Kota Fibres

Financial Management: Kota Fibres, Ltd. 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 women’s 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

The Case Papers 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 women’s 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, resulting in a stable and growing business. Demand fluctuated based on special Indian festivals and celebrations, and more specifically on the Diwali; a special celebration in mid-autumn. The unit growth forecast for Kota Fibres was 15% per year yet delivery of the yarn and several other small factors would soon play a part in their implausible success. Consumers in the villages purchased the cloth from the cloth merchant. The cloth merchant granted credit in order to support sales. The suppliers were very competitive in order to keep the merchants. They were aggressive in price, service, and credit line. Due to the fact that profit margins were thin, Kota had policies which required a plan of seasonal production. Kota operated at peak capacity for two months and decrease capacity for the rest of the year. This caused continuous hiring and layoffs. Kota had two distribution warehouses, but regardless, moving the yarn from Kota to the customer was a problem with the trip taking 10 to 15 days and the roads typically rough and one lane. Kota Fibres had been a profitable company through the years. Sales were up 11 percent in 2000. 2001 brought on challenges questioning the firm’s liquidity as Kota began to continuously overdraw on their bank account. The following issues surfaced in 2001 with Kota Fibres, Ltd.: 1. Payment of excise tax to move their product 2. Line of credit not being repaid according to the term. 3. Request for new loans from All-India Bank & Trust Company. 4. Due to inflation, interest rate may be higher in upcoming year on the loans

ETHICAL CONCERNS: When preparing a forecast, Ms Pundir, the owner, and Mr. Mehta, the bookkeeper, agree on various procedures to arrive at the numbers. The forecast should be based on actual figures. The owner should have the bookkeeper or preferably a financial person, prepare the forecast, and Ms. Pundir should be reviewing the final report. Ms. Pundir and Mr. Mehta added a quality control department with two sales agents and three nephews in order to build an allegiance to the Pundir family. There was no review or analysis mentioned in the case as to whether a quality control department was needed. There seems to more of an interest in tending to the needs of the family rather than what’s best for the business. Kota had always paid high dividends because the Pundir family believed excess funds were at risk being left in the company and so the funds should be distributed as dividends. It seems the major priority of the business is payout of dividends to the shareholders (family). Since this is a high priority of the business, then ethics might be pushed to the side to arrive at the right numbers for the bottom line. As the goal of financial management is to maximize shareholder wealth, the costs of following these high dividends for the past forty-seven years have become a large factor in bankrupting the company. Rather than valuing hard-working employees and keeping them all year long rather than working them to death during busy season, the Kota Fibres, Ltd. shareholders should have reconsidered investing some of their wealth in the company to offer lower prices, and in turn, receive more business. The shareholders believe they are following a Utilitarianism model by laying off quite a few employees, but in turn, benefitting the greatest number by saving the additional employees their jobs and saving the company from bankruptcy. Finally, in the memos noted above, Ms. Pundir requested input on the issues, but she didn’t review or meet with the Managers to discuss their input. Hence, she doesn’t rely on her managers’ input. With her ease to push away extremely profitable business ideas to the side of her desk, who knows what she is looking over or signing simply to get it out of her way. Ms. Pundir could possibly be inaccurately portraying figures in order to please family members of the profit Kota Fibres should be receiving. LEADERSHIP STYLE: Ms. Pundir’s leadership style can be defined as delegative. In relation to the crumbling of Kota Fibres, Ms. Pundir has numerous business propositions she has asked her employees to investigate but fails to take the time of day to review the results. As the managing director and owner, Ms. Pundir has agreed to pass on high dividends to herself and the 11-member extended family. Ms. Pundir involved herself in every aspect of the business. She requests input from her managers but does not utilize their input. There were several memos on her desk from key management personnel which she didn’t read. If she had read the memos, then she would have noted the following solutions:

1.

Field Sales Manager- Pondicherry Textile would become a new and one of their largest accounts. Their sales would be INR 6 million and these sales were not reflected in the current sales forecast. They are requesting credit terms of 80 days. 2. Transportation Manager-Supply shipments would become more reliable due to a new road between Kota and New Delhi. The proposal was to reduce raw material inventory from 60 days to 30 days. 3. Purchasing Agent-Hibachi Chemicals will supply polyester pellets. If feasible, the pellets inventory will be reduced from 60 days to 2 or 3 days. 4. Operations Manager-The recommendation is to level annual production. The benefits are as follows: a. Gross profit margin would rise by 2 or 3 percent due to a stable work force. b. Seasonal hiring not necessary and the workforce would be stronger with less division among workers. c. Lower manufacturing risk as there would be fewer equipment breakdowns. Ms. Pundir requests input from her managers and staff yet takes no responsibility on following through or evaluating the informative solutions her staff develops. She seems to be solely focused on pleasing the shareholders which consist solely of immediate family. FINANCIAL ANALYSIS: The company has projected gross sales to reach INR90.9 million in 2001, an approximate increase of INR15 million over the current year. Although this increase is substantial, there are several additional financial factors which need attention. These factors include seasonality of sales and production, current credit standing, receivable and collection terms, inventory turnaround, delivery lead times and production scheduling. The first step is to calculate the firm’s financial ratios to determine where their most obvious deficiencies reside. Liquidity: We first started with Liquidity, or the firm’s ability to convert assets to cash. First, the company’s Liquidity ratios showed that in 2000 both the Current ratio and Quick Ratio were above the acceptable level of 2.0 and 1.0 respectively. In fact, in 2000, the Current ratio was calculated at 3.2:1, which is well above the acceptable level of 2.0; meaning that the company is very capable of satisfying its short-term obligations as they come due. However, the forecasted ratio for 2001 shows that this ratio drops to 1.5:1, which is below the acceptable level of 2.0 set for a manufacturing firm. This means they will have some problem paying their bills on time with this forecast. The Quick ratio is a more conservative measure of a firm’s ability to convert its assets into cash. This ratio excludes inventory from its calculations. Kota Fibres, in 2000, had a ratio of 2.38:1; which is well above the acceptable level of 1.0. However, the calculations

show a decline from 2000 and 2001 of 1.37; again showing that making good on their short-term obligations may be a problem. Activity Ratios (Asset Turnover): Next we calculated Kota Fibre’s Activity ratios to determine the speed at which the company converted credit sales to cash (inflows and outflows). First we looked at the Inventory Turnover ratio. This ratio measures the firm’s activity, or liquidity, of the firm’s inventory. Kota Fibres had an Inventory Turnover of 8.46 for 2000 and a 12.12 projected for 2001. This increase is a step in the right 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. This ratio is more relevant when compared to other firms in the same industry. The firm’s Average Collection Period ratio was calculated to evaluate credit and collection policies. The firm’s collection practices are within the set 45 day credit term. Both 2000 (15.13 days) and 2001 (17.55 days) are in good standing. They should not extend their credit terms with Ponticherry Textiles because it will reduce the amount of cash on hand during the year. There are no problems with accounts receivable. According to the Average Payment Period ratio, the firm is very quick to pay its creditors, with having a 5.15 day turnaround in 2000 and a 6.31 day projected turnaround in 2001. The average collection period shows that the company is good at paying its bills on-time. They will maintain a good credit rating if they continue to operate at these levels. The last Activity Ratio, Total Asset Turnover, indicates the efficiency with which the firm uses its assets to generate sales. Total Asset Turnover reflects a lower than acceptable level of asset management. In 2000 the firm had a ratio of .18 and a .17 in 2001. These figures represent the inefficiency of the firm’s asset management and means that the company only turns its assets over .18 times a year. They will want to increase this number by increasing their amount of total assets. This is of particular interest to management, and indicates whether the firm's operations have been financially efficient. Debt Ratios: According to the Debt-to-asset ratio, which measures the proportion of total assets financed by the firm's creditors, Kota Fibres is leveraging only a small amount of borrowed money to generate their profits. In 2000 they have a ratio of 11%. Under the 2001 projection they will have over 28%, which means more indebtedness and more financial leverage that it will have. Currently, in 2000, they have 11% debt and only 89% equity. Similarly, the Debt-to-equity ratio shows that Kota Fibres is using $0.12 cents for every dollar supplied by creditors using the figures provided from 2000. The projection will increase the ratio to $0.40 cents per dollar supplied. This means they will be using less of their own money for growth. For Kota Fibres, if they use a lot of debt to finance their projected growth, the company could potentially generate more earnings than it would

have without this outside financing. If this financing were to increase profits by an amount greater than the cost of the debt, then shareholders receive more earnings. Looking at Kota Fibre’s Times interest earned ratio, which measures the firm's ability to make contractual interest payments, they are within an acceptable range in 2000 (8.57) and 2001 (5.60). With the projection in 2001, there is a lower ratio which means they will decrease their ability to fulfill interest obligations if the pursue their forecast. Profitability Ratios: These ratios enable analysts to evaluate a firm’s profits with respect to a given level of sales, a certain level of assets, or the owner’s investments. It is commonly used to compare performance across years. The higher the Gross Profit Margin, the better; the lower the relative costs of merchandise sold. In this case, Kota Fibres has an expected Gross Profit Margin ratio of 16% in 2000 and an actual ratio of 13% in 2001. This shows that they have a fairly week profit-to-sales ratio heading into the projected year. This also reflects a change in their pricing strategy and its ability to control operating costs. They will need to improve their ability to manage their operating costs if they plan on increasing their bottom line. The Return on assets ratio, often referred to as ROI, is used to measure the overall effectiveness of management in generating profits with its available resources. The higher the firms ROI: the better. Kota Fibres will see a reduction of 13% if they proceed with their 2001 projection. This is a significant indication that they will not be using their available resources as effectively as they are in 2000. In 2000, the firm has a ratio of 44%; expecting only 31% in 2001. This means that the firm earned $0.44 cents on each dollar of asset investment in 2000. The projection shows a problem in resource efficiency. Looking at the Return on Equity ratio, Kota Fibres has recorded 49% in 2000 and 43% in the 2001 projection. This ratio measures the return earned on the common stockholders’ investment in the firm. The higher the return, the more profits are distributed to the owners. In this case, following the projection there will be a 6% reduction in ROE. The goal of a business is to keep the shareholders happy with their distributions…decreasing them by 6% can cause investors to refrain from lending to the firm if they cannot increase the ROE year-to-year. This can be directly tied to the slight reduction in Asset Turnover and in ROI. CURRENT EVENTS/ECONOMIC IMPACTS: Currently, there are about 200 mills that manufacture blended and synthetic yarn. India is the world’s third-largest producer of cotton and second-largest producer of cotton yarns and textiles. The textile industry itself had been governed mainly by the MultiFibre Arrangement until 2005. This initially put restraints on shipments from exporters, reducing both production and exportation from countries such as India. In 1995, the MFA quotas were eliminated and textile production and trade became accelerated again for India (Landes, pg 2).

This past July, the industry hit rock bottom with raw material prices higher than ever and the verge of closure of many companies. The blended yarn spinners have been put at a great disadvantage as China is able to supply polyester staple fibre at a much cheaper price. At this time, the President of the Indian Spinners’ Association asked that import duties were abolished and a reduction of excise duties on all man-made fibres from 8% down to 4% to save the blended yarn spinning industry. Regardless of this cut, taxation will still remain high among the saris and synthetic fibre yarn. As a typical woman purchases three saris a year, this could easily change with a raise in price. Most Indians are extremely price sensitive and allot 55% of their income to go specifically towards food. In the past, they have spent 17% of their income on saris. As saris are a tradition, the amount spent and number purchased per year may fluctuate based on income and price per sari. Originally, the textile industry had hoped to create an additional 17.4 million jobs by 2012 yet as costs have dramatically increased, keeping the number of existing jobs will be a challenge. Mr. Ladia, the President of American Spinners Association, also explained that the top five in the textile industry reported a decline in profits of anywhere from 80 to 99% in 2007-2008 (Seihk). Most companies continue to remain small in size so they aren’t required to adhere to wage or employment security regulations. Employing more than ten people would mean a wage increase of 50-60% for an employee. Similar to Kota Fibres, layoffs in the off-season were a yearly event. As Kota Fibres is non-existent in the titles of nylon Fibre production facilities, it is clear that they were not able to survive the hit the industry recently underwent. Possibly declaring bankruptcy, the company should re-evaluate where they went wrong if the family wants to consider going back into business. The evaluations below will shift Kota Fibres, Ltd. back into the market and into a competitive, profitable position. RECOMMENDATIONS AND CONCLUSIONS: Ms. Pundir is faced with resolving a surprising cash shortage immediately. As her management style is extremely delegative, 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 company’s 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 Fibre 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, 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 firm’s inefficiency to use their assets to generate sales. Kota Fibres should boost this number by increasing their amount of total assets. Their Debt-to-equity 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. Pundir’s 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 shareholders should be willing to reinvest profits in a company that will benefit them in the long run. REFERENCES Bruner, Robert F. (2007). Case Studies in Finance: Managing for Corporate Value Creation. 5th Edition. McGraw-Hill/Irwin. Landes, Maurice. MacDonald, Stephen. Singh, Santosh. Vollrath, Thomas. "Growth Prospects for." United States Department of Agriculture 01062005. 03042009. . Seikh, Abu. "Blended yarn industry calls for immediate relief." Meri News 18072008. . 03042009 .

Sections • • • • • • • •

Introduction Ethical Concerns Financial Analysis Current Events Current Economic Impacts Recommendations Conclusions Reference Page