Kota Fibres
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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 companys 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
% Increase
Net Profit
% Increase
64,487,358
44,496,277
3,599,065
75,867,480
17.65%
53,865,911
21.06%
2,550,837
-29.13%
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)
2001 (Forecast)
Inventory
1,249,185
2,225,373
Accounts Receivable
2,672,729
3,715,152
Accounts Payable
759,535
1,157,298
Net Sales
64,487,358
77,265,092
Cost of Goods Sold
53,865,911
66,993,380
(units in days)
2001 (Forecast)
Inventory Days
(1/5)x365
12.12
Receivable Days
(2/4)x365
15.13
17.55
Operating Cycle
(6+7)
23.59
29.67
Payable Days
(3/5)x365
Cash Conversion Cycle
(8-9)
18.45
23.37
Figure 1: Cash Conversion Cycle For 2001s 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 firms disbursing and collecting cash and will unrelated to the firms size, but be dependent on the firms type of business. In this case, the positive number in cash conversion cycle means Kota Fibres have a time gap where they havent 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
Company Income Tax Rate
Interest Expense
1,240,066
1,835,620
Profit Before Tax
3,644,052
1,908,355
Income Tax
1,093,216
572,506
Net Income
2,550,836
1,335,849
Total Assets
13,295,604
15,628,161
Total Shareholders Equity
11,851,967
11,187,816
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 managements effectiveness in making profit for every dollar of assets. In the case, the short-term interest