To: Ms. Pundir – Managing Director and owner, Kota Fibers Ltd.
Dear Ms. Pundir,
As you know, Kota Fibers has been growing its sales consistently in the 15-20% range annually for the last 3 years and the 2001 forecasts are showing 20% growth. Despite these robust sales figures, net income is forecasted to be only $1.3 Million, almost half of 2000 Net Income despite the forecasted incremental increase in sales of $15 million. In addition, the Company is facing a cash crunch and the Company’s banker, the All-India bank and Trust Company are very nervous because they see their loan position with your Company being extended and Kota has failed to repay the loan as per the contract. This is a serious issue and needs to be addressed immediately.
I have reviewed the Company’s projections and cash flows for the fiscal year ended December 31, 2001 in an attempt to identify: a) the operational issues and opportunities presented by various departments and b) the integrity of the data within the forecasts and cash flows. I have done so with the intent of providing your Company with a more accurate fiscal picture for 2001 and to determine if the Company can meet its fiscal obligations to the bank and other key creditors. The following report is a summary of my findings. Please also refer to Appendix 1 which is a numerical summary of my findings. The excel spreadsheet from which it was derived has been attached to this report for your review. Please note that the Summary has been color coded and referenced in order to assist you in understanding the data and that notes to my file are included on Appendix 2. Note that the summary is a build-up of assumptions/decisions made and should be viewed as a progressive iteration. For example, we start with the assumptions changed to the base model, then we factor in the inventory adjustments, then we factor in Pondicherry sales decisions including any other adjustments made.
Overextended credit and interest rates at 14.5% with a fear of going higher
Prior to making any other decision, it appears that the Company is being very aggressive with its capital purchase requirements, its dividend payable policy and the policy to maintain a large cash on hand balance. These decisions, before anything else are having a serious impact on the loan requirements needed from All India Bank to support operational and financing decisions being made. As such, I have provided adjustments to the assumptions affected (cash on hand, dividends payable and capital expenditures) so that we can analyze the impact of these decisions prior to reviewing any initiatives with regards to inventories and extending credit to new customers to obtain large sales increases.
Inventory and Note Payable Buildup
There have been issues in the past and in the forecast with regards to a large buildup of inventory to accommodate the growth in sales, the long lead times and the seasonality of the production/selling cycle. I understand that we have received a memo from R. Sikh, the transportation manager, that due to improved reliability from our suppliers, Kota can reduce its purchasing lead times from 60 to 30 days. In addition, we have also received word from R. Mohan that we can further reduce lead times on purchases of pellets from 60 days to 30 days to essentially 2-3 days. These pellet purchases represent 35% of our overall raw materials purchases.
The cash flow and forecast you are looking at has not yet taken into account these effects. I have taken these effects into consideration when analyzing the data. By reducing purchase lead times from 60 to 30 days on 65% of our purchases and from reducing the other 35% of our purchases from 60 to 2-3 days, we can reduce inventory levels throughout the year and by over $1.7 Million from the base model.
Data Integrity Issues in the forecast and cash flow
After careful review of the supplied spreadsheets I have uncovered the following...