– forced to cease trading .Situation• Founded

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–    B33UT£LER LUMBER COMPANY -AbstractThe Butler Lumber Co. has reached the point where needs to raise bank loan due to its rapid sales growth and low profit margins. We must determine the reasons for raising the loan, estimate the amount of required, and assess the attractiveness of the loan to the bank. In Butler’s case, customers don’t pay until after the delivery of their lumber. That means that there can be quite a long period of time in which Butler Lumber has to pay for parts and labour but before they can collect from their customers. Because Butler lumber is growing so rapidly and its business is so sensitive to the seasonal influences, it is at risk of spending all of the previous year’s profits to fund the current year’s growth, and as a result running out of cash. If the company has no short-term liquidity , it won’t be able to pay workers or suppliers and will be forced to cease trading .Situation•    Founded in 1981 •    Location: Pacific Northwest•    Current operations: Retail distribution of lumber products in the local area•    Offered quantity discounts and credit terms of net 30 days on an open account•    Heavily relies on trade credit with suppliers•    Experiencing rapid growth & anticipates a substantial increase in sales•    Mark Butler is looking for a loan to satisfy the needs of Butler Lumber Company•    He is interested in a line of credit from Northrop National Bank (not to exceed $465,000)•    He currently has business relations with Suburban National Bank (loan not to exceed $250,000)Why the Loan?•    Dissatisfaction with Suburban National Bank’s termso    Securedo    Max $250,000•    Cash Shortageo    Pay off the $70,000 loan taken to pay Stark’s share (11 % interest + $7,000 annual payment; still 8 years to pay, 1991-1998)o    Investments in working capital associated with the company’s increasing sales volumeo    Pay off the mortgage on his house ($38,000 in 1979)o    $70,000 life insurance policy, payable to his wifeo    To decrease reliance on trade credit. Currently he is unable to avail discounts on purchases made because of lack of cash, with larger funds he can take advantage of discount by making payment within 10 daysNNB Loan’s possible terms and conditions•    Revolving secured 90-day note not to exceed $465,000•    Standard covenants will be applied, such as restricted additional borrowing, maintaining net working capital at an agreed level, additional investments in fixed assets can be made only with prior approval of the bank, limitations on withdrawals of funds from the business by Mark Butler•    Floating-rate interest rate of 2% points above the prime rate, with initial rate of 10.5%Butler Lumber Co.’s 4-Year Financial AnalysisAssumptions•    4 types of forecasts are used to find 1991’s year-end value:o    Conservative – the least of the percentage changes during 1988-1990 is applied to 1990’s year-end result o    Optimistic – the highest of the percentage changes during 1988-1990 is applied to 1990’s year-end resulto    Steady – for most calculations, 1991 Q1 result is multiplied by 4, and in some others, Q1 figure is used (when appropriate)o    Average – Geometric mean of percentage changes in 1988-1990 is calculated and applied to 1990’s year-end resultProfitability Ratio Analysis•    Overall no significant change in profitability over the years•    Net profit margin has been low over the years, with merely 1.8% in 1988 and shows a decrease over the years accounting to mere 1.6%. This suggests poor capacity of the company to withstand adverse economic conditions and comparatively low operating efficiency of the firm•    Conservative and Average scenarios give similar figures to the past results (1988-1990) for all profitability ratios while Optimistic and Steady scenarios are substantially (can we say that?) affected mainly by net income•    All these ratios should be compared with industry averages by the bank considering  the loan application (not available in this case but it is important to mention that would explain why we are not comparing and show we understand the procedure) and competitors’ figures to do a better analysisEfficiency Ratio Analysis•    Total Asset Turnover increased year over year, which shows a better use of existing PPEs•    Average Sales per Day also increased by 19% and 34% from 1988 to 1989 and to 1990•    Days account receivables and Days account payables slightly increased over the 2-year period.•    The Days account receivables ratio indicates whether debtors are being allowed excessive credits. A higher credit may suggest general problems with debt collection or the financial position of major customers. Days a/c Receivables is increasing which indicates poor collection policy. Ideal Days a/c Receivables allowed was 30 but we are getting 43 for 1990 which necessitates better credit collection policy•    Overall, Cash conversion cycle fluctuated slightly around 50 days•    All these ratios should be compared with industry averages and competitors’ figures to do a better analysisLeverage Ratio•    It describes lender’s contribution to each dollar of owner’s contribution. It estimates stability of the business and the Standard Value is 2:1.•    If it is less than this, it is favourable because:o    High safety margin for lenders o    Fewer interest paymentso    Scope for more loanso    No trading on Equity•    Company’s debt level increased from 1988 to 1990 which affected interest coverage to go down from 3.85 to 2.10. However, this interest coverage level can still be considered safe•    Debt-to-Equity has been increasing over the years which suggests increased dependency on external funds and high financial risk.  Moreover, it indicates rapid growth in company as well which arises greater need of external funds•    Debt ratio has been increasing over the years which increased the extent of debt financing in business. Hence, almost half of the company’s assets are being financed by external funds •    All these ratios should be compared with industry averages and competitors’ figures to do a robust analysis and corroborate the recommendationsLiquidity Ratio Analysis•    Company’s liquidity position has deteriorated and now stands at the very risky level•    The current ratio has been decreasing over the years, which suggests that it has more current claims than current assets. In fact, a satisfactory ratio of 2:1 was never achieved in any of the years. It points to a narrow margin of safety for creditors•    Liquidity ratios measure a company’s ability to pay debt obligations, and its margin of safety through the calculation of metrics including the current ratio, quick ratio and cash ratio. A ratio of less than 1 is a cause of concern•    Quick Ratio considers only cash as quick assets for meeting short-term liability •    All these ratios should be compared with industry averages and competitors’ figures to do a robust analysisDecision CriteriaPositive signs•    Ready market for Butler’s products at all times•    Careful control of operating expenses•    Purchase of materials at substantial discounts•    Efficient use of employees•    Access to a railroad siding as railway transportation is not only particularly sustainable but is also faster, safer and cheaper than other modes of transport. Also, the carrying capacity of the railways is extremely large. It is not clear from the content whether Butler Lumber already uses this transport (truck drivers mentioned once). However, there is a huge potential for this transport mode.•    Succession planning is at a good level as there is a person in the company who can replace the current CEO (Mark Butler) if he leaves, retires or passes away.•    Hedged against cyclical industry; Despite a general economic downturn, Butler Lumber’s sales are protected to some extent because of the relatively high proportion of its repair business•    Despite increasing PPE amount, total Asset Turnover increased year over year and is expected to reach 20.3 in 1991’s year-end in Average scenario, which shows a better use of existing PPEs•    Total sales amount and net income increased over the yearsNegative Signs•    Although net profit ratios seem very  low, these numbers could be close to the industry average (not available). Therefore, these ratios must be compared with competitors and can be only interpreted adequately if measured against the benchmarks •    Relying heavily on trade credit•    Sizeable personal investments may not be strong in the long-term (more than 50% mortgaged the personal house and a half interest of a house owned by his wife) and a greater percentage of these properties belong to Mark Butler’s wife, not to Butler himself. It can be problematic in the future if secured loan is considered•    Although Butler Lumber has very strong relationships with its suppliers, significantly extended trade credits in the spring of 1991 can damage them•    Borrowing amount and debts of the company rose and the Debt-to-Equity figure stands at 93% in the Average scenario•    Company’s liquidity position has deteriorated and now stands at the very risky level. Both deteriorating liquidity and increasing leverage put pressure on its ability meet the short-term debt obligations•    The balance of $465,000 will probably also be used to pay previous bank loan and loan previously taken for his initial partner at $247,000 and $7,000, respectively and not solely invested into growthAs an Adviser to Mr Butler•    More efficient inventory management system is required during the cash flow cycle•    Quantity discounts and day’s receivable needs to be reduced •    Significantly reduce Accounts Payables and paying suppliers immediately to avail the option of 2% discount•    Decreasing his personal withdrawing which is almost twice of net income, this will help in increasing the profit margin•    Operational efficiency has to be increased to achieve the higher profit margin•    Encourage him to take the line of credit if offered by Northrop National Bank in an attempt to grow the business•    The company is at the stage of rapid growth and needs a source that is sufficient enough to meet the growing needs•    Butler should seriously consider letter of credit for $465,000. This will provide him a strategic access to the capital in case of business needs. •    Cease the relationship with the Suburban bank if offered new line of credit with NNB both as condition stipulated by NNB and because of better conditions (we have estimated the interest expenses for NNB are better than SB initially, didn’t we Alex?)As an Adviser for Northrop National Bank (NNB)•    From Bank’s point of view, this LOC ($465,000) might be considered a risky transaction.  Based on the calculations made, the revenue estimates might be at $ 3 million or lower. •    The gross and profit margins are not very high either. The net profit looks consistent at $31k in 1988, $34k in 1989, $44k in 1990, and an estimated $59k in 1991, without a significant growth.  The Bank should offer a smaller loan (other conditions with pledged property apply) which ought to be in excess of current credit line with SU (? If all are in agreement -).•    Debt position and current ratio of the business could have been better as well. Therefore, NNB should reject this line of credit and consider a small amount for such transaction.  The NNB may consider whether the agreement with the Lumber company may involve conditions applied to the use of the loan (e.g. quota on how much can be used to pay other debts and creditors and how much should be invested into business growth (again , that is just a suggestion that we should address the bank response to the negative signs we have mentioned)

Categories: Accounting


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