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Cartwright Lumber Company

Following years of rapid and unwavering business growth, Mark Cartwright, the owner and
president of Cartwright Lumber Company, found himself in the situation that he needed

additional operating capital to keep the trend. However, from the information presented in the
case study, we know that his business bank, due to internal procedures, was not able to provide
additionally needed capital in excess of $250,000. Hence, he started tentative deliberations with
the other, much larger bank, Northrop National Bank. The sole purpose of these negotiations was
to ensure broader financial support that would in the end provide financing up to $465,000.
That being said, the company has been in retail business of providing lumber products such as
plywood, moldings, sash and doors to local population of growing suburb area of the large city. It
must be noted that Cartwright Lumber Company was operating in the highly competitive market
dominated by customers. In other words, buyers had a power to decide at what retail shop they
would purchase the products such as plywood, moldings, sash and doors. Consequently, and
given such environment, the companys business strategy was to act as a low cost supplier. To
pursue this direction, there was a strong emphasis on cost control throughout the company.
Pursuing sale growth, Mr. Cartwright offered to his customers a quantity discounts and credit
terms of net 30 days on an open account. Providing mentioned credit terms to the customers, it
meant that company was financing the customers for 30 days. For this purpose, Mr. Cartwright
used borrowings from the business bank. With the intention to minimize the financial pressure,
Mr. Cartwright, in some cases, was delaying payments to his suppliers, but without financial
repercussions.

As sales volume increased from year to year, volume of receivables from

customers also rise to the level of $317,000, and cash on hand where decreasing for every
subsequent year reaching $31,000 at the end of the IQ 2004. These were clear signs of the
overtrading.
By its definition, overtrading results in liquidity problems such as exceeding borrowing limits,
or slow repayment of lenders and creditors. Longerterm planning becomes difficult and
managers may spend their time going from crisis to crisis.1
Taking all realities into consideration, the Cartwright Lumber Company came in the position that
current cash flow was not sufficient to ensure satisfactory liquidity level and in the same time
1 Atrill, Peter, and E. J. McLaney. "Financial Ratios and Problem of Overtrading." Management
Accounting for Decision Makers. 4th ed. New York: Prentice Hall/Financial Times, 2005. Print.

support business operation. Although Mr. Cartwright try to offset the liquidity problems with
postponed payments of his suppliers, the measure were not enough.
As mentioned in the beginning of this essay, the Cartwright Lumber Company was operating in
the highly competitive market that was dominated by customers. This can be concluded from the
case study, where it is stated that the sale was largely build up on the basis of successful price
competition.2 This leads us to reconsider the price elasticity of demand.
From the very definition of the price elasticity of demand we know that The price elasticity of
demand is a measure of the magnitude by which consumers alter the quantity of some product
that they purchase in response to a change in the price of that product.3
That being said, the company might expect that increase in the price of its products would have
detrimental effect on the quantity of goods demanded, as the vast majority of customers would
most likely switch to other suppliers. In such situation the company should strive to maintain the
current prices, with simple aim not to decrease the current customers demand, that would have a
negative effect on the level of sales which in the end would lead to decrease of supply and finally
it would result with further reduction of the cash flow. Continuation of negative trends would
further destabilize the company, and eventually business would collapse.
To better understand seriousness of situation how competitiveness if lost may influence
Cartwright Lumber Company, we should observe in depth explanation with illustration, given by
Professor Porter.
In essence, the job of the strategist is to understand and cope with competition. Often, however,
managers define competition too narrowly, as if it occurred only among todays direct
competitors. Yet competition for profits goes beyond established industry rivals to include four
other competitive forces as well: customers, suppliers, potential entrants, and substitute

2 Piper, Thomas R. "Cartwright Lumber Company." Harvard Business School 9-204-126 (2004): 1. Print.
3 Melvin, Michael, and William J. Boyes. Demand. Principles of Microeconomics. 9th ed. Mason,
Ohio?: South-Western Cengage Learning, 2013. Print.

products. The extended rivalry that results from all five forces defines an industrys structure and
shapes the nature of competitive interaction within an industry.4

Given the prudent approach, Northrop National Bank performed due diligence (Duty of the
investor to gather necessary information on actual or potential risks involved in an investment 5),
and on the basis of those findings, Mr. Cartwright should take into the consideration the current
conditions on the market that do not promise increased sales, and where it could be expected that
the current level of demand for companys goods remain relatively constant or would even
decrease.
Mr. Dodge, representative of the Northrop National Bank, also included clear provisions, which
would have intention to stabilize current financial situation and in the future control the growth
aspect of the company.

4 Porter, Michael E. "The Five Competitive Forces That Shape Strategy." Harvard Business Review. 1
Jan. 2008. Web. 24 Mar. 2015. <https://hbr.org/2008/01/the-five-competitive-forces-that-shapestrategy/ar/1>.
5 "What Is Due Diligence? Definition and Meaning." BusinessDictionary.com. Web. 24 Mar. 2015.
<http://www.businessdictionary.com/definition/due-diligence.html>.

The provisions would be in the form of controlled investments in fixed assets, stopped
withdrawals of funds by Mr. Cartwright and maintaining current working capital without
additional borrowings. It must be underlined that all these provisions are aimed to keep the
production capabilities, or better to say supply, at the current level and in that way protect cash
flow.
Before pointing out to the differences between "economic" and accounting profit", a definition
of these terms must be given. As outlined in the textbook, the Accounting profit is net operating
income. In addition, the Accounting profit measures the cost of capital as interest expense
only. It does not include the cost of ownership, called equity capital. Economic profit includes all
opportunity costs: Economic profit = accounting profit - cost of equity capital.6
Following this definition, we should illustrate and briefly explain relevant financial data that are
derived from Operating statement and Balance sheet presented in the Exhibit 17of the case study.

2002

2003

1st Quarter 2004

income $50

$61

$86

$21

Net worth (equity) x cost of $30


capital 11%

$33

$38

$39

Economic profit = Net op. $20


income (Net worth x COC)

$28

$48

-18

(thousands of dollars)
Net
operating
(Accounting profit)

2001

Though accounting profit indicates that company makes a sound business, it is the negativity of
economic profits 1st quarter that tells us the opposite. From the textbook we know that negative

economicprofitmeansthattheresourcesusedwouldhaveahighervalueinanotheruse.
Iftotalrevenuedoesnotpayforallcosts,thenownersdontgetpaidfortheirtime,
6 Melvin, Michael, and William J. Boyes. Profit Maximization. Principles of Microeconomics. 9th ed.
Mason, Ohio?: South-Western Cengage Learning, 2013. Print.
7 Piper, Thomas R. "Cartwright Lumber Company." Harvard Business School 9-204-126 (2004): 1. Print.

effort, and investments.6 On the basis of presented calculations, and the simple fact that
negativeeconomicprofitof$18,000inthe1stquarterof2004,itbecomeobviousthatsuch
negative trend would eventually prove that assets could beused, if invested, in some other
businessopportunity.
In the beginning of the case study, we could see that $247,0008 is the amount that Mr. Cartwright
found necessary to increase its borrowing. For that reason he might decide to make prudent
approach and not engaging into contractual obligation with Northrop National Bank but rather
try to renegotiate a new loan (overdraft) terms with the Suburban National Bank with whom his
company have good business relation.
To conclude, it would be advisable to accept a strategy that will minimize further indebtedness,
maintain financial discipline through reductions of receivables as well as liabilities,
reinvestments of profit into working capital, and further lowering operating expense by
procrastinating increase of his own income.
With such approach and prospective future where demand would not decrease, Cartwright
Lumber Company might overcome current shortfalls, stabilize liquidity and eventually yield a
positive economic profit.

8 Piper, Thomas R. "Cartwright Lumber Company." Harvard Business School 9-204-126 (2004): 1. Print.