Butler Lumber Company
Are there alternative solutions to Butler lumber cash shortage problem ? 2. Options 2. 1 Status quo. 2. 2 BLC severs ties with SNB and obtains a credit line from NNB. 2. 3 SNB finds alternative sources of short term funds. 3. Recommendation BLC should sever ties with SNB and obtain a credit line from NNB. 4. Analysis Projected income statement for 1991: Beginning inventory was pulled from the previous year’s ending inventory. Purchases were projected from a trend of 75. 61% of sales for the previous 3 years. The total cost of goods sold assumed the previous 3-year average of 71.93% of sales would continue.
Provision for income taxes was calculated as 15% for the first $50 income, 25% for the second $25 income, and 34% for above $75 income. Projected Balance Sheet for 1991: The balance sheet was created by disregarding the fact that butler lumber company needs additional loan. Cash, accounts receivables as well as net property plant were computed based on the average % of sales of the 3 previous years.
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The same idea was used to determine the projected accounts payables and accrued expenses.
Net worth of Butler Lumber Company was net worth from the previous year and net income from the projected income statement for the last 1991. Based on the pro forma income statement and the balance sheet, it was determined that Butler Lumber Company would need to increase their current debt to $360,000 to continue their expansion as planned. Financial Analysis: Put the financial ratios here with the appropriate comment for each table We will start by assessing of the 2 available options presented for BLC. BLC can remain with SNB by accepting their loan offer for $250000.
The only apparent advantage of this option is the fact that a relationship already exists with the bank. This option has a few disadvantages. In fact, it might be possible for BLC to require some additional funds; and the offered loan will become secured signaling the fact that the bank might doubt that Butler will be able to pay back the loan. Despite the fact that Mr Butler will be able to repay this amount, it seems quite obvious that BLC requires a bigger sum of money to sustain its operations given deteriorating liquidity ratios, cash decrease and sales increase.
Alternatively, BLC could choose to take the unsecured 90 days cycle credit line of $465000 at 10. 5% interest from NNB. This option offers more advantages to BLC: it is more flexible, it does not require any collateral from Mr Butler and most importantly it offers a larger amount of money. However, if BLC opts for this option, it will terminate the relationship with SNB. Other disadvantages of establishing a LOC with NNB are the restrictions on the company’s imposed by the bank. 4. 1 Why does BLC have a cash problem ?
As we assess Butler Lumber’s operations from 1988 to 1990, we found out that his reliance on trade credit as well as his competitive pricing schema has allowed the company to generate revenues and grow. Despite the fact that the company was able to generate revenue at an increasing rate during the given years, BLC was unable to accumulate any cash in order to fund its operation and to move forward By looking at the source and use of funds, we will be able to determine the reason behind BLC’s cash deficit.
Given the fact that BLC is a growing firm, it has seen a remarkable increase in both the inventory and receivables account. In fact, the more customers Mr butler has, the more inventory he needs. BLC is growing faster than what its internal sources of funding can provide: cash is used to purchase inventory at a rate faster than what retained earnings can provide. As a consequence, the cash account is deteriorating. Another cause for the decrease in cash is the growth in th difference between accounts receivable account and the accounts payable account.
Since receivables are growing faster, less cash is available to the firm. The company financial situation in terms of cash unsustainable, given such growth. The need for cash is clear, however, there is multiple opportunities to raise capital. 4. 2 Are there alternatives for the cash shortage problem? If Mr. Butler does not obtain the loan from NNB, an alternative resource is Ressource factoring which consists of selling the account receivables. It is worth mentioning that the selling company is still responsible in the event of receivable default.
A factor company purchases receivables from other companies and provides the necessary capital for a small fee. This is very beneficial for companies experiencing cash flows such as BLC which is suffering from a cash shortage problem and slow paying clients. If Butler found a company to take care of 75% of the accounts receivables, $320 000 would be freed up and eliminate the need for additional funding. The particularities of the deal would have to be compared to BLC’s offer in order to determine whether or not this option is preferable. 5. Recommendation
BLC is on a growing path. In fact, the revenue has been able to grow at a fast pace; 18. 62% in 1989, 33. 83% in 1990, 29. 92% in 1991. Financing is a must for BLC since expected sales growth exceeds the firm’s sustainable growth rate and leads to a negative cash flow. We therefore suggest that BLC should sever ties with SNB and obtain a credit line from NNB. As long as BLC keeps generating a healthy sales margin, there is no risk in using this credit line as long as growth levels don’t diminish the cash account too much and growth in receivable match growth in payables.
By having an extra of over $200,000 worth in accessible cash, the company is at this time free from liquidity constraints, and can keep growing at the current pace for a few years. If the fundamentals change, the NNB credit line is still preferable to the SNB loan, because it can act as SNB, making this loan a weakly dominant strategy for BLC. It is also worth mentioning that the days sale in A/R ratio was trending in the wrong direction and it is evident that more effort needs to be spent on collecting the receivables in a timely manner.
In addition to that, inventory turnover was also on a negative trend, and hence exacerbating the shortage of net working capital. The company could improve its efficiency by better managing its inventory (making sure that there was not a growing amount of stagnant inventory) 6. Conclusion It is strategically important for him to have access to a line of credit due to the cyclical nature of the business in which he operates If BLC opts for debt financing: * BLC will have more liquidity and can prepare for anticipated expansion * Debt consolidation is possible and BLC can get a lower interest rate
Liquidity ratios of Butler Lumber Company were decreased over time. The decreasing trend was worrisome especially given the low quick ratios. The notable trend in this section was toward reduced liquidity. Butler was experiencing a shortage of working capital that needs to be addressed to sustain growth in this profitable business. Financial Leverage: The data showed that Butler is becoming a more leverage company, primarily in terms of short term debt. The debt to equity ratio is on a decreasing trend, however, from the bank’s point of view it is still safe for her to lend money for LBC. Assets utilization:
Days sales in A/R increased from 37 days in 1988 to 43 days in 1990 indicated the company takes longer days for taking payment. With increasing sales figures, these long collection days have a greater effect on the business. Inventory Turnover needs to be improved through better management of the inventory mix, and by encouraging customers to pay on time. If this is done correctly, it would reverse the downward trend of the profit margin. Profitability: The Butler Lumber Company has positive Profit Margins and ROE, therefore it is a profitable business. However, the decrease in the profit margin is clearly a concern.