Case Study: Capital Budgeting Butler Lumber Company Abstract Butler Lumber Company, a lumber retailer with a rapid growth rate, is faced with the problem of cash flow shortage. In order to support this profitable business, BLC needs a great amount of cash. The loan of $250,000 from Suburban National and a line of credit of up to $465,000 from Northrop National Bank are the two choices provided. After a brief review of the operation and financial conditions of BLC, we first make analysis of the credit level of BLC from the perspective of banker. Although the feedback from all the firms that had business dealings with Butler are quite positive , both solvency and liquidity condition and the mortgage indicates that it is not a wise …show more content…
The company’s debt position shows that there was rapid increase in Butler Lumber’s accounts and notes payable in the recent past, especially in the spring of 1991. This kind of notable increase of current liability should account for the increase mentioned above, which indicates the company’s great need of short-term funds. 1988 1989 1990 Debt Ratio 0.55 0.59 0.63 Leverage Ratio 1.2 1.42 1.68 Interest Coverage Ratio 3.85 3.05 2.61 2.1.2 Liquidity ratios Two-year decrease of liquidity measures including current ratio and quick ratio reveals the problems concerning company’s short-term solvency and liquidity. Butler Lumber Company’s current ratio decreased to 145.05% in 1990 from the level of 180.00% in 1988. The same decrease happened to quick ratio (decreased from 88.08% in 1988 to 66.92% in 1990). As the short-term lender, Northrop National Bank should have noticed that Butler Lumber Company’s ability to pay its bills over the short run without undue press needs to be carefully examined. The decrease of current ratio also implies the decreasing level of company’s net working capital, which is another sign of lower level of liquidity. 2.1.3 Operating management The days sales of inventory, days sales outstanding and days payable outstanding kept similar over the past three years. Since we cannot get the industrial average level, we cannot determine whether the level of Butler Lumber Company is reasonable. However, we can notice
This then translates to a 50% chance of not having inventory available during job opportunities. Therefore, opportunity costs might occur. The indifference of the production managers' in these aspects of inventory control is alarming and should be acted upon.
As Mr. Clarkson's financial advisor, we would caution him on expanding his business given the current financial trends and ratios of the company. The investment in inventory and receivables is too high. As a result, Clarkson Lumber's return on assets, return on equity and invested capital are lower when compared to other high profit outlets as shown in exhibit C. Additionally, a significant increase in debt, such as a $750,000 loan, will further reduce the current ratio of the company. Clarkson Lumber could benefit from some changes in its collection policies for
Upon returning from his annual two-week vacation in early July of 2002, the treasurer of the Spring Valley Forest Products Corporation, a Mr. Fred Firr, found the firm's audited balance sheet as of June 30 on his desk. Close scrutiny of the company's financial condition as reported in this document suggested to Mr. Firr that the cash flow picture for the enterprise was deteriorating. In times gone by, the firm had been able to maintain sizeable cash balances in its bank of account, Tippecanoe Trust Company, during the major portion of the fiscal year, and had found only modest seasonal borrowings necessary. Recently, however, a lengthening of credit terms to customers necessitated by intense
Although the company seems to be profitable, it has faced shortage of cash. It happened due to increase in Accounts Receivable as well as Inventories. On the other hand, Accounts Payable does not increase that rapidly and difficulties regarding cash collection become evident. Furthermore, the cash collection cycle becomes larger (59 days in year 2003, while more than 70 in year 2006).
The company lost money almost every year since its leveraged buyout by Coniston Partners in 1989. The income generated was not sufficient to service the interest expenses of the company which stood at $2.62B in 1996. From Exhibit 1, we can say that interest coverage ratio computed as EBIT / Interest Expense was 1.31 in 1989 and has been decreasing over years and currently stands at 0.59. This raises a question of how the company can meet its interest payments without raising cash or selling assets.
The reason why Butler Lumber Co. is considering finding a different line of credit is because they’ve nearly exhausted all their usable credit with Suburban National Bank, using up $247,000 of the $250,000 of the credit limit. To compile this issue, the bank is wishing to secure the loan with some of Butler’s property. Considering the company’s large debt ratios, they have decided to check with Northrop National Bank’s offer to extend their line of credit by $215,000.
Liquidity ratio. The firm’s liquidity shows a downward trend through time. The current ratio is decreasing because the growth in current liabilities outpaces the growth of current assets. The quick ratio is also declining but not as fast as the current ratio. From 1991 to 1992, it only decreased 0.35 units while the current ratio decreased 0.93 units. Looking at the common size balance sheet, we also see that the percentage of inventory is growing from 33% to 48% indicating Mark X could not convert its inventory to cash.
Even though the company has been turning in profits, the ineffective collection practice, not availing trade discounts on time and ineffective inventory management has led the company in need of larger financing needs.
The company currently faces serious financial challenges. It was struggling with declining sales and increasing costs. Since 2004, revenues had fallen by more than 40% while costs especially for employees health insurance, maintenance, and utilities climbed. Credits and loans had been borrowed to
The company becomes less flexible in its managerial decisions by taking up the new loan. It would be bounded by the negative covenants imposed by the new bank. These negative covenants place clear restrictions to Butler’s future managerial decisions, including investments in fixed assets and limited withdrawals of funds. Because of Butler’s conservative operating so far, he should be able to deal with these restrictions. Furthermore, Butler Lumber’s increased sales are shielded from the general economic downturn to some degree due to the relatively large proportion of its repair business. This will facilitate the maintenance of the net working capital even in a general economic downturn stage.
Cartwright is a retail distributor of lumber products. It built its competitive edge based on pricing and having a careful control over its operations. The company reported an operating income of $86,000 and $111,000 in 2003 and 2004, respectively. This is a 29% increase in operating income in one year, which shows the firm’s strong ability to generate cash. The firm’s account receivables and inventory are increasing from year to year which is a good sign of a growing business. Cartwright is not an asset intensive company. It does not have to have huge fixed assets; most of its assets are cash, accounts receivable and inventory which all depend on future sales. Sourcing of materials is managed very well, purchased at discounts most of the time and contribute to having lower prices.
Butler Lumber Company, a growing profitable business has exhausted its credit limit and the key issues facing it are: 1. Need for additional funds to continue the growth 2. Need to consolidate debt 3. Need to improve cash flexibility.
Liquidity In analyzing liquidity of the company, the current ratio is not very telling of a falling company. The company increased its ratio throughout the period of the income statement thus building upon its company assets and allowing for a 6-1 ratio of assets over its liabilities. This implies the company is still able to operate sufficiently even though it did not make its optimum current ratio of about 8-1. However, when one takes the inventory out of the equation with the quick ratio, the numbers show the true strength of short term liquidity. The numbers are still good, and do not indicate failure – but are
These ratios help company in determining its capability to pay short-term debts. Liquidity ratios inform about, how quickly a firm can obtain cash by liquidating its current assets in order to pay its liabilities. General liquidity ratios are: current ratio and quick ratio. Current ration can be obtain by dividing company’s current assets by its’ current liabilities. Generally a current ratio of two is considered as good (Cleverley et al., 2011). Quick ratio also known as acid test determines company’s liabilities that need to be fulfilled on urgent basis. Quick ratio can be obtained by dividing quick assets by current liabilities. Quick ratio is considered as stricter because it excludes inventories from current assets. Generally a quick ratio of 1:1 is considered as good for the company. Higher quick
The margins are not great for this industry, and BLC is no exception. Even with the excellent year over year growth in revenues for this company, BLC is on pace for another dismal year of net income in the high $40k. The net income for this company has been constant; $31k in 1988, $34k in 1989, $44k in 1990, and an estimated $49k in 1991. Net income of this size should not warrant extending a line of credit to this company. As the banker, I would not grant a LOC or any other type of loan this size. I would consider granting this company a smaller LOC with the similar stipulations of maintaining an appropriate working capital amount, fixed asset purchases would need bank approval and that Butler would put up personal property and his insurance policy as collateral for the loans that the business