Cartwright Lumber Case Study Solution

1. Why has Cartwright Lumber borrowed increasing amounts despite its consistent profitability?

Cartwright lumber has had to borrow substantial amounts of money due to the fact that the firm is a growing company with sales rising quickly. In order for the company to sustain this growth rate, they will have to get additional external funding. Growth in sales nearly doubled from 2001 to 2003, with a percentage growth of 18% and 34% in 2002 & 2003 respectively. While sales are growing steadily, the company’s cash is steadily decreasing year to year by 20% and 17% in 2002 and 2003. Taken together with the fact that accounts receivable has grown at a higher rate than sales, 30% & 42%, this firm cannot support the growing sales relying on its assets.

The DSO ratio for accounts receivable is 36.28, 39.70 & 42.36 in 2001, 2002, and 2003 respectively. With credit terms of 30 days, the DSO is showing that on average customers are not paying on time and year to year they are paying increasingly later. All these factors combined demonstrate poor management of the firm’s assets. This is the reason why the firm is primarily relying on its debts to sustain the increase in sales growth.

2. How has management met the financing needs of the company? Has the financial strength of the company improved or worsened?

In an effort to sustain the increase in sales, management has continually raised funding through borrowing from both the bank & its suppliers. The firm has extended its trade credit a significant amount in an effort to remain below the 250,000 ceiling imposed by their current bank. In turn, they are giving up discounts on their purchases made. From 2001 to the first quarter of 2004, the firms total liabilities increased tremendously by 127% from $324 to $737. We can see the effects of this financing practice by analyzing the firm’s debt management ratios. The firm’s debt ratio has increased over the past four years from 54.55% to… Cartwright Lumber Company was founded in 1994 as a partnership by Mark Cartwright and Stark. In 2001, Cartwright incorporated the business. The business was located in a large city in the Pacific Northwest and operated in retail distribution of lumber products such as plywood, moldings, and sash and door products.

We think that there are four key factors involved in their success. First is competitive customer policy, they offered their customers by quantity discounts and credit terms. Second is their good relationship with suppliers, which can be seen from Bark and other suppliers’ opinion in Banks customary investigation. Third is their conservative operation with low operation cost and proportionate plant investment. What’s more, Cartwright was a energetic person, hard working with sound judgment, and his good credit help his business successfully. From operational standpoint, company is doing well on basis of successful price competition, careful control of operating expenses and by quantity material purchases at substantial discounts. Telemarketing is also an essential part for its well operation. Mr. Cartwright must borrow great amounts of money from the bank.

The most influential reason is that sales are increasing significantly with short available funds, which leads to higher cost of goods sold so that firm needs more external financing to pay various fees. According to balance sheet, the Current Ratio is approximately 1,40 (932/690) and the Quick Ratio is around 0,50 ((932-556)/690). The Current Ratio is on an adequate level but the Quick Ratio seems to be alarming. This is because the company has a huge inventory. The Quick Ratio is perceived as a mirror to the firm’s short-term financing ability. The poor status of these ratios leads to the situation where the company can’t enjoy purchase discounts from their supplier. Cartwright Lumber’s Internal growth rate is 4,72 % (44 / 933) at the end of 2003. The firm’s sales are predicted to increase from…

Q1.) Is this company healthy? Construct common size statements for the years 2001 to 2003 based upon sales. Calculate current liabilities, long-term debt, and equity as a percent of assets over the period. Do a ratio analysis using the basic ratios shown in the Cartwright Lumber Company Spreadsheet available on blackboard. Then analyze the income statement and balance sheet from 2001 to 2003 in order to explain what they tell you, but do not make recommendations at this time. Comparative Income Statement

Analysis of comparative income statement shows that gross profit (GP) margins have increased to 28.16% during the year 2002 from 28% in the year 2001. This represents an increase of 2.15% in gross profit margins from year 2001 to 2002. Moreover, an increase in gross profit margin is mainly due to the closer control over the cost of goods sold; however, GP margin has decreased to 27.62% during the year 2003, which represents a decrease of around 3.48%. This decrease in GP margin is again due to the increase in purchase price of trading goods. Moreover, operating margin has also increased to 3.03% during the year 2002 from 2.95% in the year 2001. This represents an increase of 2.85% during the year 2001 to 2002 and operating margins are continuously improving throughout a three year period, hence; operating margin is 3.19% during the year 2003.

Therefore, a constant increase in operating margins is a result of effective control over the operating expenses in proportion to sales revenues and overall operating margin has increased by 8.35% over a three year period (2001-2003). However, the taxable income as proportionate to sales revenue is continuously decreasing because the heavy commitments of interest payments and interest expenses have increased from 0.77% in the year 2001 to 1.22% during the year 2003; which represents an increase of 60% over the three year period (2001-2003). Additionally, an increase in interest expense as proportionate to sales revenue means that Cartwright Lumber Company is not utilizing its additional borrowing in generation of sales revenues. Moreover, the tax payments are same over the year 2001 to 2002 and decrease by 4% during the year 2003; consequently, it leaves a little additional residual value for common stock holders. Comparative Balance Sheet

Analysis of comparative balance sheet reveals that cash item was 9.8% of total assets during the year 2001, but it has continuously been decreasing throughout the three year period from 2001 to 2003 and investment in cash has fallen to 4.4% during the year 2003; which represents a 55% decrease over the three year period. Since, Cartwright Lumber Company is facing liquidity problems; therefore, it is trying to lower the cash reserves in order to manage the working capital requirements. Moreover, the trade receivables are continuously increasing from 28.8% of total assets during 2001 to 34% of total assets during 2003, which represents an increase of 18% over the three year period. Further, an increase in trade receivable shows that Cartwright Lumber Company is offering longer credit period to its customers or it has failed to collect the trade receivables within due dates.

Moreover, investment in inventory has increased by 10% during the year 2001 to 2002 and during the year 2003 the same level of inventory has been kept in order to manage the working capital. However, the overall investment in working capital as proportionate of total assets has been increased by a constant percentage of 3% during the three year period from 2001 to 2003, which shows an increase in requirement of working capital in line with an increase in sales revenues. Additionally, the analysis of current and long-term liabilities as proportionate of total assets reveals that current liabilities are continuously increasing, meanwhile, long-term liabilities are decreasing, which means that Cartwright Lumber Company is heavily relying on current liabilities to finance its fixed and current assets rather than financing its fixed assets through long-term liabilities. Moreover, equity portion of Cartwright Lumber Company is not growing with the growth in its total assets; this shows that Cartwright Lumber Company is using more debt to finance investment in assets rather than equity. Ratio Analysis

Return on capital employed has improved from year 2001 to 2003 almost by 33.45% over the three year period, which means that Cartwright Lumber Company is utilizing the invested funds more effectively year by year, but this has also been noted that Cartwright Lumber Company is financing its business more by using current debt and is reducing the long-term debt and equity. As a result, this will increase its returns on capital employed. Moreover, the asset turnover ratio reveals that assets of Cartwright Lumber Company are generating 2.8 times more revenue by using its total assets employed. Receivable collection period is increasing which shows the weaker credit control; meanwhile, payable period is also increasing every year which shows that payments are being differed in order to manage the working capital.