Guna Fibres Ltd.
Presented to:
All-India Bank and Trust Co.
Presented by:
Surabhi Kumar
Re:
Remedies for current liquidity problems
Current Situation
Guna Fibres (GF) requires a loan to pay the outstanding excise tax so that the government tax inspector releases our trucks. GF faces with a cash flow shortage due to the seasonality of the business. Typically, our business is active and profitable during April through August and we expect this trend to continue. On a fiscal basis, GF has operated in a profitable manner but because we are in the middle of our slow season, additional funds are required to operate until busy season begins. GF´s working capital is not sufficient. Currently, there are approximately INR $5 million but normally the requirement is INR $14 million that is expected to be finance by short-term debt. GF is also planning to pay dividends which is not feasible when it cannot pay basic operational expenses to ensure the continuous performance of the organization.
Therefore, we have come up with the following action plan to secure these funds:
Recommendation
Immediate
In order to address the immediate concerns, we will change the investment effort made on inventory purchases supply by lowering them from 60 to 30 days. In addition we will increase the collection efforts by 10% and reduce the amount of minimum cash on hand in order to use the excess of fund (if available) more adequately.
By decreasing inventory purchases to 30 instead of 60 days, this will allow us to carry less inventory on hand and reduce the need for cash on an ongoing basis. This will also free up cash for operational expenses, such as excise tax and accounts payable. To resolve our current problem, we can use this month of inventory we do not have to pay for to our loan.
By increasing our collection efforts, we will increase our incoming cash to better manage our payables. Currently, there is a mismatch between the cashflow inflow and the outflow as GF is paying 50% of our payables at 30 days and only collecting 40% of sales. Due to this mismanagement of funds, GF is financing the liquidity gap with note payables (short-term debt). The way to make this possible is by offering a small discount early payment and accruing finance fees on late payment. This will increase customer incentive to pay as early as possible.
GF currently carries a high amount of minimum cash on hand. Obtaining a loan to maintain this minimum cash, is not a sound business strategy. Reducing the amount of minimum cash on hand, will allow for faster payment of the bank loan.
Overall, implementing this solution immediately will increase our liquidity, i.e. current ratio increases to 2.58 from 1.32 (improvement of 95%). This solution is feasible as it requires minimal operational changes and a small amount of training. This combined solution is also desireable as it produces the best liquidity for the organization.
Long-Term
Additional remedies that can be applied in the future are to level purchasing of inventory throughout the year, reduce dividend payment to shareholders and reduce overall operating expenses.
Levelling the purchasing of inventory throughout the year will increase predictability in purchasing. This will be considered for the future rather than immediate because applying a 30 day inventory rule would provide a better cashflow than the level inventory option. This would only be considered if the 30 day inventory caused problems operationally.
Reducing the dividend payment to shareholders allows to keep more cash on hand to pay suppliers and excise tax. Ideally, dividends would only be paid when GF has met financial obligations (including tax payments) and also when the financial performance is outstanding. This can be measure with Financial covenants (e.g: liquidity, efficiency and solvency). Nevertheless, this needs to be taken into consideration as a long-term action as this will change the situation for shareholders having a high probability that they will be reluctant to this change.
Reducing the overall operating expenses allows GF to have more cash on hand. This would be considered for the future as it would require an operational procedure overhaul, and require retraining of staff.

Emergency

In an emergency situation, GF could slow the payment of accounts payable, reduce cash on hand to zero and request a lower interest rate from the bank.
Slowing the payment of accounts payable could impact the business if we are unable to negotiate with suppliers and they refuse to ship goods. This would only be used in an emergency situation as it is only a short-term solution.
Reducing cash on hand to zero would provide extra cash for payment of excise tax, however this only allows for one emergency at a time. This could only be used if one payment needed to be made immediately, and the minimum would have to be reinstated as fast as possible afterwards.
Requesting a lower interest rate from the bank would relieve some cash to pay suppliers or excise tax. This would only be a last resort emergency move as it would be extremely difficult to get the bank to approve this for a company in distress.

Special Requests
Guna Fibres would like to request a revolving line of credit, with a credit limit of INR $21 Million. If the immediate action plan is put into place, this revolving credit would reach maximum in June 2012, and be completely paid in full by September 2012. Having this permament revolving line of credit will allow GF to obtain short term loan funds in slow season without having to request funds from the bank manager on a continuous basis.
As a secondary request, we would like to request a lower interest rate on the revolving line of credit. This will reduce the interest expense the company is currently experiencing and allow for a more positive cash flow.