Kota Fibres

Critical Papers

Case 10: Kota Fibres, Ltd.

William Wong

ACCT 4780 - Section R10

Feb 1, 2012

Student #: 100273429

Issues

The main issue faced by Ms. Pundir, the managing director and principal owner of Kota Fibres is the shortage of short-term cash flow due the seasonal peak of the textile industry in India. Kota has been in business for 40 years, and it is clear the company is profitable in order to stay in the business for so long. All of the problems that Ms. Pundir faces are attributed to growing too fast and new policies are needed to reduce cost of goods sold and other expenses to remain profitable.

Analysis of Year 2001 Financial Forecast

Overall Performance

Table 1 shows that the company's gross sales are increasing, yet the growth of the costs of goods are increasing at a higher rate, and thus yielding a decrease in net profit

Table 1: Percent Increase of Gross Sales, COGS, and Net Profit.

Gross Sales % Increase COGS % Increase Net Profit % Increase

1999 64,487,358 44,496,277 3,599,065

2000 75,867,480 17.65% 53,865,911 21.06% 2,550,837 -29.13%

2001 90,900,108 19.81% 66,993,380 24.37% 1,335,848 -47.63%

The net profit has been decreasing from 5.58% of Gross Sale in 1999 to 3.36% in 2000, and it continues to 1.47% for the forecast in 2001. .As a whole, the company needs to reduce the cost of goods sold or other expenses in order to improve the bottom line. This can be achieved by finding a lower-priced supplier, purchasing new equipment to improve the efficiency of the manufacturing process, or finding cheaper labour or training workers to be more efficient at their job.

Cash Conversion Cycle

Table 2: Calculations of "Days" Measurement

(units in rupees) 2000 2001 (Forecast)

1 Inventory 1,249,185 2,225,373

2 Accounts Receivable 2,672,729 3,715,152

3 Accounts Payable 759,535 1,157,298

4 Net Sales 64,487,358 77,265,092

5 Cost of Goods Sold 53,865,911 66,993,380

(units in days) 2000 2001 (Forecast)

6 Inventory Days (1/5)x365 8.46 12.12

7 Receivable Days (2/4)x365 15.13 17.55

8 Operating Cycle (6+7) 23.59 29.67

9 Payable Days (3/5)x365 5.15 6.31

10 Cash Conversion Cycle (8-9) 18.45 23.37

Figure 1: Cash Conversion Cycle For 2001's Forecasted Financial Statements

As per Table 2, the repayment days of payable is less than 7 days for 2000 and 2001, which is quite short in business context. When compared to the days in receivables before money is collected, it took an average of 15 days in 2000, and to 18 days in 2001. By adding the inventory days into the calculation, we can compute the cash conversion cycle, which measures the time span between a firm's disbursing and collecting cash and will unrelated to the firm's size, but be dependent on the firm's type of business. In this case, the positive number in cash conversion cycle means Kota Fibres have a time gap where they haven't received payments from customers but had already paid their suppliers. Furthermore, by needing to maintain the cash balance above INR 750,000, the company is short of working capital and resulted in borrowing money from the bank.

In order to reduce the cash conversion cycle, Kota Fibres could negotiate with their suppliers and ask for an extension of payments to a later day. They could also reach out to other suppliers and find another that would allow for a later payment date. Kota Fibres could also lower the inventory days by reducing the inventory at hand by refining the manufacturing cycle. Through talking to their clients, Kota Fibres could ask them to repay earlier by giving them a discount like 2/10 net 45. By collecting money earlier, even at a discount could reduce the debt and save money from paying interest.

Validity of the Assumptions

The assumptions were derived by Ms. Pundir, the owner and director of the company and Mr. Mehta, a bookkeeper. Their observations are based on the results from previous years' financial statements which were prepared by Mr. Mehta and approved by Ms. Pundir. However, in order to truly predict the future finance, they need to take into the consideration outside the company. They need to look at the industry as a whole, how their competitors, suppliers and customers businesses are performing, and about their position in the market. It might be more accurate for them to find a person with a finance and economy background to calculate the 2001 forecasted figures.

Financing from Bank

Table 3: Return on Asset and Return on Equity Calculations

2000 2001

1 Company Income Tax Rate 30% 30%

2 Interest Expense 1,240,066 1,835,620

3 Profit Before Tax 3,644,052 1,908,355

4 Income Tax 1,093,216 572,506

5 Net Income 2,550,836 1,335,849

6 Total Assets 13,295,604 15,628,161

7 Total Shareholder's Equity 11,851,967 11,187,816

8 After-tax Interest Expense (2x(100%-1)) 868,046 1,284,934

ROA ((5+8)/6) 25.71% 16.77%

ROE (5/7) 21.52% 11.94%

The ROA for years 2000 and 2001 are 25.71% and 16.77% respectively. ROA reveals the management's effectiveness in making profit for every dollar of assets. In the case, the short-term interest