Amgrow the Year of 2010 Was Not

Amgrow

The year of 2010 was not a good year for Amgrow. When considering the three financial measures listed, none demonstrated good performance. The change in cash position is not a good measure of financial performance so should be considered without a thorough examination of the statement of cash flows. The net income was poor in 2010. Whereas in 2009, Amgrow turned a profit of $63,057, it lost $68, 801. Any loss is considered poor performance, but the fact that the company was profitable in the year before highlights just how poor a year that 2010 was, as net income declined by $131,858 over the two years (p.91).

The third measure, total assets, also saw a decline for Amgrow. There are times when the assets should decline -- the sale of an operating division for example -- but nothing like that occurred for Amgrow. Instead, the company simply saw the value of its assets decrease from $668,129 to $665,763 (p. 90). Normally, a company should grow year over year, and this is not the case. The assets declined because plant, property and equipment and leasehold improvement depreciated, indicating that Amgrow remained at the same size for 2010 as it was in 2009.

2. The return on invested capital factors in the return on long-term debt, common and preferred shares (Investopedia, 2011). This ratio is typically given as 0 when the company loses money, which is what happened in 2010 for Amgrow. There was no return last year. In 2009, the return on invested capital was 13.5%. Obviously, the return was better in 2009. The same thing can be said for the company's net margin. The net margin for Amgrow was 0 in 2010 as the company posted a loss. In 2009, it was 5.2% (p.91).

3. The current ratio for Amgrow is 0.83 for 2010, compared with 0.99 for 2009. These results reflect a strong growth in the current liabilities for the company. However, the balance sheet reveals that most of the growth in current liabilities comes from $50,000 in non-interest bearing liabilities that was on the 2010 balance sheet but not on the 2009 balance sheet. We do not know what this $50,000 is, but it is likely to be paid off this year. Thus, the decline in liquidity is temporary as the result of some debt coming due. It is of concern, however, that the only real increase in the current assets comes in the form of increased inventory. Given that the company did not change in size and saw its revenues decline in 2010, an increase in inventories is a red flag for declining financial performance. The company is finding it more difficult to move inventory and it would not be surprising to see some of this inventory be written off or sold at a deep discount eventually (p.90).

The average collection period in 2010 was 16.2 days, compared to 14.4 days in 2009. In general, this indicates that the team is not collecting its bills as quickly. A decline of a couple of days is not severe, but ideally such a decline would not occur, and certainly not during a year when revenues are already down. It could be that the industry is in decline and Amgrow is being stonewalled by its customers but this is just speculative.

The average stock holding period in 2010 was 140 days. In 2009, this was 63 days. As noted earlier, the company has clearly had trouble moving its inventory, and the result is that the inventory turnover is now poor. Amgrow used to keep only two months worth of inventory on hand, and now inventory levels are at 140 days. The decline in sales accounts for this in part, and there has been a mismatch between production and demand that the company will need to address. A buildup of inventory like this is dangerous if the goods are perishable or if they will be more difficult to sell when the market picks up. Even now, they are costing the company money in that Amgrow spent money to produce the goods and now is not earning anything from them.

4. The long-term financial prospects are difficult to judge from two years of financial statements. Trend percentages are more valuable over a long period of time (CliffNotes, 2011). Certainly, the company's performance in 2010 was not good, and this raises concerns for the future. Without knowing anything about the company's operations and industry conditions over the past year, however, it is difficult to know for certain if that lousy performance was a function of an industry-wide problem or something more firm-specific. If the problems that Amgrow faced in 2010 are firm-specific in nature then the long-term prospects are poor indeed. Even if the problems are industry-wide, the company did not demonstrate a good response to the change in the business environment, especially in the way that it allowed inventory levels to rise. This implies that perhaps the company's management might be overwhelmed in the face of adverse industry conditions. That is impossible to determine for certain, however, on the basis of a single year. However, the best conclusion we at which we can arrive given what we know is that Amgrow is having problems and its long-term future does not look especially good.

5. In order to make a better assessment of Amgrow's financial situation, I would want to know two things. The first is that I would want more financial data, perhaps from 2008 and 2007. This would allow me to better see the 2010 performance in historical perspective. It could be that 2010 was a blip, but it could also be that 2009 was the blip and this company has generally struggled. The other thing that I would want is much more qualitative information. I would need to know what the industry is, how the industry performed in 2010, and what the other factors are that surrounded this company's business in 2010 that had an impact on its performance. In this situation, the company performed every differently in the two years, so I need to have a better sense of what the underlying factors are for the different performances.

Part II. 1. For Amgrow Farms, let's buy them a new combine. The combine is going to help with the annual harvest. The existing equipment is a lemon, and breaks down too often. So Amgrow wants to get a replacement, but in the process of doing so the company wants to improve productivity. So there are two major goals with this purchase -- to improve productivity and to replace old machinery.

2. In the acquisition, the major decision needs to be between brands. There are a number of factors that need to be taken into consideration. Certainly the specs are important if increasing productivity in key. But perhaps the maintenance record is the most important. Down time for a critical piece of machinery is something that creates a bottleneck in production. For a farm where the outputs are perishable and could suffer from delays that create exposure to adverse weather conditions, the loss of a key piece of machinery could be a major problem. Indeed, if we consider the financials from 2010, machinery issues could be part of the problem -- reduced revenues from lost production, and higher inventories as the result of lower quality levels. In addition, maintenance costs money so arguably this is the most important factor when deciding to purchase a new combine.

Financing this purchase is another issue. Most manufacturers will have financing options available and interest rates right now are very low. There are other options, however, including bank debts. Amgrow has some cash, but probably not enough to pay down the $50,000 current debt repayment, buy a combine and also have sufficient working capital. Amgrow is too small to issue equity publicly. Thus, debt is the only viable option and the company needs to look at the interest rate and repayment terms on financing from the manufacturer/wholesaler and a bank loan.

3. One financial rule that can be used to help make this decision is that the timing of the project and the timing of the financing should be aligned. The idea behind this principle is that the organization is going to derive financial benefit from the project over a certain period of time, these cash flows can be used to finance the project. So when the equipment is expected to last for ten years, the financing can and should be spread out over ten years. If the manufacturer/wholesaler is unable to accommodate this, bank financing over this period should be sought. If the project is financed over a shorter period of time, then it may have negative cash flows over the first few years, and that increases the risk of the project.

Financing considerations should not have any impact on the purchase, as per Modigliani and Miller (Boehme, no date). In this case, the company needs a new combine anyway, so the decision to make the acquisition has already been made. The only decisions that remain are that with respect to product selection and the financing of the project. Amgrow has selected the financing from the manufacturer, which is offered at a lower rate than what the company could have received from the bank. The bank was concerned about the company's poor performance last year, while the equipment manufacturer was more forgiving about that.

4. The project should fulfill the financial objectives. The financial objectives are related to the firm's operating objectives, in that higher standards in the combine will lead to fewer bottlenecks, delays and repairs. All of these things will contribute to production being on schedule and on budget (Roser, Nakano & Tanaka, 2002). This in turn will allow for the highest possible price to be earned on the farm's output.

Thus, the project should fulfill the stated business and financial objectives. There is no reason to believe that it would not do this.

5. The investment and finance process is irrelevant to the fulfillment of these financial objectives. Basically, when an operating need emerges, the company has to evaluate its financing options, but taking MM into consideration only taxes are likely to make a significant contribution to the bottom line in the financing distribution, which usually leads to the choice of debt over equity (Myers, 1984). Blowing off a critical investment on account of financing issues is not good business, so the purchase is going to be made, and it will probably utilize debt financing.

A small wheat farm earning $1 million a year in revenue is not exactly suited for the capital markets, and one that is faced with declining revenues has no real hope of attracting equity investment anyway. So in this case, debt is the only real option. The only issue is how to structure that debt. As noted, the situation is simply dependent on what the firm does with respect to aligning the financing with the term of the project (10 years in this case) and on the rates that are on offer.

In a competitive marketplace, financial institutions are offering roughly the same rates to small farms. The financing arm of the equipment manufacturer, however, is using finance rates as a means of attracting business, because it is in a highly competitive business. As a result, the rates offered by the manufacturer are below market rates. That makes those rates attractive to the farm. In addition, there are strategic considerations here as well. Amgrow can build a stronger relationship with its supplier by using the manufacturer's financing. Having a good relationship is beneficial when it comes time to order more equipment, or have parts or servicing ordered. Thus, it is strategically beneficial as well as financial for Amgrow to accept financing from the manufacturer rather than to seek bank debt.

Overall, firms must make purchases to improve their business, particularly when deciding on a new project that must be undertaken. Replacement projects provide an opportunity for the company to make productivity improvements with newer and better equipment, and there is cause to believe that poor equipment in agriculture can put harvests at risk -- one malfunction can destroy profitability for the entire season. Thus, it is financially beneficial for farm equipment to be modern, and that requires some investment. The payments for such investment should come out of the revenue streams that are generated by the equipment, which is the case for aligning positive and negative cash flows. Ultimately, however, firms are often faced with few choices for financing and must make the one that has the most financial and strategic advantages.