Butler Lumber Case Study Solution Case Study Objective: As Mr.

Butler¶s financial advisor, would you give urge him to go ahead with, or reconsider, his anticipated expansion and his plans for additional debt financing? As the banker, would you approve Mr. Butler¶s loan request, and, if so, what conditions would you put on the loan. The maximum loan that the Butler Lumber Company (BLC) could obtain from Suburban National was $250,000 in which his property would be used to secure the loan. Northrop National Bank offered BLC a line of credit of up to $465,000. BLC would have to sever ties with Suburban National if they were to have this LOC extended to them. As Mr. Butlers financial advisor, I would advise him to take the loan in an attempt to grow the business. One alarming fact about his business is the lack of a sales staff, yet the revenue has been able to grow at a fast pace; 18% in 1989, 34% in 1990, 19% in 1991. By adding another an experienced salesman that is working for a base salary plus commission, they can grow the revenues even more. By having this person work on commission, this will eat into the profit margin for the materials he is selling. But the net impact to the BLC will be positive. I would advise Mr. Butler to select the LOC for up to $465,000 because he can take out as little as he needs. He does not need all $465,000 this quarter, but he may need some in the first and last quarters of the year because he obtains 55% of his revenues in the second and third quarters. So it is strategically important for him to have access to this capital because of the nature of his cyclical business. As a banker, I would not grant BLC a LOC for $465,000. This is too much for a company this size, and with such little equity. The bank is too aggressive with its forecast that BLC will have revenues of $3.6 million in 1991. I believe I am aggressive in forecasting they will have $3.2 million in revenue in 1991, $400,000 less than what the bank forecasted. I came up with $3.2m by taking the 1st quarter revenue of $718,000 which is historically approximately 22.5% of the yearly revenue. Assuming this holds true again in 1991, the annual revenue in 1991 will be around $3.2m. This is a 19% year over year increase in revenue for BLC, which is inline with their year over year growth in 1989, and less than the 34% in the best year, 1990. The margins are not great for this industry, and BLC is no exception. Even with the excellent year over year growth in revenues for this company, BLC is on pace for another dismal year of net income in the high $40k. The net income for this company has been constant; $31k in 1988, $34k in 1989, $44k in 1990, and an estimated $49k in 1991. Net income of this size should not warrant extending a line of credit to this company. As the banker, I would not grant a LOC or any other type of loan this size. I would consider granting this company a smaller LOC with the similar stipulations of maintaining an appropriate working capital amount, fixed asset purchases would need bank approval and that Butler would put up personal property and his insurance

Net working capital= current assets. Let us start with net working capital. we us the first quarter¶s data to represent year 1991.policy as collateral for the loans that the business takes. There are many things to look into. so in the following discussion. 2002 Butler Lumber Company To examine Butler¶s current financial situation and to answer the question of how well Butler is doing are not an easy task. merely the absolute . HARVARD BUSINESS SCHOOL 9-292-013 REV: JANUARY 4. which is a good sign. I calculated the net working capital of Butler Lumber Company from year 1988 to year 1991. However. Net working capital can give us some ideas how much the company¶s potential reservoir money is. We see a steady increase in net working capital through these years. Using excel. only first quarter¶s data is provided.current liabilities current assets current liabilities net working capital 1988 468 260 208 1989 596 375 221 1990 776 535 241 1991 932 690 242 In thousands of dollars For 1991.

respectively. At this place. 1989. we need to add depreciation to net income. I make this chart on common size analysis based on the total asset. all the current liabilities. I see a big trouble for this company. Thus. As to the debt and liabilities. The accounts receivable. and 31 (in thousands of dollars). and 6 (in thousands of dollars) in 1989. 326. long-term debt. 48. and 556 (in thousands of dollars). in 1988. Thus. The cash in 1988. the company is a commercial company instead of a manufacturing company. respectively.221207 In thousands of dollars From the data in the above chart. This also may be positive. in terms of cash. . It could be the products the company is producing are not satisfying the customers¶ needs or other managerial problems. thought decreasing. 37.numbers are not sufficient to make further judgment. the company is growing. 418. The inventory is growing constantly and fast.258307 0. but in some sense. net working capital total assets net working capital common size 208 221 241 242 594 736 933 1094 0. so no depreciation issues need to be considered. Normally. 222. The funds can come from three areas. the company financial situation is becoming worse. Thus. net. when calculate the operating cash flow. 1989. 41. 1990 and 1991.350168 0. 1990 and 1991 are 58. and the company owns the land. so no new equity is issued. which is 27. source of funds are from operating cash flow and new issues of long-term of debt. let¶s look at the funds flows and the changes of individual items. and new issues of equity. since the company is growing. the net income is just the increase amount of the net worth.300272 0. and 345 (in thousands of dollars). Before we come to the financial ratio analysis. The inventory in 1988. 1989. and net worth are increasing logically. respectively. With on dividends. Thus. 1990 and 1991 are 171. we can see net working capital stands a very large weight in the total assets. we will discuss about the sources and usages of funds. 317. operating cash flow. Some people may want to say larger companies are not necessarily good ones. 1990 and 1991 are 239. but in this case. Then. new issues of long-term debt. the company relies on more and more credit sails and may make a heavy burden on daily operation. because the decreasing of net working capital common size is not from the decrease of net working capital but from the increase of total asset.

Debt ratio. the debt ratios are relatively low. In this case.The uses of funds also fall into three aspects.19 1989 57 361 0. we found the total sources of funds and the total uses of funds are exactly the same in numbers each year. Uses of funds are 27. meaning safe to borrow. We need to think about what we want to know most and calculate the ratio for that question.16 1990 50 398 0. and 6 (in thousands of dollars) in 1989. investment in net working capital. and then we can do a further analysis. so some ratios that can measure whether the company is borrowing too much and whether the company has the ability to pay back loans should be considered.12 In thousands of dollars As we can see from the chart. . we cannot find the real problem. Butler is facing the limit of loan from the Suburban National Bank and looking for a bigger size loan from the Northrop National Bank. Long-term debt Total long-term capital Debt ratio 1988 64 334 0. is this kind of ratio that can measure the financial leverage. After careful calculation. so only investment in net working capital and investment in fixed assets count. and dividends paid to shareholders. Another ratio that can measure the financial leverage is times-interest-earned. 1990 and 1991. there are many kinds of ratios.13 1991 47 404 0. Timesinterests-earned tells how much interest is covered by earnings before interest and taxes plus depreciation. investment in fixed assets. with no dividends. Debt ratio = (long-term debt + value of leases) / (long-term debt + value of leases + equity) The following chart shows the debt ratio of the Butler Lumber Company from year 1988 to year 1991. Speaking of financial ratios. the ratio of long-term debt to total long-term capital. 37. In this case. When we look into all of them.

I can look into the firm¶s return on assets or return on investment. The third choice is that Butler can still deal with the Northrop National Bank. strengthen internal management rather than enlarge the loan. if Butler can persuade George Dodge his company is very financially healthy company. I also may want to seek possibilities that the company get a better loan position with the Northrop National Bank. the cash that Butler holds is becoming less and less each year. However. The first choice. In order to tell which action Butler can take. Butler can give up the opportunity to cooperate with the Northrop Nation Bank. but we can still say that Butler did a very bad job in managing its cash flow.10 In thousands of dollars We always say that cash is the king. And I need to look for possible solutions that Butler can take to optimize the capital the company has been holding.85 1989 61 20 3. but try to get a better position with more proof that can show a health financial situation of his company.05 1990 86 33 2. Without further exploration. .61 1991 21 10 2. EBIT interest times-interest-earned 1988 50 13 3. we don¶t know the exact reason that cause this situation. I need to do more research on how well the Butler Lumber Company use capital. Butler can take three different possible courses of actions.Times-interest-earned = (EBIT + depreciation) / interest The following chart shows the times-interest-earned of the Butler Lumber Company from year 1988 to year 1991. The second choice is accept George Dodge¶s proposal.

we can see that interest expense is very high as the net income is relatively low. but we can still say that Butler did a very bad job in managing its cash flow. the cash that Butler holds is becoming less and less each year. Advantages: Control the interest expense and risks in the previous business model. However. From the income statement of Butler Company from 1988 to 1991. Continue to work with the Suberban National Bank and not give up the relationship with the bank built through years. we don¶t know the exact reason that cause this situation. such as 33 of interest expense to 44 of net income in the year 1990. Disadvantages: Interests will be even larger in the cost structure. Options: 1 Refuse the loan agreement offered by the Northrop National Bank. 2 Accept the loan agreement offered by the Northrop National Bank. Advantages: It can solve the Butler¶s cash problem. . Disadvantages: Butler will lose the opportunity to get more money to increase their financial position and expand their business.Problem: Butler¶s funds face a limitation with fast growth business. We always say that cash is the king. Without further exploration.

3. 4.Recommendation: Refuse the loan agreement offered by the Northrop National Bank. The following is the project of 1991 on income statement net sales cogs begin inventory purchases end inventory cogs gross profit operating expense interest expense net income befor tax income tax 1988 1697 183 1278 1461 239 1222 475 425 13 37 6 1989 2013 239 1524 1763 326 1437 576 516 20 40 7 1990 2694 326 2042 2368 418 1950 744 658 33 53 9 1991 2771 418 2732 3150 1144 2006 765 677 33 55 9 . so I assume the interest of 1991 is the same as 1990. 2. The rate of total net sales to first quarter sales in 1991 equals to the rate of that in 1990. I will do a financial projection. Accounts receivable. Cost of goods sold and nets sales of the years have a linear relationship. 5. I am very confused on how to calculate the interest expense. Reasons: First. New purchases of goods have a linear relationship with the net sales of the year before. Operating expense and nets sales of the years have a linear relationship. net will be a certain proportion of the sales. Financial projection: Assumptions: 1. 6. and then I will list some reasons.

So the problem is not on financing. the company may want to look into its internal management instead of external financing.net income 31 33 44 46 From this financial projection. With a continuous increase of inventory and a big increase in 1991. but the operation. . we can see that the ending inventory in 1991 is extremely high.

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