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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.
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