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Introduction
Background
The Butler Lumber Company had been founded in 1981 as a partnership by Mark
Butler and his brother-in-law, Henry Stark.
In 1988 Mr. Butler bought out Stark’s interest for $105,000, to be paid off in 1989.
Late in 1988, Mr. Butler negotiated a loan of $70,000, secured by land and
buildings, with an interest rate of 11%. The loan was repayable in quarterly
installments at the rate of $7,000 per year over the next 10 years.
Although Butler has a rapid growth in its business, it had experienced a
shortage of cash and had to increase its borrowing from the Suburban
National Bank to $247,000 in the spring of 1991.
Butler Lumber
Company
The maximum loan that Suburban National would make was $250,000,
and Butler had been able to stay within this limit only by relying very
heavily on trade credit.
Butler was introduced to the Northrop National Bank, who might
extend the credit up to $465,000. Interest would be set on a floatingrate basis at 2% points above the prime rate (should be 10.5% in 1991).
Your company slogan in here
Introduction
Introduction
Business Model
Product
•
•
•
Limited to the retail distribution of lumber products in the local area
Typical products included plywood, moldings, and sash and door products.
Non-cyclical
Basic Analysis of
Financial Statements
Downstream Sales
•
•
•
Retails only
Careful control of operating expenses. E.g. No sales representatives
About 55% of total sales were made from April through September
Upstream Supply
•
•
•
Get quantity discounts through bulk purchases
A discount of 2% for payments made within 10 days of the invoice date
Accounts were due in 30 days at the invoice price, but suppliers ordinarily did not object
if payments lagged somewhat behind the due date.
Introduction
Introduction
(2) Profitability Analysis - A
(1) Sales Analysis
Profitability of Butler (1990)
Sales grows rapidly！
1988
Net sales
$1,697
Cost of goods sold
Beginning inventory 183
Purchases 1,278
$1,461
Ending inventory 239
Total COGS $1,222
Gross profit
475
b
Operating expense
425
Interest expense
13
Net income before taxes
$37
Provision for income taxes
6
Net Income
$31
1989
$2,013
1990 1991Q1
$2,694 $718a
239
1,524
$1,763
326
$1,437
576
515
20
$41
7
$34
326
2,042
$2,368
418
$1,950
744
658
33
$53
9
$44
418
660
$1,078
556
$522
196
175
10
$11
2
$9
Return on Total Assets
ROA = Net Income / Average Assets
= 44/[(736+933)/2]=5.27%
Return on Equity Capital
ROE = Net Income / Average Equity
= 44/[(304+348)/2]=13.50%
Return on Invested Capital
ROIC = Net Income / Average Invested Capital*
= 44/[(304+57+7+146+348+50+7+233)/2]=7.64%
*Invested Capital= Equity + Liability with Interest**
**Liability with Interest = long-term debt + bank loans
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Introduction
(2) Profitability Analysis - B
Introduction
(3) Evaluation of financing strategy -- A
Profitability of Butler (1990)
Leverage of Butler (1990)
Gross Margin
＝Gross Profit/Revenue= 744/2694=27.62%
Debt to Total Capital
＝Total Debt/[Total Debt＋Equity]
=585 /(585+348)=62.7%
Debt-to-Equity
＝Total Debt/Equity = 585/348 = 1.68
Net Margin
＝Net Income/Revenue = 44/2694 = 1.63%
(after tax)
＝[ST Debt＋LT Debt－Cash－ST Investment]/Equity
Net-debt-to-equity
EBITDA Margin
= (585-41)/348 = 1.56
＝EBITDA/Revenue= (53+33)/2694=3.19%
(Earnings Before Interest,
Tax, Depreciation, & Amortization)
＝LT Debt/Equity = 50/348 = 14.37%
Long-term Debt-to-Equity
NOPAT Margin
(Net Operating Profit After Tax)
= (Net Income＋after-tax interest expense)/Revenue
=[44+33*(1-17%)]/2694=2.65%
*Tax rate = 17%, calculated from 1988 to 1990
Introduction
(3) Evaluation of financing strategy -- B
Introduction
(3) Evaluation of financing strategy -- C
Coverage Ratio of Butler (1990)
Times Interest Earned,
Earnings Basis
Time Interst Earned,
Cash Flow Basis
＝EBIT/Interest Expense= (44+9+33)/33 = 2.60
1988
1989
1990
Debt Ratio
55%
59%
63%
Interest cover ratio
3.85
3.05
2.61
＝[CF from Operating Activities＋Interest Expense＋
Tax]/Interest Expense
= (-70+33+9)/33 = -0.85
• Debt ratio continues to rise
• The pressure of interest payment has increased
Introduction
(4) Liquidity Analysis -A
Liquidity of Butler (1990)
Current Ratio
Quick Ratio (Acid Ratio)
＝ Current Asset / Current Debt = 776/535 = 1.45
＝(Current Asset - Inventory) / Current Debt
= (776-418)/535 = 0.67
Cash Ratio
＝(Cash＋ST Investment）/ Current Debt= 41/535 = 0.08
Operating Cash Flow Ratio
＝CF from Operating Activities/ Current Debt = -70/535 = -0.13
Introduction
(4) Liquidity Analysis - B
1988
1989
1990
Current
Ratio
1.80
1.59
1.45
Quick Ratio
0.88
0.72
0.67
Cash Ratio
0.22
0.13
0.08
Cash
Accounts receivable, net
Inventory
Current assets
Property, net
Total assets
1988
$58
171
239
$468
126
$594
1989
$48
222
326
$596
140
$736
1990
$41
317
418
$776
157
$933
Notes payable, bank
Notes payable, Mr. Stark
Notes payable, trade
Accounts payable
Accrued expenses
Long-term debt, current portion
Current liabilities
Long-term debt
Total liabilities
Net worth
Total liabilities and net worth
—
105
—
124
24
7
$260
64
$324
270
$594
$146
—
—
192
30
7
$375
57
$432
304
$736
$233
—
—
256
39
7
$535
50
$585
348
$933
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Introduction
Introduction
(5) Asset Turnover - A
(4) Liquidity Analysis - C
Asset Turnover (1990): Evaluation of investing activities
2.00
1.80
1.60
1.40
1.20
Current Ratio
1.00
0.80
0.60
1988
1989
1990
1.80
1.59
1.45
Quick Ratio
0.88
0.72
0.67
Cash Ratio
0.22
0.13
0.08
0.40
0.20
1988
1989
Current Ratio
1990
Quick Ratio
Inventory Turnover
＝Cost of goods sold / Average Inventory
= 1950/[(326+418)/2]=5.24
Days Sales of Inventory
＝365 / Inventory Turnover = 365/5.24 = 69.63
Receivable Turnover
＝Net sales / Average Receivables
= 2694/[(222+317)/2]=10.00
Days Accounts Receivable
＝365/ Receivable Turnover
= 365/10.00 = 36.50
Payable Turnover
＝Cost of goods sold /Average Payables
＝ 2042/[(192+256)/2]= 8.71
Days Accounts Payable
＝365/ Payable Turnover= 365/8.71 = 41.93
Cash Ratio
• All liquidity indicators show a downward trend
• Quick ratio and cash ratio are very low
Introduction
Introduction
(5) Asset Turnover - B
(5) Asset Turnover - C
Asset Turnover (1990): Evaluation of investing activities
＝Net Sales / Average Working Capital
=2694/{[(776-41)-(535-233-7)+(596-48)-(375-146-7)]/2}=7.03
Working Capital Turnover
Total Assets Turnover
＝Net Sales / Average Total Assets
=2694/[(736+933)/2] = 3.23
Fixed Assets Turnover
＝Net Sales / Average Fixed Assets
= 2694/[(140+157)/2]=18.14
1989
5.11
5.09
1990
5.24
Receivable Turnover
9.92
10.24
10.00
Payable Turnover
9.85
9.09
8.71
Working Capital Turnover
10.81
8.34
7.03
* Due to the lack of 1987 data, this column is calculated by year end data instead of average of the year.
＝Net Sales / Average Net Long-term Assets
=2694/[(140+157)]2]=18.144
Net Long-term Assets Turnover
1988*
Inventory Turnover
•
The ability of asset management needs to be improved
•
Increased dependence on suppliers
•
The ability of collection of receivables dropped
* Working capital = (Current assets - Cash - ST investment) – (Current liabilities - Notes payable &
Long-term debt, current position）
* Net long-term assets＝Total long-term assets－ Interest-free long-term debt
Introduction
Introduction
DuPont Analysis
Comprehensive Analysis
Extended
1988
1989
1990
Net Income/EBT
0.84
0.83
0.83
EBT/EBIT
0.74
0.67
0.62
Assets
EBIT/Sales
0.029
0.03
0.03
Equity
Sales/Asset
2.86
2.74
2.89
Asset/Equity
2.2
2.42
2.68
ROE
0.11
0.11
0.12
DuPont Analysis
ROE =
Net Income
EBT
x
Tax burden
ROE =
EBT
EBIT
Int. burden
Net Income
Sales
ROS
x
x
EBIT
Sales
x
ROS
Sales
Assets
TAT
Sales
Assets
x
TAT
x
Assets
Equity
Leverage
Leverage
Basic
1988
1989
1990
Net Income/Sales
0.018
0.017
0.016
2.89
Sales/Asset
2.86
2.74
Asset/Equity
2.2
2.42
2.68
ROE
0.11
0.11
0.12
ROA
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Introduction
Introduction
Cash Flow Analysis
1988
1989
Cash
58
48
41
Accounts receivable, net
171
222
317
Inventory
1990
239
326
418
Current assets
468
596
776
126
140
157
Total assets
594
736
933
—
146
233
105
—
—
Property, net
Notes payable, bank
Notes payable, Mr. Stark
Notes payable, trade
Decrease of cash
Mainly because the cash flow
generated by operating
activities is negative, in which
the capital occupied by
inventory exceeds twice the
net profit
CF from operating and
investing activities
—
—
—
Accounts payable
124
192
256
Accrued expenses
24
30
39
Long-term debt, current portion
7
7
7
260
375
535
64
57
50
324
432
585
270
304
348
Operating Cash Flow
594
736
933
Fixed Asset Investment
Current liabilities
Long-term debt
Total liabilities
Net worth
Total liabilities and net worth
Net Income
Minus: Changes in net
working capital
△Accounts receivable
1989
1990
1991.1
Q
34
44
9
64
114
51
95
25
28
△Inventory
87
92
138
△Accounts payable
68
64
144
△Accrued expenses
Investing Cash Flow
6
-30
9
-70
14
-14
-3
-16
17
-17
Introduction
5
-5
Introduction
Why borrow from Northrop Bank？
Issues Faced
1
Why companies borrow money？
Payables rose sharply in the spring of 1991
2
3
Spend huge amounts of
money to buy the
remaining share of the
company from MR. Stark
As
sales
increase,
additional investment in
working capital is required
Shortage
of funds
Introduction
Why borrow from Northrop Bank？
Increase
Increase
Increase
Increase
Increase
of
of
of
of
of
Source of cash
payable to bank
accounts payable
retained earnings
cash
accrued expenses
Total
Use of cash
Increase of inventory
Increase of accounts receivable
Paid to Mr. Stark
Repayment of long-term debt
Increase of property investment
Total
1990-1988
233
132
78
41
15
475
1990-1988
179
146
105
14
31
475
Introduction
How did Butler deal with the
cash shortage problem before?
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Introduction
Introduction
Credit to Suppliers
Cost of Trade Credit
The total of accounts receivable plus inventories
(percentage of sales)
24.2% as of December 31, 1988,
27.3% as of December 31, 1990.
High financing costs
for accounts payable
Purchase
$1,000 raw
materials
Pay within 10 days,
$980
Pay on the 42 th day,
$1,000
=+$ 84,000
The interest of $980 for 32 days is $20,
(3.1% of sales, 26% of the total
increase in accounts receivable and inventories)
with a annualized interest rate of
360/32*20/980=23.0%
*According to Exhibit 2, it took about 42 days for the company to pay in 1990.
days accounts payable (Days A/P)=
Average accounts payable x 365 ÷ cost of sales.
Introduction
Introduction
Q1: Is the credit size of Northrop Bank sufficient?
Will a credit line of Northrop
Bank be sufficient to meet the
company’s needs?
Forecasting: Assuming full use of cash discounts
Income Statement
(thousand of dollars)
Net sales
1988
1989
1990
1991E
1,697
2,013
2,694
3,600
183
239
326
Cost of goods sold
Beginning Inventory
Purchases
Ending Inventory
Total cost of goods sold
1,278
75.31%
239
14.08%
1,524
75.71%
326
16.19%
418
2,042
75.80%
418
15.52%
76%
576
16%
1,222
1,437
1,950
Gross Profit
475
576
744
27.62%
1,022
Operating expense
425
658
24.42%
900
25.04%
515
25.58%
2,578
Plus: Purchase discount
13
20
33
53
Net income before taxes
37
41
53
111
6
7
9
26
31
34
44
85
Net income
25%
42
Interest expense*
Provision for income taxes
*The interest expense consists of outstanding long-term loan and new short-term bank loan
** Butler was taxed at the rate of 15% on its first $50,000 of income, 25% on the next $25,000
of income, and 34% on all additional income above $75,000.
Introduction
2,736
The proportion of
income is the
same as that of
previous years
Introduction
Q1: Is the credit size of Northrop Bank sufficient?
Forecasting: Assuming full use of cash discounts
Balance Sheet
1988
Cash
1989
1990
1991E
58
3.42%
48
2.38%
41
1.52%
Accounts receivable, net
171
10.08%
222
11.03%
317
11.77%
432
12%
Inventory
239
14.08%
326
16.19%
418
15.52%
576
16%
Current Assets
Property, net
468
126
Total Assets
594
Notes payable, bank
-
596
7.42%
140
736
146
776
6.95%
157
-
-
-
-
-
Accounts payable
Accrued expenses
Long-term debt, current portion
Current Liabilities
Long-term debt
Total liabilities
Net worth
Total liabilities and net worth
64
324
270
594
192
57
432
304
736
6%
Are Northrop Bank loans risky?
667
75
The loan required
24
1.41%
30
1.49%
39
exceeds
the Northrop’s
7
7
7
credit
size 375
260
535
124
210
1,272
233
105
Notes payable, trade
1.5%
1,062
5.83%
933
Notes payable, Mr. Stark
54
256
50
585
348
933
1.45%
52
1.45%
7
796
43
839
428
1,272
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Q2: RiskIntroduction
of Northrop’s Loan
Q2: RiskIntroduction
of Northrop’s Loan
Butler may face a larger financing gap
Butler’s poor liquidity
Butler's debt burden is getting heavier
1988
1989
1990
1991E
Current Ratio
1.80
1.59
1.45
1.30
Quick Ratio
0.88
0.72
0.67
0.60
Cash Ratio
0.22
0.13
0.08
0.07
•
•
All liquidity indicators show a downward trend
Quick ratio and cash ratio are very low
Introduction
The demand for bank loans formed by the
growth of operating income at different
growth rates (when accounts payable
financing is not used)
Operating income exceeds
$4,000,000, even if Butler does not
enjoy cash discounts (i.e. financing
through accounts payable), it still
needs to increase the bank credit size
Introduction
Credit Terms
Working capital
must be maintained
at a predetermined
level, which limits
the further
expansion of
Butler’s business
Investment in
fixed assets
requires bank
approval
Does Butler have other financing
choices?
？？？
Introduction
Q1: Is the credit size of Northrop Bank sufficient?
Other financing channels
1. Keep ’borrowing’ from suppliers
Balance Sheet
Cash
1988
1989
1990
1991E
58
48
41
54
Acocunts receivable, net
171
222
317
432
Inventory
239
326
418
576
Current Assets
Property, net
468
126
Total Assets
594
Notes payable, bank
-
596
140
736
146
776
157
933
233
1,062
210
1,272
414
Notes payable, Mr. Stark
105
-
-
-
Notes payable, trade
-
-
-
-
Accounts payable
124
192
256
342
Accrued expenses
24
30
39
52
7
7
7
Long-term debt, current portion
Current Liabilities
Long-term debt
Total liabilities
Net worth
Total liabilities and net worth
260
64
324
270
594
375
57
432
304
736
535
50
585
348
933
2. The company is in a
high-growth stage,
consider introducing
VC/PE
Equals to 9.5%
of revenue
7
815
Introduction
Conclusion
• Butler needs more funds than the current line of credit
granted by Suburban National Bank.
• Butler has to continue to relying very heavily on trade credit,
otherwise the company's development will be restricted.
For Butler, there are several ways:
(1)Strive for larger bank credit lines or other sources of
financing;
(2)Slow down the company's development speed to
reduce capital needs;
(3)Continue to rely heavily on trade credit and bear high
financing costs
43
858
414
1,272
6