Butler Lumber

09.12.2016 |

Episode #3 of the course Most influential business school case studies by Magoosh

 

The Butler Lumber case is perhaps the most common introductory case in corporate finance courses. While the case features fairly simple financial concepts, it is a cautionary tale about the pressures that rapidly growing businesses can face in managing cash flows.

Butler Lumber is a small, family-owned business specializing in wood and lumber sales to construction companies. The company had grown substantially in recent years, and despite making good accounting profits was running out of cash and needed a bigger line of credit in order to keep operating. The case centers around the decisions faced by both Butler Lumber and by its potential lenders at Northrop National Bank. Should Butler Lumber seek a bigger line of credit, and should the bank extend it?

The critical takeaway from the Butler Lumber case is that, despite recording accounting profits, companies can and do run out of cash. In Butler’s case, the business is very seasonal, and customers don’t pay until after the delivery of their lumber. That means that there can be quite a long period of time in which Butler Lumber has to pay for parts and labor but before they can collect from their customers. Because Butler lumber is growing so rapidly, it is at risk of spending all of the previous year’s profits to fund the current year’s growth, and as a result running out of cash. If the company runs out of cash, it won’t be able to pay workers or suppliers and will be forced to shut down.

A critically important piece of this case is working through the provided financial documents to establish a target growth rate for Butler Lumber. The bank should not be willing to lend money to Butler if it can’t keep its growth within prescribed targets. Without constrained growth, Butler will simply take the loan and kick the financial crisis can down the road. Butler must restrict growth to get cash flows under control and remain solvent.

This case has broad applicability to any company facing irregular sales and low margins. It also highlights the key difference between finance and accounting—finance is about planning how to use a company’s assets, while accounting is about recording previous transactions. Even more simply, finance is about the future and accounting is about the past. In Butler Lumber’s case, because of growth, future costs were greater than previous profits, resulting in a business being successful on paper but risking insolvency in practice.

 

Recommended book

“The Intelligent Investor: The Definitive Book on Value Investing” by Benjamin Graham, Jason Zweig

 

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