Butler Case
With a positive net income from 1988 to 1990, Butler Lumber Company (BLC) is a profitable company; however, we can see from its net profit ratios (see “Ratios”) that the company’s ability to generate profit from its sales is decreasing.
Additionally, from BLC’s balance sheet and income statement, we can also see that the company is facing liquidity problems.
The most obvious sign of this liquidity issue is the decrease in the account cash, which goes down from 58 to 48, and then 41, in respectively 1988, 1989, and 1990, or a decrease of 16% on average (see “Ratios”).
At the same time, account receivables are increasing by 36% (see “Ratios”) on average, going from 171 in 1988 to 222 and 317 in 1989 and 1990. Moreover, even though the customers normally benefit from a net 30 days on open account, we can see from the account receivable turnover ratio in days, that the latters do not respect this term. The number of days keeps increasing since 1988 (37, 40, 43, for respectively 1988, 1989, 1990). BLC seems to boost its sales by offering better payment conditions to its customers. The other possibility would be that, because of the economic downturn, they are having difficulties collecting payments from their customers.
The inventory management is also deteriorating; in fact, with an increase 32% (see “Ratios”) on average, it grows faster than sales. With a turnover ratio that overall decreases between 1988 and 1990, they take longer to renew the inventory and, it seems, that they are having some difficulties to sell their goods.
BLC’s constant decrease of its current ratios, going from 1.8 to 1.59 and finally 1.45 in 1988, 1989, and 1990 (See “Ratios”), confirms the liquidity issue and one can foresee future difficulties to pay off short term debts.
To support its expansion BLC had to heavily rely on short-term debt with its bank (146 to 233 from 1988 to 1989; i.e. an increase of almost 60%) and on credits from its suppliers (average increase of 44%).
To conclude, BLC’s sales are growing rapidly, but it seems, from the above analysis, that the company has difficulty sustaining this growth and has to rely on external funds (bank and suppliers).
According to our projections (see “Balance Sheet and Income Statement”), BLC is going to need $587,000 to finance its operations. Included in those $587,000, are the $247,000 borrowed in the first quarter of 1991 to Suburban National Bank. Thus, BLC would need $340,000 to finance its expected expansion in sales.
In order to decide whether Mr. Butler should go ahead with his anticipated expansion plan or reconsider it, we will compare the 3 options:
Maintain the expansion plan and request the $340,000 bank loan
Lower the sales’ forecast, get