KOTA FIBRES,LTD.BYASHISH DHANANIMUDIT GARGNITIN PHOGAT

COMPANY BACKGROUND

•KOTA fibers ltd. Was founded in 1962 to produce nylon fiber at its only plant in kota.

•By using new technology and domestic raw materials the firm developed a steady franchisee among dozens of small, local textile weavers.

•It supplied synthetic fiber yarns used to weave colorful cloths for making sarees.

Synthetic –textile market

•Stable demand.•Unit demand increses with both

population & National income•15.5% growth y.o.y•Mills produce to order only i.e only

maintainace stock are kept•Competition is affected by price, service

& credit terms.

DISTRIBUTION CHANNEL

•Carry inventory through slack selling season

•Plan of seasonal prod:-peak capacity for 2 mths

- modest level for rest time

DISTRIBUTION SYSTEM :Getting finished yarn quickly was a

challenge•Poor roads•10 to 15 days trip(distance=1100 km)•One way highway•Accidents were frequent

ASSESMENT OF CURRENT SITUATIONKota Fibers has run out of cash for three

principal reasons: • sales growth (20% anticipated in 2001)•declining profitability• aggressive dividend paymentsIn the abstract, Kota cannot self-sustain its

asset growth: The additions to its assets are outstripping the firm’s growth of profits retained.

CONTINUED…

•An analysis of case reveals that net profit as a percentage of sales has fallen over the past year, from 5.6% to 3.4% of gross sales and is projected to fall to 1.5% in 2001.

• In addition, the ratio of cost of goods sold to gross sales has risen by 2 percentage points (from 69% to 71%) and is expected to mount to 73.7% in 2001.

•Operating expenses have risen by INR1.331 million.

CONTINUED…• It is conceivable that this small company, which faces a

very strong union, has simply buckled under rising wage demands, but the dramatic growth in operating expenses and the aggressive dividend policy suggest other dubious management decisions.

• Interest expense (probably driven by growth and declining profitability) has risen by a third.

• Moreover, the firm plans to pay INR2 million in dividends, although it will earn only INR1.3 million in profits.

• Finally, Kota is projected to not pay its way as an investment.

• In 2000, the firm earned a return on equity of 21.5%; in 2001, the return on equity is projected to fall to 11.9%—well below the bank’s interest rate.

CONTINUED….• The gravity of the situation cannot be overstated. Funds must be

borrowed in order to pay the excise taxes that permit the company’s goods to leave the loading dock. Unless the company gains access to cash, it could fold immediately.

• The bank has already been disappointed by the company’s inability to clean up its debt balance for 30 days during this past off-season and would be expected to advance no more cash unless the situation changes.

• The point of the 30-day clean-up covenant was to discipline Kota to convert its seasonal accounts receivable and inventory back into cash; the bank is not likely to wait any longer for Kota to clean up.

• Kota’s failure to ship goods no doubt strains customer relationships: the case mentions that the textile companies produce to order, so they cannot sustain a long delivery delay. The loss of customers would hurt a small company like Kota.

MEHTA’S FORECAST• The financial forecast reveals that the company will be

unable to clean up its seasonal line of credit for the required 30 days during the next year. The projected note balance in December 2001 is INR3.5 million, up significantly from the INR684,102 that prevailed in December 2000.

• In addition, the forecast suggests large credit needs at the peak of the seasonal cycle. The maximum loan balance of INR33 million, which occurs in June 2001, presents a large exposure for the bank, although, with almost INR39 million in inventory and receivables, the bank appears to have plenty of collateral underlying the loan. 

CASH CYCLE OF THE COMPANY

The number of days that cash takes to cycle through the working capital.• Inventory

60 DAYSKota manufactures to order. It buys raw materials 2 months before goods are shipped.

• Accounts payable30 DAYSAs the model shows, Kota pays 1 month after purchasing.

• Accounts receivable48 DAYSReceivables outstanding each month equals 40% of the previous month’s sales (aged 30 days), plus 60% of month-before-last-month’s sales (aged 60 days). Thus, days’ outstanding equals (0.4 × 30) + (0.60 × 60). The Pondicherry proposal will lengthen the collection period.

• Total (cash cycle)78 DAYS(60 − 30 + 48 = 78) Accounts payable finances half the inventory, and Kota is financing the balance of the inventory outstanding as well as its customers’ 48-days’ sales outstanding. The total net cash cycle is 78 days. By reducing its own inventory by 30 days, payables would finance inventory exactly. This would leave the receivables to be financed by other means.

SOLUTION.In essence, the company is unable to liquidate a seasonal working-capital loan for the requisite 30 days each year. This difficulty arises from two classic causes: secular growth of the company and declining profitability. Possible remedies include

• reducing inventory through more efficient transportation and warehousing,

• reducing credit terms to customers, being supplied raw materials on just-in-time raw materials,

• switching from seasonal to level production, • improving profitability, decreasing dividends, and

reducing sales growth.

DECREASING DIVIDENDS•Although cutting the dividend will conserve

INR2 million and may impress the banker with Pundir’s sincerity, it will not produce a zero-debt balance at the end of the year. Because Kota is a family owned company, the banker will probably put intense pressure on Pundir to reduce the dividend in order to prevent the family from taking equity out of the firm in a time of financial strain. Cutting the dividend to zero is a draconian move and probably unrealistic, but a sharp reduction can be expected.

SLOWER GROWTH

•slowing the growth of sales does reduce borrowing requirements, but this action will not in itself effectively produce full clean up of the debt balance. Moreover, growth is difficult in an inflating economy, and if existing customers suspected that Kota was unable or unwilling to fill their needs, it might lose customers.

IMPROVING PROFITABILITY

•improving profitability will reduce borrowing needs significantly. In combination with the new inventory policy, improved profitability may enable the accomplishment of the clean up. Overall, although improving profitability takes time and cost-cutting ingenuity, it is a laudable goal.

LEVEL PRODUCTION• A little reflection should suggest that this proposal is

also undesirable. If Kota initiates a level-production proposal now, at the nadir of the seasonal cycle, the company will exhaust its stock in advance of the peak selling season because, if production is truly at a level annual rate, only 58% of the year’s output will be produced by the end of July. About 73% of the year’s sales, however, occur in the January–July period. The time to begin level production is shortly after the peak, but doing so will cause the firm to stockpile finished goods in the off-season. This action would only worsen the company’s ability to clean up its outstanding loans at the end of the year.

THE NEW INVENTORY POLICY• Reducing raw-material inventory by 30 days will

reduce peak debt to INR25 million and ending debt to INR3 million, respectively, and will also increase the profitability of the firm by INR275,202. But company should be aware of the dangers of reducing inventory (e.g., stock-outs), a reduction from 60 to 30 days, although significant, still leaves a good margin of safety.

• To adjust the spreadsheet, simply change the purchasing from two months ahead to one month ahead. In addition, wages will have to be changed to be driven by the same month’s purchases rather than last month’s purchases.

ACTION PLAN

•Pundir needs to meet with her banker with a positive plan of action that will correct the problems underlying the current cash shortfall and the company’s inability to clean up its seasonal line of credit.

• Pundir needs to be convincing when she speaks with the banker. Vague suggestions will not do: (1) she must prepare to take specific steps; and (2) she must spell out the financial implications of those steps.

CONTINUED…• Any short list of actions should include a reduction or

elimination of the dividend, a change in the inventory policy, and a reduction in costs (especially operating costs).

• Cost reduction may be hard to accomplish in the context of 20% sales growth, although the high growth rate in operating expenses may contain some fat that may be cut.

• In addition, Pundir could simply contain the growth of the firm. If growth and cost containment are not possible, the bank will probably ask her to raise more equity capital as a foundation for long-term growth—this plan may be easier to accomplish once the profitability trends in the company begin to improve.

• Clearly, much hinges on her ability to tighten the operations of the firm. All those actions, however, are likely to produce a highly liquid company once again.

CONTINUED…When she has regained the bank’s confidence, Pundir might suggest one modification to the loan agreement:

• a rescheduling of the clean-up period. The nadir of the seasonal cycle appears to be at the end of January or early February. Why, then, is clean-up required at the end of October, before the firm can liquidate its receivables?

• All-India Bank is notoriously bureaucratic, forcing all of its seasonal borrowers into one-size-fits-all credit arrangements. The competition among banks to make loans to small yarn-producing companies in India is not great, so Kota had little choice but to accede to All-India’s wishes when the company arranged for a credit line.

ANY

QUESTIONS???