Introduction Horniman Horticulture faces increasing cash account difficulties. Cash accounts have continually been decreasing from years 2002 to 2005. Revenue growth for the business has risen by over 12 percent for years 2004 and 2005. The upcoming year of 2006 brings opportunities for expansion and increased revenue growth. The following plan outlines the state of the business and the suggested solutions to correct the cash flow problems. Background of Firm Horniman Horticulture, an established wholesale nursery business, was acquired in late 2002 by Bob Brown after purchasing the business from his father –in-law.
Horniman Horticulture is located in central Virginia and markets primarily to retail nurseries throughout the mid-Atlantic region. The business specializes in woody shrubs and carries a variety of other plants and trees. Mr. Brown and his wife, Maggie, funded the purchase of the $999,000 nursery through funds they obtained from the sale of their house, a minority-business development grant, and personal loans from family members. Horniman Horticulture employs 12 full-time employees and 15 seasonal workers to aid Mr. Brown in the operation of the 52 greenhouses and 40 acres of fields.
Utilizing the land and personnel employed by Horniman Horticulture, Mr. Brown has been able to increase the number of plant species grown at the nursery by more than 40 percent. He realized the increased demand for “instant landscape” type plants and increased Horniman Horticulture’s stock of mature plants and tree species. The “instant landscape” inventory takes two to five years to liquidate and sells for a higher cost compared to other products offered at the greenhouse. Mrs. Brown controls the business’s finances along with two clerks who oversee the business’s financials.
With Mrs. Brown in control of Horniman Horticulture’s financials and Mr. Brown’s efforts to increase the business’s product lines, they have experienced increases in both profit margin and revenue over the last several years. Mrs. Brown’s goal for managing the business’s finances was to avoid debt financing. Inventory risk was the leading factor of why she avoided bank lending. It was her fear that inventory could be destroyed by poor weather. This would make payment on loans impossible due to products being destroyed and no new revenue. In rder to keep costs low, she would make payments within 10 days to take advantage of trade discounts from suppliers. Mrs. Brown used these strategies, but Horniman Horticulture’s cash flow fell below 8 percent of annual revenue. The low cash balance is a concern for the business due to high cash supplies being the backbone of the Browns’ policy of avoiding debt financing. The Browns plan on increased demand in 2006 due to a maturing product line. They are expecting a 30 percent revenue growth over the previous year. Mr. and Mrs. Brown expect to purchase a neighboring 12 acre farm to further expand business operations in 2006.
Statement of Situation Hortiman Horticulture’s revenue growth has dramtically increased in the past two years. Revenues have increased on average 9 percent each year from 2002 to 2005. During this time, cash balances have decreased. Accounts receivable and inventory have increased in the same time span. Cash has decreased from $120. 1 thousand to $9. 4 thousand. This is a decline of 92 percent over the four year time span (exhibit). In the same period, accounts receivable went from $90. 6 thousand in 2002 to $146. 4 thousand in 2005. This is an increase of 62 percent (exhibit).
The increase in accounts receivable can potentially lead to an increase in bad debt expense Inventory has increased from $468. 3 thousand to $656. 9 thousand. This is an increase of 40 percent (exhibit). These increases and decreases may or may not be beneficial to the business. Hortiman Horticulture’s revenues are growing year to year by an average of 9 percent. The business’s assets and fixed assets are only growing by averages of about 5 percent year to year (exhibit). This information supports why the return on capital and return on assets was increasing.
The business is receiving some discounts by paying within the 10 day discount period. This is a good idea to cut costs and have more cash available, but the business is not receiving payment from their customers in a timely manner. This is shown by the 9 day increase in receivable days since 2002, from 41. 9 to 50. 9 (exhibit). Horniman Horticulture is profitable, and sales growth exceeds all industry benchmarks. The cash flow for the business remains a problem. In 2004, the business’s days sales outstanding were more than two times that of the industry benchmark. Operating improvements created a cash flow problem.
Extending credit terms gave customers more time to make payments. This limited the cash flow for the business’s operations. Inventory was another problem of the business. In 2004, the business’s days’ sales in inventory exceeded 50 days compared to the industry benchmark (exhibit). With inventory sitting on the shelves longer than necessary, this lowered the business’s cash flow, and cost it more than the industry average. Constraint on Solutions Mrs. Brown was concerned about the recent decline in the business’s cash balance to below $10,000 which is 0. 9 percent of revenue (exhibit).
This cash level was far below her operating target of 8 percent of the annual revenue. Hortiman Horticulture maintains financial responsibility by avoiding bank borrowing. Inventory risk, such as adverse weather wiping out their inventory, was the reason that Mrs. Brown did not want to raise money by financing with bank loans. There was a concern about the rise of labor prices which could affect the business’s profits next year. Although the benchmark has shown a negative percentage of revenue growth in the industry, Horniman Horticulture’s revenue has dramatically increased. Mr.
Brown expected that 2006 would be a year with revenue growth hitting 30 percent. But the increase in interest rate could slow the market demand. The Browns anticipated processing the acquisition of a neighboring 12 acre parcel of farmland. They had not yet decided to use the $75,000 capital expenditure for the purchase. The expected depreciation expense for 2006 was $46,000 which is the highest since 2002. Hidden Jewels Hortiman Horticulture’s days payable outstanding in 2002 was almost 17 days lower than the industry’s ratio. This shows it paid suppliers much more quickly than the industry average.
The business appeared to be having trouble on accounts receivables which caused too low of a cash flow. This was not the case. By taking a 2 percent discount for payments received within 10 days of 30 day payment terms, the business was making a profit. The term discount means that while the suppliers expected to be paid within 30 days of the invoice date, the suppliers allowed Horniman Horticulture an additional 2 percent discount if the invoices were paid within 10 days of the invoice date. There are 365 days in a year, or about eighteen 20 day periods (18 * 20 days = 360 days). If the business can earn 2 percent, 18 imes during the year, the result is about a 36 percent annual return. Even if the firm has to borrow money at a 6. 5 percent annual interest rate, it makes sense to take advantage of the terms discount of 2/10 net 30. Revenue growth of Horniman Horticulture has shown positive signs. The business had experienced an increase of 12. 5 percent on sales whereas the industry was down 1. 8 percent in 2004 (exhibit). That growth was due to the business’s response to a growing demand for more mature plants. Compared to the net profit margin of the benchmark, the business’s revenue was almost double with 5. 7 percent comparing to 2. percent (exhibit). By keeping a tight rein on cost of goods sold from 2003 to 2005, the business’s profit margin had increased from 3. 1 percent to an expected 5. 8 percent (exhibit). The business had a strong income statement and profitability ratios. Possible Solutions The 2006 projections of Horniman Horticulture’s financials have revenue growth reaching 30 percent for the new year. Review of the business’s financial history shows evidence that a growth rate of 30 percent is unobtainable due to negative industry revenue growth and a 3 percent increase in revenue growth between years 2004 and 2005.
The revenue is expected to increase at a slower rate which is predicted to be 17 percent (Exhibit). This is 1. 5 percent higher than the previous year’s revenue growth of 15. 5 percent. The 1. 5 percent increase was found by taking half of the increase in revenue growth between years 2004 and 2005. The 3 percent increase was adjusted to provide protection for problems in the cash and accounts receivable of the balance sheet. Implementing the proposed change in revenue growth will give Horniman Horticulture a more realistic projection of items on the income and balance sheet that are calculated with the percentage of sales method.
Issues must be addressed within Horniman Horticulture in order to free up cash and a mounting inventory problem. Much of the business’s assets are allocated in accounts receivable and inventories. While both of these accounts are considered liquid, converting them into cash would take time. Accounts receivable in 2004 for the business was 48 days. This is at least double the industry average of 22 days (Exhibit). To correct the issue, Horniman Horticulture needs to consider adopting the business practice of extending trade discounts similar to the discounts they receive from suppliers of 2/10 net 30.
More stringent terms of sale could greatly reduce the amount of time the accounts receivable remains outstanding. A shorter accounts receivable time is the first step in expediting the amount of time it takes to receive physical cash for inventory sold on credit. Horniman Horticulture’s days in inventory for 2004 was 436. 5 days. This lags behind the industry benchmark of 386. 3 days in inventory (Exhibit). High inventory days could be attributed to the the business’s recent focus of developing a mature plant line that takes years to sell off.
A history of high inventory days shows this is not the case; Horniman Horticulture has consistently lagged behind the industry average. In order to reduce inventories, the business should put a new focus on selling off its inventory to create faster cash flows. Horniman Horticulture should consider financing with debt when it comes to some purchases. Horniman’s accounts payable days is around 10 days, and this is well below the industry average of 26. 9 days (Exhibit). Payment within 10 days makes them eligible for trade discounts offered by their suppliers.
The Browns’ accounts payable policy of paying during the discount period should be continued as long as it does not short them on cash. If paying during the discount period does begin to put them into dangerously low operating cash levels, they should not be afraid to debt finance. The Browns have the opportunity to purchase a neighboring 12-acre piece of farmland. The cost of the land is $75,000, and the offered mortgage rate is at 6. 5 percent. The Browns’ policy of not financing with debt would cause further trouble for the cash account.
It is suggested that Mr. and Mrs. Brown forgo the opportunity of buying the neighboring land until they lower inventory and decrease the length of accounts receivable. Recommended Solution Horniman Horticulture is a thriving business and is greatly outperforming its competitors. The Browns need to adopt the proposed adjustments to the business’s original 2006 projections. The more realistic revenue growth rate of 17 percent will help the business in making changes in its problem areas. In order to continue its strong growth, certain areas need attention.
The business has a history of above average days in inventory. The Browns need to focus on liquidating much of their inventory items before adding more products or expanding business operations. Accounts receivable time should be reduced by extending shorter credit terms that give customers the incentive to pay early and a penalty of accruing interest for late payment. Purchase of the farmland is not advisable due to the low cash balance and the need to reduce inventories. The outlined measures provide both an increased cash flow and stability to the business.
