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Crisis at the Mill - Weaving a Turnaround

One of the large US-based distressed private equity funds contacted A&M having found serious
issues with one of their Indian portfolio companies that involved potential involvement of its top
management in irregular activities.

The portfolio company in question was a leading woollen textile manufacturer and exporter,
WoolEx Mills, with operations based in Northern India. The company had been growing, with a
turnover of ~INR 1,600 million and operating profits, but with a negative bottom line. Its products
were sold not only in India but worldwide through distribution channel partners and retail stores.

A&M MDs/ Senior Directors were requested to take over as Interim CEO, CFO and Head of
Manufacturing & Sourcing, and a person affiliated with the fund, as interim Head of Sales.

The Textile Company

Production Process

WoolEx Mills imported raw materials (called “tops”)

typically from Australia or South Africa. Tops came from
fine quality wool, combed and weeded to free it from any
defects, and then sent to the dye-house where it was treated
to obtain the required colour and shade, and dried. Dyed
tops were sent to the spinning unit for conversion to yarns.
The desired fineness of the finished fabric depended on the
fineness and quality achieved in the spinning unit. Spinning
was a critical part of the process as it established the
flexibility and elasticity of the fabric.

These yarns then moved on to the weaving unit, where a number of power looms wove them into
a fabric based on designs that were pre-fed into the looms. The fabric from the weaving unit then
went to the finishing section, where the fabric achieved its desired finish and texture. After this
last process, the fabric underwent several quality checks before it was sent to the finished goods

Creating a fine woollen fabric involved tight controls on quality at all stages. Mandatory to the
production of a high-quality fabric was state-of-the-art machinery maintained at the highest
standards, and a close control of the manufacturing process with inspections at all stages. Unlike
many price-conscious consumers in India, the company’s direct customers were major distributors
and large retailers who carried out rigorous quality checks on incoming shipments. Its export
customers imposed even more stringent quality standards.
The textile and apparel industry operated on a two-season basis, with the design departments
beginning work well in advance on new designs for the forthcoming season. Prototypes were
developed and sent to all the major distributors for their
input in the hope of obtaining orders. Once orders were
confirmed, they were integrated into production plans that
were generated in a pre-determined production cycle.

Raw Material

Wool was one of the company’s key raw materials. India boasted the third largest sheep population
in the world. However, the average yield per sheep was approximately 0.9kg compared to the
global average of over 2.4kg. From this yield, 85% of Indian wool was of a coarser grade and thus
unsuitable for the organized fabric manufacturing industry (Exhibit 1 gives an overview of the
industry). Fine quality wool production in India was insufficient to meet the organized woollen
industry’s needs and thus depended largely on raw material imports. Most of the fabric grade wool
in India was imported from Australia, New Zealand and South Africa.

Dyes were the other key raw material. The production team from A&M believed that savings of
5-10% could be achieved if they changed vendors. One of the allegations against the management
was that they took kick-backs from vendors, so replacing them would get rid of “bad” vendors.

A number of trials were carried out in the dye-house, with a goal to institutionalize new dyes. The
introduction of new systems or suppliers was made more complicated by the background of
irregularities in the existing sourcing practices.


Even though the company’s brand was well known throughout India, WoolEx Mills did not
command premium prices. It was widely believed that its products were of inferior quality to its
competitors. Its major customers in India were the large multi-brand distributors who sold its
products to multi-brand retailers. As a result, the company required few showrooms. Exports
accounted for approximately 20% of its revenues, with leading names in the fashion industry from
the USA, Europe and Japan among its customers.


Interim CEO and CFO discovered there were some serious quality issues that needed to be urgently
addressed. This came to light one morning in March 2011 when the head of sales received an email
from the company’s main export customer in Japan complaining about the quality of the latest
shipment. The Japanese customer was threatening to ask for a credit note of approximately 40%
of the value of the invoice. On questioning the head of quality, it was realized that this case was
not unusual. In the past, the company had received credit notes for quality issues from other export
customers, but a credit note for 40% of the invoice value was unheard of. The issue of quality thus
became another priority for the A&M team.
The company’s quality issues could be attributed to two main things. 1) WoolEx Mills was not up-
to speed with the technological advances in the industry and was using outdated, old equipment.
2) The company’s manufacturing processes were not designed to produce the high-quality fabrics
that were now being demanded in the industry.

Video link to the textile manufacturing process

Financial Position of the Company

The interim CFO, discovered several issues in the company’s finances. The accounts receivable
were high and outdated on a month-by-month basis. Customers paid invoices with an average of
130 days delay, leading to cash flow issues. In addition, some of the discounts given were not
recorded in the firm’s books, and no credit notes were issued. The budgeting process was not
carried out in a detailed manner. There were several loopholes in the costing process and the
Management Information System (MIS) was being maintained manually.

The price of the high-quality fine wool imports from Australia and South Africa that the company
so heavily relied upon had increased from September 2010 to March 2011 by over 65%. This
severely constrained profitability and cash flows. Raw material purchases were generally made
through advanced payments and accounted for 50% of the selling price. Other major purchase
items included dyes, chemicals and consumables that accounted for 10% of sales.

The interim CFO soon realized that the company did not follow any scientific inventory
management or ordering practices. One example was the coal for firing a steam boiler that was
stocked unnecessarily six months in advance, thus blocking working capital. There was a need to
define ordering procedures for critical purchases. Large domestic customers were contributing to
higher sales outstanding. Irregularities in sales practices with some customers contributed to high
outstanding receivables. These, together with irregular payables management, were damaging the
company’s liquidity.

Given all the above issues, reducing the high working capital through cash flow forecasting was
the primary focus for the CFO, as well as strengthening the checks and controls within the finance

Capital Expenditure Plan

The company used old and outdated equipment. About two thirds of the looms in operation broke
down frequently. Poor maintenance also contributed to losses in manufacturing efficiencies and
contributed to the quality issue. There was an urgent need to upgrade these looms with superior
technology, but the capital expenditure required had regularly been postponed.

Critical testing equipment was also amiss in the quality lab. The design function had antiquated
looms for the manufacture of prototype fabrics for new designs. Some immediate requirements in
the dye-house and finishing section had been overlooked in the capital expenditure plans. Even
though an ERP package was installed in the company, it was not used to its full potential. The
plant’s structures required immediate repairs – the poor state of infrastructure became clear when
the entire plant was flooded after a heavy day of rain during the monsoon.

Problem Statement
1. Put yourself in the shoes of interim CEO and CFO, assess the cashflow position of the
company and develop a plan of action for the interim managers in the role of finance &

2. Where do you see the opportunities to improve the performance of the firm?

3. How would you handle the sensitivities around the accusations of malpractice by (former)
senior management?

4. Finally, what would be the key ingredients to make this a successful turnaround?

1. In the groups assigned, please discuss and find solutions to the problem statements given

2. Each group will be allotted 8 minutes to present its solution (preferably using a Power Point
presentation) and 2 minutes for Q&A
Exhibit 1
Industry Background

The Indian woollen textiles sector is relatively small compared to the country’s cotton, man-made
fibre textiles and clothing industry. It is estimated to be worth approximately Rs. 100 bn. The
industry is dominated by a large number of “unorganized” players on a small scale. These are
small knitting units, power loom units, carpet manufacturers and dyeing houses. The remainder of
the industry is made up of the “organized” sector – large integrated textile mills, combing units
and spinning units.

There are only a handful of large integrated woollen textile mills in India. These mills manufacture
mostly finished fabric that is sold to the domestic and export markets. Some of the mills also sell
apparel and garments. A few have gained a reputation as quality manufacturers of woollen textiles
and their products are exported worldwide. The woollen fabric industry is dominated by one large
player that controls more than 65% of the market. Historically the market has grown at a rate of
9% in the last two years, and is expected to sustain these growth rates.

Due to the small number of players in the organized segment in India and the specialized nature
of equipment required for manufacturing woollen fabrics, the industry is dependent on imported
machinery and equipment. Most of the looms and other equipment are imported from European
countries, USA and Japan.

Appendix 1
Income Statement

FY09 FY10 Month of FY to date

(in INR millions) Mar-09 Mar-10 Nov-10 Nov-10
Sales and job work 1,597.3 1,598.8 99.0 1,222.7
Other income 16.4 35.1 10.9 26.8
Total Income 1,613.6 1,633.9 109.9 1,249.5
Cost of Goods Sold (596.3) (625.2) (21.2) (504.1)
Employee Cost (249.6) (236.2) (22.2) (173.8)
Other Expenses (540.9) (527.9) (52.4) (386.5)
Total Expenditure (1,386.9) (1,389.3) (95.8) (1,064.4)
EBITDA 226.8 244.7 14.1 185.1
as % of Income 14.1% 15.0% 12.8% 14.8%
Depreciation (131.5) (135.8) (11.3) (91.6)
Finance Charges (60.4) (50.4) (3.7) (31.6)
Profit Before Tax 34.8 58.4 (0.9) 61.8
Provision for tax (6.6) (10.2) -- (11.1)
Profit After Tax 28.2 48.2 (0.9) 50.7
as % of Income 1.7% 3.0% (0.9%) 4.1%
Appendix 2
Balance Sheet

FY09 FY10 As on
(in INR millions) Mar-09 Mar-10 Nov-10
Shareholder's Funds
Share Capital 1,356.7 1,356.7 1,356.7
Reserves and Surplus 560.7 609.0 670.8
Loan Funds
Secured Loans 395.7 272.3 223.6
TOTAL LIABILITIES 2,313.2 2,237.9 2,251.1

Fixed Assets
Gross Block 2,120.0 2,168.7 2,172.1
(less) Acc Depreciation 648.7 784.5 875.8
Net Block 1,471.3 1,384.2 1,296.2
Capital WIP 8.1 6.4 63.7
Fixed Assets 1,479.5 1,390.6 1,359.9
Investments 0.0 0.0 0.0
Current Assets
Inventories 513.0 478.6 666.0
Sundry debtors 579.9 651.4 663.8
Cash and bank balances 55.4 52.4 53.2
Loans and advances 31.6 46.3 77.7
Other current assets 0.3 1.8 --
Current Assets 1,180.2 1,230.6 1,460.7
Less: Current Liabilities and Provisions
Current liabilities 318.8 366.1 544.8
Provisions 27.7 17.1 24.7
Current Liabilities and Provisions 346.6 383.2 569.5
Net Current Assets 833.7 847.3 891.2
TOTAL ASSETS 2,313.2 2,237.9 2,251.1
Appendix 3
Cash Flow Statement

Month FY to
FY09 FY10
of date
Mar- Mar-
Nov-10 Nov-10
(in INR millions) 09 10
A Cash Flow from Operating Activities
Net Income (Loss) 34.8 58.4 (0.9) 61.8
Depreciation & Amortisation of Fixed Assets 131.5 135.8 11.3 91.4
Loss / (Gain) on sale of fixed assets (0.2) (0.0) -- --
Interest expense 55.7 47.4 -- --
Interest income (5.5) (15.2) -- --
Direct Taxes / FBT paid (6.3) (19.0) -- --
Accounts Receivables-Net (100.5) (73.9) 124.0 (12.4)
Inventories (154.7) 34.5 (84.4) (187.4)
Advance & Deposits -- -- 4.7 (26.5)
Current Liabilities & Provisions 16.3 34.2 2.4 186.3
Total Adjustments (63.6) 143.8 57.9 51.4
Cash Flow from Operating Activities (28.8) 202.2 57.0 113.2

B Cash Flow from Investing Activities

Capital Expenditure (103.1) (46.9) (2.6) (64.0)
Proceeds from Sale of Fixed Assets 0.3 0.0 0.0 0.2
Interest income received 5.7 13.7 -- --
Net Cash used by Investing Activities (97.1) (33.2) (2.6) (63.8)

C Cash Flow from Financing Activities

Borrowings/(payments) of Term Loan 133.8 (10.2) (9.0) (39.7)
Borrowings/(payments) of Working Capital
Loan 46.4 (112.4) (47.5) (9.0)
Borrowings/(payments) of Vehicle Loan 1.0 (0.9) -- --
Interest paid (52.8) (48.6) -- --
Net change in unsecured Deposits -- -- -- --
Net Cash provided by Financing activities 128.3 (172.0) (56.5) (48.6)

Net change in cash & cash equivalents 2.4 (3.0) (2.0) 0.8
Beginning cash & cash equivalents 53.0 55.4 55.3 52.4
Ending cash & cash equivalents 55.4 52.4 53.2 53.2
Appendix 4
Ageing schedule of receivables as on 30-Nov-10

Total <= 61 - 90 91 - 120 >

(in INR millions) Outstanding 60 Days Days Days 120 Days
A. Domestic :
Pb/Ch/Hr/Hp/Jk 79.0 34.7 21.3 7.4 15.6
Delhi 28.9 14.2 3.4 4.9 6.4
U.P. West 30.6 6.5 6.5 3.3 14.4
Rajasthan 10.7 6.1 2.5 0.9 1.2
Maharashtra 33.2 14.8 8.9 6.7 2.6
Gujrat 25.0 3.7 2.2 2.6 16.5
A.P. 79.6 8.4 16.3 33.4 21.5
M.P. 11.5 6.8 1.3 2.3 1.1
Tamilnadu 5.4 1.1 1.5 0.5 2.3
Karnatka 15.5 7.3 4.4 2.1 1.8
U.P. -
Allahabad 2.4 1.9 0.1 0.1 0.3
U.P. - East 19.3 9.1 7.4 1.5 1.3
North East 13.1 2.8 2.5 2.4 5.4
Bihar 27.4 12.8 8.4 2.8 3.4
Orissa 5.6 2.1 1.1 0.8 1.5
West Bengal 7.0 3.9 1.7 0.4 1.0
Nepal 58.4 36.0 11.4 0.4 10.7
U.P. Central 48.5 26.0 9.9 7.4 5.2
Convertors etc. 8.1 1.2 2.2 0.2 4.5
Sub Total 509.4 199.4 113.0 80.3 116.6
B. Govt. / Institutional 96.2 48.5 22.0 14.2 11.5
C. Export 46.0 30.9 14.1 0.4 0.5
D. Job Spinning 6.5 6.4 0.1 0.0 0.0
E. Garments 5.8 3.5 -- -- 2.2
TOTAL 663.8 288.8 149.1 95.0 130.9
Appendix 5
Inventory schedule as on 30-Nov-10

(in INR '000s)

S.No. Particulars Unit Qty. Value
1 Raw Materials
Wool Kgs. 2,48,382 1,35,689
Polyester Kgs. 2,16,433 32,482
Purchased Yarn Kgs. 36,043 11,012
Waste Kgs. 31,701 918
Dyes & Chemicals 6,573
2 Work-in-process
Dyeing Deptt. Kgs. 19,525 9,595
Spinning Deptt. Kgs. 1,02,314 41,007
Yarn stores Kgs. 1,04,861 43,200
Weaving Deptt. Kgs. 65,159 41,585
Fnshng Deptt. Mtrs. 1,26,585 30,568
3 Finished Goods
Cloth Mtrs. 9,33,511 2,43,844
Blankets Nos 7,010 3,850
Garments Nos 8,476 10,999
4 Stores & Spares 54,661
Total 6,65,982

Appendix 6
Capital Expenditure Plan

Planned Advance Expenditure

Capex to Upto Nov'10 Total Against Grand
(Budget) suppliers Oct'10 Capex Total
as on Plan
(in INR '000s) Nov-10 2009-10
Spares 28,162.1 1,766.3 7,024.4 15.0 8,805.7 121.0 8,926.7
New Machines 67,224.4 4,808.1 3,337.7 25.0 8,170.8 36,621.5 44,792.3
Building & Roads Repair 23,025.6 2,098.4 10,454.5 1,483.5 14,036.4 617.1 14,653.5
Misc. 3,075.0 1,633.4 -- -- 1,633.4 -- 1,633.4
Contingency 6,432.9 688.8 3,252.5 907.6 4,848.9 -- 4,848.9
Total 1,27,920.0 10,995.0 24,069.1 2,431.1 37,495.2 37,359.7 74,854.8
Appendix 7
Credit and Payment terms

Credit terms for all sales:

Category Credit Terms

Fabric Sales
Domestic Customers 3 months from the date of sale
Government Institutions 3 months from the date of sale
Exports 3 months from the date of sale
Job work All cash sale
Other Liquidation All cash sale
Other Income No other major source of income

Payment terms for all purchases:

Category Payment terms Additional information

Raw materials
Imported wool tops
LC; payment to banks generally 2 months from date All RM purchases can be
Imported polyester
of purchases considered to be imported
Other domestic purchases
Finance charges for LC INR 6.25 mn/ month for supporting the facility
Stores and Dyes
Local purchases 2 months from date of purchase All local purchases
Power and Fuel
Daily settlement of power bought from exchange Power (62%), coal (24%), fuel
End of month settlement for government grids (14%) of power & fuel purchase
Coal 1 week from date of purchase Orders placed in 1st week of
Furnace Oil 1 week from date of purchase month and deliveries in 2nd week
Marketing Agencies 1 month from date of incurring expenditure
Logistics/ Freight 1 month from date of incurring expenditure
All other overheads 1 month from date of incurring expenditure
Misc. daily expenses Daily settlement

Appendix 8
Please refer to the excel file “Cash Flow Template for Students - WoolEx Mills”