Question 1: Why Cartwright Lumber Company needs cash
Despite the profitability of Cartwright Lumber Company, it still faces cash flow challenges. The financial statements indicate that the company has a low balance in its cash account. Profitability does not necessarily mean the firm has a stable cash flow. The income statements indicate that Cartwright Lumber has been profitable in each of the years from 2001. The net income has increased from $31,000 in 2001 to $44,000 in 2003. However, its cash balance has declined in each of the years. Large sales and profitability do not automatically translate into cash flows. The company has large balances of accounts receivables. Sales improve cash flows only if the company sells for cash or has a shorter collection period.
Cartwright needs cash since its available cash is not sufficient to cover the operating expenses among other activities. With sales expected to increase by 20% over the next four years, the company’s cash needs will increase. Besides, it needs cash to finance the repayment of certain liabilities.
Question 3
I would not lend Cartwright the amount he needs. An analysis of the financial statements indicates that the company is not in a sound financial position. The company's current ratio shows that its assets were adequate to repay its short-term obligations in each of eth years under consideration. The current ratios were more than one at the end of each of the years. However, the large amount of inventory reduces its quick ratio.
Analysis of the company’s solvency indicates that it has a large amount of debt. The debt ratio for Cartwright was more than 0.54 in each of the years. This indicates that Cartwright finances most of its assets through borrowing. Total liabilities are more than the firm’s net worth. This shows that there is a great financial risk in lending to the company since the possibility of default is high.
The balance sheets indicate an increase in the balance of accounts payable during the period from 2001 to 2003. The company is facing financial challenges and it has not been taking advantage of trade discounts.
Lending the company the $465,000 needed will be a big risk owing to the above reasons. I would agree to lend the company an amount less than $465,000. The loan must be secured to guarantee repayment and avoid losses when the company is unable to repay. If not, it should be based on a given percentage of accounts receivable.
Question 4: Measures to improve cash flows
The company can improve its cash flow through several measures. Improving cash flows will ensure it has adequate cash to finance its daily operations as well as long-term investments. Firstly, it can adopt a more aggressive credit policy. An aggressive policy involves measures that reduce the amount of accounts receivable. As shown in the company's balance sheet, it has a large of accounts receivables. The high receivables turnover reduces cash flow availability since receivables cannot be readily used in paying for operating activities. It should reduce the credit period it allows customers, increase the standards or qualifications for credit facilities and conduct a more vigorous assessment of customers' credit worthiness.
It should also improve inventory management by keeping the inventory levels to the minimum possible amount. The balance sheet indicates that the company had a large amount of inventory in each of the years. Besides, inventory balance increased in each of the years. Inventory reduces cash flow and liquidity of the company since it represents capital or cash tied up in stock and cannot be used to meet cash flow needs. Besides, it reduces profitability by increasing inventory handling costs. This strategy can be implemented through increased advertising, adopting just-in-time inventory management, among other efficient inventory practices. Reducing inventory through improving sales will increase cash or accounts receivable thus enhancing the liquidity of the company. An increase in accounts receivable will raise the company's credit limit.
Cartwright requires a loan of $465,000 to meet its cash needs. The bank cannot lend him more than 60% of its accounts receivable balance. The accounts receivable balance as at the end of the first quarter of 2004 is $345,000 implying that the bank can lend the company a maximum of $207,000.
Finally, the cash flow situation can be improved by enhancing the efficiency of operations and reducing certain expenses. As shown in the income statement, the firm's operating expenses average about 24% of the total net sales. One significant item under operating expenses is the salary, Mr. Cartwright. He can reduce this amount for the time being until the company’s cash situation improves.
Question 6: Alternatives if Cartwright does not get the loan
Cartwright has a few alternative sources of financing if he fails to secure the loan from Northrop Bank. He can raise the capital needed through equity. In this case, he will sell a share of his ownership in the company to another person or persons who in turn will provide the needed capital. He can source for these potential investors privately or decide to do an initial public offering, although this would be costly. The limitation of this source of funding is that it will dilute Cartwright’s control of the company. The new shareholders will share the company’s earnings as well in decisions of the company.
He can also source for funding from private equity or venture capital firms. Venture capital firms will provide capital and expertise to turn around the company then sell their interest in the company at a higher price at later date.
Question 6: Attractiveness of discounts
Trade discounts are offered by sellers to encourage early payment for goods and services sold on credit. Discounts reduce the purchase price hence they are attractive to most buyers. Taking trade discounts implies the early payment of accounts payable thus reducing current liabilities. This could benefit the company by improving the company’s capacity to borrow. As shown in the case, one of the concerns of Mr. Dodge was the fact that Cartwright has not been able to take advantage of the trade discounts. This indicates that the company has no adequate funds to meet its accounts payables.
However, discounts are not always as attractive as they look. A business should assess the opportunity cost of taking trade discounts. Taking trade discounts implies early settlement of accounts payable. The company will incur opportunity cost equal to the return on capital it would have earned if it would forgo the trade discount. For instance, when a company delays the settlement of accounts payable at the expense of trade discounts, it is assumed that the amount equal to the accounts payable amount is invested in the company during the period and earns a return. This should be compared with the amount of trade discount offered to determine the suitable decision.
