Butler Lumber Case

FNCE229: Corporate Banking Butler Lumber Case Discussion Questions for Case Discussion in Class in Seminar 4 1. Is Butler Lumber Case just a bank lending/finance case? No. It is more than just a bank lending/ finance case. There are other factors such as establishing long-term relationship between the bank and the company. By fostering a long-term relationship, the bank is able to capitalize on Butler Lumber’s growth and cross sell the services to Butler Lumber Company. Additionally, the bank should consider other qualitative factors such as in the case, Butler Lumber has just been incorporated and it is located in a growing suburb of a large city. This represents a growth potential in which the Northrup National Bank could cross sell products. Other qualitative factors may affect the main revenue drivers for the Butler Lumber Company. For example, general economic slowdown may slowdown the rate of increase in sales but it may be protected to some extent from the fluctuations in new housing construction because of relatively high proportion of its repair business. As such, Butler Lumber Case is not just a bank lending/ finance case. 2. Who is the borrower in the Butler Lumber case? Butler Lumber Company. 3. How does Butler Lumber Company make money? BLC make money through retail distribution of lumber products in the local area. These include Plywood, moldings and sash and door products. 4. How is Butler Lumber Company doing financially? Is the business profitable? (You are required to provide all the financial trend analysis and historical financial ratios to support your answer.) Butler Lumber Company is well in general financially. By looking at the sales and asset growth, the company is able to gain more in terms of sales especially since the company is run with few employees. With additional employees, it is able to improve its sales growth.

Net Sales Sales Growth

1988 $1,697 -

1989 $2,013 18.6%

1990 $2,694 33.8%

Total Asset Asset Growth

$594 -

$736 23.91%

$933 26.77%

Taking into account of its the profitability, Butler Lumber Company has increasing ROE. Net Income Shareholders Equity ROE

$31 $270 0.115

$34 $304 0.112

$44 $348 0.126

Its credit terms also enable the business to increase it days in payables and its management of its inventory as a proportion of sales indicates a better management of inventory over years. Sales Inventory Inventory Turnover

$1,697 $239 7.10

$2,013 $326 6.17

$2,694 $418 6.44

On the flip side of the coin, there might some ratios that might indicate otherwise such as ROA and profit margin. However, given its strategy, the profit margin decrease is largely justified. Net Income Net Sales Profit Margin

$31 $1,697 0.018

$34 $2,013 0.017

$44 $2,694 0.016

Net Income Total Assets ROA

$31 $594 0.052

$34 $736 0.046

$44 $933 0.047

In terms of liquidity, both Butler’s current and quick ratios along with time interest earned have been the decreasing over the years. However, the numbers still indicates good ability to pay off debt in case of liquidation and still remains healthy. Total Asset Total Liabilities Current Ratio Current Assets Inventories Current Liabilities Quick Ratio

$594 $324 1.83 $468 $239 $260 0.88

$736 $432 1.70 $596 $326 $375 0.72

$933 $585 1.59 $776 $418 $535 0.67

Similarly, in terms of gearing and leverage, its numbers had been increasing however, given that Butler Lumber is in a growing business, it largely reasonable for Butler Lumber to increase its debt asa proportion of its assets. In a nutshell, based on the financial ratios alone, Butler Lumber’s remains financially sound.

Total Liabilities Shareholders Equity

$324 $270

$432 $304

$585 $348

DE Ratio

1.20

1.42

1.68

Total Debt Total Asset Debt Ratio

$71 $594 0.12

$64 $736 0.09

$57 $933 0.06

5. It seems like Butler Lumber Company is a profitable business with reasonably efficient operations… So then why has Mr Butler/ the company had to borrow so much money? Butler can meet its expected sales without additional funding. If the goal is to eliminate the trade debt, while maintaining the current bank note at $247000, Mr. Butler would need an additional $124,000, the remaining balance after subtracting $33,000 from the trade credit of $157,000. But the bank will not offer this additional funding, which would then come to $371,000 resulting in the discussions with Northrup. 6. Given your understanding of the asset conversion lending rationale and its application in this case, is Butler Lumber Company is losing controlover its short-term assets? Asset conversion is about financing short-term seasonal build-ups of working assets or financing other temporary, transactional build-ups of current assets. Inthis case, Butler is facing issues due to growth of sales along with increasing average collection period. In 1988, the days in payables turnover had increased from 35.41 to 45.76. Additionally, the increased from payables is due to increase in slower payment and increased purchases. This is followed by increased ininventory due to reduced inventory turnover and increased sales. 7. Is trade credit a good source of financing for Butler Lumber Company? Trade credit is a good source of financing for Butler Lumber Company, given the high proportion of account receivables on its balance sheet. Additionally, the growth in its account receivables over the years, it is imperative to consider trade financing as a source of financing. However, it should note that while itmay seems like a good option, it may not be optimal as Butler Lumber have togive substantial discounts at expense of growing sales. Being in the market asone which been successful through price competition, it may not be wise toconsider trade credit as a first option. Alternatively, Butler Lumber can look at getting trade credit with its suppliers instead. As Butler Lumber is getting bigger, it would enable Butler to have abetter bargaining power and at the same time, reduce the expense needed to service the loans. 8. As a banker, would you lend to Butler Lumber Company? How would youtry to control risks?

Fundamentally, Butler Lumber is a growing company and it seems wise to look at getting a bigger line of credit in order to support it growth story. This will require additional working capital to meet its current obligations to his lenders and suppliers. Current liabilities total $404,000, so the credit line under consideration will provide additional financial flexibility, which is needed considering the downward trend of the current ratio. Furthermore, the debt would be carried at a more favourable rate. Finally, based on the financial projections, Butler would have an additional $33,000 available to begin paying down this debt by the end of 1991. Hence, considering this and the other financial of Butler, loan should be given out. The cash shortage is short-term problem and that the underlying business is sound and his references and credit history are favorable. However, there aresome areas of concern that should be monitored as a condition of the loan. First,the Days Sales A/R ratio is trending in the wrong direction, and more effort needs to be spent on collecting receivables in a timely manner. Additionally, the inventory turnover is decreasing, tying up too much cash, and exacerbating the shortage of working capital. More effort needs to be spent on inventory management, making sure there is not a growing amount of stagnant inventory, and that the mix is correct for the intended market. In addition, to the condition,the bank should require 2 important ratios (Days Sales A/R and inventory turnover) return to their 1988 levels, and that Mark Butler’s compensation to be tied to these objectives. 9. Is there anything Butler Lumber Company can do to come up with more cash? What should Mr Butler do? Mr. Butler should consider improving its cash flow by both offering trade credits to its customers and the same time negotiate with its suppliers to offer trade credits in order to improve both its account receivables and payables. By doing so, it is able to utilize amount of loan for other purposes such as financing for long-term assets. However, caution should be exercised when extending trade credit since the cost of such trade credits may exceed the cost of borrowing.