Butler Lumber Company
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Mark Butler, sole owner and president of the Butler Lumber Company has approached George Dodge of the Northrop National Bank with a request for a loan of $465,000 to finance the company’s anticipated growth in the near future. The company’s current bank cannot provide it with an amount higher than $250,000, a figure too low to meet its substantially large working capital requirements. It is for this reason that Mr. Butler is seeking the new banking relationship. The problem that lies before, Mr. Dodge now is whether or not to grant the requested loan and, if yes, under what conditions. The three alternatives at his disposal are to extend the loan as wished by Mr. Butler, to extend the loan but impose weighty conditions and to refuse the loan. He must carefully evaluate each of these options in the light of Butler Lumber Company’s latest financial ratios, its sales and growth forecasts for the upcoming year and the availability and management of assets on the company’s part.As the first option, Mr. Dodge could, on behalf of his bank, consider granting to Butler Lumber Company the entire loan of as requested.
This will entail creation of a revolving, secured 90-day note worth $465,000 and will involve the bank’s standard covenants, such as restrictions on additional borrowing, additional investment, large working capital changes and withdrawals by the owner, being imposed on the company. The rate of interest will stand at 10.5%. This decision has potential to be advantageous keeping in view the highly positive trade letters received from Mr. Butler’s professional acquaintances. Moreover, the company has been rapidly growing over the recent years and according to the bank’s investigator, the sales are expected to keep rising to reach $3.6 million for the forthcoming year (Appendix 4). The company’s inventory turnover and accounts receivable ratios too are significantly impressive showing an effective asset management on its part (Appendix 3). While these facts strongly support that the company will be able to repay the loan, a number of factors provide reason for apprehension. Butler Lumber Company’s liquidity position is dismal with both the current ratio and the quick ratio significantly off the ideal 2:1 and 1:1 respectively (Appendix 3). The debt position of the company too is alarming as exhibited by the total liabilities to total assets ratio.
Finally, the company does not have sufficient assets to offer as security as the most valuable fixed facilities are already pledged against the ten year loan the company negotiated in 1988. Although asking for Mr. Butler’s personal assets as security is an option, it would be an unethical move on the bank’s part. Mr. Dodge could alternatively extend the loan but modify the conditions of the loan in order to reduce the burden of risk with Northrop National Bank. In order to do so, the amount of loan granted should be much less than the requested $465,000 and yet higher than $250,000. The standard restrictions related to additional borrowing, investment and withdrawals that apply to such a loan must be included in the agreement and possibly tightened. This decision could benefit both institutions as Butler Lumber Company will receive a loan of higher amount than it would from its current bank and Northrop National Bank will be at a much lower risk by reducing the amount of loan to less than what is requested. Secondly, the lumber company has been doing significantly well in terms of its sales and shows promise for a similar trend of profitability in the near future (Appendix 4).
Finally, as is clear from the inventory turnover and accounts receivable ratios, the company manages its assets well and a loan from the bank will only aid this (Appendix 3). On the other hand, however, the decision of granting loan to Butler Lumber Company suffers from multiple drawbacks. The financial statements already exhibit a poor debt to asset ratio and a loan of such volume will make it worse (Appendix 3). The company’s poor liquidity position as seen through the alarming current and quick ratios is another major reason for the bank to be reluctant in granting the said loan (Appendix 3). Finally, the success of this approach of trying to reduce the burden of risk with the bank depends on availability of assets to pledge against the loan but the company currently lacks any such assets. As mentioned earlier too, asking Mr. Butler to risk his personal and family equity for the same would be unethical.A third and final option that lies before Mr. Dodge in this scenario is to refuse Butler Lumber Company the requested loan. This decision is a viable one on many grounds. The company is currently suffering from acute lack of working capital and from a very poor level of liquidity (Appendix 1, 2, 3).
The debt position of the company too is a concerning aspect with the debt to asset ratio ranging between 50 and 60 for any period in the recent past (Appendix 3). Both of these factors could put the bank in a precarious situation if the loan is granted, especially without sufficient collateral. As for that, the company currently does not have enough assets to offer as security and asking Mr. Butler to pledge his personal assets for the same can come across as an unethical move on Northrop National Bank’s part. On the other side, however, the company is expected to do well in terms of sales and net income for the upcoming year (Appendix 4). The trade letters received during the investigation also reveal that Mr. Butler is committed businessman with a close check on his credit. As such, if the loan is refused, the bank could lose out on a possibly profitable client. Finally, denial of the loan will cause Mr. Butler to seek a banking relationship with a rival bank which will then reap the benefits of granting a loan to Butler Lumber Company if it goes on to do as well as it is expected to do.
A careful evaluation of each of the above alternatives particularly on grounds of the financial ratios, the growth forecasts and the asset position of Butler Lumber Company clearly suggests that Mr. Dodge should, on behalf of Northrop National Bank, refuse Mr. Butler the requested loan. The current financial position of the company is too volatile for the bank to invest in it. Increases in working capital requirements have outrun the capacity of the company to generate funds from its operations. As a result, it has also lost the opportunity to receive discounts on accounts payable. The obligation to pay the partner after his share was bought out, the ten-year loan taken to do the same and the 11% interest on this loan have exerted significant financial pressure on the company. It cannot be denied that in the recent past the company has achieved rapid increase in sales but the projections for the coming year seem considerably overestimated, especially keeping in mind the ongoing economic downturn (Appendix 4). More importantly, the recent growth may be a short-term phenomenon resulting from advantages of location, price-cutting and temporary economies of scale.
It is difficult to tell if the company will continue to do well in the longer term when these benefits reach their saturation point. A spurt of growth cannot be taken as an indicator of long-term profitability and stability for the company. This is not to say that the company will necessarily fail to perform but, keeping in mind the risk involved, investing in it in the current scenario would require a conscious leniency on the bank’s part, an attitude that will also cause displeasure among the bank’s current and most creditworthy customers. Mr. Butler’s credibility can reduce the bank’s apprehension but can definitely not be the sole basis for approving the loan. All of these factors, in addition to the earlier-mentioned concerns, clearly point towards the fact that the loan requested by Butler Lumber Company is a highly risky venture with comparatively low benefits and, therefore, should be denied.