Butler Lumber Company Case 1

Christopher Reeve

Evan Young

Christian Covert

FINA 4210 TTR 11:00 AM 12:15 PM

 Butler Lumber Company is a timber retail distributor in the Pacific northwest that has

experienced a rapid growth in its business. This company is looking for a loan to support its

expansion of its business. It must be determined whether this loan is enough to sustain the

growth of the business and whether this loan should be granted after reviewing the default risk. It

is recommended that Butler should halt its expansion and that this loan should not be granted.

Using the Pro Forma we created for 1991, his average collection period is expected to

decrease to 39.99 days. Using this average collection period, we calculated that he receives

$43,210 every 39.99 days. He also only has $88,490 cash on hand (Figure 4). We calculated his

average payment period to be 41.82 days. Using this we calculated that he will be paying

$36,224.23 of his accounts payable every 41.82 days. He also has a payment of $7,000 every

year to pay off existing long term debt. This leaves him no money left to expand business

operations, if the opportunity arises. With his net profit margins decreasing by an average of

8.09% each year, any expansion of his business will increase his profit at a falling rate (Figure

5). Looking at the common size operating sheet (Figure 1), net income as a percentage of sales is

falling each year as sales increase. With a predicted increase of $1,903,000 in sales from 1988 to

1991, yet only a predicted decrease of 0.67% for the percentage of operating expenses to sales

from 1988 to 1991 (Figure 1), it looks as though Butler Lumber Company does not operate

under the principle of economies of scale. Looking at the increasing debt ratios shows that Butler

Lumber is having to operate on more debt when sales increase. Because his current bank isnt

allowing him to increase his loan by much more, he now needs a larger loan from a different

bank.

Butler Lumber is requesting a loan of $465,000. To determine if this loan estimate is

correct, we will need to look at our pro forma financial statements. We created our forecast
assumptions for 1991 using a three-year average as a percentage of net sales. We calculated

COGS to be 71.93%, operating expenses to be 25.02%, cash to be 2.46%, accounts receivable to

be 10.96%, inventory to be 15.25%, and property to be 6.74% (Figure 1). While Butler has been

able to keep his COGS relatively the same since 1988, his cost of goods totals a large chunk of

his sales, meaning he is not left with enough money to pay expenses and debts. Mr. Butler must

pay off his existing debts if he is to take on this new loan from our bank. Taking his previous

loan of $247,000 and line of credit of $157,000 into account, the new loan will only leave him

with $61,000 to put into his business (assuming the line of credit is paid off immediately). If we

take Butlers sales estimate of $3.6 million to be correct, we strongly believe that the amount

requested will not be sufficient. Butlers net sales in 1990 were $2.69 million. Thus, he will need

to invest heavily in inventory if he is to meet the estimated 1991 sales increase of approximately

$1 million. For the end of year 1991, the estimated purchases that will be made during the year

are $2,589,341.92 worth of inventory (Figure 2). Since the company only collects money on

average every 39.99 days, much of these purchases must be made with the borrowed money.

Unless Mark Butler chooses not to take any more money out as salary in 1991, despite his

predicted 1991 salary of $105,000, this loan amount will not be enough to cover his purchases

throughout the year. On another note, the trade discount of 2% for payments made within 10

days of the invoice date is simply not enticing enough for Butler to pay early. The company is

simply not receiving funds fast enough to pay off its mountain of debt. The discount provides no

incentive considering Butler is already deep in the red.

It is recommended that Butler Lumber Company should not continue its rapid expansion.

Net profit margins are decreasing by an average of 8.09% each year, so any expansion would

increase profit at a falling rate. Figure 1 shows net income as a percentage of sales falling each
year as net sales increase. A predicted increase in sales of $1,903,000 from 1988 to 1991 and a

predicted 0.67% decrease for the percentage of operating expenses to sales indicates that Butler

doesnt operate under economies of scale. The increase in debt ratios shows that Butler operates

on more debt when sales increase. Looking at Figure 2, the marginal increase of $6,900 in net

income from 1990 to the predicted net income in 1992 is not worth the added risk of taking on

such a large loan.

Based on our analysis, we would not approve Mr. Butlers loan request. The company is

already heavily leveraged off debt and has been steadily increasing its debt over the past three

years (Figure 6). Additionally, the debt ratio and debt-to-equity have steadily increased too. If

Butler Lumber doesnt meet its sales target, the company could easily default on its debts. With

Butler already taking almost 40 days to collect from its customers, this risk is greater. The credit

risk outweighs the small increase in net income from this expansion. We also believe that

additional funds will be needed to meet the 1991 sales estimate. If we were to approve the loan,

there would have to be several conditions that ensure we receive our money back. For starters,

we suggest that his real property is put up as collateral and that all the loan proceeds be put into

the business and not taken out as salary. In addition, a prepayment penalty is highly

recommended if Butler starts to default on its payments.

Figure 1: Common Size Operating Statement

Figure 2: Pro Forma Operating Statement

Figure 3: Common Size Balance Sheet

Figure 4: Pro Forma Balance Sheet

Figure 5: Profit Margins

Figure 6: Debt Ratios