Final Project Mushtaq (SF)

Case Study : A home -brewed tragedy

Project Report

On

REVIVAL PLAN FOR KHAN BAHADUR INDUSTRIES LTD

By

Mushtaq Hussain Khan MM133038

Wasim Nasir MM133090

Amir Daraz MM112043

Submitted ToDr. Safdar Ali Butt

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Table of Contents

Table of Contents.........................................................................................................................................2

INTRODUCTION...........................................................................................................................................3

Brief History...............................................................................................................................................3

KBIL’s Business........................................................................................................................................ 3

The Board Members...............................................................................................................................3

REVIVAL PLAN FOR KHAN BAHADUR INDUSTRIES Ltd...........................................................6

A. Analysis of Causes and Effect.....................................................................................................6

B. Computation of Ratios to Support Causes and Effects Analysis.................................8

C. Measures for Revival Plan.........................................................................................................10

1. Financial Measures...................................................................................................................10

2. Operational Measure...............................................................................................................14

3. Managerial Measures...............................................................................................................15

4. General Measures......................................................................................................................15

5. Marketing & Sales Measures................................................................................................16

6. HR Measures................................................................................................................................17

D. Steps for the Approval of Revival Plan................................................................................17

E. Balance Sheets for Three Years..............................................................................................18

F. Income Statements for Three Years.....................................................................................19

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INTRODUCTION

Brief HistoryKBIL was established in 1986 and opened their first account with Dost Bank Ltd in that year. Their relationship had been excellent till the end of 2008. Due to the old relationship, the bank has so far avoided from taking any harsh action against the company. However, in line with the Prudential regulation and their own prudence policy, they suspended booking interest income on their outstanding loan at the end of 2009 when KBIL made their last repayment. Since that time, KBIL has not paid any interest or loan repayment installment.

KBIL’s BusinessKBIL is engaged in the manufacturing of household chemicals. It has three main line of products; detergents, shampoos and creams.Detergents include washing soap, washing powder, toilet soap and washing noodles etc. This department is still quite profitable.Shampoos include four main lines for men and women for different types of hair as well two brands of conditioners. This department has been incurring considerable losses as their brands appear unable to sustain their market shares.Creams include face cream, skin whitening creams, baby creams, petroleum, etc. This department has also started losing money recently.Business is fairly competitive and entrance barrier for new investor is fairly high. But KBIL have no marketing strategy to introduce new products or reshape existing ones that leads to lose market shares and low sales etc. Even after 27 years in business they had failed to make niche for themselves in the market.

The Board MembersAfter studying the file, Fahad Khan booked an appointment with the CFO of the company. He paid a total of four visits to the company office and was able to get an opportunity to talk to not only the CFO but also the Chairman, CEO and two other executive directors of the company.Mr. Barham khan Bahadur was chairman of the company and 82 years old. Even though he was technically non-executive chairman but was still making all important decisions. The CEO, CFO and one of the executive directors were his sons, while the other executive director was his son-in-law. The company’s board had four executive directors and three non-executive directors (including the chairman).Mahtab Khan Bahadur, 54 was the CEO but had little interest in the company’s major decisions because all major decisions were still taken by his father. He had no professional qualification in any discipline of management and spent most of his time by signing the papers sent to him by other directors or officials.

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52 years old Mr. Bilal Khan Bahadur was the company CFO. He had an MBA from some obscure university but had good working knowledge of his department. 48 years old Mr. Asad Khan Bahadur was company’s production director. He had a degree in mechanical engineering and had worked in the company since its inception. The weakest link in the board was Shahnawaz Raja; the company’s marketing director and chairman’s son-in-law. He had joined the company about five years ago and brought about a number of unnecessary changes in product mix. Fahad Khan found him arrogant and non receptive to good advice, a total misfit for his position.

Chairman’s Views (Barham khan Bahadur)When Fahad khan asked the chairman as to what was the board of directors doing to arrest the decline of the company, the chairman first response was that the situation was not really all that bad. When Fahad Khan showed him the analysis of the company’s performance, he simply put the blame on Govt. rather his and other management inefficiency. The inefficiency of management and leadership can be easily found by the chairman’s statement:“The company can turn around quite easily only if Mahtab (CEO) takes greater interest and Shahnawaz (Marketing Director) takes lesser interest in its affairs”. This statement also shows the lack of coordination among departments, chain of command and responsibilities etc.

CEO’s Views (Mahtab Khan Bahadur)The CEO told to Fahad Khan as:We have been paying our workers regularly, all of our utility bills are paid on time, our production has never stopped for of raw material, and we have never had a workers strike. But he does not know about the ground realities that Fahad Khan reminded him. Why company has negative equity? It had not shown any profit for the last five years. Its bank loan was overdue and also its current ratio was less than 0.5 etc.

Production Director’s Views (Mr. Asad Khan Bahadur)Asad Khan told to Fahad Khan that the company’s machines had already served their useful life. Bottling and labeling plant is now quite outdated and needs immediate replacement. Our standby generators can sustain only 40% of our production. Due to low production level, cost is going up but sales volume going down. Cost of power produced by in house generators is more than double the tariff payable to Govt. owned power supplying company. Few workers who had reached or were pass the retirement age but chairman had allowed them to continue in

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employment. These workers are unnecessary strain on the company and can be easily replaced by much cheaper and more efficient younger workers.

The Laments of CFO (Mr. Bilal Khan Bahadur)CFO, Bilal Khan Bahadur told to Fahad that there was no coordination between the directors and everyone seemed to be taking decisions without consulting anyone else. No cash planning and management because Shahnawaz get cheques prepared and signed without informing CFO. All the directors were “A” signatories to the bank account while the chief accountant and cost accountant were the “B” signatories. Personal finance of the company is not too bad and the family can invest more equity. Floating the company at the stock exchange to raise more equity is not possible in given state of financial statements.

Marketing Director’s Views (Shahnawaz Raja)The last director with whom Fahad Khan had a one to one meeting was Shahnawaz Raja, the company’s marketing director. He admitted that despite of his heavy expenditures on sales promotion, two of the product lines of the company were making losses and do not show any scope of recovery. These should be discontinued and replaced by the newer products. But chairman and the finance director are not willing to spend the money that will be required for the product development and marketing launch.

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REVIVAL PLAN FOR KHAN BAHADUR INDUSTRIES Ltd

A. Analysis of Causes and Effect

Operational SicknessCauses Effects

Outdated Plant and Machinery (Operating at 65% of its full capacity)

Higher product cost per unit, low productivity, frequent breakdowns, high maintenance cost

Weak ProductsLow sales, higher marketing expenditures, price cutting, higher discounts, loss of market shares etc.

Power Load sheddingLow production, frequent breakdowns, low sales, failure to deliver the product timely in market

Low sustainability In-house Generator High cost of product per unit, low production, stock wastage, etc.

No production manuals Lack of stock management, false invoices, high cost of inventory, low profits etc.

Supply Chain Hiccups Production disruption, higher cost, poor quality of inputs, failure to deliver products in markets in time etc.

Financial SicknessCauses Effects

Unproductive Investment (80% shares in a subsidiary)

Shares in non-core subsidiary leads to loss of income on investment, cost of borrowed funds for such investments etc.

Accrued Interest Blocked Working Capital Low stock of raw material, higher receivables, high

cost of short term borrowing etc. Lack of Cash management Problems in availing opportunities, payments, salaries

of employees ,dividend payments etc. Wrong balances of assets Too low level of current assets leads to difficulties in

production, problem in raw in material stocks as well receivables etc.

Improper use of resources More money spent on poorer segments leading to overall deterioration in profit and cash flows.

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Marketing Sickness

Causes Effects Unattractive Product Low sales, high marketing and advertising

cost, low profits etc.

Strong Competitor High marketing cost, high customers switching, low market shares etc.

Improper Distribution Problem in delivering products timely in market, increase in cost, loss of customers, market shares etc

Improper pricing strategy Low sales, loss of customers, lower revenues etc

High Advertisement Expenditures without niche market.

Wastage of resources, failure in positioning the products, low sales, lower profits etc.

HR Sickness

Causes Effects Weak Top Management Leads to Lack of control, no coordination, improper

use of resource, inefficiency of managers etc.

Centralized Decision Making Low participation of workers, improper decision making, improper response about facts about sales and production by low level management etc.

No Line of Authority Lack of reporting, no check and balance, improper use of resources, lack of responsibilities etc.

Over age workers Inefficient work, low production, low sales, wastage of time, high salaries etc.

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B. Computation of Ratios to Support Causes and Effects Analysis

Ratio Analysis 2009 2010 2011 2012 Industry Avg.(1) Liquidity Ratios Current Ratio 1.72 0.97 0.66 0.35 1.60Quick Ratio 0.89 0.54 0.35 0.14 1.20NWC Ratio 0.20 -0.01 -0.25 -0.78 0.90(2) Profitability Ratios GP Margin 38% 12% 13% 10% 50%NP Margin -16% -34% -34% 30% ROA -0.11 -0.32 -0.38 -0.63 0.30(3) Coverage Ratios Interest Cover -1.18 -3.95 -3.46 -3.69 3.40(4) Efficiency/ Activity Ratios Inventory turnover in time 3.28 4.12 4.82 2.50Inventory turnover in days 111 89 76 146A/R turnover in time 3.34 4.00 5.75 3.00Collection Period 109 91 64 122A/P turnover in time 2.53 2.14 1.95 3.20Payment Period 144 170 187 114Operating Cycle 221 180 139 268Cash Conversion/WC/Cash Cycle 76 9 -48 154Fixed Assets Utilization Ratio 1.11 1.17 1.14 1.06 3.00

Ratios of KBIL regarding liquidity, efficiency and profitably are clearly indicating that company is in financial distress. Their current ratio is less the 0.5 which means that cannot meet their short term obligations from currents assets.GP ratio also shows the decline in the gross profits over the period. And NP ratio shows that company bearing accumulated losses and these losses keeps on increasing.Interest converge ratio shows that company earning less than cost of debt that means there is a problem of using available resources. The activity or efficiency ratios are indicating that company has problems related to stock, receivables and making payments to the suppliers due to shortage of cash and no proper management regarding debtors and inventory.

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Financial distress Model (Z-score Model)Ratios Weights Ratios

WC/TA 1.2 -0.78 -0.94R.E/TA 1.4 0.00 0.00EBIT/TA 3.3 -0.50 -1.64MVE/BVD 0.6 0.00 0.00Sales/TA 1 1.56 1.56Z-Score -1.01

Financial distress model is clearly showing that company is in financial distress because Z-Score of the company is less than 1.81 that is cut point for bankruptcy. In a nutshell we can say that all the ratios and financial distress model are clear indicators of KBIL’s bankruptcy and the need for revival. We think this company can be revived because the demand of household chemicals is not that much declining but management of the company does not paying attention in company’s affairs. If we take some measures regarding finance, marketing, management and operations then in two to three years KBIL can be profitable.

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C. Measures for Revival PlanThe revival plan for KBIL encompass financial measures, operational measures, managerial measures, marketing measures and HR measures. Each of these measures is discussed in turn:

1. Financial MeasuresCompany can revive if KBIL take following financial measures:

a. Restructuring of Equityi. Revaluation of assets

The company’s fixed assets include a piece of land which is still shown in the balance sheet at cost of Rs.20 million but its currently market value is Rs.228 million as per professional assessment. If company revalues their fixed assets by restructuring equity then assets can be up-valued by debiting assets account with Rs. 208 million and crediting the restructuring account with Rs.208 million.

The accounting treatment will be as follows:

All figures in millions of rupeesFixed Assets A/C (Dr.) 208

Restructuring A/C (Cr.) 208

This amount of Rs.208 million will reduce the accumulated losses as:

All figures in millions of rupeesAccumulated losses from previous years (743.00)

Revaluation Gain by restructuring 208.00Net losses (535.00)

Reduction in accumulated losses, will results in reduction of negative equity from balance sheet and increase in the value of total assets.

ii. Injecting fresh equity by familyIf the family invests a minimum of Rs.120 million as additional capital then company can be revived, because:

When they will invest that much amount as we suggest, the accumulated losses from balance sheet could be overcome. This reduction in accumulated losses will lead to positive equity.

Through injecting that much amount they can give confidence to bank for revival and can demand for write off of accrued interest and overdrafts as well as conversion of a part of debt into equity.

If they do so then in coming years they can go for further capital through floating shares by listing company at stock exchange because the picture of financial statements will be feasible through implementing our suggestions.

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That new capital from floating shares will help them for expansion of business. But in current situation they cannot get listed because their financial reports are unfeasible.


All figures in millions of rupees

Cash A/C (Dr.) 120

Capital A/C (Cr.) 120

This amount of Rs.120 million will reduce the accumulated losses as:

All figures in millions of rupeesAccumulated losses after revaluation (535.00)

Additional Capital by Family 120.00Net losses (415.00)

iii. Cancellation of Shares If KBIL cancelled 6 million shares out of 36 million then number of outstanding shares can be reduced but that have no effect on existing shareholders because cancellation of shares in about the same way as bonus shares are issued. This reduction in outstanding shares will be results in increase of EPS in coming years after reviving the KBIL. Increase in EPS will also attract new share capital through potential shareholders by sending positive signal in market.

The accounting treatment will be as follows:All figures in millions of rupees

Share Capital A/C (Cr.) 60 Restructuring A/C (Cr.) 60

iv. Fresh issue of sharesIn the year 2015 company can get listed because the picture of financial statements will be feasible after implementation of given suggestion. If company get listed then can raise more capital of Rs. 90 million by floating new share (9,000,000*10 Rs per share) to expand their business in near future.

The accounting treatment will be as follows:All figures in millions of rupees

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Cash A/C (Dr.) 90 Share Capital A/C (Cr.) 90

b. Divestment of non-core subsidiaryIn current scenario the subsidiary company is giving Rs.5 million dividend per year. If KBIL sold the subsidiary company, as per professional assessment it can be sold at Rs.35 million today. The cost of subsidiary is 50 million and on sale, company will bear a loss of Rs. 15 million but that will be one time loss.The company can inject a sum of Rs.15 million out of Rs.35 million (cash received from sale of subsidiary) in BMR (Balancing, Modernizing and Revival of Plant) to improve the production capacity. Because, according to Fahad Khan the old plant is currently operating at 65% of its full capacity and can be improved by BMR that needs at least Rs.15 million. Through injection of Rs. 15 million in BMR also increase the fixed assets in balance sheet.By improving production capacity there will be two positive effects as follows:

The number of units produced would increase and improved sales. Secondly, decrease in cost of production through Balancing, Modernizing and

Revival of Plant.Remaining Rs.20 million (35M-15M) could be used in improving products, research & development and also in sale promotion activities to improve sales that lead to profitability.


All figures in millions of rupeesCash A/C (Dr.) 35 Loss from Sale of Subsidiary (Dr.) 15

Sales of Subsidiary A/C (Cr.) 50

c. Debt RestructuringI. Interest Relief

KBIL can request for interest relief on following grounds:As we will inject up to Rs. 120 million as additional capital in business if bank write off the accrued interest and overdrafts of the previous years.Secondly, bank can also nominate one or two non executive director in board if they write off the interest and overdrafts of the previous years.

II. Conversion of Part of Loan into Equity

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KBIL can request to bank that to covert a part of debt into equity. Conversion of debt to equity is beneficial for both parties’ bank and KBIL as:By converting Rs.200 million out of 225 million into equity then existing shareholder’s control over the company is diluted and they may no longer be able to run the company independently. The share of bank in the company will be up to 32 % of total share capital after converting loan into equity as calculated in table given below. For company perspective it is also beneficial because bank will be act as a watch dog after appointing their non executive director. In result of diluted control of existing shareholders the decisions like selling of vans at its book value as well as investments in risky projects can be controlled.Paid up Share Capital 360,000,000Cancelled Share Capital 60,000,000Sub Total 300,000,000Capital Injecting by Family 120,000,000Conversion into Equity 200,000,000Total Paid up Share Capital 620,000,000Share of bank in total Capital 32%

d. Institution of MIS to improve documentation procedureIf KBIL install MIS then they can get timely information on current financial performance, comparisons of budgeted and actual figures provided by different departments, tracking inventory, billing, sales records and payroll data etc.Through MIS Company can improve customer relationship management, human resource planning etc. In short management information system will helped in making accurate and timely decision.Company can highlight its strength and weaknesses due to the presence of revenue reports, employees’ performance etc. It will also help in planning through above information. Cost of MIS can be managed from the additional funds provided by family as well as remaining cash from sales of subsidiary after meeting BMR, sales promotion activities and R & D for improving product quality etc.

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2. Operational MeasureOperational area is the lifeblood of company because sales and profitability depends upon operational efficiency of business. It could be improved by minimizing the cost of raw material, work in process material and finished products through BMR and other operational measures as follows:

a. Balancing, modernization and revival of plant (BMR)According to Asad Khan Bahadur (Production director) bottling and labeling plants is now outdated and needs immediate replacement. As discussed in financial measures, the balancing, modernizing and revival of plant can be done through the funds received from sales of subsidiary. If company uses only Rs.15 million then the capacity of plant can be increase up to 95% -100% that is currently operating at 65%. Through BMR the operational efficiency of the company can improved that leads to increase in sales and profitability in future.

b. Change of power sourceThe current source of power in company is generator but standby generator can sustain only 40% of production as per information of Asad Khan Bahadur. And volume of sales is also not high to warrant purchase of more generators. And important thing is that the cost of power produced by in house generators is more than double the tariff payable to the government owned power supplying company. This statement clearly indicate that company should change the power source from generator to government owned power supplying company to lower the overheads cost. This will also improve the operational efficiency of the company.

c. Production Control measuresFor proper management and controlling of increasing production cost, company should rewrite its production manuals through follow ways:

Proper procedures and documentation Stock coding and identification Verifying stock through regular stock taking Setting stock check points

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3. Managerial MeasuresFollowing are the managerial measures can be taken to revive the company from this situation:

The CEO (Mr. Mahtab Khan Bahadur) and marketing director must leave the executive position because both are the biggest contributor to the company’s poor situation.CEO is taking little interest in the company’s all major decisions which were still taken by his father and . Secondly, marketing director (Shahnawaz Raja) also failed in his area of marketing the products and also gets cheque prepared and signed without the knowledge of CFO because all the directors are the “A” signatories to the bank.

The bank should appoint one or more non-executive directors on the company board.

The chairman of audit committee must be nominated by bank non-executive directors to improve to the performance of the company.

The bank also asked for personal guarantee from the directors, so that the take interest in company affairs and work efficiently.

The bank should force for the appointment of the new CEO. The company did not appear to have any real middle level management. There

should be proper middle level management and decisions should also decentralize in nature. Due to this coordination among workers, middle management and top management can be improved.

4. General Measures

a. Investment PolicyWe think KBIL should invest in the BMR of fixed assets up to the depreciation amount from the year 2015 after starting the profits. Because depreciation is non-cash expense and suppose to be as idle cash with company up to the amount of depreciation. Proper BMR of plants and machinery will reduce the break downs in production process that is the back bone of increase in sales and profitability.

b. Ownership StructureIf bank convert the part of debt into equity and also write off the accrued interest as well as overdraft then family can willing to inject more equity up to Rs.120 million as discussed above. Through these changes in balance sheet of company, the ownership structure will be also changed and beneficial for both the parties; bank will be the partner and can appoint one or two non executive directors and through diluted control of existing shareholders the decisions like selling of vans at its book

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value as well as investments in risky projects can be controlled, that is beneficial for KBIL.

Ownership Structure2013

Total Paid up Share Capital 620,000,000 100%Bank 200,000,000 32%Family 420,000,000 68%

2015Total Paid up Share Capital 629,000,000 100%Bank 200,000,000 32%Family 420,000,000 67%General Public 9,000,000 1%

5. Marketing & Sales Measures

a. Reformulation of ProductsIf company focus on reshaping the two products shampoo and cream through improving quality as well as new packaging then sale can be improved. They should not remove any of the product because customers prefer the variety rather one brand.

b. Rethink pricing policyThere are two important areas to improve the sales; price and quantity. Quantity can be improved by BMR as we suggest before. Secondly, price should be according to the competitors in market.

c. Improve promotion activitiesCurrently company has poor promotional activities and the placement of products is also not good because their marketing manager did not know about marketing strategies. They need more promotion in 2013 for sales because in initial stage they should make awareness of their product in market.

d. Improve distribution policy Currently company is distributing through a distribution company and they are charging huge trade discount. KBIL need to launch their products through direct marketing and negotiated other distribution company up to 2014 and then in next year when earn some profit, they can go for forward integration by purchasing distributors.

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e. Mass ProductionThrough BMR the production capacity of KBIL will be improved and then they can go for mass production and economies of scales to get competitive edge.

f. Research and DevelopmentThis is the key area in which KBIL should focus more because quality of the product can only be improved if company has research and development department. By following our given suggestions the company can make money for research and development expenditures.

6. HR Measures

a. Hiring new staffKBIL must hire some new staff to improve the efficiency and reduction in cost because old workers are more expensive and also work inefficiently.

b. Middle ManagementThere should be middle management to perform specific functions like planning, marketing, finance, HR and R&D.

c. Workers participation in decision makingThere should be workers participation in decision making to improve the coordination and quality of the decisions. We think workers have more information regarding day to day activities of operations and sales then top management so if they will involve their workers in decision making the results will be better.

D. Steps for the Approval of Revival PlanFollowing are the important steps regarding approval from all stakeholders before implementation of revival plan:Equity holders: For equity restructuring the approval of the equity holders should be taken which are family, bank after converting debt into equity and general public.Debt holders (Bank): The approval of bank is also necessary because bank is major contributor for revival of the company.Trade Creditors: The approval of trade creditors is necessary because they are providing inputs for the business.Management: Management approval is also important because they are running the company and there should be changes in management and that cannot be done with the consent of managementSECP: Company is yet to be incorporated; hence for the legal requirement the approval of SECP is important.Stock Exchange: In 2015 company will be listed in stock exchange so the approval of stock exchange is necessary before implementation of the revival plan.

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From above given suggestions following are the budgeted income statements and balance sheets:

E. Balance Sheets for Three Years

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F. Income Statements for Three Years

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Final Project Mushtaq (SF)