Summary of Case Discussion

Summary of Case Discussion: Guna Fibres Based on our class discussion yesterday, the objectives of the case are threefold: 

To explore a range of issues in working-capital management, with a primary focus on accounts receivable and inventory. The case illustrates how management choices about trade credit, inventory policy, production policy (i.e., producing to order versus producing to stock), and expense management influence the financing needs of the firm. The case’s financial forecast gives students the opportunity to discuss the cash cycle of the firm.

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To extend students’ skills in financial-statement modeling and analysis. This case demonstrates the technique of forecasting with T-accounts, which may be contrasted with percentage-of-sales forecasting illustrated in other cases.

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To illustrate some of the challenges in the financial (and general) management of firms in developing countries. These challenges include transportation and logistical problems, the availability of credit to merchants and consumers, high real rates of growth, tax practices of governments, and dramatic swings in demand induced by local customs and holidays.

Check whether you have achieved the objectives above. If you have not, revisit the case, go through the slides on working capital management that I have sent and sharpen your financial modelling skill. I have attached here template of exhibit 5 (Malik Forecast), rework on Malik’s forecast of exhibit 5 by reducing -

Cost of Goods Sold / Gr Sales to 71%, and Direct Labor / Purchases Last Month to 29%

Assess whether the changes improve the profit margin and ROA of the company. As a conclusion, here are the summary of actions that the genaral manager could consider in assessing financing needs and flow of funds in a firm: General managers must develop their intuition about the flow of funds through a firm or business unit as a way of understanding the financial implications of different policies and actions. Intuition about the flow of funds starts with the following points: 1. The focus of interest is cash flow, not earnings. Cash flow is the amount by which the cash balance will change over a period of time. Negative cash flows usually cannot be sustained over a long period of time without some outside financing, so the size and sign of the cash flow will help a general manager anticipate the need for external capital. Perhaps the easiest way to identify a firm’s flow of funds over time is to study the sources-and-uses-of-funds statement, which is usually included in the annual report. In turn, that statement is developed from the balance sheet and income statement—if you are skillful at understanding those reports, you can proceed directly to them for your insights.

2. What influences funds-flow and financing needs? Cash flow is improved (and financing needs are reduced) by increased earnings, reductions in assets, or increases in capital. Cash flow is worsened (and financing needs are increased) by lower earnings, increases in assets, or reductions in capital. To be more specific, consider the following effects

Earnings effects

Asset changes

Capital changes

Effects that Increase Cash Flow

Effects that Decrease Cash Flow

Increasing price and volume Reducing costs Shortening customer credit terms Tightening inventory management Cutting back on capital investing Reducing dividends Selling stock

Reducing price and volume Increasing costs Lengthening customer credit terms Relaxing inventory management Increasing capital investing Increasing dividends Buying back stock

3. Changes in demand will affect the financing needs and cash flow of the firm. Growth requires that the firm to build up assets to support business expansion; the buildup of assets requires cash or external financing. Similarly, a decline in the business should free cash as the firm scales down in the face of dwindling demand. Of course, the process of growth and decline can be witnessed each year in the seasonal fluctuations in demand that some firms face. The buildup toward the peak in demand requires investment in inventory and receivables; the subsequent seasonal ebbing allows those receivables and inventories to be liquidated, freeing up cash. 4. Management policies can also affect the firm’s financing needs. Pricing or costmanagement policies will affect the firm’s ability to generate equity capital internally. Sales managers who strive to relax credit terms to achieve higher sales will force the firm to make larger investments in working capital. Similarly, operations managers can affect the asset profile of the firm through policies on inventory management and the promptness with which the firm pays its suppliers. 5. The general manager can forecast financing needs and funds flows using one or both of two classic methods. The T-account approach simply prepares T-accounts for each line item in the financial statements. The percent-of-sales approach forecasts the income statement and balance sheet as a percentage of the firm’s business volume. Each approach has its strengths and shortcomings: T-accounts are cumbersome; percent of sales may ignore important discontinuities in the profitability or investment spending of the firm. Forecasters, greatly aided by personal computers, use a blend of the two techniques. Good funds-flow analysis entails careful tailoring of the forecasting techniques to each specific situation.