Kota Fibres Ltd Background Date of establishing 1962

Kota Fibres, Ltd. Background Date of establishing: 1962 Market Segment: produce of nylon fibre Owner: Ms. Pundir Capabilities: firm used new technology and domestic raw materials; supplied synthetic fibre yarns to local textile to make saris • Firm enjoyed, 2000: huge potentiality to grow i. e. the market keeps a steady 15% annual growth; growing sales, but one of the constraint that limit its capacity to expand increase its operation cost was seasonal demand for nylon textiles. • •

Kota Fibres, Ltd. Background • Kota was very profitable organization but at later phase of business they were pulled into the situation which was characterized by declining profit, increasing interest expenses, high dependence on loan to meet seasonal demand, and declining cash flow • Kota needed to adopt policies against overproduction and overstocking

Kota Fibres, Ltd. Background • To remain in and increase the market share Kota had to adopt low cost strategy and grant a credit to support sales • In the year 2000, sales had grown at an annual rate of 18% and their projected sales also were projected to reach to INR 90. 9 million • Due to short term cash crunch they were unable to pay short term debt, excise tax, maintain timely delivery system, and maintain seasonal line of credit with bank

Kota Fibres, Ltd. Background • All-India Bank & Trust Company had to deny any kind of seasonal credit and demand reasonable financial plan for the company • Kota required additional loan to fulfill short term obligations and for time being they also to needed to extend their line of credit • Kota’s financial statement showed that they can’t repay loan any sooner and need additional debt

Finance Statement Analysis • Mehta’s financial forecast does not show a satisfactory performance of the company. From the case, it is obvious that, although Kota Fibres Ltd. at times is suffering from cash shortage.

Historical Annual income statement Therefore, based on the Mehta’s forecasts, even though the company continues to remain profitable, its profitability will even decline in the year 2001.

` • The monthly forecast of the income statement of the company shows that the company will have a net profit in the business only in the 5 months • The inability of the company to maintain even a minimum level of profit in the rest 7 months might indicate a poor performance of the company.

• It has been a large increase in the accounts receivable and inventory according to the forecast. • This increase in the size of current assets is not desirable for the company , because its larger amount is one of the reasons for external funding without a corresponding increase in profits for the company. • They can’t get cash back as soon as possible.

` • Schedule of the cash receipts and disbursements shows that in order to fulfill all the disbursements and to maintain the cash balance of INR 750, 000 the company needs to borrow a lardge amount of money for 7 months. • From January to June and again on December • Total borrowing would be INR 32, 452, 209 whereas the repayment would be only INR 29, 672, 610 • company’s inability to pay its short term liability on time

• How did Mehta construct his financial forecast? • The forecast was created using the current accounting assumptions. Some of these assumptions were created through the observations of the past practices. • Pay the dividend of INR 500, 000 per quarter, keep the minimum cash balance of INR 750, 000

• Using the financial forecast, prepare to show the “cash cycle” of the firm？ Inventory Turnover=Cost of Goods Sold/ Inventory Receivable Turnover= Net Sale / Accounts Receivables Payables Turnover=Cost of Goods Sold/Accounts Payable

• cash cycle=(Inventories Period + Accounts Receivable Period) - Accounts Payable period • 2000 cash cycle =18. 4 • 2001 cash cycle =23. 3 • Inventory and receivables increased in the forecasted 2001 lead to increase in cash cycle.

• Examine the exhibits in the case. On the basis of Mehta’s forecast, how much debt will Kota need to arrange for the coming year? Will Kota be able to repay the line of credit this year? • The net borrowing amount for the year 2001 is INR 32, 452, 209. • The forecasts prepared by Mehta show that Kota Fibres Ltd. will not be able to repay the line of credit this year and they further require credit form the bank.

• Why do Kota’s financial requirements vary across the year? What are the key determinants of Kota’s borrowing needs? Please exercise the spreadsheet model to identify the critical forecast assumptions. • Kota financial requirements vary across the year because it is a seasonal business. • The determinants are a direct result of Kota operating cycle which consists of the following: • Suppliers of raw material provide little to no credit. • Kota has to borrow to purchase inputs in advance. Once the raw material is purchased it is processed into fiber yarn and then sold to textile factory. • The factory will purchase from Kota only if it is willing to sell the yarn on credit. The textile factory then sells the finished cloth to businessman who then sells to consumers. • At the end, the kota will get the money. But it was a long time.

As shown in the table, the company has a higher cash cycle in the months of August and September and lower cash cycles in the months of January and February.

• Consider the four memos that Pundir received. Use your intuition to assess the desirability of two of the proposals: • Pondicherry Textile’s request for credit: What will be this proposal’s effects on accounts receivable and debt balances across the year? • The level-production proposal: If Kota undertakes level production now, at the low point of the annual business cycle, what is the likelihood of inventory stock-outs at the peak of the business cycle? If Kota undertakes level production just after the peak, what will happen to inventory and debt balances at the cyclical low? • Are those proposals liable to relieve, or worsen, Kota’s ability to “clean up” its bank loan by the end of 2001? What action should Pundir take on these two proposals?

• • • Assess the impact of the other two proposals intuitively and then analyze them with the aid of the computer-spreadsheet model. What action should Pundir take on those two proposals? (Please note that the forecasting model incorporates a circular reference among the financial statements. Accordingly, students should set the model to iterate a number of times [try 15] to find a solution in which the various financial statements converge toward agreement. In Excel, students should click on options, calculation, and iteration. ) The new inventory policy proposal: (Hint: purchases will be a percentage of next month’s sales, and wages will be a percentage of this month’s purchases. ) What effect will this scheme have on inventory and debt balances? To see whether the effect will be material, reforecast the financial statements based on an adjustment to the purchases/sales ratio that produces the desired reduction in the final inventory balance (in the model, purchases drive wages and, hence, inventory). Hibachi Chemicals’ just-in-time(JIT) proposal: (Hint: assume that this proposal will reduce 35% of the firm’s inventory to about 5% of its former balance. ) What will be this proposal’s effect on inventory and debt balances? To see whether the effect is material, reforecast the financial statements based on an adjustment to the purchases/sales ratio.

• Why does the bank require a 30 -day clean-up of the loan? Should the bank continue to waive compliance with this covenant?

Identify the three most important actions or policies that Pundir should take. What should she say to the bank? To the customers?