Introduction: Horniman Horticulture is currently facing cash flow problems, as their cash accounts have decreased from 2002 to 2005. Nonetheless, their revenue has grown by more than 12% in both 2004 and 2005, suggesting potential for expansion and higher income in the future. This plan deals with the current condition of the business and offers solutions to overcome the challenges related to cash flow.
Background of Firm: Horniman Horticulture is a wholesale nursery company that was purchased by Bob Brown in late 2002 after he acquired it from his father-in-law.
Horniman Horticulture is a company based in central Virginia that primarily sells to retail nurseries in the mid-Atlantic region. They specialize in woody shrubs and also offer a variety of other plants and trees. The nursery was purchased for $999,000 with funding from the sale of Mr. Brown and his wife Maggie’s house, a minority-business development grant, and personal loans from family members. The business is managed by Mr. Brown with the help of 12 full-time employees and 15 seasonal workers. They operate 52 greenhouses and maintain 40 acres of fields.
Mr. Brown has been able to expand the variety of plant species grown at the nursery by over 40% by utilizing the land and personnel of Horniman Horticulture. Recognizing the growing demand for “instant landscape” plants, he also increased the stock of mature plants and trees at the greenhouse. These “instant landscape” products take two to five years to sell, but they fetch a higher price compared to other items available. In terms of financial management, Mrs. Brown oversees the business’s finances alongside two clerks responsible for financials.
Despite Mrs. Brown’s control over Horniman Horticulture’s financials and Mr. Brown’s efforts to expand the business’s product lines, both profit margin and revenue have increased in recent years. Mrs. Brown’s goal was to manage the business’s finances without relying on debt financing, primarily due to the risk of inventory damage caused by adverse weather conditions. This fear stemmed from the potential inability to repay loans if products were destroyed and no new revenue could be generated.
To keep costs low, Mrs. Brown ensured payments were made within 10 days to benefit from trade discounts provided by suppliers. However, Horniman Horticulture’s cash flow dropped below 8 percent of annual revenue, which is concerning as maintaining a high cash balance was integral to the Browns’ debt financing avoidance strategy.
Looking ahead to 2006, the Browns anticipate an increase in demand due to the maturity of their product line, predicting a 30 percent growth in revenue compared to the previous year. Their plans for business expansion involve acquiring a neighboring 12 acre farm.
Statement of Situation Hortiman Horticulture’s revenue growth has significantly grown in the past two years. Revenues have increased by an average of 9 percent each year from 2002 to 2005. However, during this time, cash balances have decreased while accounts receivable and inventory have increased.
Cash has declined from $120.1 thousand to $9.4 thousand, a decrease of 92 percent over the four-year period (exhibit). Accounts receivable, on the other hand, have risen from $90.6 thousand in 2002 to $146.4 thousand in 2005, an increase of 62 percent (exhibit).
The increase in accounts receivable has resulted in a potential rise in bad debt expense. The exhibit shows that the inventory has increased from $468.3 thousand to $656.9 thousand, indicating a 40 percent growth. It is uncertain whether these changes are beneficial for the business. According to the exhibit, Hortiman Horticulture experiences an annual revenue growth rate of about 9 percent, while its assets and fixed assets grow at an average rate of approximately 5 percent per year. These details support the increase in return on capital and return on assets.
The business is benefiting from discounts by paying within the 10-day discount period, which helps to reduce costs and increase available cash. However, the business is facing a delay in receiving payments from their customers. This delay is evident in the increase in receivable days from 41.9 to 50.9 since 2002 (exhibit). Despite being profitable and having sales growth that surpasses industry benchmarks, the business still faces cash flow issues. In 2004, the business’s days sales outstanding were more than twice the industry benchmark, indicating that operational improvements have created a cash flow problem.
By extending credit terms, the business allowed customers to have more time to pay, but this had the consequence of limiting the business’s cash flow. The business also faced issues with inventory, with days’ sales in inventory exceeding 50 days in 2004, compared to the industry benchmark (as shown in the exhibit). This prolonged inventory sitting on shelves unnecessarily, resulting in lower cash flow for the business and higher costs compared to the industry average. Mrs. Brown, the decision-maker, was particularly concerned about the recent decline in the business’s cash balance, which fell below $10,000, representing 0.9 percent of revenue (exhibit).
This cash level was significantly lower than the desired 8 percent of annual revenue, which is the operating target for Hortiman Horticulture. To maintain financial responsibility, the company avoids borrowing from banks. Mrs. Brown was hesitant to raise funds through bank loans due to the risk of inventory loss caused by adverse weather conditions. Additionally, there was concern about potential increases in labor prices impacting next year’s profits. Despite negative revenue growth in the industry benchmark, Horniman Horticulture has experienced a significant increase in revenue.
Brown had high expectations for revenue growth in 2006, projecting a 30 percent increase. However, the rise in interest rates could potentially impede market demand. The Browns had plans to acquire a neighboring 12 acre plot of farmland but had not yet decided whether to utilize the $75,000 capital expenditure for the purchase. The anticipated depreciation expense for 2006 was $46,000, marking the highest amount since 2002. In 2002, Hidden Jewels Hortiman Horticulture’s days payable outstanding ratio was nearly 17 days lower than the industry average. This indicates that the company paid its suppliers significantly faster than the industry norm.
The business was struggling with accounts receivables, which resulted in a low cash flow. However, they were able to overcome this by offering a 2 percent discount for payments made within 10 days of the standard 30-day payment terms. This meant that suppliers allowed Horniman Horticulture to deduct an additional 2 percent if invoices were paid within 10 days instead of the expected 30 days. By implementing this strategy, the business could earn a 2 percent return eighteen times throughout the year, resulting in an estimated annual return of about 36 percent since there are approximately eighteen 20-day periods in a year (365 days). Despite having to borrow money at a yearly interest rate of 6.5 percent, it still made financial sense for them to take advantage of this discount. Additionally, Horniman Horticulture experienced positive signs of revenue growth with their sales increasing by 12.5 percent in2004 while the industry as a whole declined by1.8 percent during that period.This growth was attributed to meeting the growing demand for more mature plants and their higher revenue margin compared to competitors.The exhibit shows that Horniman Horticulture’s net profit margin was nearly double compared to the benchmark’s net profit margin at5.7percent versus2percent respectively.Furthermore, their profit margin improved from3.1percent in2003to an expected5.8percent by2005.
The business has shown strong income statement and profitability ratios, indicating successful performance and financial health. However, it is unlikely that Horniman Horticulture can achieve their projected revenue growth of 30 percent for 2006. This is primarily because the industry revenue growth is negative and there was only a small increase in revenue growth from 2004 to 2005, which was just 3 percent.
The expected revenue growth rate is 17 percent, which is 1.5 percent higher than the previous year’s growth rate of 15.5 percent (Exhibit). This increase of 1.5 percent was determined by taking half of the increase in revenue growth between 2004 and 2005. Additionally, a 3 percent increase was adjusted to address potential issues in the cash and accounts receivable on the balance sheet. By implementing this proposed change in revenue growth, Horniman Horticulture will have a more accurate projection of income and balance sheet items that are calculated using the percentage of sales method.
The main issues that Horniman Horticulture needs to resolve are obtaining cash and addressing a growing inventory problem. The company’s assets primarily consist of accounts receivable and inventories, which are both considered liquid but take time to convert into cash. In 2004, it took an average of 48 days for accounts receivable to be paid, which is twice the industry average of 22 days (Exhibit). To address this issue, it is recommended that Horniman Horticulture implements a business practice where they offer trade discounts similar to those received from suppliers. For instance, they could provide a 2% discount if payment is made within 10 days or require the full amount to be due within 30 days.
More strict sales terms can significantly decrease the duration that the accounts receivable remain unpaid. A shorter accounts receivable period is the initial step in accelerating cash collection for credit sales of inventory. In 2004, Horniman Horticulture had a days in inventory of 436.5 days, which is higher than the industry standard of 386.3 days (Exhibit). The extended inventory period may be due to the company’s recent emphasis on cultivating a mature plant line that requires several years to sell.
Despite a history of high inventory days, Horniman Horticulture has consistently fallen behind the industry average. To address this issue and generate cash flow more quickly, the company should prioritize selling off its inventory. Additionally, Horniman Horticulture should explore debt financing options for certain purchases. Currently, their accounts payable days is only 10, which is significantly lower than the industry average of 26.9 days (Exhibit). By paying within 10 days, the company can take advantage of trade discounts provided by their suppliers.
The Browns should continue their accounts payable policy of paying during the discount period, provided it does not compromise their cash reserves. If paying within the discount period starts to deplete their operating cash to perilously low levels, they should feel comfortable exploring debt financing. The Browns are presented with a chance to acquire a 12-acre neighboring farmland, which comes with a cost of $75,000 and an offered mortgage rate of 6.5 percent. Refusing to finance through debt, as per the Browns’ policy, would worsen their cash situation.
It is suggested that Mr. and Mrs. Brown postpone buying the neighboring land until they reduce inventory and decrease the length of accounts receivable. The recommended solution for Horniman Horticulture, a successful business outperforming its competitors, is to adopt the proposed adjustments to the original 2006 projections. Implementing a more realistic revenue growth rate of 17 percent will assist the business in addressing its problem areas and sustaining strong growth.
The business has a history of above average days in inventory. The Brown family should prioritize selling off a significant portion of their inventory before considering adding more products or expanding their operations. To reduce the amount of time it takes to collect payments from customers, they should offer shorter credit terms that incentivize early payments and implement a penalty system where late payments incur interest charges. With the current low cash balance and the objective of reducing inventories, it is not recommended to purchase the farmland. These proposed measures will contribute to a boost in cash flow as well as overall stability for the business.
