Centennial Pharmaceuticals & Horniman: Compensation & Cash Flow
Centennial Pharmaceuticals: Employee Compensation
Employee compensation refers to the benefits (cash, vacation, etc.) that an employee receives in exchange for the service they provide to their employer. Employee compensation is generally one of the largest costs for any organization. This employee compensation case represents a discounted cash flow valuation problem with the consequences of changes connected to an earn-out agreement. An earn-out agreement is a contractual provision stating that the seller of a business is to obtain additional compensation in the future if the business achieves certain financial goals.
Some of the most common mistakes in employee compensation are:
- Neglecting the market: Review salary surveys to determine what other companies similar in size, industry, and location are paying their employees.
- Weak connection to performance: Without a strong link between performance and pay, employees may see raises and bonuses as entitlements or view your payout system as arbitrary.
- Disregarding internal equity: Employees should feel they are compensated fairly relative to other employees within your company.
The problem with CPC was that CloneTech’s management reacted negatively to the revised earn-out program because the CPC board hadn’t done a formal valuation of the original and revised earn-out plans. They needed current interest rate data and discounted cash flows for both contracts.
Horniman: Cash Flow Analysis
Although Horniman seems to be doing very well (profitability is strong, suppliers are being paid on time, conservatively financed), the cash balance has declined from $120,000 in 2002 to $9,400 at the end of 2005. The decline in cash balance seems odd in a business that is generating so much profit. It is important to emphasize the distinction between accounting profitability and cash flow.
It is very usual for starting small businesses to have problems with burning cash. Some of the reasons are:
- Slow paying invoices: As a small business, you have to offer 30-day to 60-day payment terms to clients. However, small companies can’t always afford to wait this long for payment. They need money sooner. Eventually, slow payments create a financial problem that can seriously affect your business even if it’s growing quickly.
- Excess inventory: Companies that manufacture goods or re-sellers that keep a warehouse stocked with products. If too much product is made or purchased, it ends up sitting on shelves and tying up cash flow.
Horniman: Cash Cycle
Moreover, the receivable days and inventory days have been increasing over the years. One of the most critical parts of the business is the cash cycle, where we take into account the inventory days, the receivable days, and the payable days. For 2015, the cash cycle was: Inventory days + receivable days = 476 + 51 = 527 = cash cycle. As we can see in this case, the cash cycle of this company is extremely long, due to the industry it works in (horticulture). This causes that any delay in converting the product into money can end up being a serious problem for the cash flow.
Horniman: Family Succession
Family business succession is the process of transitioning the management and ownership of the business to the next generation of family members. A proper business succession seeks to alleviate or lessen the above issues by setting up a smooth transition between the family owner business owner and the future owners of the business. In the case of Horniman, the company is created from savings, proceeds from the sale of their house, a minority-business development grant, and a personal loan from Maggie’s father. The best option for a smooth family succession in a business is for the parents to give the children a personal loan with a very low interest rate and encourage them to keep the business on their own.