An Analysis on estimating Funds Requirements

Presented By :
Saurabh Kumar Sinha 2009PGP049
Saurabh Patawari 2009PGP050
Siddharth Shankar Prasad 2009PGP051
Sourjyo Das 2009PGP052
Sreethala Ganapathy 2009PGP053
Shubhangi Shree 2009PGP054

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 its loans)
He also wants a larger loan that would give him flexibility
He considers Northrop National Bank as an alternative







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
Starks 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








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









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


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

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
Concept :
It describes lenders contribution for each dollar of
owners 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


LEVERAGE RATIOS
Debt equity ratio
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
Debt Ratio
It has been increasing over the years which increased
extent of debt financing in business
Hence, majority of the companys assets are being financed
by external funds





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
It has been decreasing over the years, which suggests that
it has more current claims than current assets.
In fact a satisfactory ratio of 2:1 was never achieved in any
of the years
It points to narrow margin of safety for creditors
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




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
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
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


1) To buy out Starks (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

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
Decrease in accounts payable and paying suppliers
immediately to avail the option of 2% discount
Quantity discounts and days 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