Cartwright Lumber Financials

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- Estimation of company’s loan requirement

In order to identify Lumber’s loan requirements for 2004, we forecasted the company’s P&L statement, the Balance Sheet as well as the Cash Flow Statement for the year (2004F). As a basis for our forecast, we used the $3.6 million in sales. For the remaining P&L and balance sheet, we used the following assumptions:

COGS, OPEX, A/R

2003’s percentage of sales

Net PPE, Accr. Exp.

Q1 2004 figure

Inventory, A/P

2003’s percentage of COGS

Notes Payable Suburban Bank,

Q1 2004 figure

Interest Expenses

11% on Suburban loan +

11% on 10y loan +

10.5% on new Northrop loan

Notes Payable, Trade Credit

0, 157k repaid throughout year

Income taxes

Case Footnote

Table 1: 2004F Forecast Assumptions

Based on these assumptions, Lumber’s Cash Flow to Equity results in -94 and a corresponding ending cash balance of -53. Accordingly, the company requires at least an additional loan in this amount to finance the intended business expansion. Furthermore, Lumber should add a minimum cash requirement on top of the 53 as a safety buffer as well as the option to profit more from the attractive trade discounts (see question 4). Consequently, we recommend a minimum cash balance of 50. In total, and considering the resulting interest expenses, Lumber at least requires an additional loan from Northrop National Bank of 113. As a result, the secured 90-day note of maximum 465 offered by Northrop National far exceeds the needs for funding in 2004.

- Recommendation on planned expansion from financial advisor’s perspective

From a financial perspective, Lumbers expansion policy is not sustainable. The increasing sales volume and the corresponding increase in Net Working Capital ties more cash in the business than the additional sales can generate. As a result, Cartwright depends on liabilities, both in the form of trade credits as well as bank loans. Already in 2003, Lumber has a very high debt ratio of 63%, which makes the company highly dependent on the goodwill of its suppliers as well as the banks willingness to keep funding the company. In addition, Lumber is constantly facing liquidity shortages, in particular for unforeseen events. As soon as there are changes in the market and the business will not grow as fast as planned or customers stop paying on time, Lumber risks the fate of growing to death and ending up in bankruptcy. The planned sales expansion in 2004 makes the situation even worse, with a debt ratio of 66%.

Consequently, we recommend Cartwright a more conservative, but healthier growth strategy for the future. In particular, rather than solely focusing on top-line growth, Cartwright should put a stronger emphasis in managing his net working capital to improve his liquidity situation. For this reason, we calculated two alternative scenarios: One with no and one with moderate growth. The following table compares the most important figures of the expansion, medium and no growth option.

As shown in the Appendix, all scenarios achieve roughly the same net income. While option 1 requires the above mentioned additional loan of 113 to maintain a minimum cash balance of 50, options 2 and 3 generate enough cash flow to maintain the same 50 cash balance and even to pay back some parts of the original loan from the Suburban bank. These paybacks will reduce the corresponding interest expenses as well as significantly improve the liquidity ratios of the company. Such measures should moderate Lumbers dependence on outside funding, improve its flexibility towards unforeseen events and ultimately reduce the bankruptcy risk. In addition, by not including a second bank, Cartwright also prevents jeopardizing his relationship with the Suburban national bank.

- Evaluation of Cartwright’s loan request

Based on our financial analysis and the impact of the business expansion, we would not approve Mr. Cartwright’s loan request from a bank’s perspective. Despite the significant predictions in future sales, his business has demonstrated vulnerability in terms on liquidity and cash conversion. While Lumbers predicted sales increase, the company heavily relies on debt financing, and increasingly long-term financing for operational activities, in order to function. This constant need for external funds combined with the already high debt ratio and low liquidity ratios heavily exposes the company to market fluctuations. As a result, Lumber lacks a safety buffer and could rapidly fight bankruptcy in case the markets go south. Therefore, we think that Mr Cartwright’s intended rapid expansion strategy even worsens the financial situation. Consequently, we recommend Lumber to reduce its growth ambitions and to stabilize its liquidity and financing situation.

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