Guna Fibres Ltd.
All-India Bank and Trust Co.
Remedies for current liquidity problems
Guna Fibres (GF) requires a loan to pay the outstanding excise tax so that the government tax inspector releases our trucks. GF faces with a cash flow shortage due to the seasonality of the business. Typically, our business is active and profitable during April through August and we expect this trend to continue. On a fiscal basis, GF has operated in a profitable manner but because we are in the middle of our slow season, additional funds are required to operate until busy season begins. GF´s working capital is not sufficient. ...view middle of the document...
Currently, there is a mismatch between the cashflow inflow and the outflow as GF is paying 50% of our payables at 30 days and only collecting 40% of sales. Due to this mismanagement of funds, GF is financing the liquidity gap with note payables (short-term debt). The way to make this possible is by offering a small discount early payment and accruing finance fees on late payment. This will increase customer incentive to pay as early as possible.
GF currently carries a high amount of minimum cash on hand. Obtaining a loan to maintain this minimum cash, is not a sound business strategy. Reducing the amount of minimum cash on hand, will allow for faster payment of the bank loan.
Overall, implementing this solution immediately will increase our liquidity, i.e. current ratio increases to 2.58 from 1.32 (improvement of 95%). This solution is feasible as it requires minimal operational changes and a small amount of training. This combined solution is also desireable as it produces the best liquidity for the organization.
Additional remedies that can be applied in the future are to level purchasing of inventory throughout the year, reduce dividend payment to shareholders and reduce overall operating expenses.
Levelling the purchasing of inventory throughout the year will increase predictability in purchasing. This will be considered for the future rather than immediate because applying a 30 day inventory rule would provide a better cashflow than the level inventory option. This would only be considered if the 30 day inventory caused problems operationally.
Reducing the dividend payment to shareholders allows to keep more cash on hand to pay suppliers and excise tax. Ideally, dividends would only be paid when GF has met financial obligations (including tax payments) and also when the financial performance is outstanding. This can be measure with Financial covenants (e.g: liquidity, efficiency and solvency). Nevertheless, this needs to be...