Butler Lumber Company Case Study

Hoffmeister M-W 4:30 5:45

Group #3
Sam Rosenbaum
Joel Valenti
Meg Lee
Stephanie Grob

Butler Lumber Company

Summary of Facts. Butler Lumber Company is a Pacific Northwest based lumber
distributor that sells plywood, moldings, and sash and door products. The sole owner of
Butler Lumber is Mark Butler, accompanied by one administrative assistant and ten
employees who focus on repairs and labor intensive work. Because of Butler Lumbers
competitive pricing scheme, it has seen rapid growth in the past few years. Due to the
rapid growth and a shortage of cash in 1990, Butler Lumber Company is seeking to take out
an additional loan in order for the business to sustain itself and grow in the coming years.
Butler Lumber has the option to accept a loan of $250,000 from Suburban National Bank,
or accept an unsecured revolving 90-day note of $465,000 at 10.5% interest from Northrop
National Bank. If Mr. Butler decides to accept the note from Northrop National bank, it will
sever the existing ties with Suburban National Bank and a new relationship must be
maintained.
Problem. If Mr. Butler accepts the loan from Suburban National Bank, he must agree to a
secured loan that is backed by his real property that will act as collateral for the agreed
amount of $250,000. Due to Suburban National Banks constraints, Mr. Butler is looking to
find a new banking relationship that would allow him to negotiate a much larger unsecured
loan. The amount of the loan offered by Suburban National Bank has made Mr. Butler
realize the companys growth potential - increase in sales, but also realize the increase in
debt. Since he is limited on his loan and has little cash on hand, he has turned to trade
credit for the past few years. As consultants, we will investigate the following four key
issues:
Should Butler Lumber sever ties with Suburban National bank in order to obtain a
larger loan from Northrop National Bank?
Why does Butler Lumber have a cash shortage problem to begin with, and are they
currently using their existing funds efficiently?
How much additional funding does Butler Lumber need, and will they continue to
need even more in the future?
What sort of implications does the firms growth suggest?
Are there Alternative solutions to Butler Lumbers cash shortage problems?
Analysis. The need for cash is clear; however, there could be multiple opportunities to
raise the capital that is needed. It is imperative that Butler Lumber takes into
consideration the costs associated with accepting external financing, and in turn be able to
assess whether or not it is the best solution. If relying on external financing is not
plausible, Mr. Butler will have to search for alternative methods to grow his business whether its finding a different financing solution or a way to generate cash by altering
management activities. As we assess Butler Lumbers operations from 1988 to 1990, it is
clear that his reliance on trade credit and a specific focus on having a very competitive
pricing schema has allowed the company to generate revenue up to this point. Although
the company was able to generate revenue at an increasing rate during the given years,
Butler Lumber was unable to accumulate any cash in order to fund operations moving
forward.

We will start by assessing one of the two immediately available options presented for
Butler Lumber: Butler Lumber can remain with Suburban National Bank by accepting their
loan offer of $250,000. The only apparent advantage of this option lies solely in the fact
that the relationship with the bank already exists. The disadvantages are seen in the
possibility that Butler Lumber will need additional financing past the initial loan amount,
and the offered loan is now secured (backed by Mr. Butlers real property), signaling that
the bank has doubts that Butler Lumber will pay back the loan amount. Though Butler may
be capable of repaying the amount, it is inevitable that the company will need more
financing. Due to the banks recent focus on the riskiness of Butler Lumber, this may alter
their ability to receive more funding from Suburban National Bank. Mr. Butler could
alternatively choose to take the unsecured revolving 90-day note of $465,000 at 10.5%
interest from Northrop National Bank. The apparent advantages are: it is a more flexible
option, it is an unsecured loan that requires no collateral from Mr. Butler, and it is of a
larger amount. The big disadvantages are: the termination of the banking relationship
between Butler Lumber and Suburban National Bank, and the increased interest expense
on the loan. Another disadvantage of establishing a LOC with Northrop National Bank is the
possibility of restrictions on the company stating that the net working capital be
maintained at a level agreed upon by both parties and any increase in fixed assets with
approval by Northrop. Also there would be limitations on withdrawals of funds from the
business by Mr. Butler. Another concern with the loan is that Butler Lumber would need to
draw additional loans from Northrop because the company is unable to pay back the loan
amount within the 90 day period due to the lack of cash and liquid assets.
-Why does Butler Lumber have a cash shortage problem to begin with ,and
are they currently using their existing funds efficiently? The Sources and Uses of
Funds brings forth a snapshot of the companys cash flows and illustrates the reason
behind Butler Lumbers cash deficit. For the past two years, Butler Lumber has generated
negative cash flow from operations, which is alarming for the firm. Given the typical
business model of a growing firm, Butler Lumber has seen increases in both the inventory
and receivable accounts. This makes sense because the more customers Mr. Butler has, the
more inventory he needs to have on hand and given his somewhat lackadaisical approach
on payment collection, the amount of receivables is expected as well. This could be an
issue for the firm, but if Mr. Butler has a strategy to fund operations until they are able to
generate more cash, it will not break the firm. As inventory and receivables grow, an area
to hone in on is whether or not these accounts are being turned over in a timely,
progressive manner. As seen in the Asset Utilization Analysis table, the ratios for both
receivable and inventory indicate that it is taking a longer period of time to collect money
and a is holding on to inventory for much longer (nearly 15% and 10% longer,
respectively). It is clear that Butler Lumber is not maximizing operational efficiency and
will accrue extra costs as a result.
-How much additional funding does Butler Lumber need, and will the firm
continue to need even more in the future? After analyzing and projecting Butler
Lumbers 1991 Pro Forma Balance Sheet, we have decided to separate the projections
when considering the current payable policy and also considering discounts. We have
concluded that Butler Lumber will need additional funding of $409,000 under the current
payables policy, and including purchase discounts, they will need $658,000 (seen in Exhibit
1). These figures indicate exactly how Mr. Butler has been operating, relying on specific

payment terms with his suppliers and customers. Mr. Butler is using his accounts payable
as a sort of leverage (funding) while he searches for external financing, which is
quantitatively laid out in Exhibit 4. So the question becomes whether Mr. Butler should
take advantage of the 2% purchase discount or continue to rely on the suppliers payment
flexibility. The pro-forma analysis we generated is based on recent percent of sales from
the years 1988-1990.
-What sort of implications does the firms growth suggest?
NEED SOMETHING ABOUT HOW THE SALES GROWTH OVERSHOOTS THE
SUSTAINABLE GROWTH
-Are there Alternative solutions to Butler Lumbers cash shortage problems?
If Mr. Butler does not or cannot obtain the loan through Northrop National bank, an
alternative option is Recourse Factoring. Recourse Factoring is the selling off of Accounts
receivables where 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 can be very beneficial for companies experiencing problems
with cash flows. This could be a potential option for Butler Lumber because they have
slow paying clients and an extensive cash shortage problem. Butlers Receivable turnover
has decreased from 9.92 in 1988 to 8.5 in 1991 indicating it is taking longer to recover
much needed cash. If Butler was able to factor away their receivables they would have
more working capital, a flexible funding program that will increase only as their sales
increase and also would help Butler take advantage of purchase discounts. If Butler found a
Factoring company to take on 75% of their receivables , $317,000 cash would be freed up
and eliminate the need for Additional funding. Even if Butler paid a small 2% factoring fee
they would still easily be able to maintain their rapid rate of growth with the current
$250,000 of funding through Suburban National Bank.

Recommendation: Given the analysis of the firm, in order for the firm to continue it will
need external financing. The recommendation that we give to Mr. Butler is that he accepts
the LOC from Northrop National Bank, but only if the loan does not include any negative
covenants such as restrictions on: the sale of assets, engaging in other businesses, and
voluntary prepayment of other indebtedness. This financing is needed because the
expected sales growth exceeds the firms sustainable growth rate and leads to a negative
cash flow because of the trends Mr. Butler has displayed regarding his payables and
receivables.