish both goals.
Clarkson also needs to reconsider the "bigger is better" mentality since the owner would financially benefit more from a lower level of more profitable sales. At the moment, Clarkson is a low cost provider of lumber products with substantial inventory and he will provide financing through accounts receivable. This is a mixed bag since we usually associate low margins with lower levels of inventory and relatively little credit extension. Clarkson, however, is doing both at the same time which means he is absorbing funds into new assets at a much greater rate than he can earn those funds through his profit margin. The difference is being made up from the bank loans....