Butler Lumber Company Case Study

Butler Lumber Company Case Study

Butler Lumber Company, a company mainly focusing on retail distribution of lumber products in repair business is seeking for short-term bank loans to support its profitable business in the future. Suburban National Bank was providing a loan of $247,000 to the company in the spring of 1991 and was requiring for security of real property for future loan with a limit at $250,000. Since the request did not fit the company’s anticipation, the owner, Mark Butler was seeking another loan from Northrop National Bank with an amount of $465,000 (90 days). Nevertheless, there are some questions remained to be discussed and the following part is the analysis.

1. Why does Mr. Butler have to borrow so much money to support this profitable business?

According to the case, the reasons why Mr. Butler has to borrow so much capital to support his profitable business can be boiled down to several points. At the very beginning, the declining working capital (percentage base) had been troublesome with the figure dropping from 35.02% to 22.12% between 1988 and the first season of 1991. The decreasing working capital(percentage) reflected the fact that the company was increasing its short-term debt such as notes payable from banks, trade and so on to support its arising sales volume and generate profits for the company. Another aspect of the declining working capital may also implicate that the company may face the problem of covering its debt, which is also embodied by its current ratio from 1988 to the first quarter of 1991.

However, the declining working capital may contribute to a higher level of working capital turnover, a figure presenting the efficiency of working capital. The figure below (figure 1-3) shows that the ability to generate net sales by working capital is increasing yearly. If obtaining the financing loan from the bank, the company, with its capability to increase its net sale, will benefit more from the efficiency of the working capital. From the other side, the company is faced with severe price competition. In order to achieve a more competitive price, the company needs to increase its quantity purchase of materials at massive discount from suppliers. This process is also necessary to be supported by financing capital to generate more sales volume. Other factor including the need to cover the owner’s purchase of Stark’s interest but the imperative reason may be focused on its ability to generate net sales and net income in the future.

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Figure 1-1

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Figure 1-2

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Figure 1-3

1. Do you agree with his estimate of the company’s loan requirements? How much will he need to borrow to finance his expected expansion in sales?

Relying on the information of the common-size (percentage) B/S and income statement and assuming the company follow the same operating efficiency in 1990, we can estimate the financing needs(notes payable by banks) of the company by using the operating income ratio method. As what is shown below, we choose total asset turn over as the indicator of operating efficiency and the number in the year of 1990 is 3.228. Using the predicting net sale in 1991, we can obtain the estimated total asset in the year of 1991, which is 1,115,241. Next, applying the operating income ratio method, we can further estimate the net income, retained earnings, net worth and so on. Using the data we have estimated, notes payable from banks can be predicted by using the formula:

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Since the company keep all the net income as retained earnings from 1988 to 1990, we assume that the predicted net income in 1991 is also fully kept as retained earnings, which is 58,800 and the net worth will be 58,800+348,000=406,790. Therefore, the estimated total liability is 1,115,241-406,790=708,450. As for the notes payable from bank, the estimated number will be: 708,450-444,209=264,240.

As a result, the estimation for the company’s loan requirement will be 264,240, which is higher than the number (250,000) and less than 465,000. We agree with Mr. Butler’s estimate of the company’s loan requirements and the number the company needs to borrow to finance its expected expansion in sales is 264,240.

Table 2-1

a The percentage use of the operating income ratio method is to select the net sales a year before the estimated year as a benchmark to calculate the different ratio of every title to the benchmark.