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HORTON BUILDING

SUPPLIES
Final Project

PRESENTED TO:
PROFESSOR EESHAH TARIQ
GROUP MEMBERS:
ATIF ARIF

L1F09BBAM0232

ZAIN LATIF
JAFFER KHALID
M. ZEESHAN YOUNUS
COURSE:
FINANCIAL ANALYSIS
DATE:
9TH JANUARY, 2014

HORTON BUILDING SUPPLIES - W ORKING


CAPITAL
INTRODUCTION
Horton Building Supplies (HBS) is a company located in Millsbaugh County located a
few miles south of Kansas City. With opportunity that arouse from Kansas Nebraska
Act in 1854, Thomas Horton (a land-owing farmer in Indiana) moved to Millsbaugh in
1858. Horton started his own business that that dealt in:

Retail Lumbaryad Selling to local contractors and townspeople


Paint
Hardware lines
Finished and Semi-finished Lumber items like deck flooring and fencing

HBS has been continuously run by five generations and all the important position is
occupied by a family member. Since, the company sales are seasonal, the company
slows down in colder months. January is regarded as the low point of the year and
then the sales starts to build. Labor is employed in peak season.

ISSUES WITH HORTON BUILDING SUPPLIES


One of the most important or critical aspect of the company is that they uses the
conservative approach for the working capital management. Huge cash is piled in
the off-peak seasons and in peak seasons the cash levels are reduced and account
receivables are increased due to longer collection period. Since the company is
about to grow in 3 to 5 years, Abigail Horton is thinking about the expansion and
need for financing. They are considering options between short term financing and
long term financing.

PROBLEMS
Q1. (a)
HBSs Cash Cycle for the Fourth Quarter
From the case:
Inventory Period

Average Collection
Period

Days/(CGS/Inventory)

Days/(Sales/Receivables)

90/
(1149.9/1302.1)=101.91

90/
(1543.9/1338.8)=78.04

Average Payable
Period
Days(CGS/Accounts
Payables)
90/(1149.9/304.4)=23.83

Cash Cycle = Average Collection Period + Inventory Period Average Payment


Period
= 78.04 + 101.91 23.82 = 156 Days

(b) Meaning of the Estimate


156 days cash cycle is quite large cash cycle which is in off season of the firm. The
result of the quarter cash flows shows that the firms cash flow is inversely related
to the seasonality of the business. That is, the firms cash flow increases during offpeak quarters and decrease during peak times.
Q2. Working Capital = Account Receivables + Inventory Accounts Payable
1995
Inventory
Accounts
Receivables
Account
Payables
Working
Capital

Quarter 1
$ 1,610.3

Quarter 2
$ 1,668.9

Quarter 3
$ 1,467.2

Quarter 4
$1,302.1

$ 1,003.2

$ 2,213.6

$ 1,742.3

$ 1,338.8

$ 597.9

$ 913.3

$ 478.7

$ 304.4

$ 2,015.6

$ 2,969.2

$ 2,730.8

$ 2,336.5

Q3. (a) Firms seasonal working capital


Seasonal working capital is the difference of working capital at peak times and
permanent working capital. In this case in quarter 2 the firm operation at peak and
in quarter 4 the firms operations at the low point. Hence

Seasonal working capital = Quarter 2 working capital Quarter 4 working capital


Seasonal working capital = 2969.2 2336.5 = $632.7
(b) Firms permanent working capital
Working capital at the low point of operation, which for the most companies is
December, gives an estimate of the firms permanent working capital. In this case
working capital of quarter 4 will be the permanent working capital. Hence,
Permanent working capital = Quarter 4 working capital = $2336.5

Q4.
Cash cycle is defined as the time between cash disbursement and cash collection.
When defining cash cycle in terms of working capital management it is shown as
operating cycle less accounts payable period. When we need to compare the cash
cycle of a retailer like HBS and that of insurance service, then it is obvious that a
retailer would have a longer cash cycle. Cash cycle is calculated as:
Cash Cycle = Inventory Period + Average Collection Period Average
Payment Period
It is clear from the equation that cash cycle is calculated through the involvement of
inventory, account receivables and accounts payable. A retailer can have varied
amounts of inventory level, accounts receivables and accounts payable. A retailer
like HBS primarily focuses on the fixed assets, hence they are capital intensive.
Fixed assets like land, building and warehouses are used to continue their
operations. In order to continue their daily operations, they deserve the greatest
attention when it comes to working capital analysis.
On contrarily, services sector would have a shorter cash cycle, as there are fewer or
no inventory levels, account receivables are less as compared to a retailing business
and accounts payable would be of minimum level.
Q5.
1995
Cash
Account
Receivables
Inventory

Quarter 1
$ 1,210.2

Quarter 2
$ 415.3

Quarter 3
$ 820.0

Quarter 4
$ 1,256.8

$ 1,003.2

$ 2,213.6

$ 1,742.3

$ 1,338.8

$ 1,610.3

$ 1,668.9

$ 1,467.2

$ 1,302.1

The Cash balance of the company shows an inverse relation with seasonality of the
business. From the above table, we can clearly see that during the 2nd and 3rd
quarters, cash balance is reduced and the receivables are increased. While, in offseason the results are vice versa. If the company want to proceed for the loan to
handle their working capital then Account Receivables would be the major reason
rather than inventory.

Due to longer collection period in peak season, may require the company to go for
loan as the cash resources arent enough. Nevertheless, if the company want to
ignore going for loan then they need to reduce the average collection period to raise
the level of cash.

Q6.
The firms permanent working capital will reduce by tighten the collection
procedures. The tighten collection procedures results in lower account receivables
amount which in result lower the permanent working capital.
Working capital permanent = WCP = Receivables + Inventory Account Payable
When tighten the collection procedures
Working capital permanent = WCPA = Receivables (reduce) + Inventory Account
Payable
Hence,
WCP >WCPA
Seasonal working capital is almost ineffective by tighter collection procedures
because working capital of both peak and low operation points will reduce
accordingly and the difference between both remain the same.
Seasonal working capital:
SWC = working capital at peak operation point working capital at low operation
point
When tighten the collection procedures
Seasonal working capital:
SWCA = working capital at peak operation point (reduce) working capital at
low operation point (reduce)
Working capital of both peak and low operation points will reduce accordingly and
the difference between both remain the same (almost equal, not change to great
extent).
SWC = SWCA
Q7.
The company has very much cash in hand. In peak seasons the company faces the
reduction in cash but still they have enough cash in hand to maintain the working
capital, so the company doesnt need any short term debt to finance the working
capital. But if the company wants to expand its business, they need short term debt
to finance all the company working capital. So the argument of Jane Horton all the

working capital needs to use short term debt will be applicable if the business is in
expansion mode.

Q8. (a)
Advantages of Conservative approach:
1. Expenses can be easily covered with the large balance of cash available with
the company. No need to get financing facilities from external sources.
2. Account receivables are given larger payment period to repay the amount.
This results an increase in sales revenue for the tenure. Sales would get extra
boom.
3. Inventory is also kept high, which means that customers are able to get what
they have demanded for. Higher level of inventory makes customer happy.
Disadvantages of Conservative Approach:
1. High level of collection period results in high level of bad debts.
2. Cash available could be invested and get an extra income for the company.
3. Inventory could get obsolete and may vulnerable to natural and
uncontrollable disaster.
(b) Yes, he can reduce the level of cash which he holds to at least $250,000. In
Exhibit 4 in quarter 1 which is low operating point the cash is $1210.2 and in
quarter 2 which is the peak operating point the cash is $415.3. The cash reduces
between quarter 1 and 2 is $750 which shows that the firm utilizes the cash when it
is needed.

Q9.
The maturity matching principle states that short-term assets should be financed
with short-term financing and long-term assets with long-term financing. Short-term
or current assets include cash and inventory. Short-term financing sources include
accounts payable and short-term loans. Long-term assets include buildings and
equipment. Long-term financing sources include long-term debt, common stock and
preferred stock. The maturity matching principle is important to a company's
liquidity
and
profitability.

ADVANTAGES AND DISADVANTAGES:


Advantages
1. Short term debts help to maintain a solid liquidity because it requires
companies to match the terms of assets and liabilities.
2. They are less expensive as compared to long term debts. On contrary, short
term assets are less profitable than long term assets. Mismatch between your
choices can result in reduction in profitability and an increase in your interest
expenses.

Disadvantages
1. To use this approach the company needs to manage their resources in timely
manner, to avoid any late charges repayments. Short-term financing comes
with high interest rates and in order to keep your safe side then the
management need to be well-equipped.
2. Trade-off between high and low interest rate. Loans with lower interest rates
are rejected due to limitation of resources.
Q10. Recommendations to HBS to finance its working capital
HBS should firstly maintain the proper management of their payables in relation to
their receivables. As they should have the average collection period equals to that
of average payable period. But in this case the Average collection period is 78 days
while the average payment period is 23.82 days. This results in lesser cash in hand
for the firm in managing the working capital. So, if they manage them properly
either by reducing the receivable period or increasing the payable period they could
increase the cash in hand which will be useful for maintaining the seasonal working
capital requirements in case of expansion of the firm. Moreover, the following
techniques can be used in this regard:
Commercial Paper
Commercial paper is a money-market security which can issued by HBS to get
money to meet short term requirements and it is only backed by HBSs promise to
pay the face amount on the maturity date specified on the note.
Bank overdraft
As HBS has good history credit returns to Kansas City National Bank, HBS should
bargain with KCNB to provide the bank overdraft facility up to that amount that has
been calculated by Robert Miller, an account executive at KCNB.
So, the foremost thing they should adopt is to delay taking loan from bank; this can
be achieved by adapting either one or the combination of the above mentioned
techniques and if they fail to full fill the need of seasonal working capital then they
should go for taking short-term loan.
Q11.
Since HBS wants KSNB to fund a short-term loan of $450,000, so
Current Ratios:
Quarter 2
4345.4/1110.1=3.91

CA/CL
Quarter 3
4077.3/680.9=5.99

Herein these two quarters of peak seasons, the current ratios or the working capital
ratios are very much greater than that of the ideal situation (i.e. between 1.2 and
2.0). Here, KCNB can consider giving the loan to HBS.
For further analysis KCNB can consider the debt ratios of the HBS as well.

In this scenario, the debt ratio although is increasing but still it is way lesser than
that of the industry average, so it is quite considerable for the KCNB to give the loan
to the HBS.
Miller must consider the interest coverage ratio also because if in future HBS would
want to restructure the loan for long term then this ratio will help them in
considering that point of view as well
Interest coverage ratio
1992
390.4/17.1=22.8
3

EBIT/interest expense

1993

1994

1995

307.7/15.9=19.35

333.8/10.4=32.096

473.5/17.1=27.7

These are the two quarters in which cash is needed by HBS for working capital
management, so these above calculated ratios clearly indicate that it will be safer
for the Miller to grant HBS a short-term loan.
(b) Following are the additional information that would be helpful in making a more
informed decision:

Monthly financial statements of the business


Monthly Cash flow Statements
Forecasted Income Statement, Cash Flow and Balance Sheet of upcoming
years

Q12.
Yes, indeed the increase in sales of HBS during the peak season affects the working
capital drastically

As cash cycle is inversely related to the working capital


Working capital = inventory + a/c receivables a/c payables
While,
Cash cycle

inventory Period +average collection period average payable


period

Due to increase in sales the inventory decreases while the account receivables
increase. Moreover In this case, the inventory does not show a significant change
while the account receivables show a huge difference of about two folds in the peak
season. So, here in this case, it is the account receivables which are the main cause
of lengthened cash cycle.
Q13.
Miller is interested in monthly statements because through them he would be in a
better position to judge the monthly performance of the company. A cumulative
quarter result may misguide, although it still feels feasible, but there may be some
loopholes in them. For instance, there may be chances of window dressing to obtain
loans from them. Monthly statements present a better and clear liquidity position of
the firm.

RECOMMENDATIONS AND CONCLUSION

HBs must go for short-term financing techniques despite of long-term financing


possibilities. Although, the interest rates are higher in short-term financing, longterm financing would create hassling with the bank.
Moreover, monthly financial statements must be provided, quarterly do not give a
clear picture of the company performance. Banks require monthly statements to
make a better decision and cash flow statements must also be provided.