Butler Lumber

By-Group 6

Case overview

•

• Butler Lumber Company, a growing profitable business has exhausted its credit limit and the key issues facing it are:

a) Need for additional funds to expand b) Improve cash flexibility c) Need to consolidate debt. It was found that though there are liquidity issues but

BLC still has bright prospects considering the growing industry and target market i.e. the repairs market

Question 1

• Why does Mr Butler have to borrow so much money to support this profitable business?

Answer 1

• Inventories and accounts receivable are why money is needed.

• Bank debt and accounts payable are sources of the money.

• Cash reserves decreased from 1988-1990

• From 1988-1990 Butler averaged 44.6 days to pay vendors and forfeited 2% discount

• Day sales outstanding increased to 42.9 and decreased cash available

• Money was tied up in inventory. Day's sales in inventory averaged 77.5.

• 6. Increased accrued expenses and capital expenditures had to be made to keep up with growth

• 7. Interest in Henry Stark was bought out in 1988 with long term debt

Ratio’sLiquidity Ratios 1988 1989 1990 1991 1Q Comments

Current RatioCurrent Assets

Current Liabilities 1.8 1.59 1.45 1.35 Times Trend is getting worse

Quick RatioCurrent Assets - Inventory

Current Liabilities 0.88 0.72 0.67 0.55 Times Trend is getting worse

Cash RatioCash

Current Liabilities 0.22 0.13 0.08 0.05 Times Trend is getting worse

Financial Leverage Ratios

Times Interest EarnedEBIT

Interest 3.85 3.05 2.61 2.1 Times Interest expense is increasing

Number of Days PayableAccounts PayableAnnual Purchases 35 46 46 Days Good position - helping cash flow

Asset Utilization Ratios

Inventory TurnoverCost of Goods Sold

Inventory 5.11 4.41 4.67 0.93 TimesAnticipated sales is increasing inventory on hand

Days Sales Inventory365 Days

Inventory Turnover 71.43 82.77 78.16 98.12 Days Taking longer to turn inventory

Receivables TurnoverSales

Accounts Receivable 9.92 9.07 8.5 2.08 Times

Days Sales in A/R365 Days

Receivables Turnover 36.79 40.24 42.94 43.89 Days Taking longer to receive paymentProfitability Ratios

Profit MarginNet Income

Sales 1.83 1.69 1.63 Percent Decreasing trend is a concern

Question 2

• Do you agree with his estimate of the company’s loan requirements? How much will he need to borrow to finance his expected expansion in sales (assume a 1991 sales volume of $3.6 million)

LOAN REQUIREMENT

Company Estimate- $465,000

Group Estimate- $370,000

• The forecast of Butler Lumber Company’s short-term loan requirements are appropriate.

• According to Pro Forma Balance Sheet in 1991, the total amount of bank notes payable of Butler Lumber Company is $370,000. This loan amount would help the company to expand its operational business and eliminate its trade debt. The total amount of $465,000 is not necessary for the spring quarter.

• LOC helpful in first and last quarter as 55% of sales achieved in 2nd and 3rd quarter The current bank will not offer the additional funding, which would result in the discussions with Northrop National Bank.

• So it is strategically important for him to have access to this capital because of the nature of his cyclical business.

CalculationsProjected

1988 % of sales 1989 % of sales 1990 % of sales Average 1991Cash 58 3.4% 49 2.4% 41 1.5% 2.5% 88Accounts receivable, net 171 10.1% 222 11.0% 317 11.8% 11.0% 394Inventory 239 14.1% 325 16.1% 418 15.5% 15.2% 549 Current assets 468 27.6% 596 29.6% 776 28.8% 28.7% 1,032Property, net 126 7.4% 140 7.0% 157 5.8% 6.7% 157 Total assets 594 35.0% 736 0 933 34.6% 23.2% 1,189

Notes payable, bank 146 7.3% 233 8.6% 5.3% 370Notes payable, Mr. Stark 105 6.2% 0

Notes Payable, tradeAccounts payable 124 7.3% 192 9.5% 256 9.5% 8.8% 316Accrued expenses 24 1.4% 30 1.5% 39 1.4% 1.5% 52

Long-term debt, current portion 7 0.4% 7 0.3% 7 0.3% 0.3% 7 Current liabilities 260 15.3% 375 18.6% 535 19.9% 17.9% 745Long-term debt 64 3.8% 57 2.8% 50 1.9% 2.8% 43 Total liabilities 324 19.1% 432 21.5% 585 21.7% 20.8% 788Net worth 270 15.9% 304 15.1% 348 12.9% 14.6% 401 Total liabilities and net worth 594 35.0% 736 36.6% 933 34.6% 35.4% 1,189

BLC opts for additional debt financing:• BLC will have more liquidity and can prepare for anticipated

expansion.• Debt consolidation is possible. Higher level of ownership can be

maintained and BLC will get a lower interest rate. • The risk is that the company will become highly leveraged and may

fall into a debt trap.• Mr. Butler needs a larger credit line of $370,000 to expand and

consolidate. From Mr. Dodge’s point of view, the loan should be approved based on anticipated sales, profitability and financial projections but must be backed by collateral and a check on Inventory turnover and Days Sales Outstanding must be applicable.

Question 3

• As Mr Butler’s financial adviser ,would you urge him to go ahead with ,or to reconsider his anticipated expansion and his plans for additional debt financing? As the banker ,would you approve Mr Butler’s loan request and if so ,what conditions would you put on the loan?

Banker-• Not grand LOC of $465,000.

Little equity aggressive with its forecast $3.6 million in 1991 We estimate $3.2 million in revenue in 1991, $400,000 less than what the

bank forecasted. ($3.2m by taking the 1st quarter revenue of $718,000 which is historically approximately 22.5% of the yearly revenue.) margins are not great for this industry, and BLC is no exception($31k in 1988, $34k in 1989,

$44k in 1990, and an estimated $49k in 1991)

The growth in assets is increasing with a considerable amount from 23.91% in 1989 to 26.77% in 1990. Besides, the return on sale (margin) and asset turnover are at stables rates.

We would consider granting this company a smaller LOC with the similar stipulations of maintaining an appropriate working capital amount, fixed asset purchases would need bank approval and that Butler would put up personal property and his insurance policy as collateral for the loans that the business takes.

Suggestions• Account payable:

Utilized discount• Account receivable:

Bring collection time down

Banker: • Refinance long-term

debt .• 2nd charge on assets• Assets collateralize

note • Restrict distributions

and salary• Approval of capital

expenditures