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BY ASHISH DHANANI MUDIT GARG NITIN PHOGAT
KOTA fibers ltd. Was founded in 1962 to produce nylon fiber at its only plant in kota. By using new technology and domestic raw materials the firm developed a steady franchisee among dozens of small, local textile weavers. It supplied synthetic fiber yarns used to weave colorful cloths for making sarees.
Unit demand increses with both population & National income 15.Synthetic ²textile market Stable demand.y Mills produce to order only i.e only maintainace stock are kept Competition is affected by price. .5% growth y.o. service & credit terms.
modest level for rest time DISTRIBUTION SYSTEM : Getting finished yarn quickly was a challenge Poor roads 10 to 15 days trip(distance=1100 km) One way highway Accidents were frequent .DISTRIBUTION CHANNEL Carry inventory through slack selling season Plan of seasonal prod:-peak capacity for 2 mths .
.ASSESMENT OF CURRENT SITUATION Kota Fibers has run out of cash for three principal reasons: sales growth (20% anticipated in 2001) declining profitability aggressive dividend payments In the abstract. Kota cannot self-sustain its asset growth: The additions to its assets are outstripping the firm¶s growth of profits retained.
5% in 2001. Operating expenses have risen by INR1.6% to 3.331 million. from 5. the ratio of cost of goods sold to gross sales has risen by 2 percentage points (from 69% to 71%) and is expected to mount to 73.7% in 2001.CONTINUED« An analysis of case reveals that net profit as a percentage of sales has fallen over the past year.4% of gross sales and is projected to fall to 1. In addition. .
but the dramatic growth in operating expenses and the aggressive dividend policy suggest other dubious management decisions.CONTINUED« It is conceivable that this small company. has simply buckled under rising wage demands. which faces a very strong union. in 2001. Moreover. In 2000. the firm plans to pay INR2 million in dividends. Finally.5%.9%²well below the bank¶s interest rate. Kota is projected to not pay its way as an investment. the firm earned a return on equity of 21. Interest expense (probably driven by growth and declining profitability) has risen by a third. .3 million in profits. the return on equity is projected to fall to 11. although it will earn only INR1.
The bank has already been disappointed by the company¶s inability to clean up its debt balance for 30 days during this past off-season and would be expected to advance no more cash unless the situation changes. The gravity of the situation cannot be overstated. The loss of customers would hurt a small company like Kota. Funds must be borrowed in order to pay the excise taxes that permit the company¶s goods to leave the loading dock. the bank is not likely to wait any longer for Kota to clean up. . Kota¶s failure to ship goods no doubt strains customer relationships: the case mentions that the textile companies produce to order. The point of the 30-day clean-up covenant was to discipline Kota to convert its seasonal accounts receivable and inventory back into cash. Unless the company gains access to cash. it could fold immediately. so they cannot sustain a long delivery delay.CONTINUED«.
The maximum loan balance of INR33 million. In addition.5 million. which occurs in June 2001. . the bank appears to have plenty of collateral underlying the loan. up significantly from the INR684.MEHTA·S FORECAST The financial forecast reveals that the company will be unable to clean up its seasonal line of credit for the required 30 days during the next year. although. The projected note balance in December 2001 is INR3.102 that prevailed in December 2000. with almost INR39 million in inventory and receivables. the forecast suggests large credit needs at the peak of the seasonal cycle. presents a large exposure for the bank.
The Pondicherry proposal will lengthen the collection period. payables would finance inventory exactly.60 × 60). Kota pays 1 month after purchasing. plus 60% of month-before-last-month¶s sales (aged 60 days). It buys raw materials 2 months before goods are shipped. This would leave the receivables to be financed by other means. Total (cash cycle) 78 DAYS (60 í 30 + 48 = 78) Accounts payable finances half the inventory. Thus. Accounts receivable 48 DAYS Receivables outstanding each month equals 40% of the previous month¶s sales (aged 30 days). By reducing its own inventory by 30 days. and Kota is financing the balance of the inventory outstanding as well as its customers¶ 48-days¶ sales outstanding.4 × 30) + (0. Inventory 60 DAYS Kota manufactures to order.CASH CYCLE OF THE COMPANY The number of days that cash takes to cycle through the working capital. The total net cash cycle is 78 days. days¶ outstanding equals (0. . Accounts payable 30 DAYS As the model shows.
switching from seasonal to level production. the company is unable to liquidate a seasonal working-capital loan for the requisite 30 days each year. improving profitability. . being supplied raw materials on just-in-time raw materials. reducing credit terms to customers.SOLUTION. Possible remedies include reducing inventory through more efficient transportation and warehousing. and reducing sales growth. This difficulty arises from two classic causes: secular growth of the company and declining profitability. decreasing dividends. In essence.
but a sharp reduction can be expected.DECREASING DIVIDENDS Although cutting the dividend will conserve INR2 million and may impress the banker with Pundir¶s sincerity. it will not produce a zero-debt balance at the end of the year. Cutting the dividend to zero is a draconian move and probably unrealistic. the banker will probably put intense pressure on Pundir to reduce the dividend in order to prevent the family from taking equity out of the firm in a time of financial strain. . Because Kota is a family owned company.
it might lose customers. growth is difficult in an inflating economy. but this action will not in itself effectively produce full clean up of the debt balance.SLOWER GROWTH slowing the growth of sales does reduce borrowing requirements. Moreover. and if existing customers suspected that Kota was unable or unwilling to fill their needs. .
IMPROVING PROFITABILITY improving profitability will reduce borrowing needs significantly. although improving profitability takes time and cost-cutting ingenuity. improved profitability may enable the accomplishment of the clean up. In combination with the new inventory policy. it is a laudable goal. . Overall.
LEVEL PRODUCTION A little reflection should suggest that this proposal is also undesirable. The time to begin level production is shortly after the peak. This action would only worsen the company¶s ability to clean up its outstanding loans at the end of the year. only 58% of the year¶s output will be produced by the end of July. at the nadir of the seasonal cycle. but doing so will cause the firm to stockpile finished goods in the off-season. however. If Kota initiates a level-production proposal now. About 73% of the year¶s sales. . the company will exhaust its stock in advance of the peak selling season because. if production is truly at a level annual rate. occur in the January±July period.
g. wages will have to be changed to be driven by the same month¶s purchases rather than last month¶s purchases. simply change the purchasing from two months ahead to one month ahead. still leaves a good margin of safety. To adjust the spreadsheet. although significant.202. stock-outs). respectively. . But company should be aware of the dangers of reducing inventory (e. a reduction from 60 to 30 days.THE NEW INVENTORY POLICY Reducing raw-material inventory by 30 days will reduce peak debt to INR25 million and ending debt to INR3 million. and will also increase the profitability of the firm by INR275. In addition..
. Vague suggestions will not do: (1) she must prepare to take specific steps. Pundir needs to be convincing when she speaks with the banker. and (2) she must spell out the financial implications of those steps.ACTION PLAN Pundir needs to meet with her banker with a positive plan of action that will correct the problems underlying the current cash shortfall and the company¶s inability to clean up its seasonal line of credit.
a change in the inventory policy. . Pundir could simply contain the growth of the firm. however. although the high growth rate in operating expenses may contain some fat that may be cut. If growth and cost containment are not possible. much hinges on her ability to tighten the operations of the firm. and a reduction in costs (especially operating costs). are likely to produce a highly liquid company once again. the bank will probably ask her to raise more equity capital as a foundation for long-term growth²this plan may be easier to accomplish once the profitability trends in the company begin to improve. Cost reduction may be hard to accomplish in the context of 20% sales growth. Clearly.CONTINUED« Any short list of actions should include a reduction or elimination of the dividend. In addition. All those actions.
then. before the firm can liquidate its receivables? All-India Bank is notoriously bureaucratic.CONTINUED« When she has regained the bank¶s confidence. forcing all of its seasonal borrowers into one-size-fits-all credit arrangements. is clean-up required at the end of October. . Why. so Kota had little choice but to accede to AllIndia¶s wishes when the company arranged for a credit line. The nadir of the seasonal cycle appears to be at the end of January or early February. Pundir might suggest one modification to the loan agreement: a rescheduling of the clean-up period. The competition among banks to make loans to small yarn-producing companies in India is not great.
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