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Butler Lumber Company: An Analysis On Estimating Funds Requirements

Butler Lumber is seeking a $247,000 loan from Northrop National Bank as their current bank, Suburban National Bank, is now requiring collateral for loans and has a lower credit limit. Northrop Bank offers a higher loan limit of $465,000. Butler Lumber was founded in 1981 and incorporated in 1988, and relies heavily on trade credit due to its current bank's low credit limit. While a loan from Northrop would provide more flexibility, it may reduce Butler's autonomy and profitability due to interest rate fluctuations and restrictions on expenditures. Butler's financial ratios show increasing debt levels, poor collection policies, and low profit margins.

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161 views

Butler Lumber Company: An Analysis On Estimating Funds Requirements

Butler Lumber is seeking a $247,000 loan from Northrop National Bank as their current bank, Suburban National Bank, is now requiring collateral for loans and has a lower credit limit. Northrop Bank offers a higher loan limit of $465,000. Butler Lumber was founded in 1981 and incorporated in 1988, and relies heavily on trade credit due to its current bank's low credit limit. While a loan from Northrop would provide more flexibility, it may reduce Butler's autonomy and profitability due to interest rate fluctuations and restrictions on expenditures. Butler's financial ratios show increasing debt levels, poor collection policies, and low profit margins.

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BUTLER LUMBER

COMPANY
An Analysis on estimating Funds Requirements

Presented By : PGP Group 1


CASE BACKGROUND
 Butler Lumber in Spring 1991
 Originally founded by 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
CASE BACKGROUND
(CONTD..)
 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.
CASE
BACKGROUND(CONTD.)
 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%
REASONS FOR CONSIDERING OTHER
BANKING OPTIONS :
 Low Credit Limit :
-Credit limit of Suburban National bank was $ 250,000
but the cash requirement of Butler lumber company
was $ 247,000
 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
DISADVANTAGES OF LOAN FROM
NORTHROP NATIONAL BANK
 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
DEBT EQUITY RATIO
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 favorable because:
1) High safety margin for lenders
2) Less interest payments
3) Scope for more loans
4) No trading on Equity
RATIO ANALYSES
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
CURRENT RATIO
• 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
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
DAY'S RECEIVABLES

• 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
SUSTAINABLE GROWTH RATE

 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
NEED FOR LARGE AMOUNT OF LOAN

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
SHOULD NEW BANK GIVE THE
LOAN?
• 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
OTHER OPTIONS IF BANK
REFUSES TO GIVE LOAN
• 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 withdrawing which is almost
twice of net income, this will help in increasing the profit
margin
Thank You

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