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Butler Lumber

Essay by   •  February 11, 2019  •  Essay  •  2,338 Words (10 Pages)  •  56 Views

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Butler Lumber Company is a private business owned by sole proprietor named Mark Butler. He already financed his firm with $247,000 debt provided by Suburban National Bank. Now, he starts to wonder whether to finance more money. He hopes more fund would ease the firm’s lack of cash. The other bank, Northrop National Bank, already proposes secured 90-day note that does not exceed $465,000 to him. Mr. Butler is unsure whether to accept the loan or not. Therefore, he is now sitting on the fence.

To address the company’s need of debt financing, we have calculated working capital for Butler Lumber Company. It turns out that, from 1988 to 1990, the working capital are $262,000, $326,000 and $440,000 respectively. It can be seen that the amounts rose over time. Greater working capital reflects Butler Lumber’s shortage of cash. Even though account payable increases over time, working capital still becomes greater. To explain, it can be supposed that the firm with larger account receivables and inventory is not efficient to turn its account receivables and inventory into cash. However, in reality, what firms really need is cash, not account receivables or inventory. That is why larger working capital overtime shows the sign of Butler Lumber being illiquid.

To support the ideas above, we also calculate cash cycle. The calculation is compounded with three different factors namely receivable conversion period, payable conversion period and inventory conversion period [See Appendix I]. First, from 1988 to 1990, receivable conversion periods are 36.78, 35.63 and 36.51 days respectively. These numbers exceed 30-day credit terms. Therefore, it can be assumed that Butler Lumber fails to collect its receivables within due date. Second, we obtain the numbers for payable conversion period that are 35.41, 37.84 and 40.04 days. The numbers increase over time. This is relevant to the fact that receivable conversion period is long and firm’s cash is very limited. Long payable conversion period also makes Butler Lumber fail to get early payment discount. This may consequently hold the firm back from being good at price competition. Lastly, the cash cycle we calculated, from 1988 to 1990, are 72.75, 69.54 and 66.11 days. All in all, receivable conversion period and payable conversion period show that the firm fails to manage its receivables effectively which consequently leads it to late supplier payment.

To conclude, calculated cash cycle does not present any significant change over years. Moreover, continued sales growth in the future is predicted. To serve such growth, firm needs an expansion. Thus, debt financing would allow the firm to expand their assets. Also, with poor receivable management and the lack of liquidity, Butler Lumber fails to deliver payments to its suppliers within time. It, therefore, causes the company to miss purchase discount that would reduce its raw material cost. These are the reasons why Mr. Butler wants to find the source of

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fund to improve his liquidity and pay back his suppliers even though the firm’s sales are in the good state.

Balance Sheet Projection for the year 1991-1994

To answer whether the company needs $465,000 loan, we have projected balance sheet and income statement for the year 1991-1994.

Year 1991 Balance Sheet Projection:

To begin the projection for the year 1991, we used the year 1991 estimated sales given by the case study ($3,600,000) as a multiplier. Then, we calculated forecast factor for each item on the statements (i.e. account receivable, operating expenses). To calculate forecast factors, we figured out the percentage of sales for each item on the balance sheet using data over the year 1989 to 1990. Next, we calculated an average percentage of sales for each item. Such percentage reflects the data over the 3 previous years (1989 to 1990). [See Appendix II and Appendix III] Once we obtained the percentages, we multiplied them with sales ($3,600,000). Finally, we acquired projected values. To illustrate the clear method, we show the examples of our calculation below.

Example: projected Account Receivable and Account Payable for the year 1991

Account Receivable = Sales (1991) *Average Account Receivable percentage of sales

Account Payable = Sales (1991) *Average Account Payable percentage of sales

We repeated the same steps with other items on the balance sheet, except for long-term debt and property. When it comes to property, we did not follow the above method. Instead, we figured out its average growth then multiplied such value with historical property value (year 1990). In case of long-term debt, the principal amount should be calculated using the beginning long-term debt deducted by $7,000 (long-term debt, current portion). The interest should be calculated using amortization interest.

Then, we got all the projected values on the balance sheet except note payable (bank). To figure out note payable (bank), we deducted the amount of projected total asset by projected total liabilities and equity. The value of projected note payable we obtain is $341,350. [See Appendix IV] Such value is less than $465,000.

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Year 1992 - 1994 Balance Sheet Projection:

However, we also projected the balance sheet for another 3 years forward (1992 - 1994) to see the longer run. [See Appendix IV and Appendix V] To begin with, we calculated sales growth for the year 1989 -1991. The values we obtained are 17.08%, 29.14% and 28.99% respectively. Due to economic meltdown, we expect that sales growth would not exceed 29% (the highest sales growth rate). Therefore, we chose 17.08%[see appendix VI], the lowest rate from the period 1989 – 1991, as the sales growth rate to project sales for the year 1992-1994 instead. Then, we multiplied such rate with historical sales from a year earlier.

Example:

Sales (1992) = Sales (1991) * (1+growth rate)

To find the values for the rest items on the balance sheet, we just followed the same process we did with the year 1991 projection. Finally, we acquired the amount of note payable (bank) for the year 1992-1994 as $438,356.33, $511,790.55 and $596,340.75 respectively.

According to the balance sheet projection, Butler Lumber’s expected borrowing amount for the year 1991 is $341,350.13. However, the loan amount that Northrop National Bank provides is $465,000. Such amount exceeds the expected value we acquired from the year 1991 projection. Thus, it can be assumed that $465,000 loan would be enough for 1991. On the other hand, owing to the projection over the year 1992-1994, this loan amount ($465,000) would not be enough for Butler Lumber for the year 1993 onward as long as the firm does not improve its liquidity management.

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