MFIN/EFIN 301

SECTION 1 (11.30-12.45)
INSTRUCTOR: ZEKİYE SELVİLİ
CARTWRIGHT LUMBER CASE STUDY WRITE-UP

Onur Turhan

Berke Erim Erdemoğlu

Nisanur Akdoğan

Rumet Zeki Öztürk

İpek Cebelli

Ümmüşnur Özcan

Elif Yalçın
1) How well is the Cartwright Lumber Company doing from an operational standpoint? Please
use as many efficiency and profitability ratios as possible.

Profitability Ratios 2001 2002 2003 First Quarter 2004 Average

Gross Profit Margin 27,99% 28,61% 27,62% 27,30% 27,88%
Operating Profit Margin 2,95% 30,30% 3,19% 2,92% 9,84%
Net Profit Margin 1,83% 1,69% 1,63% 1,25% 1,60%
ROA 8,42% 8,29% 9,22% 1,92% 6,96%
ROE 11,48% 11,18% 12,64% 2,52% 9,46%
Sales Growth % - 18,62% 33,83% 33,63% 28,69%
EBIT Growth % - 22,00% 40,98% -2,33% 20,22%
Net Income Growth % - 9,68% 29,41% -18,18% 6,97%

Efficiency Ratios 2001 2002 2003 First Quarter 2004 Average

Inventory Turnover 5,11 4,41 4,67 0,94 3,78
Days in Inventory 71,39 82,80 78,24 97,19 82,41
Accounts Receivable Turnover 9,92 9,07 8,50 8,32 8,95
Collection Period 36,78 40,25 42,95 43,85 40,96
Accounts Payable Turnover 10,31 7,94 7,98 10,88 9,28
Asset Turnover 2,86 2,74 2,89 2,64 2,78

Cartwright Lumber Company is a growing lumber company for the given four years. Focusing on
the operational standpoint, the Cartwright Lumber Company experienced an increase in their
sales by 18.62% between 2001-2002; 33.83% between 2002-2003. Due to fact that the company
is in the lumber sector, considerable increases in sales do not reflect to the income. When we look
at the profit margin of 2001 was 1.83% and it decreases by 1.69% in 2002 and 1.63% in 2003.
Decreases at the Net Profit Margin shows that, in terms of cost control, the company is not
successful. Additionally, when we analyze the gross profit margin of 2001, which is 27.99%, we
can see an increase to 28.61% in 2002; but, in 2003 the gross profit margin decreased to 27.62%
implying reduced effectiveness in the company. In general, the profits of Cartwright Lumber
Company can be considered as good as it could be since the overall profits are at lower rates in
the lumber industry.

If we look at return ratios, Return on Assets (ROA) grew between the years 2001 and 2004 from
8.42% to 9.22%, although there was a decrease in 2002 to 8.29%. The overall increase in ROA
implies that profits are rising with additional investments. Secondly, Return on Equity (ROE)
also implies an increase over time. In 2001, the ROE was 11.48% however; it decreased to
11.18% in 2002 (similar to the decrease in ROA between 2001-2002). The overall performance
of ROE is positive because it increased to 12.64% in 2004.

When it comes to efficiency ratios assets turnover is the commonly used and one of the most
important ratios that can be used while evaluating the performance of the companies. This ratio
was 2.86 in 2001 and then in 2002 it declined to 2.74, but in 2003 it increased to 2.89. The
overall increasing trend implies that the company is generating revenue from its assets in an
efficient way. Another efficiency ratio is Accounts Receivable Turnover (A/R Turnover), 2001
A/R Turnover is 9.92% and 2003 A/R Turnover is 8.50%. Decreasing A/R Turnover shows that
the company is performing poorly at the collection of credits from customers. Third turnover is
Accounts Payable Turnover (A/P Turnover). It implies a decrease over the period. The 2001 A/P
Turnover is 10.31% and in 2003 A/P Turnover is 7.98% showing that company cannot pay its
debts to suppliers immediately, so it takes a long time to repay them. The last turnover is
Inventory Turnover. The 2001 Inventory turnover is 5.11% and it decreases to 4.67% at 2003
meaning that company tends to hold its inventory for a longer period of time before they sell it,
which is a bad sign for company’s operations.

2) Why does Mr. Cartwright have to borrow money to support his business?

a) A useful beginning to the analysis is the preparation of a Sources and Uses (or Fund
Flow) Statement for the period 2001 through 2004’s first quarter. The “Sources and Uses
Statement” helps you get a quick (but rough) picture of where cash is coming from
(Sources) and where it is going (Uses). To construct the statement:
- Compare Cartwright Lumber’s Balance Sheet in 2001 and 2004-Q1
- Classify each Asset that has increased (decreased) as a Use (Source)
- Classify each Liability that has increased (decreased) as a Source (Use)
What are the Cartwright Lumber Company’s main Sources and Uses of funds?

b) You should also study leverage and liquidity ratios to help explain Cartwright’s need for
funds.

Liquidity Ratios 2001 2002 2003 First Quarter 2004 Average

Current Ratio 1,80 1,59 1,45 1,35 1,55
Quick Ratio 0,88 0,72 0,67 0,54 0,70
NWC/Assets Ratio 0,35 0,30 0,26 0,22 0,28
Leverage Ratios 2001 2002 2003 First Quarter 2004 Average
Times Interest Earned 3,85 3,05 2,61 2,10 2,90
Debt Ratio 0,55 0,59 0,63 0,67 0,61
Debt/Net Worth Ratio 1,20 1,42 1,68 2,06 1,59
Long Term Debt Ratio 0,19 0,16 0,13 0,12 0,15

  2001 2002 2003 First Quarter    

 2004
   
Cash $58 $48 $41 $31 -$27,00 Source
Accounts receivable, net 171 222 317 345 $174,00 Use
Inventory 239 326 418 556 $317,00 Use
Current assets $468 $596 $776 $932    
Property, net 126 140 157 162 $36,00 Use
Total assets $594 $736 $933 $1.094    
   
Notes payable, bank 0 $146 $233 $247 $247,00 Source
Notes payable, Stark 105 0 0 0 -$105,00 Use
Notes payable, trade 0 0 0 157 $157,00 Source
Accounts payable 124 192 256 243 $119,00 Source
Accrued expenses 24 30 39 36 $12,00 Source
Long-term debt, current portion 7 7 7 7    
Current liabilities $260 $375 $535 $690    
Long-term debt 64 57 50 47 -$17,00 Use
Total liabilities $324 $432 $585 $737    
Net worth 270 304 348 357 $87,00 Source
Total liabilities and net worth $594 $736 $933 $1.094    
             

The Fund Flow Statement depicts the shifts in where cash is coming from and going, as well as
the company's financial status. The company's vital Uses and Sources are growing, while cash is
declining, according to the Fund Flow Statement. We can see that as the total debt ratio rises, the
Long-Term Debt and Equity Ratios of Long-Term Debt fall. Cartwright Lumber Company has
shorter-term debt transactions rather than long-term debt transactions, as shown by this graph.
Leverage ratios are going down. It also means that the amount of time interest earned is
decreasing. Under these conditions, it's difficult for Cartwright Lumber Company to make
interest transactions. It would contribute to the company's downfall. In the first quarter of 2004,
the quick ratio dropped to 54.5 percent from 66.7 percent in 2003, The quick ratio illustrates an
organization's ability to fund its existing liabilities without selling stock or obtaining additional
financing. Corporation would have trouble meeting its obligations by the ratio getting lower.

In general, Cartwright Lumber will be unable to fulfil its obligations due to liquidity ratios
indicating that the company requires additional funds.
3) Do you agree with Mr. Cartwright’s conclusion that a $465,000 line of credit would more
than meet his foreseeable funding needs? How much will he need to borrow in order to
finance his expected sales over the next few years?

a. Assume that Sales reach $3.6M in 2004 and then increase at the rate of 25% per year
until 2007.
We will need to estimate the size of the EFN (bank loan) for each year. To do this, we will
proceed as follows:

- Forecast assets;
- Forecast non-bank liabilities, including Net Worth;
- The difference gives you the EFN (“Bank debt plug”);
- With this level of Bank debt, is interest expense what was assumed? If yes, stop.
Otherwise, repeat until you converge.
Note: no more than 3 repetitions will be necessary.

b. Repeat the same procedures as above with one change: Cartwright Lumber will pay its
accounts payable in 10 days to take advantage of the purchase discount.

Proforma Income Statement

2004 X / Sales 2005 X / Sales 2006 X / Sales 2007
Net Sales 3600 %25 Annual Growth 4500 5625 7031,25
Cost Of Goods Sold 2592 0,72 3240 0,72 4050 0,72 5063
Gross Profit 1008 1260 1575 1969
Operating Expense 900 0,25 1125 0,25 1406 0,25 1758
EBIT 108 135 169 211
Interest Expense 48 61,51 82,8 109,01
EBT 60 73 86 102
Provision for Income Taxes 9 13,25 17,49 23,61
Net Income 51 60 68 78
 Proforma Balance Sheet
2004 X / Sales 2005 X / Sales 2006 X / Sales 2007
Cash 108 0,03 135 0,03 168,75 0,03 210,94
Accounts Receivable 396 0,11 495 0,11 618,75 0,11 773,44
Inventory 540 0,15 675 0,15 843,75 0,15 1054,69
Current Assets 1044 0,29 1305 0,29 1631,25 0,29 2039,06
Property, net 252 0,07 315 0,07 393,75 0,07 492,19
Total Assets 1296 1620 2025 2531,25

Notes Payable, bank 402 550,26 751,93 1009,51

Accounts Payable 412 522,5 653,13 816,41
Accrued Expenses 36 0,01 45 0,01 56,25 0,01 70,31
Long-Term Debt, current portion 7 7 7 7
Current Liabilities 857 1124,76 1468,31 1903,23
Long-Term Debt 43 36 29 22
Total Liabilities 900 1160,76 1497,31 1925,23
Net Worth 399 459 528 606
Total Liabilities + Net Worth 1299 1620 2025,01 2531,25

EFN/PLUG -3 0 0 0
Interest Expense 48 62,51 82,91 109,19

Cartwright Lumber's working capital grew from $262,000 to $326,000 to $440,000 between 2001
and 2003. Even though the company's account payable grew over time, its working capital
increased as well. Cartwright Lumber is illiquid, and this is a symbol of that. We forecast the
proforma income statement for the years 2004-2007 to see whether Mr. Lumber needs a
$465,000 loan. As a multiplier, we used the projected net sales of $3,600,000 in 2004. For
forecast factors, we determine each item on the proforma statements. We used data from 2002 to
2003 to come up with certain forecast variables. After all, we project the proforma for the next
three years, 2005 to 2007. The estimated annual growth rate is 25%. The estimated borrowing
sum for 2004, according to the sheet, is $402,000. Despite this, The Northrop National Bank
offers a $465.000 loan. It was expected that a loan of $465,000 would be appropriate for the year
2004. The $465000 loan would not be sufficient for the company in the following years, 2005-
2007. Cartwright Lumber should strengthen its liquidity management in order to achieve its
target.
4) As his banker, would you be willing to lend to Mr. Cartwright? Why? Explain. (It might be
useful to question his growth rate of 25% at this point.)

As Mr. Lumber's bankers, we will be hesitant to lend to him because his 25% growth rate seems
unsustainable based on our proforma analysis. According to the report, Mr. Lumber's need for
exterior financing would increase exponentially, and if he follows the 25 percent growth trend, he
will need $550,26 in 2005, $751,93 in 2006, and $1009,510 in 2007 to continue company
operations. These are much larger sums than the $465,000 we had planned to lend at most.

We are unable to lend to Cartwright Lumber due to the loan cap as failure to uphold the loan
agreement will place both us and Mr. Lumber in a difficult position. Mr. Lumber would be
unable to repay his debt because he would be in constant need of additional funds. This will be
too hard for him, both legally and financially. In the other side, we would be attempting to recoup
our funds and compel Mr. Lumber to pay; we could also offer additional credit to him, but this
would trap us in a vicious circle.

We recommend that Mr. Lumber review the financial statements, determine the sustainable
growth rate, and proceed accordingly. He will keep the firm's assets and liabilities in check this
way. He'll grow gradually even if it happens slowly.