CASE 27.1: RELIABLE TEXAMILL LIMITED17

In the beginning of 2009, Mr Shyam Lal, Chairman andManaging Director of Reliable Texamill Limited (RTL)wasconcerned about the company's working capitalmanagement. As the company was expecting its net salesto increase from Rs 1,208.61 lakh in 2008 to Rs 2,185.94lakh in 2009, the management of working capital

17. This case is an adapted version of the original case written by the author and published in Pandey, LM. and Bhat, Ramesh, Cases inFinancial Management, Tata McGraw Hill, 2002.

components would assume greater importance. Thecompany would need more working capital funds tosupport the expanding sales. Mr Shyam Lal knew that itmay not be easy to get funds from banks. He was wonderinghow he could reduce the working capital funds requirementof his company without affecting the sales.

670 FinancialManagement

BackgroundRTL commenced commercial production in 2005. Itmanufactures synthetic blended yarn which is a rawmaterial for other textile weaving mills and also forhandloom and power looms. The company's mills aresituated in an industrially less developed area in a northernstate. The company has a licensed capacity of 80,000spindles and existing installed capacity of 26,390 spindles(this includes 6, 210 spindles added during 2007-08). Theaverage capacity utilization of the company was 81 percent during 2006-07 and 85 per cent during 2007-08. Itexpects to use 87 per cent of the installed capacity during2008-09.

In the year 2005-06, the company could generate netsales ofRs 191.131akh, and incurred a net loss ofRs 57.11lakh. The acute power shortage was the dominant reason,besides the initial teething troubles, for the poor beginningof the company. RTL has since been able to increase itssales to Rs 973.321akh in 2006-07, and to Rs 1,203.611akhin 2007-08 as against the estimated sales of Rs 1,767.55lakh. It produced 1,315 tonnes of yarn in 2007-08 against1,182 tonnes during the previous year. The managementofRTL has attributed the lower actual sales to the sluggishmarket conditions that prevailed during the second half ofthe year 2007-08, forcing the company to keep itsproduction at a low level, and also to a certain extent dueto the company manufacturing substantial quantity of yarnof lesser counts and blends of lower value to suit the marketconditions. After incurring a loss in the first year (thecompany operated for seven months only), the companymade a net profit ofRs 24.481akh in 2006-07. The companyshowed a net profit before depreciation ofRs 32.421akh in2007-08. Power cuts, high input costs and increasedadministrative expenses on account of expansion resultedin poor profitability.

RTL has not so far paid any tax and dividends. Its taxliability is expected to be nil for quite some time as it enjoystax benefits being a new unit located in an industriallyless' developed area. The actual and estimated balancesheets and the profit and loss account of the coinpany aregiven in Tables 27.1.1, 27.1.2 and 27.1.3.

PRODUCTION FACILITIES

The company's existing production facilities are consideredadequate for operating the spinning mills at the enhancedinstalled capacity. The production process for obtainingthe main product, viz .. the synthetic yarn, originates withthe mixing up ofthe different fibres, i.e., acrylic, polyesterand viscose, as per the blend proposedto be manufactured.The annual consumption of these fibres generally dependson the product mix manufactured during the particularyear; the actual consumption during the years 2006-07 and2007-08 being about 1,973 tonnes and 2,303 tonnes, valuedrespectively at Rs 713.11 lakh and Rs 902.30 lakh. Thecompany generally does not encounter any significantdifficulties in procuring its full requirements of raw

COMPETITION AND SELLING ARRANGE-MENTS

materials and stores at the current market prices fromsuppliers.

Because of the frequent power cuts, the company builtup adequate captive power generating capacity byinstalling one more set of 860 kVAdiesel power generator.RTL is now planning to replace two sets of 250 kVAby thepurchase of one imported SKODA set of 869 kVAat a costof Rs 47.70. The new set is expected to be more economicalIfrom the point of view of diesel consumption and usagefor longer period.

The company's end products cater to the needs of largeand medium scale manufacturers of fabrics and alsohandlooms and power looms. The major buyers, accountingfor 80 to 85 per cent of sales, include reputed firms. Theremaining 15-20 per cent is sold to small dealers andtraders.

RTL faces a fair amount of competition from a numberof companies. In spite of the stiff competition, the syntheticblended yarn manufactured by RTL is well received in themarket and is supposed to enjoy a premium'over the yarnmanufactured by other leading manufacturers in thecountry. Its four branches located in different parts of thecountry manage the selling operations of the company.Thefull-fledged sales depots, recently opened, are situated faraway from the company's factory. As a result, a good partof the finished goods remains in transit at any point oftime. About 65 per cent of the company's sales are beingaffected on credit terms ranging from 45 to 60 daysdepending on the market conditions. The company hasbeen finding it difficult to realize its dues within the normalcredit period allowed to customers. The managementattributed this to its being new to the competitive textilemarket. Till 2007-08, the company had a practice ofsellinga part of its production through selling agents to smallbuyers. This practice has been discontinued, and nowthecompany directly sells to these buyers. The company,however, allows a discount ranging between 2 to 21h percent for sales on demand/cash basis.

EXPANSIONSoon after starting commercial production in 2005, RTLplanned to undertake an expansion programme forinstallation of another 20,000 additional spindles. Sincethe company incurred a loss in the very first year, thecompany attempted a modest expansion programmeinvolving installation of additional 6,210 spindles onlyduring 2007-08. The company felt that this increase in itsinstalled capacity was absolutely necessary in order tobringabout a better economy in its operations. The expansionprogramme was completed with a capital expenditure ofabout Rs 2761akh against the estimated cost ofRs 2531akh.The additional spindles would be put to commercialproduction from April 2009.

FUTURE PROSPECTS

Theprices of the basic raw material, viz., viscose/polyesterfibres,are lower in the international market than in India.Whilethe prices of viscose/polyester fibres have increasedsubstantially during the last two years, i.e., 2006-07 and2007-08,the prices of RTL's end products have, more orless,remained at the same level. The company has notbeenable to absorb in the selling prices, the increased costsof inputs. The power supply in the state, where thecompany is situated, is presently showing signs ofimprovement, and it is expected to be satisfactory in thecomingmonths. With the consumer preference during therecent years having shifted to blended fabrics and thecompany's products being of good quality and wellacceptedin the market, RTL can hope to fare well in thecomingyears.

Table27.1.1: Reliable Texamill Limited: Balance Sheetas on March 31

(Rs lakh)~ < .!,," • ~. ~ w- ~ ..•...•; ."~' :--_

•. _ v" , .:

LIABILITIESCurrentLiabilities 625.95 805.78 866.16

Bankborrowings 366.74 490.02 622.91Trade creditors 200.94 239.16 70.79Termloans payable 10.56 5.89 98.74Misc. liabilities and

provisions 47.71 70.71 73.72Termliabilities 531.22 801.14 802.37

Term loans payable 479.68 641.88 613.73. Deferred credit 29.95 24.06 17.21Term deposits 10.27 20.54 56.77Others 11.32 114.66 114.66

Total liabilities 1,157.17 1,606.92 1,668.53

NetWorth 191.07 223.49 288.74Share capital 199.44 199.44 199.44Reserves 24.26 24.26 24.26P&Lsurplus (deficit) -32.63 -0.21 65.04

Total funds 1,348.24 1.830.41 1.957.27

ASSETSCurrentAssets 580.03 757.47 913.59

Cash and bank balance 4.35 6.06 7.44Receivables 293.25 269.48 303.19Inventory:Raw materials 162.00 202.13 275.22Stock-in process 51.02· 64.96 80.85Finished goods 22.94 160.44 177.87Consumable spares 16.80 27.20 32.34Others 29.67 27.20 36.68

FixedAssets 760.46 1,056.61 1,027.35Gross Block 820.04 1,121.13 1,146.19Acc. Depreciation 73.66 73.66 127.34Net block 746.38 1.047.47 1,018.85Other non-current assets 14.08 9.14 8.50

Intangible Assets 7.75 16.33 16.33

Total assets 1,348.24 1,830.41 1,957.27

Principles of Working Capital Management 671

RTL produced 1,182 tonnes and 1,315 tonnes of yamduring the years 2006-07 and 2007-08 respectively. In 2008-09, it has planned production of 1,758 tonnes. RTLnormally plans its production schedule on the basis ofthemarket trend, i.e., as per the counts/blends of syntheticyarn acceptable in the market, so as to sell the end productswith ease. RTL's production plan for 2008-09 has beendevised keeping in view the changes in the marketconditions and other factors. RTL has planned tomanufacture more quantities of yarn in blends of highervalue during the period 2008-09. Those blends are expectedto be more acceptable in the market.

Table 27.1.2: Reliable Texamill LimitedProfit and Loss Account for the year ending March 31

(Rs lakh). . -

- -• R,!,. ~J .. ':-- t"~ '< s.·' ",,~.:,..:.-~!".{;

Net SalesCost of goods sold

Gross profit

973.32 1,208.61775.98 921.96

2,185.941,850.33

197.34 286.65 335.61

Operating expenses:Selling and administration 97.26 123.30 127.74Interest 81.68 137.83 140.6,8

Operating profit 18.40 25.52 67.19Other income (loss) 6.08 6.90 -1.94

Profit before tax 24.48 32.42 65.25Provision 0.00 0.00 0.00

Profit after tax 24.48 32.42 65.25

Table 27.1.3: Reliable Texamill Limited: Statement ofCosts of Sales

(Rs lakh)

Raw material 685.94 933.67 1,649.36Power and fuel 36.67 55.37 64.68Direct labour 40.00 57.14 79.41Other manufacturing

expenses 12.87 27.21 36.52Depreciation 41.57 53.68

Total 817.05 1,073.39 1,883.65Add: Opening

stock-in -progress 24.92 51.02 64.96Total 841.97 1,124.41 1,948.61

Less: Closingstock-in -progress 51.02 64.96 80.85

Cost of production 790.95 1,059.45 1,867.76Add: Opening finished

goods 7.97 22.95 160.44Total 798.92 1,082.40 2,028.20

Less: Closing finishedgoods 22.94 160.44 177.87

Cost of Sales 775.98 921.96 1,850.30

The company has projected its energy costs at about3.4 per cent of the total cost of production. The other

672 Financial Management

expenses have been estimated in line with the pastexperience. Also, the assets and liabilities of the companyhave been estimated in accordance with the past trends.

RTL had depended quite substantially on trade creditfor meeting its working capital needs. Trade credit formsabout one-third ofthe current liabilities. The normal creditperiod allowed by the suppliers is 45 days; however, adiscount of 2 per cent for payments made within 15. daysof the purchase date is allowed. In the past, creditors didnot object to RTL'sstretching of payments to them. In viewof the credit squeeze, they are likely to pressurize hard forearly payment of dues.

Discussion Questions

1. Critically evaluate RTL's performance andfinancing of its operations.

2. How has the company managed its working capitalin the past? Illustrate with appropriatecalculations.

3. What are RTL'splans to improve its working capitalmanagement? Show the calculation of operatingcycle to justify your answer.

4. Do you accept the financial plan prepared by RTL?What modifications would you suggest in the planand why?