Kota Fibres Ltd.

INTRODUCTION:

Kota Fibres, Ltd. is one of India textile fiber manufactures that supply nylon fiber to domestic textile mills which make saris, the traditional women’s dress. Facing demand of India’s female population of 500 million, the saris industry consumes 12 billion yards of fabric, and the market keeps a steady 15% annual growth. Kota Fibres has been run as a family business by Ms. Pundir and her family since 1962. In the year of 2000, Kota Fibres outperform market average by growing sales revenue of 18% and achieved INR 2.6 million in net profit.

Despite healthy growth of Kota Fibres’ revenue, Pundir found out that the company was facing a serious cash flow issue. The company was virtually stopped operation due to another overdraw from its bank account. Pundir must get additional loans from Bank to keep the company operating. In this paper, we will assist Pundir to figure out the issues Kota Fibres is confronting, and to workout a plan to deal with the issues by cutting inventories, reducing account payable, gaining new sales revenue, and the most important of all, to work out a reasonable cash receipts and disbursements schedule and balance sheet to convince the bank to grand additional loan.

PROBLEM STATEMENT:

The biggest issue is that Kota Fibres is out of cash on early January. Ms. Pundir has questioned her bookkeeper and us how could a profitable and growing firm face such critical cash flow issue. We need to look into several areas on natures of how nylon fiber business operates in India. The yarn manufactures like Kota Fibres are in very upstream in India’s textile industry and is the essential financial source to issue credits to keep downstream businesses running. Kota Fibres has to keep an average of 45 days credit for its customers in order to win their businesses. Kota Fibres also has to carry out two months raw material inventory ahead of production due to poor transportation condition. The profit margin of company is also slumping in recently year due to fierce price competition and climbing operation cost, which is partially due to Pundir added more family members to the employee list. Following is a list of issues we observed in the operation of the company, and how we think we may resolve the issues to reduce spending and save more cash for the company.

CASH SPENDING

DESCRIPTION OF ISSUE

WHETHER CAN FIXED OR FIX IN SHORT OR LONG TERM

Inventory

Must buy two months inventory ahead of production. Large inventory. Our account payable date is 30 days.

Can be Fixed. If choose more nearby supplier and fix logistic time issue.

Customer Credit

Issue an average of 45 days credit. Collect receivable 40% in 30 days and 60% in 60 days

Difficult to be fixed in short term due to nature of business.

COGS (Material & Wages)

Cost of good sold is a little high, depending on material and wages

Can be fixed in near term. Cut material cost by production efficiency and effectively use labor.

Family Dividend

500K INR quarterly

Covert part of cash dividend to stock dividend

Account payable

supplier provide little trade credit – 30 days.

Try to extend to 60 days by negotiation with suppliers.

Bank Interest

14.5% interest rate on borrowing and loan-cleanup month

Negotiate for short-term with low interest rate and long-term with high interest rate

In essence, the Company cash-out is too quick while its cash-in is so slow that they are easy to fall into predicament in lack of cash-flow. We may try to focus on the two aspects to analyzie and find out the resolution eventually.

ANALYSIS:

In order to convince the Banker to extend more seasonal credit to Kota Fibres, Pundir asked her bookkeeper, Mehta, to prepare a predicted financial plan. However, the plan is on a business-as-usual basis. The result of the forecast shows that the company’s financial position will get even worse by the end of 2001. If the operations of Kota Fibres have no changes, it will be hopeless for the company to clean up the loan. The result of the bank notes forecast is as following:

Month

Jan

June

Dec

Bank Notes

1,146,268

32,950,665

3,463,701

Fortunately, there are some possible ways to improve the situation:

Get new order from Pondicherry Textiles: INR 6M annual sales;

Transportation improvement: reduce raw material inventory requirement from 60 days to 30 days;

“Just-In-Time” polyester pellets supplies: reduce inventory of pellets from 60 days to 2 or 3 days;

Improve production efficiency by adoption of level annual production: improve gross profit by 2 or 3 percent.

Negociate with suppliers to ask for credit terms of 60 days, instead of current 30 days.

We did a thorough study on each of the approaches.

APPROACH1: GET NEW ORDER FROM PONDICHERRY TEXTILES

Although it may become one of the company’s largest accounts, the biggest issue is that Pondicherry wanted to extend the credit term from 45 days to 80 days. If Pondicherry will purchase our yarn across the year in about the same pattern as other customers, we estimate the bank note will be even
worse:

Month

Jan

June

Dec

Bank Notes

1,202,510

36,054,488

3,844,456

It is very obvious that we would have at lease 3 months account receivables that could not be collected by the end of the year. Thus this is not a good choice unless Pondicherry agrees to shorten the payment term.

APPRAOCH2: IMPROVE PRODUCTION EFFICIENCY BY ADOPTION OF LEVEL ANNUAL PRODUCTION

It sounds very good to improve the gross margin by 2 or 3 percent. But if the company adopts the level production scheme, we have to face the situation of under stock somewhere in June. We cannot tolerate this situation, especially during peak seasons. The following chart shows the trend of inventory under level production scheme.

APPROACH3: TRANSPORTATION IMPROVEMENT

Since transportation is improved, raw material inventory requirement could be reduced from 60 days to 30 days. In November and December 2000, Kota Fibres has purchased enough raw materials for January and February 2001. Thus in January 2001, the company does not need to purchase the amount of raw materials according to the sale amount of February. Just supplement enough raw material inventories to make sure there is no occurrence of down stock situation in following months. We would suggest supplementing INR 600K of raw material. The raw material purchases of other months should still follow the rule of 55 percent of sales of next month. As the result, the forecast of the bank note payable will be:

Month

Jan

JUNE

Dec

Bank Notes

1,146,268

21,425,301

1,237,139

By improving the transportation, the inventory turnover ratio gets improved, and the outstanding bank notes payable is reduced by almost two thirds. The profitability is also getting better – net profit from INR 1,335,848 to 1,836,044. No doubt this is an effective approach.

APPROACH4: “JUST-IN-TIME” POLYESTER PELLETS SUPPLIES

This approach also improves the inventory turnover ratio. By adopting this approach, Kota Fibres could buy 35% of the raw materials just in time it needs them. With other assumptions consistent, this approach reduces outstanding bank notes by more than 50 percent. See detail bank notes forecast below:

Month

Jan

JUNE

Dec

Bank Notes

1,146,268

25,179,256

1,687,068

The net profit increases from INR 1,335,848 to 1,681,079. This is also good choice the company should be considering.

APPROACH5: ASK FOR LONGER CREDIT TERMS OF 60 DAYS FROM SUPPLIERS

This approach can reduce the account payable turnover rate to get cash out slower. The company could try to extend credit terms of 60 days from original 30 days by negotiating with suppliers. If successful, this approach reduces outstanding bank notes by more than 60 percent. See detail bank notes forecast below:

Month

Jan

JUNE

Dec

Bank Notes

1,146,268

18,584,693

1,193,826

However, this approach mostly depends on the other side – suppliers, instead of ourselves. So it could not be the first remedy we choose.

RECOMMENDATIONS:

Of course approaches 2 and 3 can be utilized together. If Kota Fibres adopts both one month inventory and “Just-In-Time” poly ester supplies, the forecast net profit is INR 1,925,580 and bank notes forecast is

Month

Jan

JUNE

Dec

Bank Notes

1,146,268

18,584,693

1,193,826

This result of this combined approach is better than any approach being adopted alone. However, the outstanding bank notes is still existing by the end of 2001. Other ways to improve the cash position could be:

Convince the family member to covert part of cash dividend to stock dividend. If cash dividends are reduced to 200,000 per quarter, the outstanding bank notes will be eliminated.

Accelerate depreciation if possible. Accelerated depreciation will reduce tax expenses.

Improve operating efficiency. 1 percentile of reduction on operation expenses will save 750,000 cash.

Combine the short-term loan with lower interest rate and the long-term loan with higher interest rate to get the optimal cost of loan and flexible repayment timing so that the Company can avoid cash out peak period.

Improve the collection of account receivable. The company’s average account payable term is 30 days and the average account receivable term is 45 days. There is 15 days difference between collection and payment. The more sales Kota Fibres makes, the more credit the company need to issue.

Reference

Robert F. Bruner, _Case Studies in Finance; Managing for Corporate Value Creation_, 5th edition, McGraw-Hill, 2007.