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