Butler Lumber Case

Butler Lumber Company Case ? Butler Lumber Company Case Summary of facts: In 1981 by Mark Butler and his brother-in-law Henry Stark founded the Butler Lumber Company. In 1988 Mr. Butler bought Mr. Stark’s share for $105,000 to be paid of in 1989 out of which $70,000 was raised by a loan carrying an interest rate of 11% and repayable at the rate of $7,000 over the next 10 years.

Over the past five years, Butler Lumber Company has experienced rapid growth in its business. It derives its business from retail distribution of lumber products in the local area.A large portion of its business is based in repair services, and as a result, it should be somewhat protected from a downturn in the real estate market. Sales volume has built up largely due to successful price competition, made possible by careful control of operating expenses, and quantity purchases at substantial discounts. Mark Butler, sole owner and president of the Butler Lumber Company is looking to increase the company borrowing.

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Suburban National Bank currently holds $247,000 of its debt. In order to increase its borrowing, Butler Lumber Company will have to switch debt holders from Suburban National to Northrop National Bank.Northrop National is currently analyzing the financial stability of Butler Lumber Company. Problems: Butler Lumber Company has a problem with a shortage of cash resulting in an inability to satisfy the expansion of its rapidly growing business as evident by the balance sheet forecast for 1991(Exhibit 2). For this reason, Mr.

Butler is seeking a larger unsecured loan in order to satisfy the company’s immediate need for cash. Northrop National Bank is prepared to offer Butler Lumber Company a loan of up to $465,000. Will $465,000 be enough to satisfy Butler Lumber’s expanding business? We are assume a 1991 sales volume of $3. 191 million). Why has sales growth been so strong while net income growth has been feeble at best? Butler Lumber Company Estimated Income Statement Dec.

31, 1991 (Thousands of Dollars) 1991ValueExplanation Net sales$ 3,191 22. 5% of yearly revenue Cost of Goods Sold: Beginning inventory418 From given Data Purchases2,4123,191. 11*0. 756% Of sales based on three previous years $ 2,830 Ending inventory(565)(COGS-beg inv – purchase) Total Cost of Goods Sold$ 2,2663,191. 11*0. 71% Of sales based on three previous years Gross profit925Operating expenses(798)3,191.

11*0. 25% Of sales based on three previous years Operating Profit127 Purchase Discounts35 2% of Purchases after April 1st Earnings before interest and taxes$ 162 Interest expense (48)10+(315*12. 5%)From given Data Net income before income taxes$ 114 Provision for income taxes(27) Net income$ 87 Analysis: We have prepared pro forma Balance Sheet and Income Statement for the period ending December 31, 1991 in order to determine how much Butler Lumber will need in additional debt financing if it is to expand as planned.We believe that Northrop National’s Net Sales estimate of 3. 6 million for 1991 is overly confident. Historically, 55% of total yearly net sales are made during the second and third quarter.

We can thereby assume that the first quarter revenue of $718,000 is 22. 5% of the total yearly revenue. As a result, our analysis has resulted in a forecast of $3. 191 million for 1991. Beginning inventory is derived from last year’s ending inventory.

Purchases are projected from an average trend of 75. 6% of sales over the past three years. Total Cost of Goods Sold is based on average of 25% of sales over past three years.Interest expense is calculated by adding $10,000 to interest expense of loan amount calculated in balance sheet with the rate of 12. 5% percent given in the case. Butler Lumber Company is taxed at the rate of 15% on its first $50,000 of income, 25% on the next $25,000, and 34% on all income over $75,000.

Butler Lumber Company Estimated Balance Sheet Dec. 31, 1991 (Thousands of Dollars) 1991 2nd passExplanation Cash$ 49Last year’s % Of Sales Accounts receivable, net350 Average % Of Sales Inventory565Calculated from Inc. Statement Current assets $ 963Property, net186Last year’s % Of Sales Total Assets $ 1,149 Notes payable, Northrop$ 315 Plug Value Note payable to Holtz – Notes payable, trade – Accounts payable303 Accrued expenses 46 Last year’s % Of Sales Current portion of Long Term Loan7Constant Current liabilities $ 671 Long-Term loan43$50 – $7 Total Liabilities $ 714 Net worth$4351990 Net Worth + 1991 Net Income Total Liab. & Net Worth$ 1,149 The Balance sheet was generated with the assumption that Butler Lumber would utilize the additional loan from Northrop National.Cash, Accrued Expenses, and Net Property are all based on the most recent year’s percentage of sales.

Accounts receivable is derived from average of previous years percentage of sales. In order for Total Assets and Total Liabilities & Net Worth to be in balance Butler Lumber needs additional debt financing of $315,000 as can be seen in Notes Payable. This in turn has an effect on Net Income for 1991, which is added to beginning Net Worth in order to arrive at $435,000. Liquidity Ratios1988198919901991Note Current Ratio1. 81.

591. 451. 44Downward trendQuick Ratio0. 880. 720. 670.

59Downward trend Cash Ratio0. 220. 130. 080. 07Downward trend The current and quick ratios can help us assess Butler Lumber Company’s liquidity. It helps us examine how it will be able to meet its short-term debt obligations such as accounts payable and short-term notes payable with payments due within the next year.

A current ratio of approximately 1 is desirable. Values lower than 1 indicate that the company might have difficulties meeting its short term obligations, while values higher than indicate an inefficient use of resources.Butler Lumber Company has a current ratio of 1. 45 (1990) with a downward trend, indicating a more efficient use of its resources. However, their quick ratio is only 0. 67 (1990).

This might signify a wasteful use of funds. The only difference between the current and quick ratios is inventory. Mr. Butler chooses to load up on inventory even though he is rarely able to take advantage of the 2% 10 days discount offered with quantity purchases, resulting in the large difference in liquidity measurements.The decreasing trend could be worrisome, especially given the low quick ratios. However, according to the current ratio, the company is still able to cover its short-term debt.

This table (Exhibit 4) is based on the scenario in which Butler utilizes the loan from Northrop National. Profit margin and ROA shows a steady decrease up until 1991 when the loan comes into effect. This increases both these ratios for the company. The ROE has somewhat of an increasing trend and with the new loan this slope will get even steeper.It is therefore clearly evident that the loan from Northrop will have a positive effect on company operations both for the company in and of itself as well as stakeholders.

Recommendations: Butler Lumber Company has had a steady increase in growth over the past four years, even with our relatively low estimate compared to that of Northrop National Bank. We would advise Mr. Butler to take the loan in order to expand his business and increase profitability. One worrying fact about the company is the lack of sales staff, yet the revenue has been able to grow at a pace of 19% in 1989, 34% in 1990, and 18% in 1991.By hiring a new sales representative working for a base salary plus commission, we believe that revenues could experience an even higher growth. The large amount of inventory growth along with a smaller annual growth in net income suggests poor management of funds, as evident by the current and quick ratios (see Exhibit 3), but also by the fact that in 1990, inventory was almost 45% of total assets.

Better inventory management might increase cash funds and allow for more freedom in the management of current assets.