Problems:

The main problem that the firm Guna Fibres is facing is that they lack sufficient cash flow from
operations to meet their day-to-day financial obligations. Guna Fibres has become dependent
on a revolving line of credit from the All-India Bank & Trust.

Further, due to increasing operating expenses and costs of goods sold, Guna Fibres is no
longer able to remain solvent based on their current financial practices.

The second major problem that the company was facing was that net profits had decreased
from ₹36 million in 2010 to ₹25 million in 2011 even though sales in that year showed an
impressive growth rate of 18%. Further, cost of goods sold (73.7%) and operating cost (6%)
amounted to almost 80% of the gross sales.

The third major issue was the lack of free cash. Even though the firm’s profits were reducing,
Surabhi Kumar had a policy of maintaining a cash balance of at least ₹7.5 million. Apart from
this the firm also had a policy of distributing ₹5 million as dividend among its shareholders who
were members of Surabhi Kumar’s extended family. Also, the firm’s philosophy was that it was
better to return excess funds to shareholders – who were all part of Surabhi Kumar’s extended
family – rather than keep it within the firm. This resulted in less money being available for other
activities.

The fourth problem was the fact that Guna Fibres purchased raw materials that they expected
to sell in two months at once This results in increased expenses related to warehouse storage.
Also, the firm followed a plan of seasonal production meaning the plant would operate at peak
capacity for two months in a year and at reduced capacities for the rest of the year. Hiring and
layoffs also followed the same patterns.
Background:
Guna Fibres is a textile manufacturing company located in Guna that is subject to seasonal
swings in demand as well as an increasingly competitive environment.

Guna Fibres has historically utilized a line of credit from All-India Bank & Trust to finance the
purchases necessary to fulfill the seasonal spike in demand. Historically, Guna Fibres would
repay whatever balance it had to pay on its line of credit in October, per the banks policy. At
the end of 2011, Guna Fibres found themselves running a balance on their line of credit
beyond October and was subsequently denied any more credit until the firm could prove its
ability to pay the balance off.

To examine their company’s financial position owner Surabhi Kumar and her accountant had
created a financial forecast for the month-to-month operations of the company in an attempt to
demonstrate to the bank that they firm could indeed pay off the loan.

Analysis of the monthly forecast based on the assumptions of Guna Fibres current operating
practices revealed that Guna Fibres would not be able to pay off the line of credit by the end of
the year and in fact would owe a balance of 3,858,000 Rupees to the bank by December
2012. Based on the information contained in Malik’s forecast it is certain that the bank will not
be willing to extend any more credit to Guna Fibres as currently there is no clear plan for the
firm to pay its short term debit obligations.