This scenario portrays the issues related to cash flow and working capital management commonly encountered by small, expanding enterprises. By the conclusion of 2005, Bob and Maggie Brown have successfully run Horniman Horticulture, a woody-shrub nursery generating $1 million in revenue, for three years in central Virginia. Despite enjoying a surge in demand and better profit margins, the Browns find themselves perplexed by the significant decrease in their available cash. The case emphasizes the distinction between cash flow and accounting profits, while also highlighting the adverse impact that growth can have on cash flow.
Furthermore, it serves as a platform for promoting the importance of free cash flow to business owners and managers. It introduces financial-ratio analysis, explores the concept of the cash cycle and working-capital management, and encourages the utilization of financial models.
Increase revenue
Horniman is already experiencing significant growth in revenue. To enhance profit margins and control expansion, it may be beneficial to increase prices and decrease unit growth. Additionally, the Browns should evaluate the potential for expanding into larger shrubs with higher profit margins, while being mindful of the associated inventory investment costs. Furthermore, they should focus on reducing operating expenses, as the case indicates that the business operates efficiently.
Reduce investment
Improve collection time for receivables. Horniman’s receivable-collection time is significantly higher than industry standards, raising questions about the wisdom of expanding the small-nursery business, which appears to rely on generous financing terms. Additionally, enhancing inventory days is a crucial aspect of Horniman’s operations. However, it remains uncertain if the inventory can be improved, especially if the company plans to focus on more-mature plants. Evaluating this trade-off involves a similar analysis as the payables policy, where one must calculate the marginal return on capital by dividing the expected margin gain by the increase in inventory levels. Moreover, increasing inventory levels also poses an additional concern due to the increased risk associated with uncertain interest rates and adverse weather.
Decrease spending on net fixed assets
Horniman seems to be operating well, but concerns arise regarding the need for future capital expenditure growth due to a significant increase in NFA turnover in the past year. A potential solution is for the company to consider raising business financing through debt or equity options. However, at present, with an annual free cash flow of $278,000, Horniman is depleting a substantial portion of its cash reserves. Unless changes are implemented to the business model, it is anticipated that the demand for debt will continue to rise in the coming years.
