Butler Lumber Company
Question 1 How well is Butler Lumber doing?
Despite recording a tremendous growth in revenue as follows: 2009: 18.62% 2010: 33.83% 2011: 6.
61% The profitability of Butler Lumber is on declining trend. | |2008 |2009 |2010 |1Q 2011 | |Gross Profit Margin |27.99% |28.61% |27.62% |27.
30% | |Net Income Before Taxes Margin |2.18% |2.04% |1.7% |1.53% | |Net Income Margin |1.
83% |1.69% |1.63% |1.25% | Despite the lower gross profit margin, Butler Lumber is able to limit its downside effect on the profitability with a lower operating expense relative to the revenue, reflecting a good cost management. Butler Lumber also has to deal with higher interest expenses due to its increasing debts to fund the working capital.
Question 2 What has been the company financial strategy? Why does Mr.
Butler have to borrow so much of money to support this seemingly profitable business? Has he been managing his company’s cash well flow wisely?
Mr. Butler appears to be growing the revenue of Butler Lumber with external funding. Mr Butler is borrowing so much money in order to meet the higher working capital requirement arising from the increased revenue in each year. Increased revenue will render increased accounts receivables and inventories; hence a higher net working capital cycle though the increased accounts payables will partly offset the increase. Cash flow management: from 2008 to 2010, the net working capital cycle is about 73 to 77 days, which is rather consistent with on year-to-year basis. For 1Q 2011, the higher net working capital cycle is mainly due to higher inventories level as 55% of the sales will only comes in 2Q and 3Q.
Another reason in the high inventories level in 1Q 2011 is due to the expectation that the price of lumber will increase significantly in near future which may not be effectively passed to its customers over a short period. By hedging the inventories level, Butler Lumber will be able to enjoy a protection of its profit margin.Furthermore, the longer net working capital cycle is due to Butler Lumber paying off its account payables which only give credit terms of 30 days.
In order to pay off the accounts payables, Mr Butler had to rely heavily on bank borrowings as he could not substantially cut the credit terms given to its customers or shorten the days of repairs work.