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Running head: WORKING CAPITAL SIMULATION: MANAGING GROWTH AT

Working Capital Simulation: Managing Growth at Sunflower Nutraceuticals Rachel Krebs FIN/571 October 13, 2014 William Stokes

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WORKING CAPITAL SIMULATION: MANAGING GROWTH AT

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Working Capital Simulation: Managing Growth at Sunflower Nutraceuticals

Sunflower Nutraceuticals (SNC) offers consumers the opportunity to purchase various amounts of dietary supplements through their internet-based store and catalog. SNC refers to their stock as stock keeping units (SKUs), which are offered from more than 50 third-party brands. Sunflower Nutraceuticals also has developed some private label brands including a women's sports drink and a vitamin line for teenage girls. SNC is currently breaking even and has seen a flat annual sales rate of $10 million annually, is working capital intensive, and has very thin margins. Further, SNC has minimal cash on hand with a required cash level of $300,000 and a line of credit with a limit of $3.2 million and a LIBOR of one year with an interest rate of 8%. In order to evaluate cost of capital, SNC uses a rate of 12% to evaluate any potential investment opportunities (Harvard Business Publishing, 2014). The nutraceuticals market is relatively new compared to the vitamin market, though very lucrative and is seeing growth every year. Nutraceuticals are fortified dietary supplements that focus on utilizing specific proteins and herbs to promote health and wellness. Currently, the industry is worth $128.6 billion and is expected to grow to $180.1 billion by 2017 via a 4.9% compound annual growth rate (Harvard Business Publishing, 2014). This growth rate is due to many factors including an increasing elderly population, higher health awareness and conscientiousness, and an increasing chronic disease rate (Shirwaikar, Parmar, & Khan, 2011). Sunflower Nutraceuticals, if provided with the right investment and cost of capital opportunities, can take full advantage of its market growth and flourish. Currently, SNC's financial statements, though not terrible, have definite room for improvement. Their steady sales amount of $10 million over a three year period could be increased as well as a larger cash

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availability for emergencies, followed by a more efficient cash conversion cycle. As of 2010, SNC has an equity value of $704 million and a total firm value of $3,248 million. The company's EBIT, Net Income, and Annual Free Cash Flow as of 2010 are provided in graph format.

Annual Free Cash Flow (in thousands) $600 $500 $400 $300

$510

$200 $100

$264

$292

2010

2011

$0 2012

WORKING CAPITAL SIMULATION: MANAGING GROWTH AT

Net Income (in thousands) $250 $200 $150 $100 $50

$236 $156 $62

$0 2010

2011

2012

EBIT (in thousands) $800 $600 $400 $200

$650

$440

$370

2010

2011

$0 2012

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From 2012 through to 2021, SNC had the opportunity to select projects and/or actions that could affect their working capital significantly broken down into three phases. Phase I comprised of the years 2013 through 2015, Phase II comprised of 2016 to 2018, and Phase III comprised of years 2019 to 2021, with each phase offering different decisions SNC could choose in order to improve their financial standing. During Phase I, three important decisions were made that ultimately increased sales, EBIT, and net income. However, cash flows were negatively affected with cash shortfalls in both 2013 and 2014. The first decision made was to take on Atlantic Wellness as a new customer, which resulted in an increase in sales of $4 million and an increase in EBIT of $260 million annually from 2013 through 2015, but saw a cash shortfall of -$1, 552 million in 2013. The increase in sales was favorable, though the decision also resulted in higher accounts receivable and inventory balances. The second decision made was to leverage a supplier discount by selling SNC's herbal nutraceutical line to Nutrilife and negotiating a discount with Ayurveda Naturals. This decision increased sales revenues by $2 million and EBIT $167 million annually, though a

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cash shortfall of -$804 million was seen in 2013. Overall, the drain on cash flows was offset by the increase in EBIT. The third decision made in Phase I was to tighten SNC's accounts receivable by dropping Super Sports Centers as a customer due to their slow payback. This decreased sales revenues by -$2 million and EBIT by -$130 million annually, but saw a positive cash flow of $1,269 million in 2013. This improvement in accounts receivable was well worth the loss in sales revenues and EBIT. At the end of Phase I, the total value created was $358 million. During Phase II, SNC only made one major decision that changed the company's working capital. Sales, EBIT, and net income all increased each year, and there were no cash shortfalls overall. The decision made during Phase II was to expand SNC's online presence in online retail sales. Sales revenues increased by $1,400 million in 2016, $2,170 million in 2017, and $2,655 million in 2018. EBIT also increased from $95 million, to $147 million, and finally to $180 million in 2018. Though there was a cash shortfall of -$201 million in 2016 and a shortfall of $69 million in 2017, a positive cash flow of $21 million was achieved in 2018, though this had no overall negative effect on SNC's cash flows. The total value created in Phase II was $299 million. Two decisions were made in Phase III that led to a value creation of $292 million. Sales, EBIT, and net income also increased overall. Further, there were no major cash shortfalls overall during this last phase. The first decision was to renegotiate for better supplier credit terms with Dynasty Enterprises. This significantly lowered accounts payable and improved the margin, but had no effect on sales. EBIT increase $333 million annually from 2019 through 2021, though a cash shortfall of -$1,045 million was seen in 2019, with two positive cash flows of $200 million in 2020 and 2021. The last decision made among all three phases was to adopt a global

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expansion strategy in South American with the company Viva Familia. This decision increased SNC's top line with a very modest increase in cash tied up in inventory. The overall sales revenue increase during this phase was $2,872 million while the overall EBIT increase was $194 million. Though two significant cash shortfalls of -$158 and -$197 million were seen in 2019 and 2020, a positive cash flow of $48 million was seen in 2021. The overall effect of these decisions made during the three phases led to an increase in all important working capital areas. Sales increased 43.95%, EBIT and free cash flows both increased 71.43%, and net income increased 81.36%.The firm value at the end of the phases increased to $1,653 million, and the total firm value increased to $4,197 million, which were increases of 57.41% and 22.61% respectively.

WORKING CAPITAL SIMULATION: MANAGING GROWTH AT

EBIT (in thousands) $2,000 $1,500 $1,000

$1,540

$500 $440

$0

Initial

After Phases

Sales (in thousands) $20,000 $15,000 $10,000 $5,000

$17,841 $10,000

$0 Initial

After Phases

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WORKING CAPITAL SIMULATION: MANAGING GROWTH AT

Total Firm Value (in thousands)

Free Cash Flow (in thousands)

$5,000

$1,000

$4,000

$800

$3,000

$600

$2,000

$4,197

$3,248

$200 $1

$0 1

$2 2

Net Income (in thousands) $1,000 $800 $600 $837

$400 $200 $0

$156 Initial

After Phases

Equity Value (in thousands) $2,000 $1,500 $1,000 $500

$1,653 $704

$0 Initial

$924

$400

$1,000

After Phases

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$264

$0 Initial

After Phases

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References Harvard Business Publishing. (2014). Working Capital Simulation: Managing Growth. Retrieved from University of Phoenix, FIN571 website. Parrino, R., Kidwell, D. S., & Bates, T. W. (2012). Fundamentals of corporate finance (2nd ed.). Hoboken: John Wiley & Sons, Inc. Shirwaikar, A., Parmar, V., & Khan, S. (2011). The changing face of nutraceuticals - an overview. INTERNATIONAL JOURNAL OF PHARMACY & LIFE SCIENCES, 2(7), 925932. Retrieved October 13, 2014, from the EBSCOhost database.