LIQUIDITY AND WORKING CAPITAL MANAGEMENT m= CASE: Caceres Semilla S.A. de C.v. Prudencio Jimenez B., chief administrative and financial officer of Caceres Semilla S.A. de C.V., was concerned about forthcoming negotiations with the company’s bank, Banco Popular de Santa Fe. To renew a lending arrangement, he has to pre- sent a financial plan to the bank for fiscal year 2000. In July 1998, during the past fiscal year, the company had overdrawn its account and Jimenez had received a reprimand from the general manager of the bank, Carlos Fernandez Cristobal, with whom the company has done business for a number of years. The problem arose because of inefficient bookkeeping at the company, together with a big ac- count delaying payment beyond a promised date. As the fiscal year just ended was February 28, 1999, negotiations over lending arrangements take place in March. THE COMPANY AND ITS BACKGROUND The company, located in Esperanza, Argentina, was founded in 1888 by Jaime Ca- ceres Iturriaga to sell corn seed to local farmers in the area. The company is still family run with Josefina Caceres G. as general manager and her son, Juan Pablo Caceres, as associate general manager and, effectively, chief operating officer. An- other family member, Joaquin Estaban C,, is the nephew of Josefina and partici- pates in strategy sessions as well as in sales during peak periods. However, his principal business is steer manure used for fertilizer, which he collects from outly- ing ranches, dries, and packages. His aversion to la bano results in minimum con- tact with other family members, but certain customers seem to like him. Jimenez reports directly to Juan Pablo Caceres, Esperanza is located in La Pampa, the rich agricultural heartland of Ar- gentina and the land of the legendary gaucho, The area of La Pampa occupies about a quarter of the country to the west of Buenos Aires. Extensive fields of al- falfa, maize (corn), sorghum, wheat, and sunflowers thrive in the fertile environ- 421Bae ‘y AN working Capital Management ment. The green grasslands of the prairies provide the mainstay for cattle for which Argentina is famous. Esperanza, in the province of Santa Pe, is approxi. mately 400 kilometers northwest of Buenos Aires. The nearest large city is Santa Fe, the capital of the province. In this city, the Constitution of 1853 was declared, The province has an agricultural heritage, with some historians claiming that in Esperanza ranching and farming, as we know it today began in the 1800s. Throughout the years the Caceres company, a limited liability company with variable capital, has had reasonable success. Initially, and throughout most of the twentieth century, it specialized only in corn seed. In the 1960s, it began to contract for and sell alfalfa seed. Alfalfa is the most important of the hayseeds, the others being clover, alsike, and timothy. The output of the seed, baled hay, is sold to ranchers and dairy farmers to feed cattle. Presently, the company sells more alfalfa seed than it does corn seed. For both types of seed, the seed is purchased from growers in the local area primarily in the summer and autumn (opposite to that in the Northern Hemi- sphere). Most of the growers from whom Caceres purchases seed are under con- tract to the company, with additional demand being satisfied by purchases in the spot market. The company has two buyers, whose sole responsibility is working with contract growers and purchasing seed. A great deal of emphasis is placed on quality; in corn, hybrid seeds are grown to resist diseases peculiar to the area. With contract growers, Caceres furnishes the grower with the initial, or stock, seed. By carefully monitoring the progress of each grower, the company is able to assure high quality. While quality is high with contract growers, control is more difficult with seed purchased in the spot market. After the seed is purchased by the company from growers, it is sent to the plant in Esperanza for processing. First the seed must be dried. Essentially this in- volves circulating hot air through the seeds, which are placed in specially con- structed open bins. Cleaning comes next, and this requires a special type of blowing equipment. In this procedure, it is important not to mix different types of corn seed and hayseed. To do so will result in customer dissatisfaction along with the occa- sional lawsuit. Next the seed must be sorted and bad seed eliminated. Electronic sorting machines do most of the work, but some of it still must be done by hand. It then is necessary to test the seed for purity, durability, and germination. Finally, the seed is packaged in various sized boxes and bags. Once packaged, the seed is stored in warehouses. For the most part, warehousing is done on site, but occasionally the company must use a public warehouse, which is more expensive and less efficient. DEMAND FOR PRODUCT AND RISKS The ultimate demand for the seed is from farmers, but Caceres does not distribute di- rectly to them. Rather, distribution is through grain elevators, farm and ranch cooper- atives, fertilizer and hardware stores, farm implement dealers, and assorted other re- tail outlets. Caceres employs five salespeople, who cover the provinces of Santa Fe, Cordoba, San Luis, and La Rioja, and report directly to Juan Pablo Ca-ceres. For dis- tribution reasons, it does not sell product in other provinces. During the autumn months in particular, salespeople are active in booking advance orders from cus- tomers. By close coordination between the sales people and the seed buyers, the com- pany attempts to closely tailor its purchases to demand. They keep in close touch by phone, fax, and email, carefully checking seed bookings and the latest prices. Although the company is able to vary its purchases to some extent, it is ob- ligated to its contract growers to buy a minimum amount of seed each year.Part V Liquidity and Working Capital Management 423 Should demand fall below the minimum amount of purchases required under con- tract, the seed needs to be carried over to the next selling period. In turn, this af- fects the quality. The principal appeal of Caceres seed is its purity and heartiness, as well as the fact that the company has been in business for over 110 years. To stimulate retail demand from farmers, the company has spot radio commercials in the provinces served as well as advertisements in selected farm journals and man- uals. In the 1980s, sales grew rapidly in keeping with an aggressive marketing ef- fort. The company relied on purchasing seed in the spot market to satisfy excess demand. By 1987, contract growers accounted for only 47 percent of seed pur- chases. During this time, quality problems developed and certain farmers experi- enced inferior crops. The dissatisfaction caused Josefina Caceres to scale back the sales drive and to increase the number of contract growers. Gradually, the problem ameliorated, and customers once again came to regard Caceres as synony- mous with quality. Presently, 86 percent of the seed purchased is from contract growers. The quality edge is essential to sales. When compared with the total cost of farming, the cost of seed is a minor component. Therefore, good seed is a good, value-added investment by the farmer. Other than the quality of the product itself, the other major business risk is fluctuations in the market for hay and for corn. While customers commit in advance to buy seed from the company, they cannot be held to these commitments. If demand should falter, Caceres would end up with substantial inventories. In addition, the prices of seed would fall. Despite ef- forts by Caceres and other seed companies to differentiate their products, to some extent they are commodities when it comes to pricing. For this reason, the com- pany pays close attention to the price of hay and corn in La Pampa and changes in demand. Presently both markets are reasonably robust, but cycles in agricultural products are notorious. There is considerable competition in the seed business. The principal com- petitor, of course, is the farmer who holds back seed from one harvest to plant in the next. The packaged seed companies must compete on the basis of greater yield and disease resistance. The farmer must be willing to incur the added expense to achieve greater yield, for “own seed” is always cheapest. Depending on the state of the farm economy, the percentage of “own seed” versus packaged seed in- creases or decreases. Of the packaged seeds sold, Caceres has the number one po- sition in the Province of Santa Fe with a 19 percent market share. In the provinces of Cordoba, San Luis and La Rioja, it is number 3, with an 8 percent market share overall, For the most part, distribution of product to customers is by company- ‘owned trucks. Occasionally, deliveries are delayed by truck breakdown or by road conditions in certain outlying areas where roads are not good. This causes a degree of customer irritation but is not a serious problem. THE COMPANY'S FINANCING In recent years, the company financing has consisted of a long-term mortgage loan ‘as well as bank loans. In the 1970s, some equity capital was raised from extended family members. In 1993, the company completely rebuilt its plant in Esperanza. The old plant was constructed in 1924 with add-ons over the years. By having all equipment in carefully arranged, contiguous space, seed processing efficiency was greatly enhanced. Caceres Semilla financed the plant with a 3 million peso mort- gage loan from an insurance company in Buenos Aires. The loan bears a fixed rateof 13 percent and was originally for 20 years, 3 months. For the first 5 fiscal years, principal payments of P120,000 were due semiannually in June and December. For fiscal year 1999 and beyond, principal payments of P60,000 are due semiannually, The loan is secured by the plant and 218 hectares of land, which comprise the es- tancia Caceres, on which the plant occupies 5 hectares. Although the interest rate is fixed, it is essentially dollar denominated. Should the 1-to-1 peso/dollar exchange rate regime change with the peso weakening, the loan covenants require principal payments in pesos to increase proportional to the dollar strengthening. For over a half century, the company has banked with Banco Popular de Santa Fe. The bank has accommodated the company with seasonal credit as well as occasional transactions loans of a term nature. For the unsecured, seasonal credit accommodation, inter at the reference (floating) rate, presently 12.5 per- cent. The bank had hoped to arrange the 1993 mortgage loan, taking the early ma- turities and syndicating the rest. Carlos Fernandez Cristobal, the banker, was irri- tated when the company took the deal to the Buenos Aires insurance company, However, the bank continued to accommodate the company’s seasonal borrowing needs under a line of credit. For the past fiscal year (1999), the line was for 4.8 mil- lion pesos. The company was out of bank debt in March 1998 of that fiscal year, However, in August 1998 Senor Jimenez sent in a loan note, which took total bor- to slightly above 5.0 million pesos. As this had not been discussed in ad- , Senor Fernandez was upset. Although the overage was approved, it was not without reprimand. Senor Fernandez demanded a meeting with Senor Jimenez, Josefina Caceres, and Juan Pablo Caceres. At the meeting in September, he expressed concern with the growth of receivables, inventories, and fixed assets resulting in the overage. He suggested that a term loan would make sense and that Banco Popular would be willing to consider such but at a floating rate 15 percent higher than the rate under the sea- sonal line of credit. Prudencio Jimenez assured him that they would not exceed the maximum credit limit in the future and that there was no need for a term loan. Senor Fernandez also expressed concern that he had heard that Juan Pablo was di- verting attention away from the business to his hobby of raising mules. Juan Pablo assured him that this was not the case and that the “mule thing” was done in his spare time. When discussing the matter of “other assets” on the balance sheet sud- denly increasing by P105,000, Josefina Caceres reluctantly explained that it repre- sented a direct investment in the steer manure business of her nephew, Joaquin Es~ taban C. Senor Fernandez said he did not care for this diversion of funds and that he should have been consulted prior to the investment. The meeting ended on a frosty note. FINANCIAL PLANNING REQUIRED FOR FY2000 In preparation for the meeting in March 1999 with Banco Popular, Prudencio Jimenez was required by the bank to prepare pro forma statements for fiscal yea" 2000. Such forecasts had not previously been required. With help from a local ac~ countant, Jimenez undertook the task, The important assumptions follow. A? overall sales increase of 22.7 percent is projected. Of this increase, price increase’ are expected to account for 6 percent and volume increases for the remainder. Mat ket share is expected to increase, not only as a result of an aggressive marketing fort but also because one significant competitor in the province of Cordoba t cently went into bankruptcy. Interest expenses are incorporated in the overall “general and administrative expense” category. Because Caceres Semilla S.A: 4°sis Lighadiiy and Working Capital Management 429 C.V. is a family-run business, it does not accrue taxes month by month. Rather, it pays taxes quarterly based on projected profits for the year. As to dividends, Jose- fina Caceres wants to double the dividend paid. Profitability has improved, and she feels a sense of obligation to extended family members who are not active in management. After all, when profits declined in fiscal years 1997 and 1998 she asked them to go without dividends in order to build for the future. After much effort and consultation with members of management, Senor Jimenez produced the pro forma income statements shown in Exhibit 3. While nothing is certain, the company is reasonably confident it will be able to meet these projections with respect to both revenues and expenses. Given the sales forecast, accounts receivable, inventories, accounts payable, and accruals are driven off this schedule. The average collection period assumed is 1 month after sales, whereas purchases are assumed to be paid for with a lag of 2 months. Some of the growers are upset with the 2 months, and a further stretching of payables is not possible. However, the Caceres buyers have been largely suc- cessful in keeping growers happy despite the stretching, which gives the company 2 months of free financing. On the basis of these assumptions, Prudencio Jimenez was able to produce the pro forma balance sheets shown in Exhibit 4. However, he did not know how to determine the cash position and the bank loan. Given the overdraft last July, Jimenez felt the company needed to maintain a cash position of P200,000 or more at all times. Inadvertently, he left out the retained earnings row in Exhibit 4. As the meeting with Banco Popular de Santa Fe is the next day, he will try to remedy these matters in the evening. THE MEETING Prior to meeting with the banker, Senor Fernandez, in the afternoon, Prudencio Jimenez will brief Josefina Caceres and Juan Pablo Caceres in the morning. On the morning agenda will be whether the company should be proactive in proposing a specific financing plan or reactive to the thoughts of the banker on the matter of fi- nancing. Whichever approach is taken, Senor Jimenez will need to be thoroughly prepared to defend the numbers.