Butler Lumber case study

1. Why does BL need to borrow money to support its profitable business? Draw up a Fund Flow Statement, i.e., Funding and Uses a. Funding would include Bank Borrowing, Trade Credit, Retained Earnings, Cash, Accrued Expenses b. Uses would include Inventories, A/R, Buyout, Reduction in debt, increase in fixed assets/accounts Response: BL needs to borrow money from the bank to take benefit of the purchase discounts. During the last two years, BL had taken very few purchase discounts because of the shortage of funds arising from his purchase of Stark’s interest in the business and other additional investments. If Butler is able to borrow at a rate lower than the one he will be losing by not taking the purchase discount, he should borrow from the bank. The company is anticipating substantial increase in sales over 1990-1991. If he is able to pay the money faster, he will not be able to take the trade discounts, but also decrease the company’s account payable.

2. Will the bank credit of $465,000 be sufficient to fully meet the company’s requirements at least over the next year? Why or why not? What does it depend on? Response: Without changing anything in the spreadsheet, BL needs to borrow $167K from the bank. Therefore $465K from Northrop National Bank will be sufficient to fully meet the company’s requirement. However, this implies that BL takes around 48 days to pay its bills and thus not able to take the purchase discounts. The bank borrowing depends on how many days BL takes to pay off its account. If it pays off in 10 days, BL needs to borrow $438K (which can still be covered by the loan from Northrop Financial). However if BL decides to pay off in 6 days, his bank borrowing increases to $466K, which will be more than $465K that the bank is borrowing BL. But he doesn’t get any special discount by paying it in 6 days instead of 10 days; he will get the same 2% trade discount. Thus, I think $465K is sufficient to meet his requirements over the next year.

3. How attractive is it for BL to take the trade discount? How much do you really save from taking advantage of it per year? Response: The trade discount is attractive for BL. In 1990, BL paid the bill in (((Accrued Expense + Accounts Payable)/COGS)*365) = ((39+256)/1950))*365) = 55.22 days.