UV6600

Rev: Apr. 4, 2017

Guna Fibres, Ltd.

Surabhi Kumar, managing director and principal owner of Guna Fibres, Ltd. (Guna), discovered the
problem when she arrived at the parking lot of the company’s plant one morning in early January 2012.
Customers for whom rolls of fiber yarn were intended had been badgering Kumar to fill their orders in a timely
manner, yet trucks that had been loaded just the night before were being unloaded because the government tax
inspector, stationed at the company’s warehouse, would not clear the trucks for departure. The excise tax had
not been paid; the inspector required a cash payment, but in seeking to draw funds that morning, Vikram Malik,
the bookkeeper, discovered that the company had overdrawn its bank account—the third time in as many
weeks. The truck drivers, independent contractors, cursed loudly as they unloaded the trucks, refusing to wait
while the company and government settled their accounts.

This shipment would not leave for at least another two days, and angry customers would no doubt require
an explanation. Before granting a loan with which to pay the excise tax, the branch manager of the All-India
Bank & Trust Company had requested a meeting with Kumar for the next day to discuss Guna’s financial
condition and its plans for restoring the firm’s liquidity.

Kumar told Malik, “This cash problem is most vexing. I don’t understand it. We’re a very profitable
enterprise, yet we seem to have to depend increasingly on the bank. Why do we need more loans just as our
heavy selling season begins? We can’t repeat this blunder.”

Company Background

Guna was founded in 1972 to produce nylon fiber at its only plant in Guna, India, about 500 km south of
New Delhi. By using new technology and domestic raw materials, the firm had developed a steady franchise
among dozens of small, local textile weavers. It supplied synthetic fiber yarns used to weave colorful cloths for
making saris, the traditional women’s dress of India. On average, each sari required eight yards of cloth. An
Indian woman typically would buy three saris a year. With India’s female population at around 600 million, the
demand for saris accounted for more than 14 billion yards of fabric. This demand was currently being supplied
entirely from domestic textile mills that, in turn, filled their yarn requirements from suppliers such as Guna.

Synthetic Textile Market

The demand for synthetic textiles was stable, with year-to-year growth and predictable seasonal
fluctuations. Unit demand increased with both population and national income. In addition, India’s population
celebrated hundreds of festivals each year, in deference to a host of deities, at which saris were traditionally
worn. The most important festival, the Diwali celebration in midautumn, caused a seasonal peak in the demand

This case was written by Thien T. Pham (MBA ’90), Robert F. Bruner, and Michael J. Schill as a basis for class discussion. The names and institutions in
this case are fictitious. The financial support of the Batten Institute is gratefully acknowledged. Copyright © 2013 by the University of Virginia Darden
School Foundation, Charlottesville, VA. All rights reserved. To order copies, send an e-mail to sales@dardenbusinesspublishing.com.. No part of this publication
may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means—electronic, mechanical, photocopying, recording, or otherwise—
without the permission of the Darden School Foundation.

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for new saris, which in turn caused a seasonal peak in demand for nylon textiles in late summer and early fall.
Thus the seasonal demand for nylon yarn would peak in midsummer. Unit growth in the industry was expected
to be 15% per year.

Consumers purchased saris and textiles from cloth merchants located in villages throughout the country.
A cloth merchant usually was an important local figure who was well known to area residents and who generally
granted credit to support consumer purchases. Merchants maintained relatively low levels of inventory and
built stocks of goods only shortly before and during the peak selling season.

Competition was keen among those merchants’ suppliers (the many small textile-weaving mills) and was
affected by price, service, and the credit they could grant to the merchants. The mills essentially produced to
order, building their inventories of woven cloth shortly in advance of the peak selling season and keeping only
maintenance stocks at other times of the year.

The yarn manufacturers competed for the business of the mills through responsive service and credit. The
suppliers to the yarn manufacturers provided little or no trade credit. Being near the origin of the textile chain
in India, the yarn manufacturers essentially banked the downstream activities of the industry.

Production and Distribution System

Thin profit margins had prompted Kumar to adopt policies against overproduction and overstocking,
which required Guna to carry inventories through the slack selling season. She had adopted a plan of seasonal
production, which meant that the yarn plant would operate at peak capacity for two months of the year and at
modest levels the rest of the year. That policy imposed an annual ritual of hirings and layoffs.

To help ensure prompt service, Guna maintained two distribution warehouses, but getting the finished
yarn quickly from the factory in Guna to the customers was a challenge. The roads were narrow and mostly in
poor repair. A truck was often delayed negotiating the trip between Kolkata and Guna, a distance of about
730 km. Journeys were slow and dangerous, and accidents were frequent.

Company Performance

Guna had experienced consistent growth and profitability (see Exhibit 1 for firm’s recent financial
statements). In 2011, sales had grown at an impressive rate of 18%. Recent profits were INR25 million, down
from INR36 million in 2010.1 Kumar expected Guna’s growth to continue with gross sales reaching more than
INR900 million in 2012 (Exhibit 2).2

Reassessment

After the episode in the parking lot, Kumar and her bookkeeper went to her office to analyze the situation.
She pushed aside two items on her desk to which she had intended to devote her morning: a message from the
transportation manager regarding a possible change in the inventory policy (Exhibit 3) and a proposal from
the operations manager for a scheme of level annual production (Exhibit 4).

1 INR = Indian rupees.

2 At the time, the rupee exchange rate for U.S. dollars was roughly at the rate of INR50 per dollar.

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To prepare a forecast on a business-as-usual basis, Kumar and Malik agreed on various parameters. Cost
of goods sold would run at 73.7% of gross sales—a figure that was up from recent years because of increasing
price competition. Annual operating expenses would be about 6% of gross annual sales. Operating expenses
were up from recent years to include the addition of a quality-control department, two new sales agents, and
four young nephews in whom Kumar hoped to build allegiance to the family business. Kumar had long felt
pressure to hire family members to company management. The 4 new fellows would join 10 other family
members on her team. Although the company’s income tax rate of 30% accrued monthly, positive balances
were paid quarterly in March, June, September, and December. The excise tax (at 15% of sales) was different
from the income tax and was collected at the factory gate as trucks left to make deliveries to customers and the
regional warehouses. Kumar expected to pay dividends of INR5.0 million per quarter to the 11 members of
her extended family who owned the entirety of the firm’s equity. For years, Guna had paid substantial dividends.
The Kumar family believed that excess funds left in the firm were at greater risk than if the funds were returned
to shareholders.

Accounts receivable collections in any given month had been running steadily at the rate of 48 days,
comprised of 40% of the previous month’s gross sales plus 60% of the gross sales from the month before that.
The cost of the raw materials for Guna’s yarn production ran about 55% of the gross sale price. To ensure
sufficient raw material on hand, it was Guna’s practice each month to purchase the amount of raw materials
expected to be sold in two months. The suppliers Guna used had little ability to provide credit such that
accounts payable were generally paid within two weeks. Monthly direct labor and other direct costs associated
with yarn manufacturing were equivalent to about 34% of purchases in the previous month.3 Accounts payable
ran at about half of the month’s purchases. As a matter of policy, Kumar wanted to see a cash balance of at
least INR7.5 million. To sustain company expansion, capital expenditures were anticipated to run at
INR3.5 million per quarter.

Guna had a line of credit at the All-India Bank & Trust Company, where it also maintained its cash balances.
All-India’s short-term interest rate was currently 14.5%, but Kumar was worried that inflation and interest rates
might rise in the coming year. By terms of the bank, the seasonal line of credit had to be reduced to a zero
balance for at least 30 days each year. The usual cleanup month had been October,4 but last year Guna had
failed to make a full repayment at that time. Only after strong assurances by Kumar that she would clean up
the loan in November or December had the lending officer reluctantly agreed to waive the cleanup requirement
in October. Unfortunately, the credit needs of Guna did not abate as rapidly as expected in November and
December, and although his protests increased each month, the lending officer had agreed to meet Guna’s cash
requirements with loans. Now he was refusing to extend any more seasonal credit until Kumar presented a
reasonable financial plan for the company that demonstrated its ability to clean up the loan by the end of 2012.

Financial Forecast

With some experience in financial modeling, Malik used the agreed-upon assumptions to build out a
monthly forecast of Guna’s financial statements (Exhibit 5). To summarize the seasonal pattern of the model,
Malik handed Kumar a graph showing the projected monthly sales and key balance sheet accounts (Exhibit 6).
After studying the forecasts for a few moments, Kumar expostulated:

3 The 73.7% COGS rate assumption was determined based on these purchases and direct cost figures: 73.7% = 55% + 55% × 34%.
4 The selection of October as the loan-cleanup month was imposed by the bank on the grounds of tradition. Seasonal loans of any type made by the
bank were to be cleaned up in October. Kumar had seen no reason previously to challenge the bank’s tradition.

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The loan officer will never accept this forecast as a basis for more credit. We need a new plan, and fast.
Maintaining this loan is critical for us to scale up for the most important part of our business season.
Please go over these assumptions in detail and look for any opportunities to improve our debt position.

Then looking toward the two proposals she had pushed aside earlier, she muttered, “Perhaps these
proposals will help.”

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Exhibit 1
Guna Fibres, Ltd.
Guna’s Annual Income Statements (in millions of Indian rupees)

2010 2011
Gross Sales 644.8 758.7
Excise Tax 96.7 113.8
Net Sales 548.1 644.9
Cost of Goods 445.0 538.6
Gross Profits 103.1 106.3
Operating Expenses 35.0 48.3
Depreciation 7.7 9.1
Interest Expense 9.1 12.4
Profit Before Tax 51.4 36.5
Income Tax 15.5 10.9
Net Profit 35.9 25.6

Cash 9.0 7.6

Accounts Receivable 23.9 26.7
Inventory 29.7 34.5
Total Current Assets 62.6 68.8
Gross Plant, Property, and Equipment (PPE) 88.7 100.9
Accumulated Depreciation 11.7 14.8
Net PPE 77.0 86.1
Total Assets 139.6 154.9

Accounts Payable 6.0 8.2

Notes to Bank 0.0 8.0
Accrued Taxes −0.6 −0.9
Total Current Liabilities 5.4 15.3
Owners’ Equity 134.2 139.6
Total Liabilities and Equity 139.6 154.9
Source: All exhibits created by case writer.

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Exhibit 2
Guna Fibres, Ltd.
Guna’s Monthly Sales, 2011 Actual and 2012 Forecast
(in millions of Indian rupees)

2011 2012
(Actual) (Forecast)
January 20.1 26.2
February 23.1 28.9
March 34.2 44.5
April 70.4 88.0
May 120.7 138.9
June 152.9 175.9
July 141.9 163.2
August 71.4 85.8
September 40.2 50.3
October 34.2 44.5
November 27.2 35.3
December 22.1 27.7
Year 758.7 909.0

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Exhibit 3
Guna Fibres, Ltd.
Message from Transportation Manager

January 2, 2012

To: S. Kumar

From: R. Sikh

As you asked me to, I have been tracking our supply shipments over the past year. I have observed a substantial
improvement in the reliability of the shipments. As a result, I would propose that we reduce our raw-material
inventory requirement from 60 days to 30 days. This would reduce the amount of inventory we are carrying by
one month, and should free up a lot of space in the warehouse. I am not sure if that will affect any other
department since we will be buying the same amount of material, but it would make inventory tracking a lot
easier for me. Please let me know so we can implement this in January such that I don’t purchase any additional
raw material this month.

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Exhibit 4
Guna Fibres, Ltd.
Message from Operations Manager

January 7, 2012

To: S. Kumar

From: L. Gupta

You asked me to estimate the production efficiencies arising from a scheme of level annual production where
our production rate is level over the year rather than highly seasonal as it currently is. To provide for the
estimated production needs in 2012 and 2013 with level production, I recommend that purchases shift to
INR50 million per month.

There are significant operating advantages to be gained with this operating scenario:
 Seasonal hirings and layoffs would no longer be necessary, permitting us to cultivate a stronger work
force and, perhaps, to suppress labor unrest. You will recall that the unions have indicated that reducing
seasonal layoffs will be one of their major negotiating objectives this year.
 Level production entails lower manufacturing risk. With the load spread throughout the year, we would
suffer less from equipment breakdowns and could better match the routine maintenance with the
demand on the plant and equipment.

With level production my team believes that direct labor and other direct manufacturing costs could be reduced
from a forecasted 34% of purchases down to 29% of purchases.

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Exhibit 5
Guna Fibres, Ltd.
Monthly Financial Statement Forecast (in millions of Indian rupees)

Assumptions
Excise Tax Rate 15% Minimum Cash Balance 7.5
Annual Operating Expenses / Annual Gr Sales 6.0% Accounts Receivable Collection
Depreciation / Gross PPE 10% In One Month 40%
Interest Rate on Borrowings (and Deposits) 14.5% In Two Months 60%
Income Tax Rate 30% Purchases / Gr Sales in Two Months 55%
Dividends Paid (in March, June, Sep, Dec) 5.0 Direct Labor / Purchases Last Month 34%
Capital Expenditures (every third month) 3.50
Implied Operating Margin 26.3% Accounts Payable / Purchases 50%

Nov-11Dec-11 Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 Sep-12 Oct-12 Nov-12Dec-12 2012 Jan-13 Feb-13
Gross Sales 27.2 22.1 26.2 28.9 44.5 88.0 138.9 175.9 163.2 85.8 50.3 44.5 35.3 27.7 909.0 34.0 36.2
Excise Taxes1 3.9 4.3 6.7 13.2 20.8 26.4 24.5 12.9 7.5 6.7 5.3 4.2 136.3
Net Sales 22.2 24.6 37.8 74.8 118.0 149.5 138.7 72.9 42.8 37.8 30.0 23.5 772.6
Cost of Goods Sold2 19.3 21.3 32.8 64.9 102.3 129.6 120.2 63.2 37.1 32.8 26.0 20.4 669.9
Gross Profit 3.0 3.3 5.0 9.9 15.7 19.9 18.4 9.7 5.7 5.0 4.0 3.1 102.7
Operating Expenses3 4.5 4.5 4.5 4.5 4.5 4.5 4.5 4.5 4.5 4.5 4.5 4.5 54.5
Depreciation4 0.8 0.8 0.9 0.9 0.9 0.9 0.9 0.9 0.9 0.9 0.9 1.0 10.7
Interest Expense5 0.1 0.2 0.6 1.4 2.6 3.7 4.2 3.4 2.0 1.0 0.6 0.4 20.3
Profit Before Taxes -2.5 -2.3 -1.0 3.1 7.7 10.7 8.8 0.9 -1.8 -1.5 -2.1 -2.8 17.2
Income Taxes -0.8 -0.7 -0.3 0.9 2.3 3.2 2.6 0.3 -0.5 -0.4 -0.6 -0.8 5.2
Net Profit -1.8 -1.6 -0.7 2.2 5.4 7.5 6.2 0.6 -1.2 -1.0 -1.5 -2.0 12.0
Dividend 5.0 5.0 5.0 5.0

1 Gross Sales × Exercise Tax Rate

2 Gross Sales × (Raw Material Cost % + Direct Labor Cost %)

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3 Annual Operating Expenses ÷ 12
4 Gross PPE × Depreciation Rate ÷ 12
5 Notes Payable (t − 1) × Interest Rate ÷ 12
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Exhibit 5 (continued)

Dec-11 Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 Sep-12 Oct-12 Nov-12 Dec-12
Cash 7.6 7.5 7.5 7.5 7.5 7.5 7.5 7.5 7.5 7.5 7.5 7.5 7.5
Accounts Receivable6 26.7 27.7 32.9 50.1 103.0 179.9 247.5 256.9 171.9 90.0 62.9 50.3 37.1
Inventory 34.5 45.1 80.5 140.6 198.4 218.7 166.7 90.2 60.9 51.5 40.6 38.4 44.3
Total Current Assets 68.8 80.3 120.9 198.2 308.9 406.1 421.7 354.6 240.3 149.0 111.0 96.2 88.9
Gross PPE7 100.9 100.9 100.9 104.4 104.4 104.4 107.9 107.9 107.9 111.4 111.4 111.4 114.9
Accumulated Depreciation 14.8 15.6 16.5 17.4 18.2 19.1 20.0 20.9 21.8 22.7 23.6 24.6 25.5
Net PPE 86.1 85.3 84.4 87.0 86.2 85.3 87.9 87.0 86.1 88.7 87.8 86.8 89.4
Total Assets 154.9 165.6 205.3 285.2 395.0 491.4 509.6 441.6 326.4 237.7 198.7 183.0 178.3

Accounts Payable8 8.2 12.2 24.2 38.2 48.4 44.9 23.6 13.8 12.2 9.7 7.6 9.4 9.9
Note Payable9 8.0 17.1 47.2 119.1 215.7 307.9 345.4 278.4 163.9 86.9 51.5 36.1 38.6
Accrued Taxes10 -0.9 -1.7 -2.4 -2.6 -1.7 0.6 0.0 2.6 2.9 0.0 -0.4 -1.1 -1.9
Total Current Liabilities 15.3 27.7 69.1 154.6 262.3 353.3 369.0 294.9 179.0 96.6 58.6 44.4 46.6
Shareholders’ Equity11 139.6 137.9 136.2 130.6 132.7 138.1 140.6 146.8 147.4 141.1 140.1 138.6 131.6
Total Liabilities & Equity 154.9 165.6 205.3 285.2 395.0 491.4 509.6 441.6 326.4 237.7 198.7 183.0 178.3

Inventory Detail Nov-11 Dec-11 Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 Sep-12 Oct-12 Nov-12 Dec-12 2012
Purchases12 14.4 15.9 24.5 48.4 76.4 96.7 89.7 47.2 27.7 24.5 19.4 15.2 18.7 19.9 508.2
Direct Labor and Other Mftg Costs13 4.9 5.4 8.3 16.5 26.0 32.9 30.5 16.0 9.4 8.3 6.6 5.2 6.4 171.4
Cost of Goods Sold 19.3 21.3 32.8 64.9 102.3 129.6 120.2 63.2 37.1 32.8 26.0 20.4
Inventory14 34.5 45.1 80.5 140.6 198.4 218.7 166.7 90.2 60.9 51.5 40.6 38.4 44.3

6 AR(t − 1) + GSales(t) − 40% × GSales(t − 1) − 60% × GSales(t − 2)

7 Gross PPE(t − 1) + Capex(t)
8 50% × Purchases(t)
9 Total Assets − AP − AccTax − ShrEquity
10 AccTax(t − 1) + IncTax(t) or 0 if positive balance and month of quarterly payment
11 ShrEquity(t − 1) + NetProfit(t) − Dividend(t)

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12 55% × GSales(t + 2)
13 35% × Purchases(t − 1)
14 Inventory(t − 1) + Purchases(t) + Direct Labor(t) − COGS(t)
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Exhibit 6
Guna Fibres, Ltd.
Forecast of Accounts by Month

400

350

300

250

200

150

Millions of Indian rupees

100

50

0
Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jun-12 Jul-12 Aug-12 Sep-12 Oct-12 Nov-12 Dec-12
Net Sales Accounts Receivable Inventory Accounts Payable Notes Payable

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