Butler Lumber Company Case Study
At first glance, the current ratio appears to be in good form with a small decreasing trend from 1988 (1.8) - 1990 (1.45). Though the ratio is decreasing, Current assets are still greater than current liabilities, which gives us the impression of liquidity.
However, when one analyzes the quick ratio it is apparent that inventory accounts for a large portion of current assets, and becomes a larger portion over time; the quick ratio has a decreasing trend from 1988 (0.88) - 1990 (0.67). This is worrisome because they have very little cash on hand, and increasing accounts receivables, which points out to a serious liquidity issue.
Overall, the leverage ratios are fairly steady, but there is a clear trend of increasing leverage from 1988 - 1990. The days payable of BLC is well above the standard 30 days payable, and conditional 2% discount for early payment (10 days): 1988 (35.41) - 1990 (45.75). That being said, they are being financed by their suppliers with no physical cost, but risk the intangible cost of good supplier relationship. Furthermore, The times interest earned portrays BLC’s high earnings, and ability to pay off more than double their interest expense, which means they have more room for debt: 1988 (3.85) - 1990 (2.61). Based off the previous ratios, It is no surprise that BLC’s assets are increasingly …show more content…
This will eventually deteriorate the relationship and goodwill of the firm with regards to their main suppliers. Although these costs cannot be estimated with the information provided, they could have serious consequences on the operations and profitability of the Butler company. They must therefore be kept in mind when making the financial decision with regards to the short term fund requirements of the firm.
In order to determine those requirements, we calculated the external financing needs based on the 1991 Q1 assets and liabilities, coming out to a total of $166,474 on top of current borrowing situation. This implies that if the Butler company were to go with Northrop National Bank, it would need to borrow the EFN previously calculated, plus the outstanding balance of the Suburban loan at the end of 1991 Q1, amounting to a total of $413,474. In our proforma analysis we will predict both balance sheets and income statements for two potential scenarios: stay with Suburban National Bank and continue to rely on the trade payables extended by suppliers as well as putting up extra collateral, or switch to a new loan with the Northrop National …show more content…
Instead we decided to stick with the 1989-1990 growth rate of 25.3%. However, this is a number subjective not only to operating efficiency, but to market forces that are out of the control of the managerial staff of the firm. It is therefore important to create a sensitivity analysis with regards to the growth rate of sales for the year, and how that number will affect different profitability ratio. Appendix 1 clearly shows that as the sales performance decreases, the profitability ratios get tighter and TIE decreases. A critical level to take notice of is the a -15% growth rate and below, which would result in sales amount insufficient to cover Interest expenses, putting the firm at risk of lowering their NWC below levels at which the bank could force bankruptcy.