The Gilbert Lumber Co. is faced with a need for increased bank financing due to its rapid sales   growth and low profitability. Students must determine the reasons for the rising bank borrowing, estimate the amount of borrowing needed, and assess the attractivenessf of the loan to the bank.  Allows students to practice ratio analysis, financial forecasting, and evaluating financing


1. Why has Gilbert Lumber borrowed increasing amounts despite its consistent profitability?

Due to the increase in sales growth, the company may not sustain on smaller loans, but instead needs to look on the ones that offer them bigger loans and greater autonomy with these loans. Due to a shortage of cash, the maximum loan provided by Ferryn National Bank to the

borrower may not be enough, which is why it needs to rely heavily on trade credit. Sales rose by 18.62% in 2012 and by 33.83% in 2013. Additionally, the COGs had risen by 59.6 percent. The  increase in sales might put a strain on the company's ability to keep up with market demand in    the future, causing an increase in its operating activities, which would require more assets and    property. In order to keep up with the financial needs of the company, Gilbert Lumber is

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considering a new banking relationship with Kai National Bank that is more flexible and provides unsecured loans.

2. How has Mr. Gilbert met the financing needs of the company during the

period 2011 through 2013 Has the financial strength of the company improved or deteriorated? From 2011 to 2013, the company's net sales increased by 58.8%, and the total cost of goods

sold increased by 59.6%. This means that Mr. Gilbert has always controlled the proportion of

investment. In addition, the increase in net sales, total assets, and total liabilities also means the company can have new markets every year. Therefore, Mr. Gilbert was able to meet the

company's financing needs during the period from 2011 through 2013. As for the company's

financial strength, however, the current ratio declined from 1.8 to 1.45, and the quick ratio

decreased from 0.88 to 0.67 from 2011 through 2013, making them farther from the standards of 2 and 1 respectively. This means that the company's debt repayment ability decreased, so the

financial risk was higher, and financial strength deteriorated.

Despite strong sales growth and revenue, the company is facing liquidity issues. The

company has a working capital ratio of .169 in 2011 and 0.178 in 2013 which is signaling these   liquidity issues. In addition, the times interest earned ration decreased from 3.85 in 2011 to 2.6 in 2013 meaning less operating income is available to cover interest on debt financing. A TIE ratio   below 2.5 puts a company at higher risk of default or bankruptcy. With increased demand and

sales, the company expanded its debt obligations to finance operations and company growth, the debt to capital ratio increased from .353 in 2011 to .385 in 2013.

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The company is facing tight margins as it expands operations. As the company is growing due to strong sales growth the costs are increasing along with revenue and the gross margin has

decreased from 27.99% in 2011 to 12.10% in 2013. In addition, the company may be facing

increased COGs and operating expenses with return on sales decreasing from 1.83% in 2011 to 1.63% in 2013. This may signal profitability and efficiency issues in the future if costs do not   stabilize or revenue and sales growth declines. The company is growing its operating income    slowly but the margins are very tight, the operating income ratio increased from 2.96% in 2011 to 3.19% in 2013. Overall, Mr. Gilbert is using debt financing to operate his company and

expand operations, margins are tight, and the company needs cash to cover debt obligations and improve its financial position.

3. How attractive is it to take the trade discounts?

Trade discount is the discount on price allowed on a product per the agreement agreed between two parties. In the case of The Gilbert Lumber Co, the terms of agreement provided for a

discount of 2% for payments made by the lumber company within 10 days of the invoice date.   This is highly beneficial and should be utilized because taking the total purchases of one quarter and multiplying by the 2% discount give the amount saved by Gilbert if payments are made

within 10 days to suppliers.

4.  Do you agree with Mr. Gilbert’s estimate of the company’s loan

requirements? How much will be needed to finance the expected expansion in sales to $3.6 million in 2014and to take all trade discounts?

In order to understand how much funds Mr. Gilbert needs to finance his

expansion, we forecasted a scenario showing the effects of using the trade discount of 2% on all 2014 purchases. Operating under the assumption

that the trade discount is utilized, we added back a trade discount “profit” of $44,000 ((forecasted  purchases 2014 – first quarter purchases

2014)*2%) to income taxes, leading to a final net income of $53,000.

While this net income is larger than the $44,000 yielded in 2013, the

profitability decreases from 1.63% in 2013 to 1.39 in 2014 due to higher interest expenses from larger debt.

We do not agree with Mr. Gilbert’s estimate of the company’s loan

requirements, and he will need to borrow more than $465,000 both if he

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continues operations like the previous years, and if he reduces his DPO

and takes advantage of the trade discount. If he takes the trade discount they would need a loan of $712,000, showcasing that besides the cost

savings from the discount, the approach requires considerable more financing.

5. As Mr. Gilbert’s financial advisor, would you urge him to go ahead with, or to reconsider, his anticipated expansion and his plans for additional debt

financing? As the banker, would you approve his loan request, and, if so, what conditions would you put on the loan?

As a financial advisor, I recommend that Mr. Gilbert reconsider his anticipated expansion and additional debt financing plans. The company's sales increased every year from 2011 to

2013. However, the return on sales ratio decreased annually, from 1.83% in 2011 to 1.63% in

2013. Even though the Gilbert Lumber company still has good profitability, the ratio shows it did not control its costs well. In addition, the company is carrying a large amount of debt. Its debt-to- equity ratio increased sharply in 2011, 2012, and 2013, 65.19%, 69.08%, and 83.33%,

respectively. In the first quarter of 2014, its percentage reached 128.29%. The Gilbert Lumber Company's leverage is well above the medium ratio of the companies related to the lumber

industry (Lumber and Wood Products, n.d.).

As a banker, I would not approve his loan request. Although Gilbert Lumber's sales are

on a good upward trend, its profitability has not improved significantly in the previous three

years' figures. Moreover, the year-on-year decline (from 3.85 in 2011 to 2.61 in 2013) in its times interest earned ratio shows it is gradually deteriorating from a healthy company. The company is  also running out of cash. The current ratio declined in the previous three years from 2.28 (2011)   to 1.59 (2012) and 1.45 (2013). The company's quick ratio has also been declining year after year and has been below 1. The company does not have enough liquid assets to meet its short-term

obligations. Gilbert Lumber runs a high-risk business (IBISWorld - Industry Market Research,

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Reports, and Statistics, n.d.). Therefore, considering its business operations condition, the risk of investing in this company is relatively high.


IBISWorld - Industry Market Research, Reports, and Statistics. (n.d.).

Lumber And Wood Products, Except Furniture: industry financial ratios benchmarking. (n.d.).