1.

INTRODUCTION
1.1

COMPANY BACKGROUND
Kota Fibres, Ltd. was founded in 1962 in Kota, India. Created to

produce nylon Fibre, Kota Fibres provided synthetic Fibre yarns to local
textile weavers mainly to make the traditional womens dress in India; the saris. Ms.
Pundir was both the managing director and principal owner of the company. Kota Fibres
used new technology and domestic raw materials to produce their quality product. The
demand for saris amounted to 12 billion yards of fabric.
1.2

SYNTHETIC TEXTIE MARKET

The demand was stable with year-to-year growth. Due to growing population and

national income of India, synthetic textile market enjoyed huge potentiality to grow i.e.
the market keeps a steady 15% annual growth. Though Kota Fibres enjoyed growing
sales, but one of the constraint that limit its capacity to expand and increase its operation
cost was seasonal demand for nylon textiles. Thus, the seasonal demand for nylon yarn
would peak in mid-summer. Competition is affected by price, service & credit terms.
Their existed high competition among suppliers to retain merchants as consumers directly
purchased the cloth from the cloth merchant. To remain in and increase the market share
Kota had to adopt low cost strategy and grant a credit to support sales. Kota Fibres had
been consistently profitable. Sales had grown at annual rate 18% in the year 2000. Gross
sales were projected teach INR90.9 million in 2001. Net profit reached INR2.6 million in
2000

2.0

KOTA FIBRES, LTD. QUESTIONS

2.1

What is the current situation? Why did the company run out of cash? What
are the consequences for the company?
The current situation is Mrs. Pundir was faced with some problems, Firstly, the

payment of excise tax to move their product. The government tax inspector would not
clear their trucks for delivery, because the excise tax had not been paid. Secondly, Mr.
Mehta, the company bookkeeper, went to draw funds for the excise tax when he
discovered that the company had overdrawn its bank account again, so this created
problem of requesting new loans from All-India Bank and Trust Company. The company
needed to figure out a solution to restore the firms liquidity. Thirdly is line of credit not
being repaid according to the term. Kota Fibres had a required cleanup month, usually
being in October, but had promised to repay in November or December. When they failed
to repay during all three months, the bank refused to extend anymore seasonal credit until
a reasonable financial plan for the company was presented. Lastly, due to inflation, Mr.
Mehta was worried the interest rate may be higher in upcoming year on the loans.
Kota Fibres has run out of cash because was persist borrowing money from All
India Bank because they are undergoing peak sales around late summers due to festival
Diwali which is their financial requirements varied between the years. The key
determinant for the borrowing of Kota Fiber is, their sales depend on their credit period
given, so the more credit, more their market share. They required more loans during peak
season because they need strong stock in advance during that time. Unfortunately, in
production and distribution system, they are facing bad infrastructure. The transportation
2

period of raw material will increase and will also increase the cash cycle which caused
the delayed in the supply of order. Pundir proposed to pay dividend of INR500,000 per
quarter to the eleven members of her extended family who held the entire equity of the
firm. For years Kota had paid high dividends. The Pundir family believed that excess
funds left in the firm were at greater risk than if the funds were returned to shareholders.
This has caused the company run out of cash.
The consequences for the company are they are unable to deliver order to
customer because they failed to pay excise tax. The seasonal line of credit had to be
cleaned up for at least 30 days each year, but Kota Fiber had failed to make a full
repayment at that time.
2.2

What does Mehtas financial forecast show? How was the forecast
constructed?
Mehtas financial forecast does not show a satisfy performance of the company.

From the case, it is clear that, although Kota Fibres Ltd. at times is suffering from cash
shortage, it is a profitable company that has been enjoying profit as well as sales growth
in the past. But, the financial forecast has shown that the forecasted profit of 1335848
rupee in the year 2001 is far below than the profit of 2550837 rupee in the year 2000.
Therefore, based on the Mehtas forecasts, even though the company continues to remain
profitable, its profitability will even decline in the year 2001. Also, the monthly forecast
of the income statement of the company shows that the company will experience a net
profit in the business only in the 5 months, which is during the months of the seasonal
peak in the demand for the nylon yarn. 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. By comparing the forecasted balance sheet of the company for 2001 with the
actual balance sheet for 2000, it has been seen that there has been a considerable increase
in the accounts receivable as well as inventory according to the forecast. This has
increased the size of investments in current assets from 35% (4,684,237/13,295,604) of
the total assets in the year 2000 to 43% (6,690,525/15,628,161) as forecasted in the year
2001. This increase in the size of current assets is not desirable for the company as its
larger amount is one of the reasons for the need for external funding without a
corresponding increase in profits for the company. The forecasted schedule of cash
receipts and disbursement shows that in order to meet all the disbursement and maintain a
cash balance of 75,000 rupee companies need to borrow large amounts of money for 7
months, that is, from January to June and again on December. So, based on this forecast,
the number of total borrowing companies will be 32,452,209 whereas the refund will
only 29,672,610, which can be a sign of inability to pay in full the company short-term
liabilities on a timely basis.
Financial Ratio
Current ratio
Quick ratio

Actual (2000)
4,684,237/1,443,637 =3.2
(4684237-1,249,185)/ 1,443,637 =2

Forecast (2001)
6,690,525/4,440,345 =1.5
(6690525-2,225373)/

Average collection

2,672,729/ (64,487,358/365) =

4,440,345= 1
3,715,152/(77,265,092/365)

period
Average payment

15.127
759,535/(53865,911/365) = 5.146

= 17.550
1,157,298/(66,993,380/365)

64,487,358/13,295,604 =

= 6.305
77,265,092/15,628,161 =

period
Total asset turnover
ratio
Gross profit margin

4.850
64,487,358/10,621,447=
4

4.943
77,265,092/10,271,712=

Return on assets

0.164705882 or 16.47%
2,550,837/ 13,295,604=0.19185563

0.1329412 or 13.29%
1,335,848 /15,628,161=

or 19.18%

0.085477 or 8.57%

With current ratio 3.2 and quick ratio 2, Kota is operating within acceptable
levels. However, the forecasted ratio of 2001 shows that this ratio decline to 1.5:1, thats
mean below the acceptable level for a manufacturing firm. They well have some problem
paying their bills on time with the projects production and sales levels. In 2000, Kota has
a quick ratio of 2:1 which is well above the acceptable level. However, its drop from
2000 to 20001 of 1, this leads people to believe that the Kota will have issues paying their
short-term debt/bills can be a problem in the future. An Inventory Turnover showed in
year 2000 is 43.12 and in projected 2001 are 30.10. This increase is a step in the wrong
direction. A firm does want its inventory to turnover more often throughout the year;
therefore, the projection may be contributed to the more efficient level annual production
proposal. Weve also calculated Average collection period, Average payment period, Total
asset turnover ratio to determine how fast firm convert their credit sales into cash. There
is low turnover rate in 2001 compared to past and this is because firm is carrying large
number of inventory. Average collection period is not very large, which is good and their
average payment period is very low which means that they are fast in paying their bills.
Due to this they might be given high rating by their suppliers but there exist high gap
between receivables and payables and this situation might lead to shortage of cash flow.
If we look upon the debt ratios, we can infer that Kota is using high debt compared to
past i.e. in 2000. Profit margin shows that it has declined from past which suggest that
they will have to increase the sales or reduce expenses.
5

The forecast was created using the current accounting assumptions. Some of these
assumptions were created through the observations of the past practices. The construction
of the forecasts gives instruction available issues with the company. There are some real
issues, and some of the assumptions that were placed on the forecast are meant to serve
the shareholders in the short-term by keeping the dividends paid consistently high. Taking
into account the needs of the company for the long-term, decreasing the dividend in the
short-term to support the continued profitability and longevity of the company should be
something that Kota should seriously consider.
2.3

What are Pundirs alternatives for action? What impact might the four

operating

proposals have on the financial needs of the firm?

Alternative 1: Pondicherry textiles - increase sales with lax credit terms

The first alternative involves a proposal from Pondicherry Textiles that is willing
to offer Kota Fibers an increase in sales revenue of Rs. 6 million provided that Kota gives
them a credit period of 80 days, which is a significant increase from Kotas standard
credit period of 45 days.
Impact of the proposal on financials of Kota
The proposal from Pondicherry will have a positive impact on profitability of
Kota as it involves an increment in sales revenue. More specifically, the forecasted profit
for the forecasted period(2001) will increase by Rs. 126,325, which is a 8.64% increase
in net profit. However, we recommend that Kota should not go ahead with this proposal
because Kotas problem is not that of profitability but cash management and this proposal
from Pondicherry will have a detrimental impact on the firms short-term debt and cash
6

position. For example, accepting this proposal will require Kota to consistently borrow
more in all months so that its highest debt outstanding (in the month of July) will increase
from Rs. 32 million to Rs.35 million.

Debt
Adjusted

Jan

Feb

March

May

June

28,941,414

35,240,240

8,767,030

April
18,729,07
0
17,419,37
9

1,344,092

3,370,024

9,503,690

2,962,622

26,997,556

32,950,665

407,402
Aug

736,660
Sep

1,309,692
Oct

1,943,858
Nov

2,289,575
Dec

16,955,838
15,795,793

8,970,898
8,352,899

5,399,639
5,002,010

3,562,712
3,278,054

3,704,996
3,463,701

1,160,045

618,000

397,630

284,657

241,295

Outstanding

Debt Outstanding
1,146,268
Increase
in
debt
outstanding
197,824
Jul
Debt
Outstanding
Adjusted
29,076,414
Debt Outstanding
27,167,192
Increase
in
debt
outstanding
1,909,222
Jan
New
Borrowings
(Repayments)
659,990

Feb

March

April

May

2,025,932

6,133,666

9,225,381

10,212,344

Borrowings adjusted
Increase in borrowings

1,816,354
209,578
Aug
(12,120,576
)
(11,371,400
)
(749,176)

5,804,408
329,258
Sep
(7,984,940
)
(7,442,894
)
(542,046)

8,652,349
573,032
Oct
(3,571,259
)
(3,350,889
)
(220,370)

9,578,178
634,166
Nov
(1,836,928
)
(1,723,956
)
(112,972)

462,166
197,824
Jul

New
Borrowings
(Repayments)
(6,163,826)
Borrowings adjusted
Increase in borrowings

(5,783,473)
(380,354)

June
6,298,82
6
5,953,10
8
345,717
Dec
142,284
185,647
(43,363)

Alternative 2: Reduce inventory through better transportation management

The first alternative involves a proposal from the transportation manager who
suggests that since shipments in the last 6 months have been on time due to the new road
between Kota and New Dehli, Kota can reduce its raw material inventory requirement
from 60 to 30 days, which would reduce the companys inventory by one month.

Impact of the proposal on financials of Kota

The proposal will have a good impact on Kotas short-term debt position as
reduced amount of inventory will reduce the debt outstanding in all the months from
January to December as can be seen from the table below.
Debt Outstanding
Debt Outstanding
Adjusted
Decrease in Debt
Outstanding

Debt Outstanding
Debt Outstanding
Adjusted
Decrease in Debt
Outstanding

Jan
1,146,268
20347.324
1

Feb
2,962,622
158861.29
09

Mar
8,767,030
3107487.0
81

Apr
17,419,379
8974693.11
7

May
26,997,556
17496956.
08

Jun
32,950,665
25889398.
04

1,125,921
Jul
27,167,19
2
23616381.
2

2,803,761
Aug

5,659,543
Sep

8,444,686
Oct

9,500,600
Nov

7,061,267
Dec

15,795,793
13579044.
42

8,352,899
6585028.0
64

5,002,010
3727314.5
87

3,278,054
2088851.3
68

3,463,701
1984962.1
01

3,550,811

2,216,748

1,767,871

1,274,695

1,189,203

1,478,739

The proposal will also reduce the monthly borrowing requirement in most months from
January to December as can be seen from the table below.

Borrowings

Jan
462166.053
2

Adjusted

455363.613

Feb
1816353.58
5
1792611.75
7

Decrease in
Borrowings

6802.44021
7
Jul

23741.8281
3
Aug

Borrowings

5783472.57

11371399.6

Adjusted

5847587.21

11406245.3

Decrease in
Borrowings

64114.6362
1

34845.6697
7

Mar
5804408.03
8
5753275.57
8

Apr
8652348.71
4
8567135.66
5

May
9578177.56
9
9469758.13
3

51132.4602
3
Sep
7442893.92
3
7430057.44
8
12836.4751
1

85213.0483
3
Oct
3350888.76
3369270.92
9

108419.436
1
Nov
1723955.52
2
1738841.57
4

18382.1688
2

14886.0521
5

Jun
5953108.39
4
5965658.26
2
12549.8679
8
Dec
185646.851
9

169528.035
16118.8168
8

The decrease in borrowing requirement and debt outstanding makes sense as the proposal
reduces inventory requirements to half, which means that the amount of financing
required for current assets is lesser.
Alternative 3: Purchase the raw materials on just-in-time basis from Hibachi
Chemicals
This alternative involves purchasing 35% of the raw materials (polyester pellets)
from Hibachi Chemicals on a just-in-time basis. This action is expected to reduce the
inventory of pellets from 60 days outstanding to only 2 to 3 days.
Impact of the proposal on financials of Kota
The proposal will have a good impact on Kotas short-term debt position as
reduced amount of inventory with the use of just-in-time purchase will reduce the debt
outstanding in all the months from January to December as can be seen from the table
below.
Jan

Feb

Debt Outstanding
Debt Outstanding
Adjusted
Decrease in Debt
Outstanding

1146268.5

778892.76
Jul

2962622
978996.5
9
1983625.
5
Aug

Debt Outstanding
Debt Outstanding
Adjusted

27167192

15795793

24648261
2518931

Decrease in Debt
Outstanding

367375.7

Apr

May

Jun

17419379

26997556

32950665

11384942

20205093
6792463.
7
Nov
3278054.
4
2456531.
3

27910000

14235423

Mar
8767030.
1
4732628.
5
4034401.
6
Sep
8352898.
6
7114973.
5

1560369.
2

1237925.
2

883318.9
7

6034437
Oct
5002009.
9
4118690.
9

821523.1

5040665
Dec
3463701.
2
2434617.
6
1029083.
6

The proposal will also reduce the monthly borrowing requirement in most months from
January to December as can be seen from the table below:Jan

Feb

Mar

Apr
9

May

Jun

462166.
05
457460.
24

1816353
.6
1799663
.4

Decrease in 4705.81
Borrowing
04
Jul
5783472
Borrowings
.6
5829145
Adjusted
.1
Decrease in 45672.5
Borrowing
59

16690.2
14
Aug
1137140
0
1139604
5
24645.7
72

Borrowings
Adjusted

5804408
5768049
.1

8652348
.7
8591516
.1

9578177
.6
9500681
.7

36358.9
14
Sep
7442893
.9
7433632
.9
9261.04
62

60832.5
67
Oct
3350888
.8
3363704
.6
12815.8
5

77495.8
58
Nov
1723955
.5
1734255
.6
10300.0
88

5953108
.4
5961889
.1
8780.73
56
Dec
185646.
85
174466.
1
11180.7
49

The decrease in borrowing requirement and debt outstanding makes sense as the proposal
reduces the inventory holdings by a considerable amount, which means that the amount
of financing required for current assets is lesser.
Alternative 4: Adopt the Scheme of Annual Level Production
The fourth proposal is a memo from the Operations Manager, L. Gupta, to whom
Pundir had requested to estimate the production efficiencies arising from a scheme of
level annual production.
Impact of the proposal on the performance of Kota
According to Exhibit 7, the significant advantages to be gained are:
The first advantage is that due to absence of certain seasonal training and setup costs,
labor savings and production efficiencies is gained from a stable work force, therefore
increasing the gross profit margin by 2% or 3%.

The seasonal hiring and layoffs would stop. This will allow Kota to create a stronger
work force and, perhaps, to suppress labor unrest. As their unions have indicated that

10

reducing seasonal layoffs will be one of their major negotiating objectives this year,
this will help them negotiate on more favorable terms with the union.

With annual level production, the machineries would be in function all year round,
thus, they would suffer less from equipment breakdowns and could better match the
routine maintenance with the demand on the plant and equipment.

2.4

What action should Pundir take?

Ms. Pundir is faced with resolving a surprising cash shortage immediately. As her

management style is extremely delegate, it is important that she analyzes Kota Fibres
financial situation before making any decisions. With success in the company for the past
forty years, Ms. Pundir weighs her focus on shareholder profits more so than the
companys liquidity and forecast for the future. The following recommendations
regarding the financial situation the company currently stands in as well as advice on the
memos are discussed below:
Overall, Kota Fibres, Ltd. is doing a good job at managing their liquidity,
although the projection does show a slight decline in this area. This means they could
have potential issues with paying their bills on time and converting their assets to cash if
they follow the 2001 projection.
In the area of Asset turnover and AR/AP, Kota Fibres is operating at an acceptable
level across the board. However, one red-flag is the extended credit term of 80 days net
requested by Ponticherry Textiles. This would reduce the amount of cash on hand during
the year and increase their liabilities due to the 80 day credit term. In this circumstance,

11

Kota Fibres should not accept this memo as it will have an unfavorable effect on the
business. Having less cash on hand, tied up in receivables, will not allow Kota Fibres to
be able to pay off the All-India bank before December.
In addition, the two proposals from the Transportation Manager and the
Purchasing Agent should be approved. A reduction in raw material inventory and finished
goods inventory on hand will result in less inventory being accounted for in the financial
statements and increase the amount of overall liquidity since Inventory is the least liquid
asset.
Kota Fibres must also recognize the contributing factor of the shortage of cash on
hand. This is due to the firms inefficiency to use their assets to generate sales. Kota
Fibres should boost this number by increasing their amount of total assets. Their Debt-toequity standing reflects another sign of how they can increase their cash on hand. The
projection for 2001 addresses this area well, and should be pursued.
Kota Fibre will need to rethink its strategy to generate a profit using the 2001
projection. Across the board, they will be facing a decrease in profitability if they execute
this plan. They will need to improve their operating efficiencies and levels of
indebtedness to increase their bottom line, ultimately resulting in their ability to make
their creditors and shareholders happy. It is crucial that shareholders are informed on the
recommended actions. This may allow for a different approach to business rather than
Ms. Pundirs sole objective of maximizing shareholder wealth. Understanding the
seriousness of the financial situation Kota Fibres is in with regards to paying their bills on
time and future forecasts, ethics and responsibility may also come forward as

12

shareholders should be willing to reinvest profits in a company that will benefit them in
the long run.

13