Duc Nguyen

AF 495, Financial Policy

Professor: Lal, Chugh

Butler Lumber Company

I.

Introduction
Butler Lumber Company was found in 1981 by a partnership of Mark Butler and
his brother in law, Henry Stark. In 1988, the business was incorporated after the
acquisition of Butler over Starks interest. At the same time, the company had shifted
from a partnership into a corporation. The companys operations are about retail
distribution of lumber products included plywood, moldings, and sash and door products.
During the period of 1988-1990, Butler Lumber Company has proven that it is a
profitable company. At the same time, it has a greater capital needs than it should have.
Its current maximum loan amount of $250,000 with Suburban National Bank is not
sufficient. Furthermore, the company is seeking a line of credit (LOC) from Northrop
National Bank with an amount of $465,000 at an interest rate of prime plus 2 percent
basis point. The purpose here is assessing the situation from perspective of the owner
Mark Butler and the Northrop banker George Dodge.
II.

Butler Lumber Company fund-need purposes

For a profitable company, Butler Lumber should have to engage in the borrowing
market in order to satisfy its needs for capitals. The purposes for requirement of funds are
to support the current operation business, improve cash flexibility and consolidate the
outstanding debts. As the company is trying to expand the current business, short-term
loan would ease the tension in the lacks of credits of Butler Lumber. Furthermore,
according to the historical data from 1988 to 1990, the companys inventory turnover is
decreasing which lead to the shortage in net working capital. Therefore, receiving the
loan will allow Butler Lumber to finance the working capital to make sure its inventory is
ready for the projected sales increase in the coming year. Besides, cash flexibility is also
an issue with this company due to its many outstanding debts. Theoretically, according to
the balance sheet, no additional funding is necessary to meet the growth in sales in 1991.
In fact, the balance sheet shows that Mark can pay down his debt by $43,000. However,
there are advantages to borrowing additional funds to improve the cash flexibility and to
consolidate the debt at a lower interest rate.
III.

Estimation of Butler Lumber Companys short-term loans requirements

The forecast of Butler Lumber Companys short-term loan requirements are
appropriate. According to Pro Forma Balance Sheet in 1991, the total amount of bank
notes payable of Butler Lumber Company is $393,000. This loan amount would help the
company to expand its operational business and eliminate its trade debt. The total amount
of $465,000 is not necessary for the spring quarter. Besides, considering the majority of
the companys revenue is from the second and third quarters, the extra money would be
used in the first and last quarters of the year. The current bank will not offer the
additional funding, which would result in the discussions with Northrop National Bank.

IV.

Butler Lumber Company should expand its current operation business as

well as take up the short-term loan
Butler Lumber Co. should head on and take out the loan. The amount of debt
would help the company to anticipate its expansion plan. According to the historical data
from previous years in 1988-1990 period, the sales revenues has been able to grow at a
fast pace; 18.62% in 1989, 33.8% in 1990; 33.6% in 1991. Therefore, attaining this loan
would also provide the company a consider amount of capital to finance the working
capital in order to keep up its inventory levels for the project sales, especially in second
and third quarters which make up a total 55% of sales. Furthermore, this short-term loan
would provide finance flexibility, sustainable purchases discounts, and consolidation of
debts and have a favorable interest rate.
V.
Northrop National Bank decisions and requirements
*Analyze strengths and weakness of Butler Lumber Company:
+ Strengths
Butler Lumber Company has proven its growth in sales revenue from 1988 to
1991 with a fast pace; 18.62% in 1989, 33.8% in 1990; 33.6% in 1991. Furthermore, the
growth in assets is increasing with a considerable amount from 23.91% in 1989 to
26.77% in 1990. Besides, the return on sale (margin) and asset turnover are at stables
rates. Purchases were projected from a trend of 75.5% of sales for the previous 3 years.
The total cost of goods sold assumed the previous 3-year average of 72% of sales would
continue. These indicate the sustainable growth of the company. About liquidity
measure, the current ratio in 1991 is 1.315 which suggests that the capable of the
company to pay off its obligations. Historical data from 1988 to 1991 has shown that the
company had already rolled out partial of its debts. However, the quick ratio is simply
low at 0.61. The return on equity is increasing at a stable rate.
+ Weaknesses
Liquidity Ratios is decreasing with a small amount. Moreover, Butler is
experiencing a shortage of working capital that needs to be addressed to sustain growth in
this profitable business. Leverage Ratios, the data shows that Butler is becoming more
leveraged, primarily in terms of short term debt. It further shows that the interest expense
is outpacing the earnings growth, which could be helped by securing the new loan at a
more favorable interest rate. Utilization Ratios, the numbers are also trending in the
wrong direction, but this is an area that can be more directly managed. In particular,
average inventory turnover was 5.37 for the previous 3 years and requires to be improved
through better management of the inventory mix, and that increased effort is required to
encourage customers to pay in a better timely manner. These two actions should actually
help reverse the downward trend in profit margin. Profitability Ratios, again, all of these
ratios are trending in a negative direction.
Cash shortage is always an issue for every company in short-term. However,
Butler Lumber Company has been successful in keeping current on its debts, and based
on projections should have the means to start paying these debts down. The company has
a potential growth in sale as well as a capability to pay off its obligations. Therefore,
Northrop National Bank should decide to lend out the loan for Butler Lumber Company.
The conditions were outlined in the case are acceptable. As well, the manager of Butler
Lumber should take actions on the ratios includes: liquidity, leverage, average inventory,
and profits.