Butler Lumber Company was founded in 1981, in a large city in the Pacific Northwest. Typical products of the company included plywood, moldings, and sash and door products. After a rapid growth in its business during recent years, the company in the spring of 1991 anticipated a further substantial increase in sales. Despite good profits the company experienced a shortage in cash and found it necessary to increase its bank borrowings. Issues: •Butler Lumber Company is a profitable company. Why do they need external financing? •Butler Lumber Company is being offered a discount from its suppliers.
Should they take the discount? •Project their Income Statement and balance sheet for all of 1991. -If they take the discount -If they do not take the discount Analysis: Butler Lumber Company is a profitable company, anticipating a substantial increase in sales in the spring of 1991; despite being profitable it is experiencing a shortage in cash and finds it necessary to increase its bank borrowings. The company needed funds as it was noted that there was a rapid increase in the Butler Lumber’s account and notes payable in the recent past especially in the spring of 1991.
Also the company took few trade discounts in the past 2 years as Mr. Butler purchased the interests of his partner which created further shortage of funds for the company. Analyzing the sources and uses of cash in the company (exhibit 4), it is evident that external financing is needed because the company is growing faster than the growth rate sustainable by the retained earnings. Exhibit 4 is showing the analysis of sources and uses of the cash. The company is mainly using its cash under inventory and the account receivable heads and the main source of cash is accounts payable and retained earnings.
Accounts receivable have increased from 19% to 45% of the used cash and inventory increased from 33% to 43. 6% from 1989 to 1990 (exhibit 4). In the same time frame source of cash, account payable and the net worth ,increased from 26% to 30% and 13% to 21% respectively. This signals that although company is profitable but the retained earnings are not enough to fuel the exponential growth of the company. Payable period increased from 35 days in 1989 to 45 days in 1990(Exhibit 2), which shows that the company is lagging behind the standard due date of 30 days.
This sole dependency on accounts payable for the uses of cash will make the situation worse. Therefore for additional inventory and accounts receivable to sustain the growth company needs external financing from the bank. Also current ratio of the company during 1988-1990 (exhibit 3) indicates that liquidity position of the company is deteriorating as ratio is falling from 1. 80% in 1998, to 1. 59% in 1989 and finally reaching 1. 45% in 1990. Similar trends are seen in the quick ratio as it has descended from 0. 88% in 1988 to 0. 67% in 1990 (exhibit 3).
Days sales outstanding represent the number of day’s sales remains outstanding it has shown a substantial increase for 36. 78 days in 1988 to 42. 95 days in 1999 (exhibit 3), giving signals that the company is fueling its growth from cash crunch. Hence to fuel their growth of 40%, the company needs external financing. As noted above we decided that Butler Lumber Company should go for the discount. In case of the company not going for the discount the pro forma income statements and balance sheet of the company represent the following out come in the without discount scenario.
As we see in exhibit 1 in the income statement, assuming that the company sales for the year ended 31st December 1991 will be $4 million, we see a slight increase in the purchases from $3052 (exhibit 2) to $3096 (exhibit 1) a difference of $ 44 million ($3096-$3052), similarly the total cost of goods sold is lower in comparison (compare exhibit 1 &2) being calculated for both scenarios @72% of sales an average from the previous years (exhibit 3), we assume the operating expenses to remain constant at 25% of sales (taken as an average from the previous years).
Interest expense to be $49 million as the bank loan (PLUG number is lower in without discount case) interest is calculated at 10. 5% on bank loan + 11% on long term loan (exhibit 1- assumptions), giving us the figure of $71 million for net income before taxes (exhibit 1), which is lower than the with discount scenario (see exhibit 2 for comparison). Provision for taxes calculated at $12. 63 million (see exhibit 1 for calculations under assumptions), this gave a net profit of $58 million exhibit 1). In the balance sheet section of the pro forma statement for the year ended 31st December 1991 for without discount scenario, cash to be $50 thousand (given assumption), and accounts receivable calculated @ 11% of sales taken as an average from the previous years (exhibit 3 under A/R as a % of sales). Inventory as a percent of cost of goods sold will grow @22% (an average taken from previous years shows 21. 23%, but we assumed it to be 22%, exhibit 3). nder the property net head we assume there will be no further investment , as there is restriction put by the bank for further investment in fixed assets (given in the case). Notes payable to Mr. stark remain $0 as all paid in 1988, notes payable in trade remain $0, as all the external financing is from the bank loan. Under the scenario of without discount the accounts payable will be 13% of cost of goods sold (taken as an average from the previous two years which show similar growth in sales)(exhibit 3).
Accrued expenses calculated as $58 million @2% of the cost of goods sold (taken as the average from the previous years (exhibit 3). This yields to a positive net worth of $408 million, which is lower than the net worth in the with discount scenario (compare exhibit 1 &2). Ratio analysis Current ratio for the year ended 31st December, 1991 in without discount scenario is 1. 35 times, however in the with discount scenario we get 1. 37 times which is better (exhibit 3), this shows that the company has a relatively higher liquidity in with discount scenario. Payable period in with discount scenario is 44. 4 days which gets reduced to 14. 91 days (exhibit 3). Under debt ratios it is revealed that 0. 68% of the company’s assets in book value terms, come from its creditors in without discount scenario, which is reduced to 0. 67% in with discount scenario (exhibit 3). Under profitability ratios company enjoys a profit margin of 1. 51% in without discount scenario, which is now increased to 1. 83% in with discount scenario (exhibit 3). Without discount scenario reveals that the company has an ROA of 4. 69% which indicates that the company has earned an average of 4. 9 cents on each dollar tied up in the business, however in the with discount scenario we get a higher ROA of 5. 70% which is better for the company (exhibit 3), ROE of the company is 14. 77% in the without discount scenario, and in with discount scenario we get a higher ROE of 17. 39% this indicates that the percentage return to owners on their investment is higher in the with discount scenario (exhibit 3). We also see an increase in the gross margin of the company from 28% (without discount scenario) to 29. 11% (with discount scenario) (exhibit 3).