Assumptions and Methods We Used to Predict the Financial Statement for the Year 1991

Assumptions and Methods We Used to Predict the Financial Statement for the Year 1991

1. Assumptions:

We assume that sales are expected to reach $3.6 million in 1991 as the investigator predicted.

2. Methods We Used to Predict the Financial Result for the Year 1991:

First of all, we constructed common-size income statements and statements of financial position for the year from 1988 to 1990 according to each account’s percentage of sales. We also averaged the percentage of sales for each account in the last 3 years, and sales volume of $3.6 million was assumed for the year 1991. According to the average percentage of sales, we drafted the financial statement of 1991, and the loan figure for 1991 is left blank intentionally.

Then, we made several adjustments to the financial statements. Firstly, for income tax, which is calculated using different tax rates, we calculated it separately as 0.15*50+0.25*24=14 in thousand. Secondly, property may not increase in proportion to its sales, because as the suppliers said that Mark Butler was conservative and had never wasted money in disproportionate plant investment. So, we use the average growth rate of property from 1988 to 1990 to predict that of 1990 and the property in 1991 is predicted to be about 175,000. Thirdly, as for notes payable, we knew from the suppliers’ opinions that Mark Butler is a person who keeps close check on his credits and he tried to keep good relationship with his suppliers, so we assumed that the notes payable for trade will be paid off by the end of the year. Also, we assumed that the company will not pay any dividend, so the equity figure for the year 1991 equals the equity figure in 1990 plus net income in 1991, which is 406 in thousand.

Lastly, using the accounting equation (asset=equity + liability), we calculated loan needed, which is about 383,000 in 1991.

Q1 Answer：

Mr. Butler has to borrow so much money for the following reasons:

1) Although Butler Lumber Company has continuously positive working capital figure through the past three years and the forecasted coming year, its net working capital figure stays negative in the same period and the absolute value keeps growing (see Appendices c, the AAGR of the absolute value is about 120%). It is also mentioned in the materials that Mr. Butler keeps close check on his own credits, meaning that he has no efficient power to boost cash flow by squeezing suppliers. As a result, the company face potential liquidity problems in the short term.

2) Since 1989, the amount of notes payable to bank has grown dramatically, from $146 thousand to $247 thousand in 1991 Q1. Such loan figure has almost reached the $250 thousand ceiling imposed by the Suburban National Bank, so the company need some new cash for loan replacement.

3) For preparation of the coming season of sales, the company has to stock up more inventory, which may cause occupation of funds and aggravates cash shortage.

Q2. Answer:

No, we do not agree with his estimate of loan requirement. As we predicted previously, the company only need 382,000 loan in 1991. In case of need, the real figure may be a little bit higher than that, but it will not be necessary to borrow that much as he estimated.

Q3. Answer:

As we have answered in the Q2, we don’t think it’s a wise choice for Mr. Butler to borrow as much money as $465,000. We will advise him to slow down the company’s expansion speed to a more appropriate level, judging from our analysis on the company’s operating efficiency. The main operating efficiency ratios(Receivable Turnover, Inventory Turnover, Payable Turnover) of Butler Lumber company can be found in the Appendices b).

All the three ratios peaked in 1988 and went down in next three years, which means the company’s operating efficiency was getting worse. So the priority for Mr. Butler was to bring the company back to highly operated status and lay solid foundation for further prosper instead of borrowing excessive money. To improve the operating efficiency ratios, Mr. Butler did need to take measures to gain more revenue, such as making full use of existing retail distribution of lumber products in the local area, exploiting wholesale distribution channel and even making an effort to leverage his business to nearby area. But gaining more revenue doesn’t necessarily mean burning money and hiring 2-3 new employees could be a choice good enough which can set the current staff free from overloaded work and give them the ability to work more efficiently and win more new orders.

As a banker, I would approve Mr. Butler’s loan request judging from the company’s ability to make profit and pay its short-term liabilities. The main liquidity ratios and profitability ratios of Butler Lumber company are illustrated as follow:

1988 1989 1990 1991 Forecast

Current Ratio 180.00% 158.93% 145.05% 136.84%

Interest Coverage 3.85 3.05 2.61 3.07

Although the current ratio was decreasing, they stayed at an acceptable level. The interest coverage ratio was around 3, which indicated the company did have the ability to pay back interest. In addition, both the Butler Lumber Company and the Butler couple possessed some real property, which can be left as the collateral for the loan.

Sufficient realizable assets of Butler Lumber Company and Mr. Butler’s family would support the loan request and make the default risk exposure smaller. Based on the corporate financial situation, 30% - 40% of the $465,000 loan can be secured by the existing property (the land and 2large storage building), which values $162,000 in the balance sheet at March 31, 1991 and is expected to possess further fair values due to the growing suburb circumstance and the land’s favorable location. Account receivable of $300,00 can also be used as collateral. Except the corporate assets, taking the respective shares of Mr. Butler and his wife in their private houses into consideration, we contemplate 13.23% (($34,000 + $55,000 * 0.5) / $465,000) of the loan could be guaranteed by the value of their houses. In addition, the $70,000 life insurance policy payable to Mr. Butler’s wife could be another repayment source to cover 15% loan since clients are allowed to take out an insurance policy loan, which holds policy account value as the corresponding collateral.

For security of the loan, we would put forward the following conditions on the loan:

• Mr.