Butler Lumber Company Analysis Essay

Based on the information and corresponding financial statements provided, we concluded that: Bulter Lumber Company has to collect money from outside resources to compensate its funding gap of 383,000 USD. From the perspective of banker, we won’t approve Mr.Butler ‘s loan request From the perspective of firm’s financial advisor, it is better to finance from new shareholders than to borrow from bank. II. Analysis i. Funding gap There are three main reasons why Butler Lumber Company has to finance itself through outside resources. Firstly, It was mentioned in the document that Butler is offered a trade discount by suppliers, which is 2/10 with 30 days span of due. However, Mr. Bulter had never been able to use such a discount because of the shortage of funds. Purchase of Stark’s shares and expansion of current business both contribute to the lack of cash. The inability to take advantage of trade discount directly lead to the increase in COGS and further lower down the company’s profitability despite the fact that sales is increasing (statistics shown in table 10). therefore, it would be a wise choice for Mr. Butler to fully utilize the discount to ease his pressure on liquidity and further lower costs to increase profitability. Secondly, the situation of operating efficiency in Butler Lumber Company is worrisome. As showed in table 6, past three years have seen a rise up in days of accounts receivable, from 36.7 to 40.2 days, indicating that for every one receivable dollar , the company needs 40.2 days to collect from customers. Consequentially, the same increase applies to days of accounts payable which is rising sharply from 37 to 47.9 days. It means that for every payable dollar, the company needs 47.9 days to pay back. This combine contributes to the inefficiency of operating turnover which is of vital importance for a trade company. Therefore, in order to avoid illiquidity resulted from suddenly change of macroeconomic and support company’s continuous growth, Mr. Butler has to increase cash to buffer itself. Thirdly, We also noticed that notes payable should reach a higher level (382,000 USD) if the assumed sales volume (3,600,000 USD)of 1991 is to be achieved. We use statistics of 1990 as basis and calculate the proportion of some accounts to net sales. then we apply these proportion to forecast the income statement and balance sheet for 1991(the calculation process is shown in Table 3 ).since the amount of notes payable in 1990 should be paid back by the end of 1991, so the ending number of note payable in 1991 should be the amount of newly borrowed money from bank .In other words, to realize the sales goal, another 382,000 USD should be financed. Therefore, we disagreed with previously estimated amount of 465,000 USD by Butler and Dodge and we recommend a lower amount of 382,000 USD is enough to sustain the daily operations of the company for the whole year. ii. Prospective from banker Based on the grades of credit, capacity and collateral, we perceive the risks for lending money overwhelm the benefits and decide to veto Butler’s application for the loan. We evaluate Butler Lumber Company’s application for loan through grading the credit, capacity and collateral with three levels: poor, normal, and great. (1) Credit For small businesses, the character of the entrepreneur is very essential. Our customary investigation found out Butler is an energetic man totally dedicated to his business. Barker Company, one of Butler’s large suppliers, reckoned he possesses sound judgment and a willingness to devote into his work and keeps close eye on his own credit. Moreover, there is no evidence evincing Butler involving any delinquent event. Generally, we believe Butler is a reliable business man. However, the financial data of Butler Lumber Company is not that palatable. The company is mired by the debt (table 9). As of 1990, the current liability is 535,000, equivalent to 19.86% of net sale. In fact, leverage ratio is worsening during last three years. The ratio of debt and equity surges from 1.2 in 1988 to 1.68 in 1990. What’s more, the operation efficiency (table 6)still has room to elevate. Average account receivable days are too long. Account payable keeps ascending. To sum up, we give Bu tler a grade of â€Å"Normal†. (2) Capacity With regard to the capacity for repay the loan, we mainly consider the company’s profitability 〠coverage ratios and liquidity ratios In this aspect, the company’s performance is somewhat disappointing (table 10). The net sale reached 2,694,000 dollar in 1990 with a strategy mixed price competition and control of operating expenses and costs. Yet net profit margin experienced a downward trend during last three year. In addition, the liquidity is worsening (table 8). Both the ratio of EBIT/Interest expense and the current ratio slumped from 3.85 to 2.61 and from 1.8 to 1.45 respectively during last three years. Hence, our conclusion is Butler’s company is quite risky deserved a grade of â€Å"Poor†. (3) Collateral Until the end of 1990, the net property of the company is worth approximately 157,000 dollars. Butler held jointly with his wife equity in their house, which had cost 72,000 dollar in 1979, yet was mortgaged for 38000 dollar. These entire assets together amounts 190,000 dollars. If we lend 465,000 dollar to Butler and collect all his asset as collateral, the ratio of loan to value(LTV) is 40.86%, which is unacceptable. Thus, when it comes to collateral, we have to render a â€Å"Poor† to Butler. iii. Prospective from financial advisor As Mr. Butler’s financial advisors, instead of encouraging Mr. Butler to go ahead with debt financing, we recommend that it is more favorable to financing through new shareholders for the following reasons. Firstly, as the analysis showed above, we understand it is not that easy for the company to borrow money from banks. Even we successfully reach the agreement with bankers, we may subject to very severe debenture, which may form obstacles for company’s further development. Secondly, indictors of operating return, such as ROE and ROIC, both show a steady increase during the past three years. ROE increased from 11.48% to 12.64%, a 10% gain. ROIC jumped from 12.90% to 19.01%, an increase of 47.4%. These two ratios indicate that the company has earned on its past investments and it is able to find investment opportunities that are very profitable. These ratios may be attractive to introduce new shareholders. Hence, we suggested that it is better for the company to finance by equity than by debt. Moreover, the joint of new shareholders in the management team can help to improve the management and operation of the company, especially in the aspect of inventory and credit policy. III. Appendix Table 1 – Income Statement Table 2 – Common Size Income Statement Table 3 – Balance Sheet Table 4 – Common Size Balance Sheet Table 5 – Free Cash Flow to Firm Table 6 – Operating Efficiency Table 7 – Operating Returns Table 8 – Liquidity Ratio Table 9 – Leverage Ratio Table 10 – Profitability Ratio