Cash flow | BBA | heriot watt

Aggro Stores is a 30 year old cooperative (not for profit) business based in a remote island community of less than 10,000 residents. The original purpose of the business was  to  supply  agricultural  products  such  as  animal  feed  and  farm  equipment  to  the mainly  rural  population  of  the  island,  which  collectively  set  the  business  up  for  that purpose.  The  business  is  run  by  a  general  manager  who  has  a  small  staff  of  five people to support the operations; mainly by taking calls, maintaining and organising stocks,  serving  the  customers  and  keeping  the  accounts.  Recently  a  new  manager has been appointed after the dismissal of the old manager for undisclosed reasons. The manager reports to the board of the cooperative, but has reasonable autonomy in the way that he wishes to run the business. On taking up the appointment the new manager is dismayed to find that the business is  not,  as  he  had  been  told,  stable  and  profitable,  but  is  in  fact  in  a  poor  state  after years of underinvestment and neglect. Within a few weeks he has identified that the store carries a very limited range of stock and that stock levels of those lines that are carried  are  low.  In  addition,  some  lines  of  stock  are  aging  and  close  to  obsolete. Customer footfall is also low as there is not much to buy in the store apart from the agricultural supplies. There  is  significant  competition  on  the  island  from  a  road  haulage  contractor  who brings in supplies of animal feed on the trucks that would otherwise be empty when they return to the island after shipping out the crops and animals that are the island’s main  outputs.  Further  competition  comes  from  a  larger  haulage  company  on  a neighbouring island, which is also bringing animal feed back in its empty trucks. The  animals  (mainly  sheep)  that  leave  the  island  are  intended  for  meat  markets  on the  mainland.  Most  of  the  farmers  on  the  island  are  part  of  a  quality  assured  meat scheme  that  increases  the  value  of  their  animals.  As  part  of  the  scheme  they  are required  to  buy  their  animal  feed  from  a  supplier  that  is  also  part  of  the  quality assurance scheme, to ensure that the feed is being of a good standard and is being kept  in  a  safe  manner.  The  facilities  to  keep  the  feed  in  this  manner  are  costly  and lead to the feed being more expensive than that supplied by the haulage contractors. The  manager  is  aware  that  many  of  the  farmers  are  buying  their  feed  from  the haulage  contractors,  despite  that  being  in  breach  of  the  terms  of  the  quality assurance scheme. The  store  buildings  are  large,  but  underutilised  and  in  poor  repair.  Purpose  built when  the  store  opened  30  years  ago,  they  are  suffering  from  rot  in  the  roof,  the drainage is no longer up to standard and the car park is full of holes and is constantly full  of  mud  from  the  high  rainfall  in  the  region.  The  manager  has  identified  that  the roof  is  unsafe  in  places  and  that  the  drainage  is  on  breach  of  local  environmental regulations.  In  addition,  the  interior  decoration  of  the  store  is  very  poor  and  it  is  an unpleasant place both to work in and to visit. 

The  store  turned  over  £480,000  in  2018,  but  cost  of  goods  sold  was  £360,000  and staff and other operating costs were £140,000. The only good news is that it appears that while the previous manager had run down the stock, he had increased the cash at the bank and there is a positive balance of £136,000 in the store’s bank account. Only  £10,000  is  due  to  suppliers  who  provide  the  feed  and  agricultural  supplies  on 30  days  credit  terms.  Customers  of  Aggro  also  receive  30  days  credit  and  the debtors balance is currently £80,000. The manager meets with the Chairman of the Board and discusses the following: Stocks and margins: The  manager  observes  that  stocks  have  been  run  down  and  that  the  store  cannot sell  what  it  does  not  have.  Additionally,  the  lack  of  stock  is  reducing  customer interest in the store and leading to less footfall in the premises. Further, the focus on agricultural  products,  particularly  animal  feed  has  led  to  very  low  margins  as  the market  for  these  products  is  very  competitive  and  particularly  so  with  the  haulage contractors  undercutting  them  on  the  feed.  The  manager  would  like  to  introduce  a wider  range  of  stock  lines,  such  as  hardware  and  other  goods,  which  have  much higher margins. The manager calculates that the animal feed has an average margin of 10 %, with the other agricultural products having an average margin of 35%. The current  product  mix  is  40 %  animal  feed  and  60 %  other  agricultural  products.  The manager argues that the goods he would like to introduce carry margins of 60-100% with an average of 80 % envisaged. He estimates that any such stock introduced will turnover  every  six  months, but accepts  that  there  is uncertainty as they  have  never sold this type of thing before, so he suggests that there is a 20 % chance that stocks might turn over every four months and a 30 % chance that they might only turn over every 12 months. The  Chairman  acknowledges  the  problem  and  concedes  that  there  is  a  market  for other  products  as  the  islanders  currently  have  to  order  many  things  on  the  internet and wait for their delivery by sea. This is expensive as mainland companies always charge  a  premium  for  delivery  to  the  islands.  Nevertheless,  he  is  unsure  of diversifying  in  this  way.  He  has  been  chairing  the  board  for  the  last  15  years  and feels  strongly  that  there  is  a  need  to  ensure  a  retention  of  focus  on  the  agricultural side as that was the original purpose of the business. He also argues that to bring in these  new  lines  would  require  the  purchase  of  a  lot  of  new  stock,  which  would  be very expensive. Also, the store in its current configuration does not have the display racking for new lines and display racking is also very expensive. On  this  last  point  the  manger  observes  that  the  large  food  store  on  the  island  is currently being upgraded and he has spoken to its manager about their old racks. He has  got an  assurance  that he can have  as much  of the racking as  he wants as the food  store  would  otherwise  have  to  pay  for  its  disposal.  Using  staff  from  Aggro Stores,  supported  by  casual  workers  to  collect  and  assemble  the  racking  could  be done  for  about  £3,000,  he  argues.  This  would  allow  for  up  to  £160,000  of  stock  (at cost) to be carried. He also argues that some redecoration is required to the area of the store that he plans to use, but that it can be done for another £3,000. As soon as possible he would like to redecorate and refit the rest of the store at a further cost of £10,000. 

Buildings and infrastructure: Another issue the manager raises with the Chairman is the amount of shrinkage that they are suffering due to the poor state of the building. Because the roof is leaking in places, they often find that stocks of animal feed get wet and are spoiled. About 10% of the feed that is bought in is lost in this way and due to health regulations, the store is paying £5,000/year for the disposal of the spoiled feed. That £5,000 and the cost of the spoiled feed are part of the cost of goods sold. As well as this problem the manager points out that the roof is dangerous in places and urgent action needs to be taken. Restoring the roof to a sound condition can be done  via  a  temporary  repair  for  £15,000,  or  by  a  full  repair  for  £35,000.  The temporary repair would be good for no more than three years at which point the full repair would have to be done. Alternatively, they could rent an empty building on the adjacent site. The lease for this building has become available and could be secured for  £1,000/month.  All  of  the  animal  feed  could  be  shifted  into  this  building,  which  is sound  and  dry.  Securing  the  lease  would  also  provide  additional  storage  and  yard space for agricultural building products that currently are not stocked. These carry a margin of 50 % and up to £100,000 of additional stock could be carried which would turn over every four months. As there is a history in the store of selling these type of products,  he  is  confident  of  the  figures.  He  is  not  confident  that  the  lease  of  the building will not be taken up by someone else if Aggro do not move on it soon. The manager then points out that the drainage problem is a health and safety issue, which threatens not only staff on site, but also their licenses to sell animal feed. The issue is serious, but can be remedied by the installation of a septic tank for £5,000. He  is  aware  that  the  authorities  are  currently  unaware  of  the  problem,  but  is concerned  that  if  they  find  out  they  would  act  quickly  and  close  the  store.  He concedes that it is unlikely that they will find out within the next 6 months. Finally,  he  raises  the  issue  of  the  car  park.  He  argues  that  spreading  gravel  in  the car  park  will  stabilise  the  surface  and  make  it  much  more  pleasant  for  customers. This  will  cost  £5,000,  but  will  be  good  for  five  years  and  he  estimates  will  increase footfall  in  the  store.  The  additional  footfall  will,  he  estimates,  increase  the  sales  of their  core  animal  feed  and  agricultural  supplies  (non-building)  by  30 %  of  their current level for each of the next three years, so that in 3 years time, sales will have increased by 90 %. He believes that the redecoration and refitting of the part of the store that currently holds this core stock would increase footfall and sales by another 10 % each year from current levels. The Chairman is worried by this discussion. He can see that the manager has done a good job and has identified many problems and has offered solutions, but as they are  both  aware  the  store  does  not  have  the  money  to  make  all  the  improvements right  away  and  there  is  no  prospect  of  raising  finance  elsewhere.  The  manager wants  to  use  all  of  the  available  cash  to  progress  things  as  fast  as  possible.  The Chairman would prefer to progress more slowly as he worries about having no cash reserves. He also worries about the reaction of the rest of the board to this news. 

The brief: 1.  In  groups  of  5-6,  analyse  the  situation  at  Aggro  Stores,  considering  the competitive environment and financial constraints. Aspects of the problem are best shared out amongst the group. 2.  Consider  the likely  outcomes,  financial and otherwise,  of the  options that  the manager has offered and seek optimal outcomes. 3.  In  a  report  of  not  more  than  4,000  words  produce  a  five  year  plan  that  the manager and the Chairman can present to the Board as a way forward for the business that will ensure its future prosperity. You should include budgets and cash flow forecasts for the alternatives and show clearly (in appendices) how you have arrived at the numbers that you present. Clearly justify in the report the  choices  you  have  made,  discussing  in  particular  how  you  think  the customers and competitors will respond to the actions of Aggro. Remember, there is not  one  correct  way  forward  in  this  case.  There  are  a  range  of options  that  depend  on  the  quality  of  the  manager’s  information  and  the  likely responses of the competition and the customer base. Credit will be given for creative solutions. You should not restrict yourself to the information that has been provided, but should reflect on other factors and opportunities as well. 

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