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An Analysis on estimating Funds Requirements
Presented By :Saurabh Kumar Sinha 2009PGP049
Saurabh Patawari 2009PGP050Siddharth Shankar Prasad 2009PGP051
Sourjyo Das 2009PGP052Sreethala Ganapathy 2009PGP053
Shubhangi Shree 2009PGP054
Butler Lumber in Spring 1991Originally 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 BankRelies heavily on trade creditWhy 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 flexibilityHe considers Northrop National Bank as an alternative
Reasons for choosing Northrop over SuburbanHigher cap on loans $465,000This 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 daysTerms 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%
AssumptionsProjected sales in 1991 at $3.6 million with
scope for improvementAbout 55% of the sales during April-
September periodPermanent severance of relationship with
Suburban Bank
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 restrictions imposed by National Bank
Concept :It describes lender’s contribution for each
dollar of owner’s contribution It estimates stability Standard Value is 2:1If it is less than this, it is favourable because:1)High safety margin for lenders 2) Less interest payments3) Scope for more loans4) 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 concernQuick Ratio Considers only cash as quick assets for
meeting short term liability
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
It points to narrow margin of safety for creditors
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 RATIONet 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 comparitively low operating efficiency of the firm
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 increasingAccounts receivable to sales increasingQuick and current ratio is decreasingProjected 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