An Analysis on estimating Funds Requirements
Presented By :
Saurabh Kumar Sinha 2009PGP049 Saurabh Patawari 2009PGP050 Siddharth Shankar Prasad 2009PGP051 Sourjyo Das 2009PGP052 Sreethala Ganapathy 2009PGP053 Shubhangi Shree 2009PGP054
Butler Lumber in Spring 1991
Originally founded but Butler and Stark
Butler buys out Stark for $105,000 by taking a $70,000 loan payable over 10 years at 11% p.a.
Needs $247000 - approaches Suburban National Bank Relies heavily on trade credit
Why does Butler Lumber want to shift banks?
Now, Suburban National bank wants ‘real’ collateral for its
loans
He, however, wants a larger unsecured loan (Suburban bank
has cap of $250,000 on it’s loans)
He also wants a larger loan that would give him flexibility He considers Northrop National Bank as an alternative
Reasons for choosing Northrop over Suburban
Higher cap on loans $465,000
This credit line would provide to him larger flexibility
Company History
• Began in 1981 as a partnership by Butler ad Stark
• Business incorporated in 1988 by Butler by buying out
Stark’s share for $105,000
• Paid $35,000 ,$70,000 as bank loan at interest rate of 11%
repayable at $7000 over a period of 10 years
Business operating conditions
Located in a suburb in Pacific Northwest
Company owned land and buildings near a railroad Credit term of 30 days offered to customers
Company had a good reputation as researched by Northnorp National
Bank
Personal assets of Butler-joint equity on a house of $72,000 mortgaged
at $38,000
Company pays suppliers after 30 days not availing the discount of 2%
offered by the suppliers for payment within 10 days
Terms of Northrop National Bank
Secured 90-day note with a limit of $465,000
Maintaining the net working capital to an agreed level
Constraints on capital expenditure and withdrawing
Interest rates on floating basis at 10.5%
Assumptions
Projected sales in 1991 at $3.6 million with scope for improvement
About 55% of the sales during April-September period Permanent severance of relationship with Suburban
Low Credit Limit :
-Credit limit of Suburban National bank was $ 250,000 but the cash requirement of Butler lumber company
was more
Heavy reliance on Trade Credit:
-To stay within credit limit Butler had to rely heavily on Trade Credit. A larger loan amount would ease this
reliance
Security for loan :
-Suburban was now seeking Collateral whereas Butler wanted unsecured loan
Limitations would be placed on withdrawal of funds
which may negatively impact his salary
Loss of autonomy for making investments in fixed
assets as approval of Bank would be required
Loan would be issued on variable interest rate which depends on market fluctuations- a high Interest rate will decrease net income
Rigid control on Working Capital level will have to be
maintained
Loss of flexibility in regard to additional borrowing as
Concept :
It describes lender’s contribution for each dollar of
owner’s contribution
It estimates stability
Standard Value is 2:1
If it is less than this, it is favourable because: 1) High safety margin for lenders
2) Less interest payments 3) Scope for more loans 4) No trading on Equity
LEVERAGE RATIOS
Debt equity ratio
It has been increasing over the years which suggests
increased dependency on external funds and high financial risk . Moreover , it indicates rapid growth in company as well which arises greater need of external funds
Debt Ratio
It has been increasing over the years which increased extent of debt financing in business
Hence, majority of the company’s assets are being financed by external funds
Concept :
Indicates availability of Current Assets for each unit of Current Liability
It estimates short term Liquidity of the Company
It also estimates margin of safety for creditors – a high
ratio means less risk for creditors
A ratio of less than 1 is a cause of concern Quick Ratio
Considers only cash as quick assets for meeting short
CURRENT RATIO
It has been decreasing over the years, which suggests that it has more current claims than current assets.
In fact a satisfactory ratio of 2:1 was never achieved in any
of the years
The ratio indicates whether debtors are being allowed excessive credits
A higher credit may suggest general problems with
debt collection or the financial position of major customers
Days Receivables is increasing which indicates poor collection policy
Ideal Days Receivables allowed was 30 but we are
getting 43 for 1990 which necessitates better credit collection policy
If sustainable growth is higher than internal growth rate,
need for external funds will be less
Company will be able to fund its growth requirements
Internal growth rate vs Sustainable growth rate
In all the years, the sustainable growth rate is higher than the internal growth rate of the company, which indicates that the company will sustain for a long period of time and indicates a positive scope.
Hence, it makes sense to go for bank loans and it is convincing as well for the bank to grant required loan amount
PROFITABILITY RATIO
Net profit margin
It has been low over the years, with merely 1.8% in
1988 and shows a decrease over the years accounting to mere 1.6%
This suggests poor capacity of the company to withstand adverse economic conditions and
1) To buy out Stark’s (former partner) interest he took a loan of $ 70,000
Payment of installments ( 11 % interest + $7000 annual payment) reduces available cash
2) To fund the growth of the company funds were needed.
3) To decrease reliance on trade credit. Currently he is unable to avail discounts on purchases made because of lack of cash, with larger funds he can take advantage of discount by making payment within 10 days
Accounts payable to sales increasing Accounts receivable to sales increasing
Quick and current ratio is decreasing
Projected sales high compared to what actually the
company can achieve on the basis of the trend over last few years(assuming for 1st quarter sales are 22.5%)
Out of $465,000, $247000 will be used to pay previous
bank loan and $7000 to pay as part of loan previously taken to pay his initial partner
Decrease in accounts payable and paying suppliers
immediately to avail the option of 2% discount
Quantity discounts and day’s receivable needs to be reduced
Operational efficiency has to be increased to better the
profit margin
Decreasing his personal withdrawings which is almost
twice of net income, this will help in increasing the profit margin