Case #9: HORNIMAN HORTICULTURE Synopsis and Objectives This case captures the problems concerning cash flow and working-capital management typical of small, growing businesses. At the end of 2005, Bob and Maggie Brown have completed their third year of operating Horniman Horticulture, a $1-million-revenue woody-shrub nursery in central Virginia. While experiencing booming demand and improving margins, the Browns are puzzled by their plummeting cash balance. The case highlights the difference between cash flow and accounting profits, as well as the common negative effects of growth on cash flow.
It also provides a forum for instilling appreciation for the relevance of free cash flow to business owners and managers, introducing financial-ratio analysis, developing the concept of the cash cycle and working-capital management, and motivating the use of financial models. Questions 1. What is your assessment of the financial performance of Horniman Horticulture? 2. Do you agree with Maggie Brown’s accounts-payable policy? 3. What explains the erosion of the cash balance? 4. What do you expect the financial position of the business to be in 2006?
Extend the financial statements through 2006, assuming that Bob Brown grows revenue by 30%.
Note: To make the balance sheet balance, define cash as equal to (Curr. liab. + Net worth) – (Accounts receivable + Inventory + OCA + Net fixed assets). What are the alternatives for solving the business’s cash problem? The free-cash-flow calculation provides a reasonable framework for establishing the alternatives facing the Browns. a. Increase profits Increase revenue. Horniman already seems to be growing the top line aggressively.
It may be worth considering raising prices to improve margins and slowing unit growth. Although the Browns might consider further expansion into larger shrubs with better margins, such a move would incur an additional inventory-investment cost. Reduce operating costs. The case suggests that the business is run efficiently. b. Reduce investment Improve receivable-collection time. Horniman is well above industry norms. One can question the wisdom of growing the small-nursery business, which appears to require generous financing terms.
Improve inventory days. This is part of Horniman’s business; it is unclear whether the inventory can be improved, particularly if they are moving to more-mature plants. The analysis to make this trade-off is similar to that of the payables policy. One would divide the expected margin gain by the increase in inventory levels to compute a marginal return on capital. One additional level of concern is the substantial additional risk associated with increasing inventory when facing uncertainty with respect to the effects of interest rates and adverse weather.
Reduce investment in net fixed assets. Horniman already seems to be operating efficiently. NFA turnover has increased strongly over the past year; in fact, there is valid concern that capital expenditures are going to need to increase going forward. c. Increase business financing Debt or equity financing. With annual free cash flow reaching levels of ? $278,000, the business is burning a lot of cash. One should expect that if nothing is done to the business model, debt requirements will become larger and larger.
It is unclear whether Maggie is interested in leveraging the business and risking possible default with an adverse weather event. HORNIMAN HORTICULTURE Projected 2006 Free Cash Flow for Horniman Horticulture (in thousands of dollars) | 2002| 2003| 2004| 2005| 2006E| | | | | | | | | Scenario 1: Exhibit TN1 assumptions with cash balance as plug| | | | | | | | | Operating profit| | 38. 4| 78. 2| 100. 0| 137. 2| | ? Taxes| | 13. 1| 26. 2| 39. 2| 53. 8| | + Depreciation| | 38. 4| 36. 3| 40. 9| 46. 0| | Operating cash flow| 63. 7| 88. 3| 101. 7| 129. 4| | ? Capex| | 38. | 88. 1| 4. 5| 75. 0| | ? Inc. in NWC| | 24. 9| 0. 2| 97. 2| 54. 4| | Free cash flow| | 0. 0| 0. 0| 0. 0| 0. 0| | | | | | | | | | | | | | | | Scenario 2: Exhibit TN1 assumptions with cash balance at 8% of revenue| | | | | | | | Operating profit| | 38. 4| 78. 2| 100. 0| 137. 2| | ? Taxes| | 13. 1| 26. 2| 39. 2| 53. 8| | + Depreciation| | 38. 4| 36. 3| 40. 9| 46. 0| | Operating cash flow| 63. 7| 88. 3| 101. 7| 129. 4| | ? Capex| | 38. 8| 88. 1| 4. 5| 75. 0| | ? Inc. in NWC| | 24. 9| 0. 2| 97. 2| 332. 7| | Free cash flow| | 0. 0| 0. 0| 0. 0| ? 278. 3| |
Cite this Horniman Horticulture
Horniman Horticulture. (2019, May 01). Retrieved from https://graduateway.com/horniman-horticulture/