Butler Lumber Company An Analysis on estimating Funds

Butler Lumber Company An Analysis on estimating Funds Requirements Presented By : Saurabh Kumar Sinha 2009 PGP 049 Saurabh Patawari 2009 PGP 050 Siddharth Shankar Prasad 2009 PGP 051 Sourjyo Das 2009 PGP 052 Sreethala Ganapathy 2009 PGP 053 Shubhangi Shree 2009 PGP 054

Case Background � 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

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. ) Business operating conditions Located in a suburb in Pacific Northwest Company owned land 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%

Case Background(contd. ) 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

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 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

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 favourable because: 1) High safety margin for lenders 2) Less interest payments 3) Scope for more loans 4) No trading on Equity

RATIO ANALYSES ü Debt equity ratio LEVERAGE RATIOS 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 ü 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

CURRENT RATIO ü It has been decreasing over the years, which suggests that it has more current claims than current assets. ü In fact a satisfactory ratio of 2: 1 was never achieved in any of the years ü 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 ü 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 ü 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 1 st 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 withdrawings which is almost twice of net income, this will help in increasing the profit margin

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