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Case #9: Horniman Horticulture: A. Increase Profits

Horniman Horticulture is experiencing strong revenue growth but declining cash balances. While profits and margins are improving, the growth is requiring significant investments in working capital like inventory and accounts receivable. This is causing free cash flow to turn negative despite profitability. To solve the cash flow problem, alternatives include increasing profits through price increases, reducing costs, improving collection of receivables, managing inventory levels more efficiently, or obtaining financing through debt or equity.

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Ryan Youngren
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274 views

Case #9: Horniman Horticulture: A. Increase Profits

Horniman Horticulture is experiencing strong revenue growth but declining cash balances. While profits and margins are improving, the growth is requiring significant investments in working capital like inventory and accounts receivable. This is causing free cash flow to turn negative despite profitability. To solve the cash flow problem, alternatives include increasing profits through price increases, reducing costs, improving collection of receivables, managing inventory levels more efficiently, or obtaining financing through debt or equity.

Uploaded by

Ryan Youngren
Copyright
© © All Rights Reserved
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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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 38.8 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

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