Butler Lumber Case Study

Butler Lumber Analysis

Dear Mr. Stark,

We understand you have some concerns about Butler Lumber’s shortage of cash on hand even though the company is marginally profitable and looking to expand. Your concerns are valid, especially since Mr. Butler is seeking additional financing to support the company’s growth. In fact, this is a common issue many businesses encounter when they experience rapid growth. Our findings indicate Butler Lumber is in a solid position to assume additional debt, with conditions, in order to fund its expansion. Our analysis should answer all of your questions and give you confidence in the financial future of Butler Lumber.

        Although revenues for Butler Lumber have been steadily increasing (Appendix, Figure 1), it is important to note the effects of cash-flow when evaluating the financial health and possibility of investing in future expansion. Butler Lumber is currently very cash-poor. That is to say there is not a sufficient amount of cash on hand after all expenses have been accounted for, in order to support expansion efforts on its own. Expenses such as costs of goods sold and operating expenses remain a consistent proportion of sales (Appendix, Figure 2). This means expenses are rising as sales increase, so the increase in operating expenses is not the cause of the cash flow issues.

The primary cause of Butler’s lack of cash is the increasing accounts receivable collection period. This increase implies that more customers are buying on credit. As with most retailers of goods, the business must use its funds to purchase products to sell before the customer pays the business. This causes cash collected to lag behind recorded sales (Appendix, Figure 3). This cycle very often leads to the cash shortage situation Butler Lumber is currently facing. In 1990, Butler Lumber averaged 43 days sales outstanding, waiting for receivables from customers, also known as your “collection period”. To further clarify, even with a small profit margin, more customers are taking advantage of buying on credit. The Cash Conversion Cycle (CCC), which is how long a company can convert its resources into cash flows, is another useful metric in evaluating the financial health of the business. While the CCC has not significantly changed over the last few years (Appendix, Figure 4), there has been an increased level of necessary inventory to meet sales. This in turn requires the firm to have more cash on hand to make the required purchases.

The additional borrowing will further leverage Butler Lumber with debt.  At this point, incurring debt is more cost effective than raising additional equity, so it is in Butler Lumber’s best interest to pursue an increase to its credit limit. The debt used for expansion is also tax-deductible which allows for an increase in working capital. This fulfills one of the loan provisions which states Butler Lumber must maintain a certain favorable level of working capital at all times. We agree with the company’s loan requirements. The calculated additional funds needed (AFN) for its growth is slightly over $155K. The company would be increasing its line of credit limit by $218K will be sufficient to cover the additional funds needed. Although, the debt-to-equity ratios do show an increase in the company’s reliance on debt which makes the overall business riskier in the eyes of lenders. However, it is also a reasonable decision to pursue options for financing in excess of the current demands since Mr. Butler expects his company to grow and require additional funds in the near future.