Horniman Horticulture - Cash flow Essay Example
Horniman Horticulture (Horniman) revenue growth is increasing since 2003 it showing a rapid growth then the industry benchmark, which is decreasing by 1.8% per year. In 2004 and 2005 Horniman is constantly growing with increase in the revenue from 2.4% in 2003 to 12.5% in 2005 and 15.5% in 2005 as well as increase in total asset net profit and return on equity respectively, which indicate that it’s doing well within the industry. As we can see in exhibit 1 They have stabilized depreciation as its only rose 20% from 2003 to 2005 (38.4 to 40.9) . The same goes for tax expanse it hasn’t change much by staying around 34 to 34%. One of the Key strength of Bob Brown in regard to management is that he has a good relationship with the employee and customer.
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On the other hand, as we can see in exhibit 1 during this time cash balance has decreased from $120.1 in 2002 to $9.4 in 2005, it’s a decline of 92% over the four year due an increased in total asset by 14.4% and inventory by 8.7% in the last four year from 2002 to 2005. If nothing is done to solve cash problem and continue to burn a lot of cash, debt requirement will become larger and larger and will become a major hazard to the business. Horniman is not collecting payment as the industry benchmark indicates which is 21.8 days it takes Horniman twice as long that is 51 days to collect receivable. As a result account receivable went from $90.6 in 2002 to $146.4 in 2005, an increase of 62.2%. Horniman takes longer to pay its supplier then the industry benchmark that is 26.9 days. In 2003 it’s payable days was 13.3 that is continue with 10.2 days in 2004, which is less than half of the industry benchmark days.
We use the formula (FCFE= NI – Cap Exp – Change WC + Net Borrowing) to get the free cash flow to the firm for 2005.
Operating ProfitTaxesAdd DepreciationOperating Cash FlowCAPEXChange in NWCFCF 100(39.2)40.9101.7(4.5)(97.2)0
As to calculate the conversion cycle of Horniman for 2005 we use the following formula. Cash Conversion Cycle (CCC) = Average Collection Period (ACP)+Inventory Conversion Period (ICP)-Payable Period (PP). ACPPlus ICPMinus PPEqual CCC
Maggie’s Policy just makes PP smaller, which will increase CCC .Cash Conversion Cycle (CCC) is having a substantial impact on the company cash flow. If Horniman left CCC problem unaddressed, it will lead to difficulty meeting payment obligations, funding future growth and potentially solvency. As we can see in Exhibit 2 All three of Horniman CCC working capital categories are worse than the industry average. Horniman using its cash to buy more inventory and to extend their property by 12-acres. Bob Brown is working to move on more mature plants as they are in high demand and are selling for best possible price. As a result, Bob used its majority of cash in the inventory. It also attract new client and increased the risk of non-payment from customer. Browns are making payments almost five times faster than they receiving them in which they are paying for purchases within the 10 day period to receive a 2% discount. That’s why there is gradual decline of the cash balance over the 2004, and 2005 which is resulted from account receivable, inventory and lack of borrowing.
After doing financial forecast in 2006 in Exhibit 1, we found that Horniman needs more cash besides of an increase in the sale that we estimated to growth at 20% in 2006. The cash amount still does not reach the minimum cash level requirement of 8% of the revenue which is about $100.68. It might be due to the fact that the company experiencing an expansion for the past four years.
We estimated the sale to grow at 20% in 2006, although as sales increase Horniman needs to use more operating capital in 2006 to support its growth, we feel that the adjustments made to our NWC policies will slow growth in
2006. . Horniman NWC is increasing since 2004 to 2006 it show that the company is able to increase its operation but as net working capital increase the company need more cash. We think as NWC increase as well as its operation Horniman need more credit sales to increase account receivable in 2006
With the change in payables policy, COGS is estimated to increase from 46% of sales in 2005 to 52% in 2006. Most of the Horniman supplier provides 30-days payment terms with 2% discount for payment made within 10 days which Maggie accepts the term always. Maggie didn’t determine if it is worth for instance the most important factor is current interest rate it helps to determine whether to take the discount or to delay payment till the final day. Furthermore Maggie didn’t look for alternative that in which Maggie should look for better alternative. Maggie always had cash on hand to make the payment on time to take the discount but in long run it will hurt the business. Increasing the payable days would help to reduce the cash conversion cycle as well.
There a few ways that Maggie could use to raise the amount of cash that they have on hand. First, as customer demand may increase for mature plants in 2006, it may be hard for Horniman to improve inventory days. Although, improving both receivable and payable days to benchmark will benefit the company an increase in one-time cash benefit. This will help Horniman to improve cash flow issues and will help with Maggie’s unwillingness to bank borrowing. Second, Maggie need to solve the issue of timing her inflow with outflow in which her outflow are made within 10 days, but she is not collecting from customer every ten days. In order to solve the issue of short term liquidity she need take action. Third, they are planning a huge expenditure next year. They should consider taking a 30 year mortgage for the 6.5% to finance $75000 acquisition. This will save them a huge amount of money in 2006 instated of paying it with the cash they have on hand. And the final option is they should have a preferred customer policy for instate like those customer that always pay early. They could decrease a
percentage of the price for early payment.
Maggie is concerned about future cash flows that it will not be enough in order to provide a sustainable growth. Horniman cash levels is under $10,000 which led to a serious problem and concerns for the business in the future and its operating target of 8% of annual revenue. Maggie’s don’t like the idea of becoming leveraged by debt because it is the possible that the nursery will not generate enough profit to handle the payment for the bank loans and interest. As a result, she has no option but to use her strategy of using the firm’s cash to pay off all inventory demand. But there is a risk involved if the company becomes more leverage by debt. Maggie and Bob borrowing credit continue to increase with this the risk of failing to pay back increase as well in case of unexpected natural disaster. This is major concern for the future that Bob and Maggie face as it’s understandable but not voidable. The family has high hopes for the future and It’s might be possible to achieved the 20% growth based on 2005 operating profit and revenue that are ahead of 2004.