Butler Lumber Company Case Solution and Anaysis Casesol

This will eventually deteriorate the relationship and goodwill of the firm with regards to their main
suppliers. Although these costs cannot be estimated with the information provided, they could have
serious consequences on the operations and profitability of the Butler company. They must therefore be
kept in mind when making the financial decision with regards to the short term fund requirements of
the firm.

In order to determine those requirements, we calculated the external financing needs based on the
1991 Q1 assets and liabilities, coming out to a total of $166,474 on top of current borrowing situation.
This implies that if the Butler Lumber Company Casesol were to go with Northrop National Bank, it
would need to borrow the EFN previously calculated, plus the outstanding balance of the Suburban loan
at the end of 1991 Q1, amounting to a total of $413,474. In our proforma analysis we will predict both
balance sheets and income statements for two potential scenarios: stay with Suburban National Bank
and continue to rely on the trade payables extended by suppliers as well as putting up extra collateral,
or switch to a new loan with the Northrop National Bank.

The two scenarios outlined above were then estimated by projecting the income and balance
statements using a historical percentage of sales and growth rates. In both scenarios, Butler Lumber
Company Case Solution Casesol sales grow at a historical average growth rate of 25.3%.

The financing from the new bank option was to be used to pay suppliers within 10 days and pay off the
balance of the company’s trade payables. Also, paying within 10 days grants Butler a 2% purchase
discount and the accounts payable account in the balance sheet will decrease since the payable period is
shorter (10 days). The banknote payable will change every 90 days, depending on the amount borrowed
during the period. The second quarter will exhibit a decrease of $247 (Butler must pay off debt issued by
the other bank) and an increase of up to $465,000. In turn, this changes the interest payment every 90
days. The interest expense on balance sheet at the end of 1991 becomes $54. These factors will increase
net income to $68 over the next year, in comparison to $57 under the smaller loan amount available.
The covenants of the Northrop National Bank allows for greater flexibility since it is unsecured.
Moreover, the new line of credit will have a higher ceiling, allowing for potential capital investments to
reach new markets such as new housing construction. However, the Northrop National Bank will impose
more restrictive covenants in terms of fixed assets investments. This can be beneficial in terms of getting
an external expert’s opinion although it reduces the control over the final decision outcome. Moreover,
the floating rate could result in increased interest expense at inconvenient times, especially due to the
seasonality of sales which are concentrated in the April-September period.

Under the current scenario, we assume Butler Lumber will need to extend his credit to the maximum
amount of 250,000. Likewise, since cash is already low, the trade payable he took at the end of the first
quarter in 1991 will likely grow (assuming that the growth rate equals sales growth). The change in cash
flow from the end of the first quarter in 1991 and the end of the last quarter in 1991 will be $-329. This
cash flow is negative and significantly larger than Butler’s cash balance at the end of the first quarter of
1991. This means that the A/P and notes payable must increase to satisfy their increasing sales and lack
of cash to sustain the growth.

In order to determine the fund requirements of the Butler Lumber company, we picked a conservative
growth rate with regards to the analyst’s prediction of $3.6MM of sales. Instead, we decided to stick
with the 1989-1990 growth rate of 25.3%.

However, this is a number subjective not only to operating efficiency, but to market forces that are out
of the control of the managerial staff of the firm. It is therefore important to create a sensitivity analysis
with regards to the growth rate of sales for the year, and how that number will affect different
profitability ratio.

Appendix 1 clearly shows that as the sales performance decreases, the profitability ratios get tighter and
TIE decreases. A critical level to take notice of is the -15% growth rate and below, which would result in
sales amount insufficient to cover Interest expenses, putting the firm at risk of lowering their NWC
below levels at which the bank could force bankruptcy.

Final recommendation

As seen throughout this case, the main problem The Butler Lumber company needs to address is the
short term fund requirements necessary to sustain operations. If they were to maintain their current
capital structure, they would need to extend the trade credits and count on suppliers to be generous
with regards to late account payables, and insist on a stricter accounts receivable policy. Relying on
trade payables and generosity of suppliers will eventually deteriorate business relationships to the point
of the detrimental effect on the profitability of the firm, especially since the business model is based on
cost leadership resulting from bulk buy of raw materials.’

The potential loss of goodwill, although hard to estimate precisely, would be a huge cost to the firm. It is
therefore clear that the Butler Lumber Company needs to go with the new loan from Northrop, starting
with a balance of $413,474 and borrowing additional funds depending on the current state of
operations. This will result in an increase in liquidity, which in turn will reduce days outstanding for
account payables and allow the firm to take advantage of the 2% discount.

Moreover, the agency problem needs to be addressed. Mr. Butler should separate himself from the day
to day operations and let his assistant take over. He should retain authority with regards to major
investment decisions but his salary needs to be adjusted as a percentage of net profit, and not a cash
salary that goes into operating expenses.