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The case study Guna Fibres, Ltd. analyzes why a yarn company in India experienced a cash shortage using a "base-case" forecast. It also looks into the effectiveness of applying different possible solutions like the reduction of inventory, decreasing credit terms to customers, changing from seasonal to level production, reducing dividends, among others.
Michael J. Schill; Robert F. Bruner; Thien T. Pham
Harvard Business Review (UV6600-PDF-ENG)
February 04, 2013
Case questions answered:
- Guna Fibres Ltd. has a policy to maintain a minimum cash balance of 7.5M. Therefore, the plug variable would be the “note payable” account, and the amount of “note payable” in a sensitivity analysis would exemplify the magnitude of the influence that each factor has on their cash shortage. As such, the level of “note payable” could be seen as inversely proportionate to the level of “cash”, meaning that a high level of note payable would mean a shortage of cash.
- As seen from the excel snapshot, when reduction of inventory is implemented, it significantly reduces the amount of note payable to 6.9M, as it reduces the amount of capital held in inventory, which frees up more cash for payment of A/P and notes. Therefore, this solution would be able to greatly reduce the severity of the firm’s seasonal problem but not solve it entirely.
- What is your recommendation for Kumar in terms of solving her company’s current financial problems?
- Is Guna Fibres, Ltd. a financially healthy business? As part of your assessment, consider the return on assets of the business.
- Examine Vikram Malik’s monthly financial forecast. Why do Guna’s financial requirements vary across the year? What are the key determinants of Guna’s borrowing needs?
- On the basis of Malik’s forecast, how much debt will Guna need to arrange for the coming year? Will Guna be able to zero out the line of credit this year? If not, what is the cause of Guna’s ongoing need for debt?
- Using the monthly forecast model, do you expect that the two proposals would relieve or worsen Guna’s ability to clean up its bank loan?
- What other steps can Malik take to reduce Guna’s cash problems? What are your recommendations for Surabhi Kumar?
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Case answers for Guna Fibres, Ltd.
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Guna Fibres Ltd. has the policy to maintain a minimum cash balance of 7.5M. Therefore, the plug variable would be the “note payable” account, and the amount of “note payable” in a sensitivity analysis would exemplify the magnitude of the influence that each factor has on their cash shortage. As such, the level of “note payable” could be seen as inversely proportionate to the level of “cash”, meaning that a high level of note payable would mean a shortage of cash.
1: It is noted that the high dividend pay-out of 5M per quarter reduces their working capital substantially, which might have contributed to their shortage of cash.
As seen in the excel snapshot below, for every reduction in dividend pay-out per quarter, it improves their note payable account significantly, with the best-case scenario resulting in a mere 17.6M note payable by the end of 2012.
2: It is noted that the long cash cycle could be a possible reason for the shortage of cash during a certain season. As such, a sensitivity analysis for the percentage of accounts receivables collected in the 1st and 2nd-month after-sales are conducted. And the following snapshots show that if Guna Fibres Ltd were to collect a larger percentage of their credit sales within the 1st month, they would have…
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