Butler Lumber Company Case Study Risk

Butler Lumber Company Case Study Executive Summary Following years of strong growth, Butler Lumber Company looked to banks for loans despite profitable and expansive operations. The company was founded in 1981 by Mark Butler and Henry Stark. Years later in 1988, Butler bought out Stark’s portion of the company via a note payable for $105,000. This note would be paid off in 1989 after proper financing was decided upon. Most of this note payable would be paid off via a $70,000 loan, paid off over the course of the next 10 years. To further grow the business and finance the remaining portion of payment to Stark, Butler is now considering seeking financing options. Given that Suburban National Bank would only issue additional loans secured by property, Butler sought other options to finance expansion and Stark’s payout. This case report further analyzes the reasons behind Butler’s need and history of financing, estimations of loan requirements, and recommendations from the perspective of Butler’s financial advisor and the bank. Sources and Uses of Funds Over the past 2 years, the main sources of funding for the Butler Lumber Company have been primarily bank loans from the Suburban National Bank, in addition to accruing expenses and waiting to pay accounts payable to suppliers until after the discount period in order to use that money. Thus, all of the main sources for funds are liabilities and are used to provide the company with liquid cash, inventory, and additional assets in order to make sales and collect revenue year after year. It seems as though Butler Lumber Company has entered a bit of a cycle where Butler takes out increasingly larger scale loans as the industry grows in order to keep the company profitable. Butler also used funding to pay off the note to Stark in 1988 via a note that would be paid in 1989. Reasons for Borrowing The main issue for Butler Lumber’s company is the rapid growth of their company hindering their ability to pay off previous loans. While Butler Lumber has remained profitable and steadily increased these profits, they are only able to maintain this with increasingly substantial loans. Increased purchases of Property, Plant, and & Equipment have also been needed to support this growth. Their lack of cash is not only due to several loans and rapid growth, but because they haven’t been able to take advantage of purchase discounts due to their lack of cash. This has caused them to enter a slight hole of debt where only a substantial loan from a new bank can cause them to take advantage of purchase discounts, increase cash flow, and pay off previous loans. Some of these previous loans include the $105,000 note payable to Mr. Stark for funding the business and loans taken from Suburban Bank that have increased up to a $247,000 loan taken in the spring of 1991. Significant cash has also been tied up in inventories and accounts receivable. Estimation of Loan Requirements While Mr. Butler plans on taking a loan amount of $465,000, we believe the amount of loan he actually needs given the expected sales volume would only be $396,000. This amount is the percentage of sales (11% of $3.6 million) that Mr. Butler would have in his accounts receivable so that he would be fully able to pay off this new loan once he receives these payments. Given that his payables period is around 40 days and the note has to be paid within 90 days, he would have these payments long before they were due. Although this amount is what he can afford within the first 40 days with his accounts receivable, he should explore taking a larger amount to anticipate more expansion efforts and debt financing. Financial Advisor Recommendation As Mr. Butler’s financial adviser, I would encourage him to take advantage of the loan being offered by Northrop National Bank and to go ahead with the planned expansion of Butler Lumber Company. With revenues increasing at a steady rate YOY and a projected revenue growth of 33.6% in 1991, Butler Lumber Co. is a quickly growing business that just needs more capital in order to support their ever-expanding sales volume. If Butler could utilize this funding to take advantage of purchase discounts, they could greatly improve their profit margins and thus bolster their growth even more, creating the opportunity to take hold of more of the lumber market share. Until this point, Mr. Butler’s company has focused solely on the retail market for lumber in the locale. However, if Butler could foster a healthy relationship with Northrop National Bank and continue growing his company at the rate it is currently, I believe there could be some opportunity for Butler to utilize his access to a railroad line and adjoining storage buildings to greatly increase his sales volume, potentially even shifting into lumber wholesale down the road. With Mr. Butler’s reputation of being a hardworking, creditworthy businessman he could almost surely achieve this growth when furnished with the proper capital. Bank Approval of Loan As the banker, I would approve Mr. Butler’s loan request with several conditions. I would include the previously mentioned covenants including restrictions on additional borrowing, bank approval of additional investment in fixed assets, and other limitations on withdrawals by Butler. By preventing Butler from taking out additional debt or purchasing additional assets, Butler would be more likely to make payments of our loan. If necessary for safe company growth, we would be able to approve such increases in liabilities through our own bank or a reputable lender. In addition to these covenants, I would also enact several maintenance covenants. To make sure that the company remains solvent to pay off the loan, I would require that Butler maintains a current ratio of at least 1.2 and a profit margin of at least 1%. The requirement of a current ratio of at least 1.2 will reduce the risk of the company taking on additional liabilities in respect to their assets. This will reduce the likelihood of Butler defaulting on the loan. The addition of a profitability covenant would also act as a safeguard against adverse company performance and prevent default on the loan. Given the strong projected performance and track record of Butler Lumber Company, I believe that a properly written loan agreement would be mutually beneficial between the Bank and Butler.