Fin 461

Butler Lumber Company

Case Study

Jun Jiang

    Wenyong Xiao

Dee Soon Koh

Xinyi Tong

Summary of facts：

The Butler Lumber Company is a retail distribution located in Pacific Northwest by selling plywood, moldings, and sash and door products. Butler Mark and Henry Stark had founded the Butler Company in 1981 as a partnership. Due to the rapid growth in the past few years, the company had experienced a shortage of cash. Therefore, Butler is seeking for a loan to solve the cash shortage issue and grow the business.

Problem：

Butler Lumber Company has successfully survived and growth in this industry by utilizes some business strategies, such as offering quantity discount to buyers, credit sales and good at controlling operating expenses. Despite good sales, the company had experienced a shortage of cash because too much credit sales occurred. Besides that, Butler Lumber Company did not benefit from quantity discount by its supplier. As a result, Mark Butler, the sole owner of Butler Lumber Company thinks that it is necessary to increase its loan. The Suburban National Bank is not willing to offer more than $250,000 without securing the loan with real property. However, the Northrop National Bank is able to offer Butler Lumber Company an unsecured 90-day note of $465,000 with 10.5% interest rate. This offer from Northrop Bank seems like is a good deal to Mr. Butler, but we need to examine the company financial condition before making any decision to prevent company goes bankruptcy. As a result, we will analyze the company capital structure, debt repayment ability, company profitability and operating performance to figure out whether Mr. Butler should take more loans or not.

Butler Lumber Company Capital Structure Analysis

After analyzing the Butler Lumber company balance sheet, we realized that the company capital structure is mainly financing by debt. Debt capital refers to the short-term and long-term loans provided by the creditor to the enterprise. As Exhibit 1 shows, company’s total asset has increased year by year from $594,000 in 1988 to $1,094,000 in 1991. This seems like a good signal that the company is growing. But at the same time, with the rapid growth in assets, total liabilities has increased from $324,000 in 1988 to $737,000 in 1991 as well. It seems like the increase of liabilities have been off set by the increase in assets, but the fact is that Butler Lumber Company’s liability to asset ratio has reached as high as 62.7% in 1990. In other words, Butler Lumber Company’s operating heavily relies on debt.

Repayment Ability Analysis

Furthermore, we analyze the debt repayment ability of company by using several financial ratios, such as debt to total asset, current ratio and quick ratio. The debt to total assets ratio of 1988 is 54.55%; in 1989, the ratio is 58.70%; in 1990, it is 62.70%. The ratio sharply increased to 67.37% in 1991 (Exhibit 2). The percentage of debt to total asset ratio is too huge, and a higher percentage of debt to total assets ratio indicates more leverage and more risk.

The current ratio is a liquidity ratio that measures a company's ability to pay short-term and long-term obligations. The current ratios of 1988, 1989, 1990 and 1991 are 1.8, 1.59, 1.45 and 1.29 (Exhibit 2). In the recent years, the current ratio of Butler Lumber Company is lower than 2, which is an ideal current ratio represents the company is healthy. The quick ratio is a measurement of how liquidity a company is to meet its short-term financial liabilities without including inventory. The quick ratios of 1988, 1989, 1990 and 1991 are 0.88, 0.72, 0.67 and 0.61 (Exhibit 2). For example, every dollar Butler Lumber Company owed in 1990 that 67 cents have to be paid out, which means Butler Lumber Company is not liquidity. In conclusion, the analysis of the ratio above indicates that the Butler Lumber Company has weak sufficient repayment ability.

Exhibit 1

[pic 1]

Exhibit 2

[pic 2]

Company Profitability Analysis

Besides that, we find that the Butler Lumber Company has applied some business strategies to increase its sales. According to the data on the balance sheet, the inventory in 1988, 1989, 1990 and 1991 are 239, 326, 418 and 548.  In addition, the net account receivable in 1988, 1989, 1990 and 1991 are 171, 222, 317000 and 454 respectively (Exhibit 5). We recognize that the company’s inventory and account receivable have rapidly increased in past couple of years. As a result, we conclude that Butler Lumber Company is actively providing credit sales to its customers during these years, which lead to its sales growth. However, the company holding cash in 1988, 1989, 1990 and 1991 are 58, 48, 41, and 40  (Exhibit 5). Obviously, the cash holding by Butler Lumber Company is decreasing year by year. Combining the data trend of increasing in account receivable and decreasing in cash, we worried that the company might face a serious debt issue.