Kota_Fibers

Executive Summary Kota Fibres, LTD. October 3, 2012 Background: Kota Fibres, Ltd. was founded in 1962 in order to produce nylon fiber at its plant in India. The fiber yarns are used to produce saris. Kota Fibres manufactures the yarn and acts as the intermediary in the fiber process. The demand for nylon fibers is 12 billion, and the company represents a stable and growing business. However, there is a seasonal peak in demand during mid-autumn, due to the Diwali celebration. Due to seasonal demand, the merchants maintain low levels of inventory throughout the year, and dramatically increase their inventory before and during the two- month peak-selling season. Seasonal demand creates a constant hiring and laying off of employees, which results in retraining efforts. The company has two distribution warehouses to provide timely service to its customers, yet the roads between the warehouses are often in poor condition, causing distribution delays. Overall, the company is profitable, experiencing an 18% sales growth in 2000. The firm is a family owned business; therefore, the managing director pays dividends of INR500,000 per quarter to the owners. Also, Kota Fibres has a line of credit at the All-India Bank & Trust Company. Kota Fibres has a cleanup requirement to pay off their loan with the bank by October, and this date was changed to December, due to the company’s less than adequate cash balance. Analysis/Assumptions: * Because no credit is given to the manufacturers, the accounts payables exhibit a minimum term, whereas the accounts receivable exhibit a maximum term. Therefore, there is a large gap between the cash flows of the company. * The supply of orders is delayed (AR), so the firm runs out of cash for other needs. * The excise tax (15%) poses a liquidity issue for the firm, requiring INR750,000 cash on hand. * If the firm pays out dividends of INR500,000 quarterly, then INR2,000,000 dividends will be distributed per year. If this value is subtracted from the net profit of INR2,550,837, then the firm will have INR550,837 to roll into retained earnings. However, value is much lower than the previous year that generated INR1,599,065. Recommendation: Kota Fibres is still a profitable company, experiencing an increase in sales, yet the firm is undergoing a cash shortage due to their decrease in profitability and large dividend payouts. The company should not completely eliminate dividend payouts because of Indian tradition, but rather should consider reducing the amount the dividend payouts. By reducing the dividend payout to IRS1,500,000 per year, and also factoring 15% of the account receivable balance in June (Appendix II), Kota will be able to, in the short-term, reach a cash balance to pay off the loan by the clearing period of December. In fact, the note payable balance for the bank loan actually clears in November. However, since the company’s profits have been shrinking over the past few years, we still believe that it is in the company’s best interest to reduce the dividend payout in effort to reinvest in the family business for the future. As for the long-term, we see some additional issues. Financial ratios help portray some potential solutions to the cash shortage issue. The cash conversion cycle illustrates how many days it takes for a company to transform inputs into cash flows. Overall, the shorter the cash cycle, the less time cash will be tied up in the business, and this will increase the profit of the company. The cash cycle for 2000 is 18 days and this number is forecasted to increase to 23 days in 2001 (Appendix I). Overall, by shortening the cash cycle, there will be less need for external financing. Therefore, Kota Fibres should focus on reducing the days outstanding in inventory, reduce the number of days that accounts receivable are outstanding, or increase the payables period. Furthermore with this knowledge, Kota Fibres must examine the memos from mangers concerning business proposals: Looking at the field sales manager’s proposal, it is understandable that sales revenue will increase, therefore increasing profit. However, Kota Fibres’ main challenge is to decrease their large cash cycle. Accepting this proposal would have a negative effect on the cash management of the company because of the increased credit terms. This would most likely require the firm to borrow more money in order to achieve the credit terms of 80 days. Increasing the financing needs of the firm is not an option at this point. Thus, Kota Fibres must reject the field sales manager’s proposal. The second memo from the transportation manager and the third memo from the purchasing agent should both be accepted, because as the cash cycle reveals, by decreasing days outstanding in inventory, the company can decrease the cash cycle, and increase the bottom line. By reducing inventory, financing requirements are reduced. Therefore, the debt outstanding will decrease as well. Finally, because of the seasonality of the business, the field manager’s memo has the company running the risk of depleting its inventory before the peak-selling season even begins. By storing the goods, the company is impairing their ability to clean up the loans on a timely basis. Thus we have decided to reject this memo’s proposal. Appendix I: Cash Cycle Ratio Calculations:   | 2000 | 2001 (forecast) | COGS | 53,865,911 | 66,993,380 | Inventory | 1,249,185 | 2,225,373 | Net Sales | 64,487,358 | 77,265,092 | Accounts Receivable | 2,672,729 | 3,715,152 | Accounts Payable | 759,535 | 1,157,298 |   |   |   | Inventory Turnover | 43.121 | 30.104 | Inventory Period | 8.465 | 12.124 | Receivables Turnover | 24.128 | 20.797 | Receivables Period | 15.128 | 17.550 | Payables Turnover | 70.920 | 57.888 | Payables Period | 5.147 | 6.305 | Cash Cycle | 18.446 | 23.370 | ** The Cash Cycle Ratio Calculation chart shown above illustrates that the recommended proposals should be implemented to avoid further deterioration of the cash management situation. Appendix II: *This is a spreadsheet with a projection of 15% factoring of the accounts receivable in the month of June when the spread was the greatest between A/R and the loan due. Fifteen percent is the maximum we can factor and still have a positive account receivable balance at the year’s end. **Factoring expense is 10% of the account receivable based on average rate for account receivable factoring from DBS Bank.