Summary of Case Discussion: Guna Fibres

Based on our class discussion yesterday, the objectives of the case are threefold:

 To explore a range of issues in working-capital management, with a primary focus

on accounts receivable and inventory. The case illustrates how management choices
about trade credit, inventory policy, production policy (i.e., producing to order versus
producing to stock), and expense management influence the financing needs of the
firm. The case’s financial forecast gives students the opportunity to discuss the cash
cycle of the firm.

 To extend students’ skills in financial-statement modeling and analysis. This case

demonstrates the technique of forecasting with T-accounts, which may be contrasted
with percentage-of-sales forecasting illustrated in other cases.

 To illustrate some of the challenges in the financial (and general) management of

firms in developing countries. These challenges include transportation and logistical
problems, the availability of credit to merchants and consumers, high real rates of
growth, tax practices of governments, and dramatic swings in demand induced by
local customs and holidays.

Check whether you have achieved the objectives above. If you have not, revisit the case, go
through the slides on working capital management that I have sent and sharpen your financial
modelling skill. I have attached here template of exhibit 5 (Malik Forecast), rework on
Malik’s forecast of exhibit 5 by reducing

- Cost of Goods Sold / Gr Sales to 71%, and

- Direct Labor / Purchases Last Month to 29%

Assess whether the changes improve the profit margin and ROA of the company.

As a conclusion, here are the summary of actions that the genaral manager could consider in
assessing financing needs and flow of funds in a firm:

General managers must develop their intuition about the flow of funds through a firm or
business unit as a way of understanding the financial implications of different policies and
actions. Intuition about the flow of funds starts with the following points:

1. The focus of interest is cash flow, not earnings. Cash flow is the amount by which the
cash balance will change over a period of time. Negative cash flows usually cannot be
sustained over a long period of time without some outside financing, so the size and
sign of the cash flow will help a general manager anticipate the need for external
capital. Perhaps the easiest way to identify a firm’s flow of funds over time is to study
the sources-and-uses-of-funds statement, which is usually included in the annual
report. In turn, that statement is developed from the balance sheet and income
statement—if you are skillful at understanding those reports, you can proceed directly
to them for your insights.
 2. What influences funds-flow and financing needs? Cash flow is improved (and
financing needs are reduced) by increased earnings, reductions in assets, or increases
in capital. Cash flow is worsened (and financing needs are increased) by lower
earnings, increases in assets, or reductions in capital. To be more specific, consider the
following effects

Effects that Increase Cash Flow Effects that Decrease Cash Flow
Increasing price and volume Reducing price and volume
Earnings effects
Reducing costs Increasing costs
Shortening customer credit terms Lengthening customer credit terms
Tightening inventory Relaxing inventory management
Asset changes
management Increasing capital investing
Cutting back on capital investing
Reducing dividends Increasing dividends
Capital changes
Selling stock Buying back stock

3. Changes in demand will affect the financing needs and cash flow of the firm. Growth
requires that the firm to build up assets to support business expansion; the buildup of
assets requires cash or external financing. Similarly, a decline in the business should
free cash as the firm scales down in the face of dwindling demand. Of course, the
process of growth and decline can be witnessed each year in the seasonal fluctuations
in demand that some firms face. The buildup toward the peak in demand requires
investment in inventory and receivables; the subsequent seasonal ebbing allows those
receivables and inventories to be liquidated, freeing up cash.

4. Management policies can also affect the firm’s financing needs. Pricing or cost-
management policies will affect the firm’s ability to generate equity capital internally.
Sales managers who strive to relax credit terms to achieve higher sales will force the
firm to make larger investments in working capital. Similarly, operations managers
can affect the asset profile of the firm through policies on inventory management and
the promptness with which the firm pays its suppliers.
5. The general manager can forecast financing needs and funds flows using one or both
of two classic methods. The T-account approach simply prepares T-accounts for each
line item in the financial statements. The percent-of-sales approach forecasts the
income statement and balance sheet as a percentage of the firm’s business volume.
Each approach has its strengths and shortcomings: T-accounts are cumbersome;
percent of sales may ignore important discontinuities in the profitability or investment
spending of the firm. Forecasters, greatly aided by personal computers, use a blend of
the two techniques. Good funds-flow analysis entails careful tailoring of the
forecasting techniques to each specific situation.