Butler Lumber Company

Butler Lumber Company

Financial Management Case Studies

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Issues: * Business Expansion Funds * Choose Short-term Sources of Funds * Creating Value

MAGISTER MANAGEMENT UNIVERSITAS GADJAH MADA 2011

FINANCIAL MANAGEMENT CASE STUDIES

Butler Lumber Company

KEY ISSUES

The key issues of this case studies are:

* * * *

Is the funding needs of these companies short-term or long-term? Is the funds offering by Northorp Bank amounting to $465,000 should be accepted by the Butler? Should the butler take the cash discount on trade credit even if it must borrow from the bank? Should Buttler take a loan from the Northorp Bank and make expansion his business?

ANALYSIS

Income Statement As shown at the income statement that beginning inventory was pulled from the previous year's ending inventory. Purchases were projected from a trend of 76% of historical sales for the previous 3 years. The total cost of goods sold assumed the previous 3-year average of 72% of historical sales would continue. Provision for income taxes was calculated as 15% for the first $50 income, 25% for the second $25 income, and 34% for above $75 income (scheduled given in footnote 1). See the detailed of income statement projection in table 3. Balance Sheet For this case (see balance sheet projected in table 4), the balance sheet was created with the assumption that Butler wouldn't take the additional loan. The trend that cash followed from the previous years was used to project the cash asset. Account receivable was based on % of historical sales previous year. Property was expected to increase by 6% based on the previous year's trends. According to the table 4, accounts payable stayed at 10 days of purchases. Accrued expenses were based on historical 3 years for 1.5% of historical sales. The long-term debt for the purchase of the company would be paid down to $43,000. And net worth of Butler Lumber Company was from the previous year and net income from the projected income statement for the last 1991. Based on the proforma income statement and balance sheet, it was determined that Butler Lumber would need to increase their current debt to approximately $661 to continue their expansion as planned. Liquidity To measure the liquidity this company, we can calculate the current ratio and quick ratios. It were designed to indicate the organization's ability to meet its short-term obligations such as payments and other short-term debts, which typically were paid for current assets. A current ratio aproaching one was desirable. A lower value could indicate that a company might be having difficulties meeting its short-term obligations, while a current ratio value higher than one could be indicative of poor or inefficient use of funds. From the calculation, the Butler Lumber Company's current ratio was quite high at 1.45, yet its quick ratio was only 0.67 (in 1990). It is indicate that Butler Lumber Company was purchased too large quantities of inventory. Liquidity ratios of Butler Lumber Company were decreased yearly.For its current ratios, the company still can pay off its current liabilities through its current assets even has decreased. The decreasing trend was worrisome especially given the low quick ratios. But Butler Lumber Company covers its 1 | h a l a m a n

FINANCIAL MANAGEMENT CASE STUDIES

Butler Lumber Company

interest expenses 2.61 times in 1990 although the trend for TIE was also worsening (shows in table of Financial Leverage). The notable trend in this section was toward reduced liquidity. Butler was experiencing a shortage of working capital that needs to be addressed to sustain growth in this profitable business. Profitability The Butler Lumber Company has positive Profit Margins and ROE, therefore it was a profitable business.However, the profit margin of company only had 1.83% in 1988 and always decline every year. Beside that, all of these ratios are trending in a negative direction, as a result of the analysis presented above. Financial Leverage In 1990, Total Debt Ratio of Butler Lumber Company was about 63%. This was high given the slow move in inventories and low liquidity ratio. The trend showed increase in the use of debt. The data showed that Butler was becoming more leveraged, primarily in terms of short term debt. It further showed that the interest expense was outpacing the earnings growth, which could be helped by securing the new loan at a more favorable interest rate. Asset Utilization Total asset turnover is slightly less than 3 for the three years under consideration. Butcomparison of the three years indicate deteriorating trend with respect to average collection period and inventory turnover ratios. Average collection period increased from 37 days in 1988 to 43 days in 1990 indicated the company takes longer days for taking payment. With increasing sales figures, as displayed in the previous years by the Butler Lumber Company, these long collection days have a greater effect on the business as the amount of outstanding - proportional to the sales figures - increase also. Inventory Turnover needs to be improved through better management of the inventory mix, and that increased effort is required to encourage customers to pay in a timelier manner. Done correctly these two actions should actually help reverse the downward trend in profit margin.

RECOMMENDATIONS

Butler Lumber Company was on a growing path. It was evident from the case that the volume has been built due to successful price competition, careful control of operating expenses and purchases at substantial discounts. As Mr. Butler's financial advisor, we wouldt advise him take the loan in an attempt to grow the business even though the business was profitable and growing. Because we uses eastern and western approach methods. Based on the projected 1991, the business will be grow. As a banker, we would not grant Butler Lumber Company a LOC for $465,000. According to historical on 1988-1990, the spread was negative.

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FINANCIAL MANAGEMENT CASE STUDIES

Butler Lumber Company

CONCLUSION

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