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%...
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