CSF 2

Solution to Questions

Question one

One of the strengths of the Horniman horticulture is Bob’s excellent work ethics, leadership, and tendency to be a people person when dealing with clients and employees. Bob plays an indispensable role of developing a positive working environment for clients and employees. Consequently, building a strong relationship with employees and customers. Bob’s degree in Agriculture economics is a strength for the firm. After graduating, he was installed as the supervisor. He was responsible for increasing the business product lines. For example, due to his response to growing demand for more mature plants there was a steady margin improvement. Reliable and stable growth rate is a strength for the firm. This increased efficiency and productivity of the firm. Consequently, the firm can increase sales and reduce expenses. As can be seen from the portfolio, revenues grew to 33% and cost of goods grew to 25%, an indication of prosperity.

Major weakness of the Horniman Horticulture is Maggie’s payable policy. From the portfolio, the payable days are below the benchmark. This shows that the firm is not able to exploit the leeway in payment. This leads to cash problem because the payable time is short while the collection period is too long. Another weakness is the erosion of cash. The cash reserve of the firm has drastically reduced from $120,00 in 2002 to $9,400 in 2005. If the firm proceeds at this alarming rate, it can run to solvency issues.

Question two

FCFE = Operating Cash Flow – Change in Net Working Capital – Change in Investments

Operating profit before tax is 100 + 40.9 = 140.9

Cash outflow = 39.2

Working Capital in 2004 = 732.3 – 43.2 = 689.1

Working Capital in 2005 = 833.6 – 47.3 = 786.3

Change in working capital =786.3 – 689.1 = 97.2

Capital expenditure in 2005 = 4.5

FCFE = 140.9 -39.2 – 97.2 – 4.5 = 0.1

Cash Cycle = DIO+ DSO – DPO

DIO = Days Inventory Outstanding =476

DSO = Days Sales Outstanding =51

DPO = Days Payable Outstanding = 10

Cash Cycle = 476 + 51 – 10 = 517 days

The cash reserve for Horniman Horticulture greatly reduced from $120,000 in 2002 to $9,400 in 2005. The productivity of Horniman Horticulture has increased by 40% in 2006 by extending property by 12%, this reduced a lot of cash. Horniman Horticulture offers a longer period or DSO and shorter days for payments plus 2% discount, therefore, improves its credit terms. DIO for the firm is still a primary concern. Bob focuses on maturing plants and therefore their inventory is longer than the benchmark. Even at its lowest it is still greater that the benchmark.

Question three

By 2006, Horniman Horticulture growth trend is anticipated to be stronger. Even with such anticipation the cash deficit has been a primary concern since capital expenditure and working capital need to be increased in order to hold leverage to solve this crisis.

Financial Summary of Horniman Horticulture (in thousands of dollars)

Profit and loss statement

Gross Profit

SG&A Expense

Depreciation

Operating profit

Net Profit

Balance sheet

Accounts receivable

Inventory

Other Current Assets

Current assets

Net Fixed Assets

Total Assets

Accounts Payable

Wages Payable

Accounts payable

Wages Payable

Other payables

Current Liabilities

Net Worth

Capital Expenditure

Purchases

Question four

Horniman Horticulture current accounts payable policy of ten days is 2.7 times faster than the benchmark of 27days. This system is not suitable because a client is offered up to 51 days, which is twice the benchmark. In 2005, the net profit margin was 5.8%, while the benchmark was 2.8%; therefore, Horniman Horticulture was not required to pay for supplies early. Instead, the firm should exploit the credit terms offered of one month to pay back for purchase commodities. In addition, Horniman Horticulture will reduce their credit terms, thus leaving more money available as the CCC will be shorter. If Horniman Horticulture fails to transmute in the long run, the inadequate cash may lower the purchasing power and operating capacity of the firm.

Question five

In order to solve the impending cash crisis, Horniman Horticulture needs to provide discounts to buyers who make early payments.This will enable the firm to collect money. The firm also needs to take full advantage of the offered credit terms. Using this strategy holds more cash for the firm. The firm also needs to reduce the pace of expansion and capital expenditure. The firm can sell products that do not take longer to mature as this eliminates risks associated with storing the plants. The firm can also raise funds by transforming the firm into a partnership, and benefit from labor and property of the partners.

Question six

Sustainable growth = ROA x Leverage x Retention

ROA = Net profit/Total assets = 5.4%

Leverage= Total Assets/Net Worth= 1181.5/1134.2=1.04

Retention =1-Divident Payout Ration = 1- (185.1/60.8) = — 2.04

Sustainable growth = 5.4% x 1.04 x -2.04=-0.115

Economic profit= (ROA – Cost of Capital) x Total Assets

Cost of capital = 10%

Total Assets = 1181.50

Net Worth=1134.20

Economic profit= (5.4% — 10%) x1181. 50 = -54.35

From the calculations, the profit is negative, indicating that the company does not earn revenue from the capital. The business is experiencing dismissing level of cash. Consequently, the company will attain a negative cash level. From the calculations, a lot of cash is held up in the inventory and account receivables. Horniman Horticulture needs to increase their credit terms. This is beneficial in averting the risk associated with dealing with the longer mature range of the products.

List of references

Bruner, RF, Eades, KM & Schill, M J 2013, Case Studies in Finance, 7th ed. McGraw-Hill/Irwan, United States.