Butler Lumber Company

Finance Management

xx
xx
xx
Nanda Pujiputranto 10K16008
Yuliyanti 10K16016

INTRODUCTION

MAGISTER OF BUSINESS ADMINISTRATION

GADJAH MADA UNIVERSITY
2010
 Butler Lumber Company
Case Study of Financial Management WE-16 Group II

Butler Lumber Company was a growth company in the late 1980. This Company faced tremendous sales
growth since it had been founded in 1981 by Mr. Butler and his brother-in-law, Henry Stark.In 1988, Mr. Butler
bought Mr. Stark’s share for $105,000 that would be paid off in 1989. For this payment, Mr. Butler has been
loan of $70,000 in late 1988. This loan was secure by Butler’s land and buildings, carried an interest rate of
11% and was repayable in quarterly installments at the rate of $7,000 a year over the next 10 years. Mr. Butler
was also mortgaged his house for $38,000. Besides that, Mr. Butler held a $70,000 life insurance policy,
payable to Mrs. Butler.

Mr. Butler as the owner waslooking for new source of funding by extends his current unsecure bank loan
because the company had shown a significant decrease in cash and increase in liabilities over the last three
years.The maximum loan that the Butler Lumber Company could obtain from Suburban National was $250,000
in which his property would be used to secure the loan.

George Dodge, an officer of a much larger bank, the Northrup National Bank. He offered Butler Lumber
Company a line of credit of up to $465,000. The interest on the new loan would be prime 2%. Butler Lumber
Company would have to sever ties with Suburban National if they were to have this LOC extended to them.

MAIN ISSUES

Was Butler Lumner Company a profitable business? Why Mr. Butler has to borrow so much many to support
his company?

Butler Lumber Company had a problem with a shortage of cash that was not allowing them to expand the
business. For this reason, thecompany needed a larger unsecured loan that would allow them to expand the
bussiness. The company expected larger sales figures in the near future. Therefore ButerLumber Company
needed to determine if it wanted to grow the business or not.

Northrup National Bank offered Butler Lumber Company a line of credit of up to $465,000. Was the bank’s
offer of $465,000 revolving credit enough (assume a 1991 sales volume of 3.5 million)?Could the cash flows of
Butler Lumber support additional debt or stay with Suburban National’s loan?

A quick glance at Butler Lumber’s Operating Statements and Balance Sheets might seem positive because the
company was seeing a steady increase in Net Sales.After closer examination, Butler Lumber Company was not
as might expect with such robust growth in sales.One main question begs to be asked, why was sales growth
so robust, but net income growth anemic at best?

ANALYSIS

PROFORMA

Pro forma Income Statement and Balance Sheet for period ending December 31, 1991 is prepared to
determine how much Butler Lumber Company will need to borrow if it expands as planned.

1|P a g e
 Butler Lumber Company
Case Study of Financial Management WE-16 Group II

INCOME STATEMENT

Table 1 Projected Income Statement for 1991 of Butler Lumber Company

BUTLER LUMBER COMPANY

Projected Income Statement for December 31, 1991
(thousands of dollars)
        Assumptions
      1991 Value Explanation
Net sales $ 3,500 $ 3,500 Given in case
Cost of good sales
Beginning Inventory $ 418 $ 418 From Exhibit 2 1990
Purchases $ 2,646 75.61% Historical % of sales based on prior 3 years
$ 3,064
Computed value (total COGS - beg inv -
Ending Inventory $ (546)
purchases)
Total cost of
$ 2,517 71.93% Historical % of sales based on prior 3 years
goods sold

Gross Profit $ 983

Operating expense $ (876) 25.02% Historical % of sales based on prior 3 years
Operating Profit $ 107
Assume purchase discounts of 2% taken on all
Purchases Discount $ 40 2%
purchases after April 1, 1991.
Interest expense $ (45) 10.50% Given in case
Net income before
$ 101
income tax
Provision for income
$ (22) 34%
tax
Net income $ 78

Beginning inventory was pulled from the previous year’s ending inventory. Purchases were projected from a
trend of 75.61% of sales for the previous 3 years. The total cost of goods sold assumed the previous 3-year
average of 71.93% of sales would continue. Provision for income taxes was calculated as 15% for the first $50
income, 25% for the second $25 income, and 34% for above $75 income.

BALANCE SHEET

Table 2 Projected Balance Sheet for 1991 of Butler Lumber Company

BUTLER LUMBER COMPANY

Projected Balance Sheet for December 31, 1991
(thousands of dollars)
Assumptions
1991 Value Explanation
Assets
Cash $ 53.27 1.52% Recent % of sales
Accounts receivable, net $ 411.84 11.77% Recent % of sales
Inventory $ 546 Computed value from above

2|P a g e
 Butler Lumber Company
Case Study of Financial Management WE-16 Group II

Current assets $ 1,011.29

Property, net $ 203.97 5.83% Recent % of sales
Total assets $ 1,215.26

Liabilities
Notes payable, bank $ 616.28
Accounts payable $ 72.50 10 Days of purchases
1.45% Historical % of sales based on prior 3
Accrued expenses $ 50.78
years
Long-term debt, current position $ 7 $ 7 Constant amortization
Current liabilities $ 746.56
Long-term debt $ 43
Total liabilities $ 789.56 Computed value
Net worth $ 426
Total liabilities and net worth $ 1,215.26
           
* Bank note $ 616.28

The balance sheet was created with the assumption that Butler wouldn’t take the additional loan. The trend
that cash followed from the previous years was used to project the cash asset. Account receivable was based
on % of sales previous year. Property was expected to increase by 5.83% based on the previous year’s trends.

Accounts payable stayed at 10 days of purchases. Accrued expenses were based on historical 3 years i.e. 1.45%
of sales. The long-term debt for the purchase of the company would be paid down to $43,000. Net worth of
Butler Lumber Company was net worth from the previous year and net income from the projected income
statement for the last 1991.

Based on the pro forma income statement and balance sheet, it was determined that Butler Lumber would
need to increase their current debt to approximately $616.28 to continue their expansion as planned.

FINANCIAL CONDITION

LIQUIDITY

Table 3 Liquidity Ratio of Butler Lumber Company

Liquidity Formula 198 198 199 1991 Comments

Ratio 8 9 0 Q1
Current Assets 1.80 1.59 1.45 trend is getting
Current Ratio Current Liabilities 1.35x
x x x worse
Current Assets - 0.88 0.72 0.67 trend is getting
Quick Ratio Inventory 0.54x
Current Liabilities x x x worse
Cash 0.22 0.13 0.08 trend is getting
Cash Ratio Current Liabilities 0.04x
x x x worse

The current and quick ratios were designed to indicate the organization’s ability to meet its short-term
obligations such as payments and other short-term debts, which typically were paid for current assets. A
current ratio aproaching one was desirable. A lower value could indicate that a company might be having

3|P a g e
 Butler Lumber Company
Case Study of Financial Management WE-16 Group II

difficulties meeting its short-term obligations, while a current ratio value higher than one could be indicative of
poor or inefficient use of funds.

Butler Lumber Company’s current ratio was quite high at 1.45, yet its quick ratio was only o.67 (in 1990). This
indicate that Butler Lumber Company was not best use of the funds available to it. Mr. Butler choosed to
purchase inventory in quantities large enough to quality for discount for promt payment, but he rarely was
able to take advantage of that discount. All of the difference in the current and quick ratios was inventory.

Liquidity ratios of Butler Lumber Company were decreased yearly.For its current ratios, the company still can
pay off its current liabilities through its current assets even has decreased. The decreasing trend was
worrisome especially given the low quick ratios. But Butler Lumber Company covers its interest expenses 2.61
times in 1990 although the trend for TIE was also worsening (shows in table of Financial Leverage).

The notable trend in this section was toward reduced liquidity. Butler was experiencing a shortage of working
capital that needs to be addressed to sustain growth in this profitable business.

FINANCIAL LEVERAGE

Table 4 Liquidity Ratio of Butler Lumber Company

Financial Leverage
Formula 1988 1989 1990 Comments
Ratio
Total Assets - Total Equity Trend towards
Total Debt Ratio Total Assets 55% 59% 63%
increased leverage
Total Debt
Debt-Equity Ratio Total Equity 1.20x 1.42x 1.68x
Total Assets
Equity Multiplier Total Equity 2.20x 2.42x 2.68x
EBIT Interest expense is
Times Interest Earned Interest 3.85x 3.05x 2.61x
increasing
EBIT + Depreciation
Cash Coverage Interest 3.85x 3.05x 2.61x
Number of Days Accounts Payable Good position -
Annual Purchases/365 35 days 46 days 46 days
Payable helping cash flow

In 1990, Total Debt Ratio of Butler Lumber Company was about 63%. This was high given the slow move in
inventories and low liquidity ratio. The trend showed increase in the use of debt.

The data showed that Butler was becoming more leveraged, primarily in terms of short term debt. It further
showed that the interest expense was outpacing the earnings growth, which could be helped by securing the
new loan at a more favorable interest rate.

ASSET UTILIZATION

Table 5 Asset Utilization of Butler Lumber Company

Asset Utilization
Formula 1988 1989 1990 Comments
Ratio
Anticipated sales is
Inventory Cost of Goods Sold
Inventory 5.11x 4.42x 4.67x increasing inventory on
Turnover
hand
Days Sales 365 Days Taking longer to turn
Inventory Turnover 71 days 83 days 78 days
Inventory inventory

4|P a g e
 Butler Lumber Company
Case Study of Financial Management WE-16 Group II

Asset Utilization
Formula 1988 1989 1990 Comments
Ratio
Receivables Sales
Accounts Receivable 9.92x 9.07x 8.50x
Turnover
365 Days Taking longer to receive
Days Sales in A/R Receivables Turnover 37 days 40 days 43 days
payment
Average Collection Accounts Receivable
Sales/365 Days 37 days 40 days 43 days
Period
Total Asset Sales
Total Assets 2.86x 2.74x 2.89x Stable
Turnover
Total Assets
Capital Intensity Sales 0.35x 0.37x 0.35x Stable

Total asset turnover is slightly less than 3 for the three years under consideration. Butcomparison of the three
years indicate deteriorating trend with respect to average collection period and inventory turnover ratios.  

Average collection period increased from 37 days in 1988 to 43 days in 1990 indicated the company takes
longer days for taking payment. With increasing sales figures, as displayed in the previous years by the Butler
Lumber Company, these long collection days have a greater effect on the business as the amount of
outstanding – proportional to the sales figures – increase also.

Inventory Turnover needs to be improved through better management of the inventory mix, and that
increased effort is required to encourage customers to pay in a timelier manner. Done correctly these two
actions should actually help reverse the downward trend in profit margin.

PROFITABILITY

Table 6 Profitability of Butler Lumber Company

Profitability Ratio Formula 1988 1989 1990 Comments

NI
Profit Margin Sales 1.83% 1.69% 1.63% Decreasing trend is a concern
NI 11.48 12.64
ROE Total Equity 11.18%
% %
NI
ROA Total Assets 5.22% 4.62% 4.72%

The Butler Lumber Company has positive Profit Margins and ROE, therefore it was a profitable
business.However, the profit margin of company only had 1.83% in 1988 and always decline every year. Beside
that, all of these ratios are trending in a negative direction, as a result of the analysis presented above.

SUGGESTION

Butler Lumber Company was on a growing path. It was evident from the case that the volume has been built
due to successful price competition, careful control of operating expenses and purchases at substantial
discounts. The data was tabulated below:

Table 7 % Increase in sales of Butler Lumber Company

% increase in sales of Butler Lumber Company

1988 1989 1990 Expected 1991
 Net Sales $ 1,697 $ 2,013 $ 2,694 $ 3,500

5|P a g e
 Butler Lumber Company
Case Study of Financial Management WE-16 Group II

% NA 18.62% 33.83% 29.92%

Increase

As Mr. Butler’s financial advisor, we wouldn’t advise him take the loan in an attempt to grow the business even
though the business was profitable and growing. The revenue has been able to grow at a fast pace; 18.62% in
1989, 33.83% in 1990, 29.92% in 1991 but it was not recommended that Butler continue with their expansion
plans. Although sales are high, the company was still relying heavily on borrowed funds to finance its daily
activities. Increasing the loan amount would drive the company closer to bankruptcy, if the funds were used
for expansion. Butler could however use the money to pay his account payable

As a banker, we would not grant Butler Lumber Company a LOC for $465,000. This was too much for a
company like this size, and with such little equity. The Days Sales A/R ratio was trending in the wrong direction,
and more effort needs to be spent on collecting receivables in a timely manner. Additionally, the Inventory
Turnover was decreasing, tying up too much cash, and exacerbating the shortage of working capital. More
effort needed to be spent on inventory management, making sure there was not a growing amount of
stagnant inventory, and that the mix was correct for the intended market.In addition to the conditions
stipulated in the text, the bank should put require that these two ratios (Days Sales A/R and Inventory
Turnover) return to their 1988 levels, and that Mark Butler’s compensation be tied to these objectives.

CONCLUSION

Based on its profitability ratios, Butler Lumber Company was a profitable business. Butler Lumber Company
has borrowed increasing amounts despite its profitability because the net income was growing at a slower rate
than operating expenses. Between the years of 1988-1990 the net income only rose from 31, 34, 44 thousand
repectively. The operating costs for the 3 years rose from 425, 515, 658 thousand repectively. Mr. Butler
needed to take out loan so he could increase the purchasing power of goods. This would be accomplished by
Mr. Butler has liquid cash to use for prompt payment, which would lead to acquiring trade discounts and then
Mr. Butler would have a competitive advantage in terms of buying power.

Table 8 Spread of Butler Lumber Company for 1988-1990

1988 1989 1990

ROIC 12,29% 13,52% 17,63%
ROE 11,48% 11,18% 12,64%
D/R 54,55% 58,70% 62,70%
Sprea -1,47% -3,98% -7,95%
d

The table above shows the spread of butler lumber company from 1988 to 1990. From the table it can be seen
that the spread continues to show negative results. This is due to its ROIC value greater than the value of its
ROE. ROE was the result of the advantage if using internal and external funds, while ROIC only use internal
funds only. Value of negative spreads continued to show that the company could not grow anymore. Thus
Butler Lumber Company wasn’t recomend to continue their expansion plan. Increasing their loan made the
company become bankruptcy.

Table 9 Spread of Butler Lumber Company for projected 1991

projected 1991
ROIC 17,43%
ROE 18,30%
D/R 64,90%

6|P a g e
 Butler Lumber Company
Case Study of Financial Management WE-16 Group II

Sprea
1,33%
d

On the prediction of financial statements for the year 1991, the company would increaseits spread. This only
happened if the company has 3,5 million for volume sales in 1991.

If sales volume of Butler Lumber Company assumed in 1991 was 3,5 million so the company has to increase its
debt until 616.28 thousands. The Northrup National Bank’s offer of 465 thousand revolving credit was not
enough.

Table 10 % Inventory to total assets of Butler Lumber Company

1988 1989 1990

% Inventory to total assets 40.24% 44.16% 44.80%

Based on the table, Butler was short on funds due to their inventory. In 1990, inventory was almost 45% (i.e
44.80%) of their total assets. Better inventory management might increase the cash fund as well as free up
space in the warehouses.

ATTACHMENT

Table 11 Exhibit 1 of Butler Lumber Company

BUTLER LUMBER COMPANY

EXHIBIT 1
Operating Expenses for Years Ending December 31, 1988-1990, and for First Quarter 1991
(thousands of dollars)
            1st Qtr.
      1988 1989 1990 1991
$ $ $
Net sales $ 718 (1)
1,697 2,013 2,694
Cost of good sales
Beginning $ $ $
$ 418
Inventory 183 239 326
$ $ $
Purchases $ 660
1,278 1,524 2,042
$ $ $
$ 1,078
1,461 1,763 2,368
$ $ $
Ending Inventory $ (556)
(239) (325) (418)
Total cost of $ $ $
$ 522
goods sold 1,222 1,438 1,950

$ $ $
Gross Profit $ 196
475 576 744
$ $ $
Operating expense(2) $ (175)
(425) (515) (658)
$ $ $
Interest expense $ (10)
(13) (20) (33)
Net income before income $ $ $
$ 11
tax 37 41 53
$ $ $
Provision for income tax $ (2)
(6) (7) (9)
Net income $ $ $ $ 9

7|P a g e
 Butler Lumber Company
Case Study of Financial Management WE-16 Group II

31 34 44

PS:

(1) In the first quarter of 1990 sales were $698,000 and net income was $7,000
(2) Operating expenses include a cash salary for Mr. Butler of $75,000 in 1988, $85,000 in 1989, $95,000 in
1990, and $22,000 in the first quarter of 1991. Mr. Butler also received some of the perquisites commonly
taken by owners of privately held business

Table 12Memo Items for Exhibit 1 of Butler Lumber Company

Memo Items 1988 1989 1990 Average

1 Purchase to sales 75.31% 75.71% 75.80% 75.61%
2 Cost of good sales to sales 72.01% 71.44% 72.38% 71.94%
3 Operating expense to sales 25.04% 25.58% 24.42% 25.02%
4 Growth (sales) - 18.62% 33.83%
5 Growth (assets) - 19.29% 21.11%

Table 13 Exhibit 2 of Butler Lumber Company

BUTLER LUMBER COMPANY

EXHIBIT 2
Balance Sheets at December 31, 1988--1990, and March 31,1991
(thousands of dollars)
      1st Qtr
        1988 1989 1990 1991
Assets
Cash $ 58 $ 49 $ 41 $ 31
Accounts receivable, net $ 171 $ 222 $ 317 $ 345
Inventory $ 239 $ 325 $ 418 $ 556
Current assets $ 468 $ 596 $ 776 $ 932
Property, net $ 126 $ 140 $ 157 $ 162
Total assets $ 594 $ 736 $ 933 $ 1,094

Liabilities
Note payable, bank $ - $ 146 $ 233 $ 247
Notes payable, Mr. Stark $ 105 $ - $ - $ -
Notes payable, trade $ - $ - $ - $ 157
Accounts payable $ 124 $ 192 $ 256 $ 243
Accrued expenses $ 24 $ 30 $ 39 $ 36
Long-term debt, current position $ 7 $ 7 $ 7 $ 7
Current liabilities $ 260 $ 375 $ 535 $ 690
Long-term debt $ 64 $ 57 $ 50 $ 47
Total liabilities $ 324 $ 432 $ 585 $ 737
Net worth $ 270 $ 304 $ 348 $ 357
Total liabilities and net worth $ 594 $ 736 $ 933 $ 1,094

8|P a g e
 Butler Lumber Company
Case Study of Financial Management WE-16 Group II

Table 14 Memo Items for Exhibit 2 of Butler Lumber Company

1st
Memo Items 1988 1989 1990 Average
Qtr.1991
1 Networking capital $ 208 $ 221 $ 241 $ 242 $ 228
2 Networking operating capital $ 320 $ 374 $ 481 $ 653 $ 457
3 Cash to sales 3.42% 2.43% 1.52% 2.46%
4 Account receivable to sales 10.08% 11.03% 11.77% 10.96%
5 Net property to sales 7.42% 6.95% 5.83% 6.74%
6 Accrued expenses to sales 1.41% 1.49% 1.45% 1.45%
7 Account payable to sales 7.31% 9.54% 9.50%

9|P a g e