Roger Barton hummed along to a seasonal carol on the van radio as he made his way over the dark and icy roads of Amherst County, Virginia. He and his crew had just finished securing their nursery against some unexpected chilly weather. It was Christmas Eve 2020, and Roger, the father of four boys ranging in age from 5 to 10, was anxious to be home. Despite the late hour, he fully anticipated the hoopla that would greet him on his return and knew that it would be some time before even the youngest would be asleep. He regretted that the boys holiday gifts would not be substantial; money was tight again this year. Nonetheless, Roger was delighted with what his company had accomplished. Business was booming. Revenue for 2020 was 15% ahead of 2019, and operating profits were up even more. Roger had been raised to value a strong work ethic. His father had worked his way up through the ranks to become foreman of a lumber mill in southwest Virginia. At a young age, Roger began working for his father at the mill. After earning a degree in agricultural economics at Virginia Tech, he married Christine Nelson in 2008. Upon his return to the mill, Roger was made a supervisor. He excelled at his job and was highly respected by everyone at the mill. In 2015, facing the financial needs of an expanding family, he and Christine began exploring employment alternatives. In late 2017, Christines father offered to sell the couple his wholesale nursery business, Nelson Nurseries, near Lynchburg, Virginia. The business and the opportunity to be near Christines family appealed to both Christine and Roger. Pooling their savings, the proceeds from the sale of their house, a minority-business-development grant, and a sizable personal loan from Christines father, the Bartons purchased the business. They agreed that Roger would run the nurserys operations and Christine would oversee its finances. Roger thoroughly enjoyed running his own business and was proud of its growth over the previous three years. The nurserys operations filled 52 greenhouses and 40 acres of productive fields, and the business employed 12 full-time and 15 seasonal employees. Sales were primarily to retail nurseries throughout the midAtlantic region. The company specialized in such woody shrubs as azaleas, camellias, hydrangeas, and rhododendrons, but also grew and sold a wide variety of annuals, perennials, and trees.1 Over the previous two years, Roger had increased the number of plant species grown at the nursery by more than 40%. Roger was a people person. His warm personality endeared him to customers and employees alike. With Christines help, he kept a tight rein on costs. The effect on the businesss profits was obvious, as its profit margin had increased from 3.1% in 2018 to an expected 5.8% in 2020. Roger was confident that the nurserys overall prospects were robust.

Footnote 1. Over the previous year, Nelson Nurseries had experienced a noticeable increase in business from small nurseries. Because the cost of carrying inventory was particularly burdensome for those customers, slight improvements in the credit terms had been accompanied by substantial increases in sales.

With Roger running the business full-time, Christine focused on attending to the needs of their active family and, with the help of two clerks, oversaw the companys books. Roger knew that Christine was concerned about the recent decline in the firms cash balance to below $10,000. Such a cash level was well under her operating target of 8% of annual revenue. But Christine had shown determination to maintain financial responsibility by avoiding bank borrowing and by paying suppliers early enough to obtain any trade discounts.2 Her aversion to debt financing stemmed from her concern about inventory risk. She believed that interest payments might be impossible to meet if adverse weather wiped out their inventory.

Christine was happy with the steady margin improvements the business had experienced. Some of the gains were due to Rogers response to a growing demand for more-mature plants. Nurseries were willing to pay premium prices for plants that delivered instant landscape, and Roger was increasingly shifting the product mix to that line. Christine had recently prepared what she expected to be the end-of-year financial summary (Exhibit 1).3 To benchmark the companys performance, Christine had used available data for the few publicly traded horticultural producers (Exhibit 2).

Roger and Christine agreed that across almost any dimension of profitability and growth, the business appeared to be strong. They also knew that expectations could change quickly. Increases in interest rates, for example, could substantially slow market demand. The companys margins relied heavily on the hourly wage rate of $10.32, currently required for H2A-certified nonimmigrant foreign agricultural workers. There was some debate within the US Congress about the merits of raising this rate.

Roger was optimistic about the coming year. Given the ongoing strength of the local economy, he expected to have plenty of demand to continue to grow the business. Because much of the inventory took two to five years to mature sufficiently to sell, his top-line expansion efforts had been in the works for some time. Roger was sure that 2021 would be a banner year, with expected revenue hitting a record 30% growth rate. In addition, he looked forward to ensuring long-term-growth opportunities by buying a neighboring 12-acre parcel of farmland, on which he expected to close next month.4 But for now, it was Christmas Eve, and Roger was looking forward to taking off work for the entire week. He would enjoy spending time with Christine and the boys. They had much to celebrate for 2020 and much to look forward to in 2021.

Footnote 2. Most of Nelsons suppliers provided 30-day payment terms, with a 2% discount for payments received within 10 days.

3 As compensation for the Bartons services to the business, they had drawn an annual salary of $50,000 (itemized as a selling, general, and administrative [SG&A] expense) for each of the previous three years. This amount was effectively the familys entire income

4 With the acquisition of the additional property, Christine expected 2021 capital expenditures to be $75,000. Although she was not planning to finance the purchase, prevailing mortgage rates were running at 6.5%. The expected depreciation expense for 2021 was $46,000.

.

Footnote:

1 Inventory investment was valued at the lower of cost or market. The cost of inventory was determined by accumulating the costs associated with preparing the plants for sale. Costs that were typically capitalized as inventory included direct labor, materials (soil, water, containers, stakes, labels, chemicals), scrap, and overhead.

2 Other current assets included consigned inventory, prepaid expenses, and assets held for sale.

3 Net fixed assets included land, buildings and improvements, equipment, and software.

4 Purchases represented the annual amount paid to suppliers.

Footnote: 1 Benchmark figures were based on 2019 financial ratios of publicly traded horticultural producers.

Questions:

Exhibit 1 Nelson Nurseries Projected Financial Summary for Nelson Nurseries (in thousands of dollars) 2017 2018 2019 2020 908.2 Profit and Loss Statement Revenue Cost of goods sold Gross profit SG&A expense Depreciation Operating profit Taxes Net profit 788.5 402.9 385.6 301.2 34.2 807.6 428.8 378.8 302.0 437.7 470.5 1,048.8 503.4 545.4 404.5 40.9 356.0 38.4 36.3 50.2 38.4 78.2 100.0 17.6 13.1 26.2 39.2 32.6 25.3 52.0 60.8 120.1 105.2 66.8 9.4 146.4 Balance Sheet Cash Accounts receivable Inventory Other current assets? Current assets Net fixed assets Total assets 90.6 99.5 468.3 507.6 20.9 19.3 699.9 731.6 332.1 332.5 1,032.0 1.064.1 119.5 523.4 22.6 732.3 384.3 1,116.6 656.9 20.9 833.6 347.9 1,181.5 6.0 5.3 4.5 5.0 24.4 19.7 22.0 22.1 Accounts payable Wages payable Other payables Current liabilities Net worth 10.2 15.4 16.6 17.9 47.3 35.9 42.7 43.2 996.1 1,021.4 1,073.4 1,134.2 22.0 38.8 88.1 4.5 Capital expenditure Purchasest Source: All exhibits created by author 140.8 145.2 161.2 185.1 Exhibit 2 Nelson Nurseries Financial Ratio Analysis of Nelson Nurseries and Benchmarking 2017 2018 2019 2020 Benchmark 2.9% 2.4% 12.5% 15.5% (1.8% 48.9% 46.9% 51.8% 52.0% 48.9% Revenue growth Gross margin (gross profit / revenue) Operating margin operating profit/ revenue) Net profit margin (net profit / revenue) 6.4% 4.8% 8.6% 9.5% 7.6% 4.1% 3.1% 5.7% 5.8% 2.8% 3.2% 2.4% 4.7% 5.1% 2.9% Return on assets (net profit / total assets) Return on capital (net profit) total capital) 3.3% 2.5% 4.8% 5.4% 4.0% 41.9 45.0 48.0 50.9 21.8 424.2 432.1 436.5 476.3 386.3 Receivable days (accounts receivable [AR] / revenue * 365) Inventory days inventory / cost of goods sold [COGS * 365) Payable days (accounts payable [AP] / purchases * 365) Net fixed assets (NFA) turnover (revenue / NFA) 15.6 13.3 10.2 9.9 26.9 2.4 2.4 2.4 3.0 2.7 This case was written in March 2020 but case date is Dec 2020. The case author has chosen not to show the impact of the pandemic. We will run the base case as the author intended but address the pandemic in a sensitivity analysis for the year 2021. In addition, please assume you are a consultant to Nelson Nurseries and you found a bank willing to lend short term. The loan amount should not exceed 30% of inventories and 50% of accounts receivable. You have convinced the Nelsons to borrow when needed. Assume capex was incurred in early 2021 as described by the case. Please put forecast balance sheet and income statement in ppt. 1. What is this company doing well? 2. Run an analysis of historical ratios (numbers are already provided on exhibit 2) over time and against benchmark competitors. Is Nelson financially healthy? Please make sure to comment on CCC (using days receivables, inventory and accounts payables) and SGR. Be prepared to explain accounts payables terms. Assume accounts receivables have same terms as payables. Assumptions: Days payable should be calculated as Accounts payable/average COGS for simplicity. For simplicity, do not use the purchases numbers in this exam. 3. Base case: Run a forecast of income statement and balance sheet for 2021. For numbers 3, 4 and 5 below, where there are no assumptions provided you may run your own and justify. Assumptions: Revenue growth of 30%, same days receivable, inventory and accounts payable as 2020. Assume same percentage to revenue as 2020 for following accounts: COGS, SGA, Other current assets, Wages Payable, Other payables. Tax rate is same as 2020. Assume cash is 8% of revenues. Loan interest rate is 7%. Please calculate Accounts payable based on the formula above. Hint: you may use goal seek to make sure Assets-(Liabilities plus equity) = 0 and use loans as the balancing number (if there is a drawdown) Describe your results and what is driving results. 4. Sensitivity 1 for 2021 income statement and balance sheet: What if the company were able to achieve the same working capital management metrics as its benchmarks, i.e. same receivable days, inventory days and accounts payable days? Assume the competitor benchmarks have the same receivable and payable terms as Nelson. Use the same loan interest rate and cash percentage to sales as number 3 for Nelson. Describe your results and what is driving results. 5. Sensitivity 2 (Pandemic) for 2021 income statement and balance sheet: Please run a sensitivity for 2021 assuming an unfavorable economic environment such as the pandemic. Assume revenues decline by 25%. Loan interest rate is a concessionary 6.5%. Use same receivables, inventory and accounts payable days and capex as base case. Because of certain price concessions, gross margin is reduced to 47% and certain cost cutting measures will drive SG and A to a flat $450,000 (rather than percentage of sales). Describe your results and what is driving results. 6. Free Cash Flow or Cash flow from Assets - Please provide a detailed 2021 free cash flow estimate for base, sensitivity 1 and sensitivity 2 scenarios. For comparison, also calculate free cash flow for 2018, 2019 and 2020. For changes in net working capital, to simplify calculations, please only use changes in receivables, inventory and accounts payable and not current assets minus current liabilities). Compare to net income. Interpret your results. 7. Recommendations: How can this company improve its performance under normal circumstances? Exhibit 1 Nelson Nurseries Projected Financial Summary for Nelson Nurseries (in thousands of dollars) 2017 2018 2019 2020 908.2 Profit and Loss Statement Revenue Cost of goods sold Gross profit SG&A expense Depreciation Operating profit Taxes Net profit 788.5 402.9 385.6 301.2 34.2 807.6 428.8 378.8 302.0 437.7 470.5 1,048.8 503.4 545.4 404.5 40.9 356.0 38.4 36.3 50.2 38.4 78.2 100.0 17.6 13.1 26.2 39.2 32.6 25.3 52.0 60.8 120.1 105.2 66.8 9.4 146.4 Balance Sheet Cash Accounts receivable Inventory Other current assets? Current assets Net fixed assets Total assets 90.6 99.5 468.3 507.6 20.9 19.3 699.9 731.6 332.1 332.5 1,032.0 1.064.1 119.5 523.4 22.6 732.3 384.3 1,116.6 656.9 20.9 833.6 347.9 1,181.5 6.0 5.3 4.5 5.0 24.4 19.7 22.0 22.1 Accounts payable Wages payable Other payables Current liabilities Net worth 10.2 15.4 16.6 17.9 47.3 35.9 42.7 43.2 996.1 1,021.4 1,073.4 1,134.2 22.0 38.8 88.1 4.5 Capital expenditure Purchasest Source: All exhibits created by author 140.8 145.2 161.2 185.1 Exhibit 2 Nelson Nurseries Financial Ratio Analysis of Nelson Nurseries and Benchmarking 2017 2018 2019 2020 Benchmark 2.9% 2.4% 12.5% 15.5% (1.8% 48.9% 46.9% 51.8% 52.0% 48.9% Revenue growth Gross margin (gross profit / revenue) Operating margin operating profit/ revenue) Net profit margin (net profit / revenue) 6.4% 4.8% 8.6% 9.5% 7.6% 4.1% 3.1% 5.7% 5.8% 2.8% 3.2% 2.4% 4.7% 5.1% 2.9% Return on assets (net profit / total assets) Return on capital (net profit) total capital) 3.3% 2.5% 4.8% 5.4% 4.0% 41.9 45.0 48.0 50.9 21.8 424.2 432.1 436.5 476.3 386.3 Receivable days (accounts receivable [AR] / revenue * 365) Inventory days inventory / cost of goods sold [COGS * 365) Payable days (accounts payable [AP] / purchases * 365) Net fixed assets (NFA) turnover (revenue / NFA) 15.6 13.3 10.2 9.9 26.9 2.4 2.4 2.4 3.0 2.7 This case was written in March 2020 but case date is Dec 2020. The case author has chosen not to show the impact of the pandemic. We will run the base case as the author intended but address the pandemic in a sensitivity analysis for the year 2021. In addition, please assume you are a consultant to Nelson Nurseries and you found a bank willing to lend short term. The loan amount should not exceed 30% of inventories and 50% of accounts receivable. You have convinced the Nelsons to borrow when needed. Assume capex was incurred in early 2021 as described by the case. Please put forecast balance sheet and income statement in ppt. 1. What is this company doing well? 2. Run an analysis of historical ratios (numbers are already provided on exhibit 2) over time and against benchmark competitors. Is Nelson financially healthy? Please make sure to comment on CCC (using days receivables, inventory and accounts payables) and SGR. Be prepared to explain accounts payables terms. Assume accounts receivables have same terms as payables. Assumptions: Days payable should be calculated as Accounts payable/average COGS for simplicity. For simplicity, do not use the purchases numbers in this exam. 3. Base case: Run a forecast of income statement and balance sheet for 2021. For numbers 3, 4 and 5 below, where there are no assumptions provided you may run your own and justify. Assumptions: Revenue growth of 30%, same days receivable, inventory and accounts payable as 2020. Assume same percentage to revenue as 2020 for following accounts: COGS, SGA, Other current assets, Wages Payable, Other payables. Tax rate is same as 2020. Assume cash is 8% of revenues. Loan interest rate is 7%. Please calculate Accounts payable based on the formula above. Hint: you may use goal seek to make sure Assets-(Liabilities plus equity) = 0 and use loans as the balancing number (if there is a drawdown) Describe your results and what is driving results. 4. Sensitivity 1 for 2021 income statement and balance sheet: What if the company were able to achieve the same working capital management metrics as its benchmarks, i.e. same receivable days, inventory days and accounts payable days? Assume the competitor benchmarks have the same receivable and payable terms as Nelson. Use the same loan interest rate and cash percentage to sales as number 3 for Nelson. Describe your results and what is driving results. 5. Sensitivity 2 (Pandemic) for 2021 income statement and balance sheet: Please run a sensitivity for 2021 assuming an unfavorable economic environment such as the pandemic. Assume revenues decline by 25%. Loan interest rate is a concessionary 6.5%. Use same receivables, inventory and accounts payable days and capex as base case. Because of certain price concessions, gross margin is reduced to 47% and certain cost cutting measures will drive SG and A to a flat $450,000 (rather than percentage of sales). Describe your results and what is driving results. 6. Free Cash Flow or Cash flow from Assets - Please provide a detailed 2021 free cash flow estimate for base, sensitivity 1 and sensitivity 2 scenarios. For comparison, also calculate free cash flow for 2018, 2019 and 2020. For changes in net working capital, to simplify calculations, please only use changes in receivables, inventory and accounts payable and not current assets minus current liabilities). Compare to net income. Interpret your results. 7. Recommendations: How can this company improve its performance under normal circumstances