Butler Lumber Case

Case Report on

Butler Lumber Company

By

AFM FB Group 7

Q1

As making quantity purchases requires a substantial amount of money, we find that internal retained earnings at the end of 1991 Q1 cannot meet the Company’s demand for funds to reach target sales volume. Therefore, Mr. Butler has to borrow money from external sources (assuming he will not invest any more of his own money into the business).

Q2

We look at the operating assets and liabilities as percentages of net sales to assess the operating efficiency of the company. For that purpose, we construct the common-size B/S & I/S as shown in Appendix 1, from which we can derive that

1. Operating assets is on average 35.40% of net sales, with the variance of 0.007%
2. Operating liabilities is on average 10.23% of net sales, with the variance of 0.011%
3. IS items have variance below 0.002%.

Such small variances indicate that the operating efficiency of Butler Lumber Company (BLC) remains unchanged from 1988 to 1990. Because the overall operation strategy of the company does not change in 1991, it is reasonable to expect that operating efficiency is likely to stay on that same level in 1991. Based on that expectation, we could assume that

1. if the sales increase in 1991 by 1 unit, the net operating asset is likely to increase by Pa
2. if the sales increase in 1991 by 1 unit, the net operating liability is likely to increase by Pl
3. IS items except interest expense^[1] can be approximated by their average percentage of net sales.

where Pa and Pl are operating asset and liability as percentage of net sales respectively. For interest expense, we notice a circular relationship between debt and interest expense, so we decide to use iterative calculations to determine the numbers. Given all that, we could construct estimated BS & IS for 1991 shown in Appendix 2, where we include two scenarios in our estimation. We conclude that the total amount of money to finance adds up to approximately $415,403 if the company forgoes early payment discounts, and approximately $658,370 if the company utilizes all as much discount as possible.

 Q3

As a recommendation to Mr. Butler it is clearly important for his cash assets to increase in order to be fully prepared for the likely increase in demand in business, however it is important to note that Mr. Butler has taken out previous loans in the past and despite seeing increases in his profits has been unable to reflect that with increases in cash, choosing instead to invest heavily in property and increasing the size of the inventory. It can be argued that this growth in net sales should have been focused on reducing the size of the debt book as opposed to further extension and taking out further loans will jeopardise his company’s future security, even if it leads to short term benefits.  

As the banker, they are many reasons to approve Mr. Butler’s loan request, firstly Mr. Butler’s business has grown rapidly in recent years and has a secure business future projection with his repair business offering a substantial backup in the event of an unforeseen dip in the market.

Furthermore, significant securities add assurance to the loan; most significantly is the land owned by the business based in a growing suburb of a large city in the Pacific Northwest, which includes two large storage buildings, and the companies balance sheets show increasing current assets which far exceed the maximum loan amount. They are however a number of issues for concern, such as BLC difficulty in obtaining cash which has decreased year on year despite large amounts of loans taken out by BLC. It is important to note that BLC are still obliged to pay back the remainder of a 70k loan taken out in 1988. Although organisations that had conducted business with BLC were full of praise for Mark Butler’s work ethics and acumen. It was also stated he occasionally paid suppliers after the due date., for these reason some precautions are essential to ensure the loan is kept secure; such as placing limits on additional borrowing, maintaining net working capital and current assets above the rent amount, permission would be required for the purchase of any additional investments in fixed assets and Butler himself would have restrictions on cash withdrawals he can make from the business and would be required to reduce his tremendously high salary. The interest on the rolling loan would be set at 3% above the prime rate, with the possibility of reducing it to 2% should the company maintain a good record of paying on time.  BLC shall also be forced to end relationship with SNB, this will ensure that BLC do not fund the repayments of the NNB loan by taking out further loans.    

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