Management Accounting

Case (1) Financial Planning: Butler Lumber Valuation

1. Although Mr Butler has seen an increase in his sales for the last few years, there are a few reasons why he needed a loan from the bank to keep his operations going.

1) Shortage of Cash: Despite good profits, Mr. Butler had experienced a shortage of cash from 1988 to 1990. During this period of time, there was a decrease in cash reserves, as well as in inventory turnover, indicating that Mr. Butler’s money had been tied up in his inventory. This can be resolved by working on his receivables turnover ratio, which decreased from 1988 to 1990, as seen in Appendix A. 2) Debt Consolidation: In late 1988, Mr. Butler took a loan of $70,000 that carried an interest rate of 11%. The annual interest payable to the bank compounded to his cash shortage problem. 3) Expansion of operational business: Additional investments in working capital and inventory purchases will be required to keep up with the company’s increasing sales volume.

2. As illustrated in Appendix B, assuming that 1991 sales volume will be $3.6 million, Butler Lumber will only need a loan of roughly $333,600.00 to finance the expected expansion in sales. The company’s estimate of the loan requirements is inaccurate.

3. In the first quarter of 1990, sales were $698,000, approximately 25.91% of the yearly revenue. Based on this ratio, we estimate that Butler Lumber Company will generate approximately yearly revenue of 2.8 million in 1991, which is 800,000 less of what the bank forecasted. With the projected yearly revenue, the company will only need a loan of $288,000 for 1991. However, Butler Lumber has good credit reports from suppliers, also, as mentioned in question 1; the company can easily improve the cash flow of the company by improving their receivables turnover ratio. Since this is a request for a revolving line of credit up to $465,000 and not the entire sum up in one instance, we will approve the company’s revolving credit line, but with the following conditions: • BLC shall fulfill its loan obligation to Suburban National bank making Northrop National Bank the primary creditor to Butler Lumber. As primary creditor Northrop Bank will have the 1st right to the Butler’s total assets in the event of loan default. • BLC shall review its credit terms with their customers to help improve their cash flow. Furthermore BLC shall maintain a healthy cash flow greater than 75,000 starting at the beginning of the 4th quarter for 1991. • BLC shall make a diligent effort to fulfill at least 25% their purchase accounts payable within 10 days of invoice to obtain the 2% discount for the 1991 year. Further after, BLC shall maintain the 25% and continue to fulfill an additional 10% each year thereafter, ie 35% in 1992, 45% in 1993 etc. The overall level of effort will be determined by the Northrop National Bank Account Manager for this credit line, and will occur on a semiannual basis in the first year; and adjusted for more or less reviews in the following years based on BLC’s performance to meet this condition. • BLC shall maintain a net working capital above 240,000 for 1991 and reevaluated for 1992 at a later date by the Northrop National Bank Account Manager for this credit line. • BLC shall request prior approval for any additional investments in fixed assets. • Limitations shall be placed on withdraws of funds from the business by Butler in excess of 10,000 per month.

APPENDIX A – RATIO CALCULATIONS BUTLER LUMBER COMPANY

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APPENDIX B – BALANCE SHEET PROJECTION (Assuming 1991 sales volume to be $3.6 million)

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