The following questions will help you in the preparation and analysis of this case. Use these questions as a guide in your study of the case. However, do not limit yourselves to these questions only, but rather allow yourselves to expand your thinking and analysis of this case. 1. How did Mehta construct his financial forecast? Using the financial forecast, prepare to show the “cash cycle” of the firm (i. e. , the flow of funds through the working-capital accounts of the firm).
2. Examine the exhibits in the case.
On the basis of Mehta’s forecast, how much debt will Kota need to arrange for the coming year? Will Kota be able to repay the line of credit this year? 3. Why do Kota’s financial requirements vary across the year? What are the key determinants of Kota’s borrowing needs? Please exercise the spreadsheet model to identify the critical forecast assumptions. 4. Consider the four memos that Pundir received. Use your intuition to assess the desirability of two of the proposals: ? Pondicherry’s request for credit: What will be the effect of this proposal on accounts receivable and debt balances across the year? The level-production proposal: If Kota undertakes level production now, at the low point of the annual business cycle, what is the likelihood of inventory stock-outs at the peak of the business cycle? If Kota undertakes level production just after the peak, what will happen to inventory and debt balances at the cyclical low? Are these proposals liable to relieve, or worsen, Kota’s ability to “clean up” its bank loan by the end of 2001? What action should Pundir take on these two proposals? 5.
Why does the bank require 1 30-day “clean-up” of the loan?
Should the bank continue to waive compliance with this covenant? 6. Please identify the three most important actions or policies that Pundir should take. What should Pundir say to the bank and to the customers? 1. Mr. Mehta developed a monthly forecast of financial statements using the current operating assumptions. As an alternative way of looking at the forecasted funds flows, Mr. Mehta also prepared a forecast of cash receipts and disbursements. To prepare a forecast on a business-as-usual basis, Mr.
Mehta used various parameters such as Cost of goods sold (a figure that was up from recent years because of increasing price competition), operating expenses (up from recent years to include the addition of a quality control department, two new sales agents, and three young nephews in whom she hoped to built an allegiance to the Pundir family business), the company’s income tax rate, and the exercise tax. Calculation using 2001 Forecast Annual Income Statements (Exhibit 2) and 2001 Forecast Balance Sheets (Exhibit 3) Days Inventories Outstanding (DIO)= Inventories / COGS per Day = 2,225,373 / (66,993,380 / 365) = 12. 2 ( Round Up = 13 Days Days Sales Outstanding (DSO)= Account Receivable / Sales per Day = 3,715,152 / (90,900,108 / 365) = 14. 92 ( Round Up = 15 Days Days Payables Outstanding (DPO)= Account Payable / COGS per Day = 1,157,298 / 66,993,380 / 365) = 6. 31 ( Round Up = 7 Days Kota Fibres’ Cash Cycle = DIO + DSO – DPO = 13 + 15 – 7 = 21 Days 2. Total Debt Outstanding= 153,303,169 Total New Borrowings= 2,779,599 Total Kota Fibres’ Debt= Total Debt Outstanding + Total New Borrowings = 156,082,768 Total Sales= 90,900,108 Total Account Receivable Collected= 89,857,685 Total Sales + Account Receivable Collected= 180,757,793
Even the Total Sales + Total Account Receivable Collected is bigger than Total Kota Fibres’ Debt, since the cash money that Kota Fibres’ have only 89,857,685 (Total Account Receivable Collected), Kota Fibres’ cannot repay the line of credit. Except Mr. Pundir and Mr. Mehta can assure that all of the sales can be collected into cash, Kota Fibres can pay all it’s debt. 3. Kota’s financial requirements vary across the year because the demand for synthetic textiles especially Nylon is influenced by seasonal event and competition among suppliers that was keen. We can say that Kota’s business is seasonal business in this case.
The key determinant of Kota’s borrowing needs is the suppliers who buy the nylon fiber. Kota has to borrow to purchase raw material for production. If we analyze the Schedule of Cash Receipts and Disbursements for 2001 (Exhibit 9) in the first 4 months, the purchase of Kota Fibres is bigger than sales. Since the business influenced by seasonal peak in demand in late summer and early fall, Kota make money at May – December. The suppliers that buy the nylon from Kota usually ask for credit also. 4. Pondicherry’s request for credit terms of 80 days (since the Kota’s standard terms only 45 Days) will increase Kota’s account receivables.
This mean Kota’s make good sales but no cash in. This will affect to the payment of Kota’s debt. The level-production proposal: If Kota undertakes level production and the inventory stock-outs at the peak of business cycle, Kota’s sales will decrease and debt can’t be paid. If Kota undertakes level production just after the peak, the inventory will not overload. Kota can decrease the cost of production and the safety can be used to pay debt. If we consider to these two memos, I think the most liable to relive to support Kota’s ability to “clean up” its bank loan by the end of 2001 it the level-production proposal.
Mr. Pundir is recommended to take the level-production proposal by undertakes level production just after the peak. 5. The bank require 30-day “clean up” of the loan to ensure that money lent under a line-of-credit (short-term loans) do not turn into long-term loans and can make a full repayment at the due date. The seasonal line of credit had to be cleaned up for at leas 30 days each year (the usual clean up month had been October in this case). Yes, the bank should still waive compliance with this covenant to monitor the lender and make sure the lender can make a full repayment at the due date. . 3 most important actions / policies that Mr. Pundir should take: a. 30 day inventory policy and Partial JIT– to prevent inventory overload and free up a lot of space in the warehouse. b. Level Production – Undertakes the level production just after the peak. c. 0 Dividends in 2001 – Split off strategy / Increase share holders stock strategy. To Bank: Plan to obtain the long term and fixed rate loan from the bank in order to align Kota’s capital expenditures with long term debt. To Customers: 2%-5% discount-Net 30 – to attract customer pay quickly.