Pre- Read Assignment

Pre- Read Class Assignment

Guna Fibres Ltd Case
Pre- Read Assignment

Contents

Contents
Case Overview ........................................................................................................................................ 3
Five Critical Financial Problems............................................................................................................. 3
Analysis and Interpretations ................................................................................................................... 4
Recommendations .................................................................................................................................. 5
Pre- Read Assignment

Case Overview
Surabhi Kumar, the MD and Principal Owner of Guna Fibres, Ltd, found out one morning while parking in front
of the company that trucks intended for the customers were not allowed to pass as the government tax collector
has stopped it due to non-payment of excise taxes. This was the third time and in as many months when there was
no money to pay the government.

The liquidity condition was weak, and she had to speak with their bank the All-India Bank & Trust and its branch
manger to extend the credit. He initially was adamant to do it but later agreed to extending credit. Kumar was
angry at it as she could not understand how they had shortage of cash even when they were a profitable company.

Guna Fibres is a yarn manufacturer company located in India. By using new technology and domestic raw
materials, the firm steadily grew its customers. The yarn was used to make sarees and with the bulging female
population in India and a huge market and a varied scope.

The demand for synthetic yarn was stable and grew along with the income and population of India. Demand grew
especially during the festivities and they were expecting a growth of 15%. They used to build stocks for the
festivities and use it at the time of peak demand. The suppliers to the yarn manufacturers gave no credit but due
to competition yarn manufacturers did extend credit.

Guna had steady growth and and sales had grown by 18% YoY. Profits were Rs. 25 Mn down from Rs 36 Mn in
2010. Expected revenues were Rs. 900 Mn.

Kumar got two mails from her transportation and operations manager which she brushed aside for now. COGS
were 73.7% of gross sales. Annual operating expenses were 6% of annual sales. 4 family members joined in to
strengthen the business and income tax rate of 30% accrued monthly. Excise tax of 15% and dividends were paid
at Rs. 5 Mn per quarter. AR was 40% of previous month and 60% of this month. Inventories were bought for 2
months. Direct labour and Manufacturing Costs were 34%. Guna tried to maintain a cash of 7.5 Million and Capex
was 3.5 Million per quarter.

Bank charged Guna an interest rate of 14.5% and they repaid it by October. But this time they were unable to do
so because of the liquidity crunch.

Malik handed over the B/S of the company and Kumar after reading the mails from the transportation and
operations manger felt that something can be done to salvage the situation.

Five Critical Financial Problems.

1. How is a reduced working capital an advantage to any company?
Working with low inventory makes inventory purchases based on the sale orders received. This leads to
following advantages:
• No obsolete goods.
• Defects in raw material manufacturers were easily weeded out.
• New technological up gradations can be easily set into the system before the competition turns over
the existing inventory. Thus, Dell had a first mover’s advantage in being abreast with latest technological
inclusion.
• High inventory turnover and low inventory days. This resulted in low cash conversion cycle.

2. How do company’s fund themselves?

This is basically through the increase in assts and holding back retained earnings. Thus, the operating
asset must increase to meet the expenses. The liabilities less accounts payable will increase. Thus, the
firm can make sufficient funding through internal sources. The increase in current liability and a
subsequent increase in current asset will follow.

3. What effect does days of inventory have on the overall competitive scenario?
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This means that the company with a lower days of inventory saves a lot of money in locked-up capital.
As in this case the money that will be saved from a months savings of inventory will in trun save on the
direct purchase and the subsequent interest payments as well.

4. What does dividends do to the cash flows?

Dividends reduce the net cash inflows and is very difficult to mange the cash in case of liquidity crunch.
It is sometimes better to check the FCFE before paying any cash out and see if any expenses are pending.
If we increase the A/P by some days and are able to reduce the A/R then the cash saved will improve the
working capital of the firm. This in turn will reduce dependency of the firm on borrowed money and will
unlock the dead capital.

5. Does producing as per requirement or producing to maximum capacity a better way?

Producing as per requirement is indeed a better way to go about things. If the production is too seasonal
in nature as the case here then producing as per the maximum capacity will entail a lot of stuck up capital.
This will in turn reduce our flexibility and just in case the goods are not sold due to any other reasons
will lead to high costs of inventory and low net working capital.
Production should always go with demand and efforts should be made to make our production in line
with this demand to better or improve our profitability.

Analysis and Interpretations

1. Analysis of the monthly forecast based on the premises of Guna Fibres current operating patterns
revealed that Guna Fibres would not be able to pay off the loan by the end of the year and in fact would
owe a balance of 38.6 million Rupees as notes payable to the bank by December 2012. Based on the
information contained in Malik’s forecast it is certain that the bank will not be willing to give more loans
to Guna Fibres as presently there is no clear program for the firm to pay its short term debt.

2. First. by looking at Guna Fibres income statements one can clearly see several tendencies that are present.
While gross gross revenues have increased from 2010 to 2011 from 644.8 to 758.7 million rupees. Guna
Fibres’s cost of goods sold increased from 445 to 538.6 million from 2010 to 2011. Additionally. due to
managerial decisions to increase quality control and spread out relationships with other houses, Operating
expenses have increased from 35 to 48.3 million rupees. As a result of this, despite increase in gross
sales, the EBIT has decreased from 51.4 to 36.5 million.

3. As a result of transportation and shipments problem, the raw material inventory requirement was 60 days.
Therefore, lot of inventory would pile up in the warehouse. Accounts receivables collections had been
increasing at the rate of 48 days which comprised of 40% of the previous month and 60% of the gross
sales from the month before that. However, the suppliers had little ability to provide credit, so the
accounts payable were hardly two weeks. This required Guna Fibres to rely on the loans from bank to
manage its working capital requirement.

4. There were two factors impacting cash flow of Guna as a result of its policies. Guna Fibres pays out a 5
million Rupee dividend to stockholders in every quarter. Guna believes that the cash is safer with
stockholders than with the house. Looking at the financial forecast for the beginning of 2012, Guna
Fibres is expected to be running at a net loss for the first one-fourth yet still pays a dividend and continues
to keep the same cash balance of 7.5 million rupees.

5. It is very important to address current situation of Guna Fibres as they presently have a deficit cash flow
which in turn makes it difficult for daily operations. There are various things which can be done by
altering some of the company’s policies and processes.

6. One option includes to eliminate paying dividends in 2012. The cash recovered can be used to cover net
losses. This can also improve the monthly balanced carried on the line of recognition leading to better
effect on the year-end balance.
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7. Sikh’s proposal to capitalise on betterments in transporting times to better stock list trailing had some
effects that could be really good for Guna Fibres. By transporting merely 30 days’ worth of inventory,
Guna Fibres is able to dramatically cut down the sum of capital that is invested in their inventory. This
reduces entire assets and also lowers the dependence on banks to manage working capital. Implementing
Sikh’s program instantly would fulfil both of the Banks necessary conditions. The inventory management
policy would let the balance of notes collectible to be satisfied and that Guna Fibres will be able to pay
zero out the balance. The greatest benefit is that the company can continue paying dividend. This should
hold a positive consequence on company morale and stockholders.

Recommendations
1. Based on the given analysis of the proposed solutions. Guna Fibres should implement the inventory
management program that was proposed by Sikh. Based on Sikh’s mail to Surabhi Kumar the
transportation and shipment has improved, and this program can be implemented instantly. This program
should be adequate to carry the cash balance that Guna Fibres will be able to pay their debts by the end
of the year. The main point is to predict accurately the demand for the following period as holding 30
days less inventory will replenish Guna Fibres ability to trust on excess inventory when demand exceeds
their projections. Attempts to turn to these concerns could include developing a more communicative
relationship with the distributers that Guna Fibres sells to derive better information for doing their
projections.

2. If Guna Fibres implements this policy, they still have the flexibleness to cut their dividend. By showing
this new inventory management program to the bank with the extra eventuality of potentially cutting the
quarterly dividend, Guna Fibres should be able to restart operations and a relationship with the bank.