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Pondicherry textile considering making kota fibers as their prime yarn prime yarn supplier giving them the sales of 60 lakh rupees. Pondicherry textile is asking for 80 days credit net. Kota fibers current credit period is 45 days.

If the company plans to expand to Pondicherry following will be the forecast. The result shows that this expansion would fetch a profit of 2,60,400
Gross sales Excise tax(15%) Net Sales Cost of goods (73.6% of gross sales) Gross Profit Operating expense (6% of net sales) Interest Depriciation Profit before tax Income tax @30% Net profit 60,00,000 9,00,000 51,00,000 44,22,000 6,78,000 3,06,000 0 0 3,72,000 1,11,600 2,60,400

NOTE:- Assuming that no borrowings are taken for this expansion hence no interest and depriciation is also taken as nill.

Looking at the proposal it looks good as it is a profitable deal and also will help company to expand Also it will help in increasing sales upto 60 lakh.

Liquidity ratios measures the firms ability to meet short term obligations. 1. Current ratio Current asset/current liability 231213561/194085970 = 1.2 Ideally higher the current ratio better is the ability of the company to meet payment obligations. It should be around 2 hence this ratio states that they will have some problem paying their bills on time with this forecast.

2.Quick ratio  The Quick ratio is a more conservative measure of a firms ability to convert its assets into cash.


(Current assets-inventories)/current liabilities (231213561-91156896)/194085970=0.72 Ideally it should be 1 or above 1 again showing that they would face problem in meeting up short terms obligations.

The ratios shows that company wont have enough liquidity to meet up the short term obligations. The company has already taken loan to keep the bank balance of 7,50,000 The company also needs an urgent loan to payoff the excise duty.

The company would require another loan to start the production. Also one red-flag is the extended credit term of 80 days net requested by Pondicherry Textiles. This would reduce the amount of cash on hand during the year and increase their liabilities due to the 80 day credit term.

I would suggest that the company must not go for this deal as they cannot afford to go for another loan at this moment and also the credit period is very high and would reduce the amount of cash in hand increasing the liability. However they can try to arrange the funds from other sources like:1 Ms.Pundir must cut down the dividend as the rate of dividend given is too high to the shareholders hence a huge amount of cash of around 20 lakh is drawn annually which must be reduced to an extent or should be stopped for a year. 2. If the members do not agree for stopping the dividends then they must try to arrange some capital from their side so that they can use it for the expansion in Pondicherry. 3. Dissolve the cash balance of 7.50 lakh.

In this circumstance, Kota Fibers should not accept this memo as it will have an unfavorable effect on the business. Having less cash on hand, tied up in receivables, will not allow Kota Fibers to be able to pay off the All-India bank before December. Hence overall its a good proposal from the point of view of increasing the sales and beneficial from the short term perspective but not good for the future financial stability of the company as it would lead to increase the borrowings of the company.