An Analysis on estimating Funds Requirements

Presented By :
Saurabh Kumar Sinha 2009PGP049
Saurabh Patawari 2009PGP050
Siddharth Shankar Prasad 2009PGP051
Sourjyo Das 2009PGP052
Sreethala Ganapathy 2009PGP053
Shubhangi Shree 2009PGP054
 Butler Lumber in Spring 1991
 Originally founded but Butler and Stark
 Butler buys out Stark for $105,000 by taking a $70,000 loan
payable over 10 years at 11% p.a.
 Needs $247000 - approaches Suburban National Bank
 Relies heavily on trade credit
 Why does Butler Lumber want to shift banks?
 Now, Suburban National bank wants ‘real’ collateral for its
loans
 He, however, wants a larger unsecured loan (Suburban bank
has cap of $250,000 on it’s loans)
 He also wants a larger loan that would give him flexibility
 He considers Northrop National Bank as an alternative
Reasons for choosing Northrop over Suburban
 Higher cap on loans $465,000
 This credit line would provide to him larger flexibility

Company History
• Began in 1981 as a partnership by Butler ad Stark
• Business incorporated in 1988 by Butler by buying out
Stark’s share for $105,000
• Paid $35,000 ,$70,000 as bank loan at interest rate of
11% repayable at $7000 over a period of 10 years
Business operating conditions
Located in a suburb in Pacific Northwest
Company owned land and buildings near a railroad
Credit term of 30 days offered to customers
 Company had a good reputation as researched by Northnorp National Bank
 Personal assets of Butler-joint equity on a house of $72,000 mortgaged at $38,000
 Company pays suppliers after 30 days not availing the discount of 2% offered by the
suppliers for payment within 10 days
Terms of Northrop National Bank
 Secured 90-day note with a limit of $465,000
 Maintaining the net working capital to an agreed level
 Constraints on capital expenditure and withdrawing
 Interest rates on floating basis at 10.5%
Assumptions
Projected sales in 1991 at $3.6 million with scope for
improvement
About 55% of the sales during April-September period
Permanent severance of relationship with Suburban
Bank
Low Credit Limit :
-Credit limit of Suburban National bank was $ 250,000
but the cash requirement of Butler lumber company
was more
Heavy reliance on Trade Credit:
-To stay within credit limit Butler had to rely heavily
on Trade Credit. A larger loan amount would ease this
reliance
Security for loan :
-Suburban was now seeking Collateral whereas Butler
wanted unsecured loan
 Limitations would be placed on withdrawal of funds
which may negatively impact his salary
 Loss of autonomy for making investments in fixed
assets as approval of Bank would be required
 Loan would be issued on variable interest rate which
depends on market fluctuations- a high Interest rate
will decrease net income
 Rigid control on Working Capital level will have to be
maintained
 Loss of flexibility in regard to additional borrowing as
restrictions imposed by National Bank
Concept :
It describes lender’s contribution for each dollar of
owner’s contribution
 It estimates stability
 Standard Value is 2:1
If it is less than this, it is favourable because:
1) High safety margin for lenders
2) Less interest payments
3) Scope for more loans
4) No trading on Equity
 LEVERAGE RATIOS
 Debt equity ratio
It 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
It has been increasing over the years which increased
extent of debt financing in business
Hence, majority of the company’s assets are being
financed by external funds
 Concept :
Indicates availability of Current Assets for each unit
of Current Liability
It estimates short term Liquidity of the Company
It also estimates margin of safety for creditors – a high
ratio means less risk for creditors
A ratio of less than 1 is a cause of concern
Quick Ratio
 Considers only cash as quick assets for meeting short
term liability
 CURRENT RATIO
 It 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 narrow margin of safety for creditors
The 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 Receivables is increasing which indicates poor
collection policy
Ideal Days Receivables allowed was 30 but we are
getting 43 for 1990 which necessitates better credit
collection policy
 If sustainable growth is higher than internal growth rate,
need for external funds will be less
 Company will be able to fund its growth requirements
 Internal growth rate vs Sustainable growth rate
In all the years, the sustainable growth rate is higher than
the internal growth rate of the company, which indicates
that the company will sustain for a long period of time and
indicates a positive scope.
Hence, it makes sense to go for bank loans and it is
convincing as well for the bank to grant required loan
amount
 PROFITABILITY RATIO
 Net profit margin
It 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
comparitively low operating efficiency of the firm
1) To buy out Stark’s (former partner) interest he took a
loan of $ 70,000
Payment of installments ( 11 % interest + $7000 annual
payment) reduces available cash
2) To fund the growth of the company funds were
needed.
3) 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
days
Accounts payable to sales increasing
Accounts receivable to sales increasing
Quick and current ratio is decreasing
Projected sales high compared to what actually the
company can achieve on the basis of the trend over
last few years(assuming for 1st quarter sales are 22.5%)
Out of $465,000, $247000 will be used to pay previous
bank loan and $7000 to pay as part of loan previously
taken to pay his initial partner
Decrease in accounts payable and paying suppliers
immediately to avail the option of 2% discount
Quantity discounts and day’s receivable needs to be
reduced
Operational efficiency has to be increased to better
the profit margin
Decreasing his personal withdrawings which is
almost twice of net income, this will help in
increasing the profit margin