I. Statement of Financial Problem
Butler Lumber Company, a growing profitable business has exhausted its credit limit and the key issues facing it are: 1. Need for additional funds to continue the growth 2. Need to consolidate debt 3. Need to improve cash flexibility.
In this case study I will be discussing following problem: Why has Butler Lumber been profitable in the increasing volume of sales but at the same time it is experiencing cash difficulties in 1988 – 1990? This is a historical problem and my calculations and assumptions are based on income statement and balance sheet for 1988 – 1990.
II. General Framework for Financial Analyses
There are different financial ratios and questions they answer:
• Liquidity ratio – current ratio: Will Butler Lumber be able to pay off his debts as they come due? Satisfactory liquidity ratio is necessary if Butler Lumber is to continue its operations.
• Asset management ratio: Does Butler Lumber have the appropriate amount of assets versus sales? How effectively is Butler Lumber managing its assets?
• Debt management ration: Does Butler Lumber have the right mix of debt and equity?
• Profitability Ratios: Are sales high enough? Do sales exceed the unit cost?
It is necessary to calculate different types of financial ratios to examine different aspects of Butler Lumber’s operations.
Key accounts for sources of funds for Butler Lumber Company are: retained earnings from previous years, cash accounts, accounts receivables and borrowing funds from bank
Uses of funds are: accounts payables, inventory, fixed asset accounts, buyout of Mr. Stark, long term and short term debt.
III. Applying of the financial framework
Before identifying the reasons in increasing/decreasing in sources/funds of cash, I have calculated following financial ratios to help understand the trends over the years of 1988 – 1990. The financial ratios are summarized in Exhibit # 1.
Current Ratio is significantly decreasing 1988 – 1.8, 1989 – 1.59 and 1990 – 1.45. This indicates that the current liabilities are increasing much faster than current assets and it should be the first indicator of possible financial problems.
Current assets include cash, inventory and accounts receivable. Butler Lumber’s current liabilities consist of notes payable, accounts payable, accrued expenses and current portion of long term debt. All of these are due within one year. Butler Lumber was paying the accounts payable more slowly and started to borrow more money from the bank.
Inventory turnover ratio, part of asset management ratios, shows how many times is inventory “turned over“ during the year. The numbers are: 1988 – 7.1, 1989 – 6.17, 1990 – 6.4. The volume of inventory assets seems to be consistent with the increasing volume of sales. Total asset turnover ratio for 1988 – 2.86, 1989 – 2.74, 1990 – 2.89. To improve the operations, inventories should be reduced and receivables collected faster.
Another indicator is debt ratio 1988 – 58.7%, 1989 –58.7% and 1999 – 62.70%. This means that the creditor supplied more than half of its total funds and this number keeps increasing. The debt ratio is very high and this will make relativly costly for Butler Lumber to borrow additional funds without raising more assets first.
Debt ratio can be used to determine the overall of financial risk. The greated the amount of debt, the greater the financial risk to bankruptcy.
Profit margin is decreasing :1988 – 1.8%, 1989 – 1.7%, 1990 – 1.8%. This trend could be caused by two reasons: first, Butler Lumber has a high operating cost or second, Butler’s high use of debt – higher interest expenses.
We can see an increase in total of working capital for 1988 - $208, 1989 - $221 and 1990 - $241. Also there has been even greater increase in non-financial working capital for...