Indiana Building Supplies - Comment
An analysis of these ratios shows that both Clemens and Willis are right. All of the profitability ratios for IBS are higher than the industry average. Thus, IBS seems to have done well. And indeed, it was done well for its shareholders in 2005. Note, however, that the current and quick ratios have generally been trending downward and are significantly lower than the industry averages as well as the stipulations in the loan covenants. Thus, liquidity is poor. Moreover, inventory is turning over very slowly and the average collection period has increased significantly. These figures are manifestations of IBS’s policy of raising prices and focusing almost exclusively on Indiana customers who are relatively price-insensitive but have a more uncertain demand. It seems like IBS is charging a sufficiently high price to overcome a sales level that is significantly lower than it was in 2004. In fact, it has probably been lucky to encounter a robust demand from its Indiana customers (it is reasonable to assume negligible demand from Ohio and Missouri), so that it did not experience a more precipitous decline in sales relative to its 2004 sales. In addition to this, IBS has also experienced very high volatility in its liquidity and inventory turnover ratios during 2005, another development that is consistent with its pricing strategy. The lengthening of the collection period seems to indicate that Indiana customers are more risky in the sense that they don’t pay as promptly as the average customer.
What does this mean for the bank? Peter Willis is correct in being concerned. What IBS seems to be doing is to adopt a strategy of increasing risk for the possibility of higher profit. Raising the prices of its outputs is equivalent to concentrating on the Indiana market and excluding the Ohio and Missouri markets. This means changing its market in such a way that IBS now faces a riskier demand schedule for its products, but one that...
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