Complete Kota Fibres

1.0 INTRODUCTION

1.1 COMPANY BACKGROUND

Kota Fibres, Ltd. was founded in 1962 in Kota, India. Created to

produce nylon Fibre, Kota Fibres provided synthetic Fibre yarns to local

textile weavers mainly to make the traditional women’s dress in India; the saris. Ms.

Pundir was both the managing director and principal owner of the company. Kota Fibres

used new technology and domestic raw materials to produce their quality product. The

demand for saris amounted to 12 billion yards of fabric.

1.2 SYNTHETIC –TEXTIE MARKET

The demand was stable with year-to-year growth. Due to growing population and

national income of India, synthetic textile market enjoyed huge potentiality to grow i.e.

the market keeps a steady 15% annual growth. Though Kota Fibres enjoyed growing

sales, but one of the constraint that limit its capacity to expand and increase its operation

cost was seasonal demand for nylon textiles. Thus, the seasonal demand for nylon yarn

would peak in mid-summer. Competition is affected by price, service & credit terms.

Their existed high competition among suppliers to retain merchants as consumers directly

purchased the cloth from the cloth merchant. To remain in and increase the market share

Kota had to adopt low cost strategy and grant a credit to support sales. Kota Fibres had

been consistently profitable. Sales had grown at annual rate 18% in the year 2000. Gross

sales were projected teach INR90.9 million in 2001. Net profit reached INR2.6 million in

2000

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2.0 KOTA FIBRES, LTD. – QUESTIONS

2.1 What is the current situation? Why did the company run out of cash? What

are the consequences for the company?

The current situation is Mrs. Pundir was faced with some problems, Firstly, the

payment of excise tax to move their product. The government tax inspector would not

clear their trucks for delivery, because the excise tax had not been paid. Secondly, Mr.

Mehta, the company bookkeeper, went to draw funds for the excise tax when he

discovered that the company had overdrawn its bank account again, so this created

problem of requesting new loans from All-India Bank and Trust Company. The company

needed to figure out a solution to restore the firm’s liquidity. Thirdly is line of credit not

being repaid according to the term. Kota Fibres had a required cleanup month, usually

being in October, but had promised to repay in November or December. When they failed

to repay during all three months, the bank refused to extend anymore seasonal credit until

a reasonable financial plan for the company was presented. Lastly, due to inflation, Mr.

Mehta was worried the interest rate may be higher in upcoming year on the loans.

Kota Fibres has run out of cash because was persist borrowing money from All

India Bank because they are undergoing peak sales around late summers due to festival

Diwali which is their financial requirements varied between the years. The key

determinant for the borrowing of Kota Fiber is, their sales depend on their credit period

given, so the more credit, more their market share. They required more loans during peak

season because they need strong stock in advance during that time. Unfortunately, in

production and distribution system, they are facing bad infrastructure. The transportation

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period of raw material will increase and will also increase the cash cycle which caused

the delayed in the supply of order. Pundir proposed to pay dividend of INR500,000 per

quarter to the eleven members of her extended family who held the entire equity of the

firm. For years Kota had paid high dividends. The Pundir family believed that excess

funds left in the firm were at greater risk than if the funds were returned to shareholders.

This has caused the company run out of cash.

The consequences for the company are they are unable to deliver order to

customer because they failed to pay excise tax. The seasonal line of credit had to be

cleaned up for at least 30 days each year, but Kota Fiber had failed to make a full

repayment at that time.

2.2 What does Mehta’s financial forecast show? How was the forecast

constructed?

Mehta’s financial forecast does not show a satisfy performance of the company.

From the case, it is clear that, although Kota Fibres Ltd. at times is suffering from cash

shortage, it is a profitable company that has been enjoying profit as well as sales growth

in the past. But, the financial forecast has shown that the forecasted profit of 1335848

rupee in the year 2001 is far below than the profit of 2550837 rupee in the year 2000.

Therefore, based on the Mehta’s forecasts, even though the company continues to remain

profitable, its profitability will even decline in the year 2001. Also, the monthly forecast

of the income statement of the company shows that the company will experience a net

profit in the business only in the 5 months, which is during the months of the seasonal

peak in the demand for the nylon yarn. The inability of the company to maintain even a

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minimum level of profit in the rest 7 months might indicate a poor performance of the

company. By comparing the forecasted balance sheet of the company for 2001 with the

actual balance sheet for 2000, it has been seen that there has been a considerable increase

in the accounts receivable as well as inventory according to the forecast. This has

increased the size of investments in current assets from 35% (4,684,237/13,295,604) of

the total assets in the year 2000 to 43% (6,690,525/15,628,161) as forecasted in the year

2001. This increase in the size of current assets is not desirable for the company as its

larger amount is one of the reasons for the need for external funding without a

corresponding increase in profits for the company. The forecasted schedule of cash

receipts and disbursement shows that in order to meet all the disbursement and maintain a

cash balance of 75,000 rupee companies need to borrow large amounts of money for 7

months, that is, from January to June and again on December. So, based on this forecast,

the number of total borrowing companies will be 32,452,209 whereas the refund will

only 29,672,610, which can be a sign of inability to pay in full the company short-term

liabilities on a timely basis.

Financial Ratio Actual (2000) Forecast (2001)

Current ratio 4,684,237/1,443,637 =3.2 6,690,525/4,440,345 =1.5

Quick ratio (4684237-1,249,185)/ 1,443,637 =2 (6690525-2,225373)/

4,440,345= 1

Average collection

period

2,672,729/ (64,487,358/365) =

15.127

3,715,152/(77,265,092/365)

= 17.550

Average payment

period

759,535/(53865,911/365) = 5.146 1,157,298/(66,993,380/365)

= 6.305

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Total asset turnover

ratio

64,487,358/13,295,604 =

4.850

77,265,092/15,628,161 =

4.943

Gross profit margin 64,487,358/10,621,447=

0.164705882 or 16.47%

77,265,092/10,271,712=

0.1329412 or 13.29%

Return on assets 2,550,837/ 13,295,604=0.19185563

or 19.18%

1,335,848 /15,628,161=

0.085477 or 8.57%

With current ratio 3.2 and quick ratio 2, Kota is operating within acceptable

levels. However, the forecasted ratio of 2001 shows that this ratio decline to 1.5:1, that’s

mean below the acceptable level for a manufacturing firm. They well have some problem

paying their bills on time with the projects production and sales levels. In 2000, Kota has

a quick ratio of 2:1 which is well above the acceptable level. However, its drop from

2000 to 20001 of 1, this leads people to believe that the Kota will have issues paying their

short-term debt/bills can be a problem in the future. An Inventory Turnover showed in

year 2000 is 43.12 and in projected 2001 are 30.10. This increase is a step in the wrong

direction. A firm does want its inventory to turnover more often throughout the year;

therefore, the projection may be contributed to the more efficient level annual production

proposal. We’ve also calculated Average collection period, Average payment period,

Total asset turnover ratio to determine how fast firm convert their credit sales into cash.

There is low turnover rate in 2001 compared to past and this is because firm is carrying

large number of inventory. Average collection period is not very large, which is good and

their average payment period is very low which means that they are fast in paying their

bills. Due to this they might be given high rating by their suppliers but there exist high

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gap between receivables and payables and this situation might lead to shortage of cash

flow. If we look upon the debt ratios, we can infer that Kota is using high debt compared

to past i.e. in 2000. Profit margin shows that it has declined from past which suggest that

they will have to increase the sales or reduce expenses.

The forecast was created using the current accounting assumptions. Some of these

assumptions were created through the observations of the past practices. The construction

of the forecasts gives instruction available issues with the company. There are some real

issues, and some of the assumptions that were placed on the forecast are meant to serve

the shareholders in the short-term by keeping the dividends paid consistently high.

Taking into account the needs of the company for the long-term, decreasing the dividend

in the short-term to support the continued profitability and longevity of the company

should be something that Kota should seriously consider.

2.3 What are Pundir’s alternatives for action? What impact might the four

operating proposals have on the financial needs of the firm?

Alternative 1: Pondicherry textiles - increase sales with lax credit terms

The first alternative involves a proposal from Pondicherry Textiles that is willing

to offer Kota Fibers an increase in sales revenue of Rs. 6 million provided that Kota gives

them a credit period of 80 days, which is a significant increase from Kota’s standard

credit period of 45 days.

Impact of the proposal on financials of Kota

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The proposal from Pondicherry will have a positive impact on profitability of

Kota as it involves an increment in sales revenue. More specifically, the forecasted profit

for the forecasted period(2001) will increase by Rs. 126,325, which is a 8.64% increase

in net profit. However, we recommend that Kota should not go ahead with this proposal

because Kota’s problem is not that of profitability but cash management and this proposal

from Pondicherry will have a detrimental impact on the firm’s short-term debt and cash

position. For example, accepting this proposal will require Kota to consistently borrow

more in all months so that its highest debt outstanding (in the month of July) will increase

from Rs. 32 million to Rs.35 million.

Jan Feb March April May JuneDebt Outstanding Adjusted 1,344,092 3,370,024 9,503,690

18,729,070 28,941,414 35,240,240

Debt Outstanding 1,146,268 2,962,622 8,767,030 17,419,379 26,997,556 32,950,665

Increase in debt outstanding 197,824 407,402 736,660 1,309,692 1,943,858 2,289,575 Jul Aug Sep Oct Nov DecDebt Outstanding Adjusted 29,076,414 16,955,838 8,970,898 5,399,639 3,562,712 3,704,996 Debt Outstanding 27,167,192 15,795,793 8,352,899 5,002,010 3,278,054 3,463,701 Increase in debt outstanding 1,909,222 1,160,045 618,000 397,630 284,657 241,295

Jan Feb March April May JuneNew Borrowings (Repayments) 659,990 2,025,932 6,133,666 9,225,381 10,212,344

6,298,826

Borrowings adjusted 462,166 1,816,354 5,804,408 8,652,349 9,578,178 5,953,108

Increase in borrowings 197,824 209,578 329,258 573,032 634,166 345,717 Jul Aug Sep Oct Nov DecNew Borrowings (Repayments) (6,163,826)

(12,120,576)

(7,984,940)

(3,571,259)

(1,836,928) 142,284

Borrowings adjusted (5,783,473)(11,371,400)

(7,442,894)

(3,350,889)

(1,723,956) 185,647

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Increase in borrowings (380,354) (749,176) (542,046) (220,370) (112,972) (43,363)

Alternative 2: Reduce inventory through better transportation management

The first alternative involves a proposal from the transportation manager who

suggests that since shipments in the last 6 months have been on time due to the new road

between Kota and New Dehli, Kota can reduce its raw material inventory requirement

from 60 to 30 days, which would reduce the company’s inventory by one month.


The proposal will have a good impact on Kota’s short-term debt position as

reduced amount of inventory will reduce the debt outstanding in all the months from

January to December as can be seen from the table below.

Jan Feb Mar Apr May Jun

Debt Outstanding 1,146,268 2,962,622 8,767,030 17,419,379 26,997,556 32,950,665

Debt Outstanding Adjusted

20347.3241

158861.2909

3107487.081

8974693.117

17496956.08

25889398.04

Decrease in Debt Outstanding 1,125,921 2,803,761 5,659,543 8,444,686 9,500,600 7,061,267

Jul Aug Sep Oct Nov Dec

Debt Outstanding27,167,192 15,795,793 8,352,899 5,002,010 3,278,054 3,463,701

Debt Outstanding Adjusted

23616381.2

13579044.42

6585028.064

3727314.587

2088851.368

1984962.101

Decrease in Debt Outstanding 3,550,811 2,216,748 1,767,871 1,274,695 1,189,203 1,478,739

The proposal will also reduce the monthly borrowing requirement in most months from

January to December as can be seen from the table below.


Borrowings462166.0532

1816353.585

5804408.038

8652348.714

9578177.569

5953108.394

Adjusted 455363.6131792611.757

5753275.578

8567135.665

9469758.133

5965658.262

Decrease in 6802.44021 23741.8281 51132.4602 85213.0483 108419.436 -

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Borrowings 7 3 3 3 112549.86798


Borrowings-5783472.57

-11371399.6

-7442893.923

-3350888.76

-1723955.522

185646.8519

Adjusted-5847587.21

-11406245.3

-7430057.448

-3369270.929

-1738841.574 169528.035

Decrease in Borrowings

64114.63621

34845.66977

-12836.47511

18382.16882

14886.05215

16118.81688

The decrease in borrowing requirement and debt outstanding makes sense as the proposal

reduces inventory requirements to half, which means that the amount of financing

required for current assets is lesser.

Alternative 3: Purchase the raw materials on “just-in-time” basis from Hibachi

Chemicals

This alternative involves purchasing 35% of the raw materials (polyester pellets)

from Hibachi Chemicals on a “just-in-time” basis. This action is expected to reduce the

inventory of pellets from 60 days outstanding to only 2 to 3 days.


The proposal will have a good impact on Kota’s short-term debt position as

reduced amount of inventory with the use of “just-in-time” purchase will reduce the debt

outstanding in all the months from January to December as can be seen from the table

below.


Debt Outstanding 1146268.5 29626228767030.1 17419379 26997556 32950665

Debt Outstanding Adjusted 367375.7

978996.59

4732628.5 11384942 20205093 27910000

Decrease in Debt 778892.76 1983625. 4034401. 6034437 6792463. 5040665

9

Outstanding 5 6 7


Debt Outstanding 27167192 157957938352898.6

5002009.9

3278054.4

3463701.2

Debt Outstanding Adjusted 24648261 14235423

7114973.5

4118690.9

2456531.3

2434617.6

Decrease in Debt Outstanding 2518931

1560369.2

1237925.2

883318.97 821523.1

1029083.6

The proposal will also reduce the monthly borrowing requirement in most months from

January to December as can be seen from the table below:-


Borrowings462166.05

1816353.6 5804408

8652348.7

9578177.6

5953108.4

Adjusted457460.24

1799663.4

5768049.1

8591516.1

9500681.7

5961889.1

Decrease in Borrowing

4705.8104

16690.214

36358.914

60832.567

77495.858

-8780.7356


Borrowings5783472.6

11371400

7442893.9

3350888.8

1723955.5

185646.85

Adjusted5829145.1

11396045

7433632.9

3363704.6

1734255.6

174466.1

Decrease in Borrowing

45672.559

24645.772

9261.0462

12815.85

10300.088

11180.749

The decrease in borrowing requirement and debt outstanding makes sense as the proposal

reduces the inventory holdings by a considerable amount, which means that the amount

of financing required for current assets is lesser.

Alternative 4: Adopt the Scheme of Annual Level Production

The fourth proposal is a memo from the Operations Manager, L. Gupta, to whom

Pundir had requested to estimate the production efficiencies arising from a scheme of

level annual production.

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Impact of the proposal on the performance of Kota

According to Exhibit 7, the significant advantages to be gained are:

The first advantage is that due to absence of certain seasonal training and setup costs,

labor savings and production efficiencies is gained from a stable work force, therefore

increasing the gross profit margin by 2% or 3%.

The seasonal hiring and layoffs would stop. This will allow Kota to create a stronger

work force and, perhaps, to suppress labor unrest. As their unions have indicated that

reducing seasonal layoffs will be one of their major negotiating objectives this year,

this will help them negotiate on more favorable terms with the union.

With annual level production, the machineries would be in function all year round,

thus, they would suffer less from equipment breakdowns and could better match the

routine maintenance with the demand on the plant and equipment.

2.4 What action should Pundir take?

Ms. Pundir is faced with resolving a surprising cash shortage immediately. As her

management style is extremely delegate, it is important that she analyzes Kota Fibres’

financial situation before making any decisions. With success in the company for the past

forty years, Ms. Pundir weighs her focus on shareholder profits more so than the

company’s liquidity and forecast for the future. The following recommendations

regarding the financial situation the company currently stands in as well as advice on the

memos are discussed below:

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Overall, Kota Fibres, Ltd. is doing a good job at managing their liquidity,

although the projection does show a slight decline in this area. This means they could

have potential issues with paying their bills on time and converting their assets to cash if

they follow the 2001 projection.

In the area of Asset turnover and AR/AP, Kota Fibres is operating at an

acceptable level across the board. However, one red-flag is the extended credit term of 80

days net requested by Ponticherry Textiles. This would reduce the amount of cash on

hand during the year and increase their liabilities due to the 80 day credit term. In this

circumstance, Kota Fibres should not accept this memo as it will have an unfavorable

effect on the business. Having less cash on hand, tied up in receivables, will not allow

Kota Fibres to be able to pay off the All-India bank before December.

In addition, the two proposals from the Transportation Manager and the

Purchasing Agent should be approved. A reduction in raw material inventory and

finished goods inventory on hand will result in less inventory being accounted for in the

financial statements and increase the amount of overall liquidity since Inventory is the

least liquid asset.

Kota Fibres must also recognize the contributing factor of the shortage of cash on

hand. This is due to the firm’s inefficiency to use their assets to generate sales. Kota

Fibres should boost this number by increasing their amount of total assets. Their Debt-to-

equity standing reflects another sign of how they can increase their cash on hand. The

projection for 2001 addresses this area well, and should be pursued.

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Kota Fibre will need to rethink its strategy to generate a profit using the 2001

projection. Across the board, they will be facing a decrease in profitability if they execute

this plan. They will need to improve their operating efficiencies and levels of

indebtedness to increase their bottom line, ultimately resulting in their ability to make

their creditors and shareholders’ happy. It is crucial that shareholders are informed on the

recommended actions. This may allow for a different approach to business rather than

Ms. Pundir’s sole objective of maximizing shareholder wealth. Understanding the

seriousness of the financial situation Kota Fibres is in with regards to paying their bills on

time and future forecasts, ethics and responsibility may also come forward as

shareholders should be willing to reinvest profits in a company that will benefit them in

the long run.

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