Horniman Horticulture

1. What is your assessment of the financial performance of this business? What is going well and what concerns you?

With revenue exceeding $1 million for the first time in the company’s history, Horniman Horticulture has been highly successful in growing sales at an increasing rate year over year ever since the Browns took over the business in 2002. Along with consistent top line growth, Horniman has kept cost of goods sold (COGS) relatively stable – between 53 and 48 percent of revenue – which has allowed for expanding profitability. SG&A expense has also been in check and kept below 40 percent of revenue in all of the last four years, which has helped the company’s operating margin remain over 4.5 percent and increase over the last two years. All these factors have contributed to an expanding net profit margin for the last two years, a trend expected to continue in 2006. If the expected 30 percent revenue growth does materialize in 2006, revenue of almost $1.4 million would push net profit margin to over 6 percent – or even higher – and would thrust the company in its most profitable moment ever. Other two measures that point toward Horniman’s success are ROC and ROA, which, at 5.4 and 5.1 percent respectively, are both significantly higher than industry averages.

However, for the company to grow sales by 30 percent in 2006, its cash flow management must improve. Some concerning points that surround this matter are Horniman’s accounts receivable and cash balance. Though Horniman has successfully led revenues up, its accounts receivable balance has also steadily gone up due to the company’s lax receivables policy. Consequently, the cash account has dwindled dramatically to well below the 8 percent of revenue operating target to end 2005 at $9,400. Such a minimal cash balance offers no buffer for unexpected significant contingencies that might require Horniman’s lay out of a substantial amount of cash. A scenario of this type could render the company insolvent and force the sale of assets at a discount in order to maintain the company in business.

Receivables vs. Cash

Figure I

2. What explains the erosion of the cash balance?

As previously laid out, Horniman has failed to establish a sustainable accounts receivable policy that will help the company’s liquidity situation by maintaining a robust available cash balance. At 50.9 days, Horniman’s receivables-days ratio is almost 2.5 times the industry average. Collecting its receivables month and a half after making the sale, the company is taking 25 percent longer to get paid than it did four years ago. This portrays Horniman’s increasing lack of urgency when collecting from its clients. Additionally, the company has constantly expanded its inventory largely financed by internally generated funds. A very strict policy has kept the accounts payable balance around $5,000 and the company’s payables-days ratio at an astounding 9.9 - incredibly low compared to industry standards. Lastly, Horniman’s inventory-days ratio has also increased over the last four years, and at 476 days in 2005 the metric is almost 25 percent higher than the benchmark of 386.3 days. In spite of the much higher than average inventory-days ratio, Horniman has justified keeping its inventory in stock much longer than its competition by centering its business strategy in offering more mature products that take longer to reach a prime point and yield higher profit margins. Perhaps this strategy, paired with other smart cash management tactics, will help improve the company’s cash flow situation.

3. What is your opinion of Maggie's account payable policy?

Taking advantage of available trade discounts is beneficial for Horniman so long as its cash balance permits the prompt payment of payables, which evidently is not the company’s current condition. Therefore, Maggie’s account payable policy is undoubtedly contributing to the rapid depletion of the company’s cash holdings. Though the account payable policy is not solely to blame for the sharp drop in the cash account, extending the payables-day ratio by as much as 100% to about 20 days, or more, could give Horniman more financial flexibility. Maggie, as the person in charge of the company’s finances, should try to bridge gap between the company’s receivables and payables period (51 vs. 10 days). Ideally, the course to take is to substantially lower how long it takes to collect the company’s receivables, but relaxing the account payable policy could enhance Horniman’s cash on hand.

Figure II

A feasible new account payable policy would be to forego trade discounts and extend payable

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