Cartwright Lumber Company
Local Distributor of Wood Based Products
Mark Cartwright and Henry Stark opened up Cartwright Lumber Company in 1994. The company is based in a large city in the Pacific Northwest. Most of the company’s distribution was in the local area. Recently in 2004 Cartwright had to borrow money to be able to meet higher sales for the company. However, more money is needed to be able to meet the anticipated sales growth for the future. Cartwright is considering a larger loan that would allow Cartwright Lumber Company to meet any cash needs of the future. I recommend going ahead with the expansion, but for Cartwright to pay for it in house.
Cartwright Lumber Company had been borrowing money to allow it to realize greater net income. Part of this is due to the fact that Cartwright Lumber Company has been taking longer to collect their ...view middle of the document...
Cartwright has used leverage to his advantage allowing his company to realize greater net income than they would have otherwise. The real problem of concern is that while Cartwright is a profitable business than the negative cash flows of the company puts them at risk to not meet the obligatory requirements of the loan. The negative cash flows primarily due to what I discussed in operations high inventory and accounts receivable.
Another area of concern is with the EBIT to cover interest expense. It was right around 36 in 2001 and has decreased every year to 22 in 2004. If Cartwright were to increase the loan amount this would get even worse putting the company in a riskier situation. Cartwright’s debt to asset ratio was .55 in 2001, if Cartwright increases this debt more with a larger loan it is projected to get to .75 in 2004. Unless Cartwright begins to free up more cash, I strongly recommend against this.
One thing that the expansion with debt would increase is the return on equity from .13 in 2003 to .15 in 2004. Then in 2005 another increase of .4 is expected raising it to .19. This is caused by net income increasing because of the increase in sales while funding this with debt as opposed to equity.
Another thing Cartwright should look at is the impact of the extra debt on their current and quick ratio. Both have decreased from 2001 to 2004 with the quick ratio decreasing even more rapidly. Cartwright’s quick ratio was .88 in 2001 and is projected to be .5 in 2005. This is caused by Cartwright’s current liabilities increasing faster than their current assets primarily due to the increase in notes payable.
Cartwright as a company has been successful and the decision to go ahead with the expansion should only increase their success. This will only happen though if they secure a larger loan or go with what I recommend which is to improve their Cash Conversion Cycle and increase their inventory conversion period. If Cartwright is able to do this there will be no need in the relative future for Cartwright to get a larger loan and still realize greater net income.