case a i -...
TRANSCRIPT
Case A I
The Anna Cooperative Spinning Mill, Theni
Introduction
The Anna Cooperative Spinning Mill, a cotton growers mill, was registered
under the Tamil Nadu Cooperative Societies Act on 22nd February 1982.
It commenced its commercial production on 6th June 1984 with 7000 spindles.
It has been operating with its full-licensed capacity of 24960 spindles since April
'85. As one of the main objectives of the mill is to promote the interests of cotton
growers in the jurisdiction, a large number of members admitted are
"cotton-growers". Of the total number of 1078 members, the cotton
grower-members alone constituted 88 per cent in 1998. The share capital
contribution from the growers was Rs.8.93 lakhs accounting for 2.07 per cent of
the total paid-up share capital. The cotton-grower-members economically benefit
by marketing their cotton through Cooperative Cotton Marketing Society.
The mill has been manufacturing 40s to 80s carded and combed yam
(both in hank and cone) and polyester blended cotton yarn. The raw material
required for manufacturing the different counts of yarn is procured from the
Cooperative Cotton Marketing Society and the Tamil Nadu Cooperative Spinning
Mills Federation (TANSPIN). TANSPIN serves as a nodal agency for procuring
cotton from Gujarat, Maharashtra and Punjab and supplying them to member-
cooperative spuming mills.
The yarn produced by the mill is mostly supplied to Tamilnadu Handloom
Weavers Cooperative Society (COOPTEX), which in turn supplies yarn to Primary
Weavers' Cooperative Societies. Apart from sale of yam to Cooptex, the null also
sells yarn to weavers in the open market, but die price of yarn sold in the open
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market should not be less than the price fixed by the price fixation committee
constituted by the Director of Handlooms and Textiles (DMT). The affairs of the
mill, at present, is managed by an Officer deputed by the state called
Administrator, who is vested with the powers of the board.
Capital Budgeting Decision Practices
The mill has been operating with 24960 spindles since its inception. Having
felt the need for expansion with an equal number of existing spindleage for
improving the economic viability and profitability, the mill proposed in the year
1990, an expansion programme of 25000 spindles. A proposal was prepared and
submitted to the DHT at a project cost of Rs.U54 Lakhs. But it was not
recommended by DHT for financial assistance due to the then prevailing general
crisis in India.
Again in 1996, a total modernisation programme (reconstruction package)
for a complete reorganisation of the mill was prepared and submitted, with a total
outlay of Rs. 1116 lakhs. This proposal also was not sanctioned due to the
recession and glut in the spinning industry all over India. Hence, die discussion on
capital budgeting decision as far as this mill is concerned centres around the
"establishment" of the mill. The capital budgeting decision as practiced by the mill
is described below.
Potential Investment Idea
The origination of the idea of establishment of the new mill comes from
the State Government, which is the controlling authority of the Cooperative
Spinning Mills in Tamilnadu. Establishing the new mill is a kind of strategic
decision taken by the government as the mill extends social and economic benefits
to the society. The investment idea for establishing the mill in Theni has been
supported by various factors, like availability of raw materials, cheap labour,
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uninterrupted power supply and availability of adequate water and other
infrastructural facilities. Theni is a well known place for cotton market in
Tamilnadu as cotton is cultivated largely in the adjoining areas. For establishing
a new spinning mill, uninterrupted supply of cotton is a pre-requisite which in the
case of Theni was ensured. The investment idea was given due consideration for
political reasons too. Andipatti, the place where the mill is located, is an assembly
constituency from where the then chief Minister of Tamilnadu was elected. The
area being agriculture based, agricultural operations were seasonal. Hence,
availability of cheap labour was ensured. Infrastructural facilities like., water,
power and road were also available.
The potential for marketing of yarn was also considered. Marketing of yarn
did not pose a problem as the mill had assured market like Cooptex and Weavers
Cooperatives.
Project Formulation
As the project formulation is related to establishment of a new mill, the task
was entrusted to the professional Chartered Accountants. The main objective of
project formulation is to make a comprehensive and systematic analysis of various
factors for arriving at an investment decision. It involves a series of phases which
include technical analysis, market analysis, financial analysis, and economic
analysis of the project idea.
Technical analysis: The factors considered under technical analysis are product
mix, production process, purchase of machinery, and other infrastructural
facilities. Product mix is decided by taking into consideration the availability of
raw materials in the nearby areas and the demand for different varieties of yarn
required by the weavers' cooperatives and the demand for yarn in the open market.
Therefore, the allotment of spindles for different product mix was made after a
Market Analysis: It is done through the description of the products, its uses,
scope for the market and possible competition. The market for different counts and
types of yarn proposed to be produced annually is studied based on the spindle
allotment. The estimation of sale of yarn is based on the various counts of yarn
manufactured, extent of yam manufactured under each count, the scope for selling
the yarn among the existing customers (primary weaves cooperative societies) and
in the open market. For instance, the total sales estimated for each year was
Rs. 564.10 lakhs of which the sales estimate for 40s hank yarn was Rs. 177.82
lakhs, for 40s hosiery cone was Rs. 146.99 lakhs and for the 60s (carded and
combed hank) was Rs. 240.01 lakhs. Of the total sales estimated, the estimate for
the sale of 40s yam work out to 57.5 per cent (See Table A1.2). Further, of the
total estimated sales, 80 per cent of the yam is to be sold to weavers' societies and
the rest in the open market.
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thorough study and analysis of the availability of inputs and the demand for
outputs. The production of hank yarn is obligatory for the sustenance of handloom
industry. Another logic behind deciding the distribution of spindles for production
of different counts of yam is counterbalancing the low demand for any particular
counts.
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Cost of the Project: While making financial analysis, it must be seen that
all the necessary items have been covered and the expenditure under each head is
reasonable. The mill has prepared the cost of the project with all details
(Table A1.3). The composition of the project cost determined by the technical
experts is based on the estimation of spindleage capacity, plant and machinery,
buildings and other infrastructural facilities required for the establishment of the
mill. The total cost of the project was estimated at Rs. 706 lakhs. Of which, 63 per
cent was planned to be invested in plant and machinery followed by miscellaneous
fixed assets (11 per cent) and factory and non-factory buildings (10 per cent).
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It could be seen from the table that 10 per cent of the cost on building, plant and
machinery has been provided towards contingencies so as to meet any unforeseen
escalation in cost at the time of implementation of the project.
Sources of Finance: The major sources of investment finance proposed
are debt and equity. The sources of equity are: share capital contribution from
a) Government of Tamilnadu; b) Tamilnadu Government under Central
Government rehabilitation scheme for provision of employment to 225 Sri
Lankan repatriates in the mill (at the rate of Rs. 15,000 per worker);
c) Government of Tamilnadu under special component plan for provision of
employment to 225 Adi-dravidas at the rate of Rs, 15,000 per worker;
d) National Cooperative Development Corporation (NCDC) and; e) the members.
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The total share capital estimated to be contributed by the various sources was
Rs.353 lakhs (50 per cent of the project cost). The remaining 50 per cent of the
project cost (Rs. 353 lakhs) was to be secured from Term Lending Financial
Institutions as long term loans. The debt equity ratio proposed was thus 1:1.
Of the total equity, the share of government of TamilNadu and NCDC would be
22.5 per cent each as promoters' contribution. The remaining 5 per cent was to be
collected as equity from the members.
Financial Projections: Financial projections help to know the production
and sales, profitability, assets and liabilities position. Financial projections are
guided by some assumptions developed by convention. Assumptions are made on
capacity utilisation, production of yam in quantity and value, cost of production,
sales in quantity and value, gross profit and net profit.
Cost of production and income statements are prepared in a condensed
form of manufacturing, trading and profit and loss account for ten years. Through
this statement, we could understand the projected cost of production, sale
realisation, depreciation, interest, gross profit and net profit. Projected balance
sheet has also been prepared for ten years. The purpose of preparing balance
sheet and other financial statements for ten years is to understand the mill's
sustainability in its operations, over the period. The loans borrowed by the mill
from Term Lending Financial Institution was a long-term loan and the repayment
period had been spread over eleven years with a moratorium of first two years.
Economic Analysis: It deals with the employment generation of the project,
monetary benefits to Government exchequer in the form of taxes, duties and levies
and the social benefits. Provision of employment to the economically deprived
sections of the community is one of the objectives for establishing the mill.
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It was estimated to give employment to 450 persons (225 Sri Lankan repatriates
and 225 Adi-dravidas). Capital formation in the region helps to attain civic status,
and facilities come in gradually. Quality products and services ensuring reasonable
price for inputs and outputs are the signs of the social benefits.
Project formulation is a time consuming process. It involves careful
forecast and tedious calculations and coherent presentation of projection. Hence
the task of preparation of the project proposal was done by the professional
Chartered Accountants. Project reports of similar investment decision are also
referred to in the process. The technical guidance was sought from SITRA and
SIMA.
Project Appraisal
The project report is submitted to the technical cell of DHT for appraisal.
The office of the DHT has overwhelming power on matters related to the
sanctioning of capital budgets submitted by the mills. The DHT may modify,
revise and retransmit the proposals to the mill, if it is not satisfied with the
proposals. If the "technical cell" of DHT is satisfied with all the essential aspects
of the project, it would recommend the proposal to the funding agencies.
Appraisal Technique: Payback method was adopted for appraising the capital
expenditure proposal. The reason for adoption of the technique is that it is easy to
calculate and facilitates in ascertaining the period of repayment. It is mostly a
ender-driven method, as the financing bank insists upon the borrower's capability
of repayment. The method of calculating the payback period in the selected mill
may be stated. The cash flow from the project is estimated. The total term loan to
be borrowed from the term lending financial institution is estimated. The term loan
is divided by the annual average cash flow to arrive at the pay back period.
Table A 1.11)
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The payback period is calculated only for the term loan of Rs.353 lakhs, out
of Rs.706 Lakhs. The balance amount was not covered under the payback period,
as it is mobilised in the form of equity and subsidy.
Financial Assistance
Term lending financial institutions (TLFI), before sanctioning loans
appraise projects in all respects. They visit the field and understand the ground
reality. The total term loan required for the project was shared by three term
lending financial institutions. The total loan amount borrowed was Rs. 357 lakhs.
Of which, the share of IDBI was 50 per cent, ICICI was 25 per cent, aid IFCI was
25 per cent (Table A 1.5).
Project Implementation and Monitoring 1
Timely implementation of the project helps in early commissioning of the
project. The land for spinning mill was acquired from different individual
farmers. Public Works Department undertook construction of civil work on •'!•
contract basis. Plant and machinery was purchased through the TamilNadu ]
Textile Corporation (TNTC), the nodal agency for purchase of machinery. TNTC
maintains a list of suppliers of machinery and also the erectors. It decides the
machinery to be purchased and calls for quotations from the suppliers.
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Commissioning of the Project
The project was commissioned partially on June 1984 with 7000 spindles.
The mill was formally inaugurated by the then Chief Minister of Tamilnadu, on
18th July 1984. The spinning mill, with a full capacity of 24,960 spindles started
functioning only from April 1985.
Evaluation of Capital Budgeting
Having discussed the capital budgeting practices in the selected mill we
make an attempt to evaluate the capital budgeting decisions by comparing the
actuals against the projected budget. The key variables considered for evaluation
are; i) project cost, ii) sources of project finance, iii) time schedule for
implementation, iv) capacity utilisation, v) production, vi) sales and vii) profit.
It must be noted here that the mill has not undertaken post-audit of investment
decision, nor has it undertaken an annual evaluation of the investment decision.
Cost of the project: A comparision between estimated and actual cost of the
project indicates that the actual has increased by Rs. 18.85 lakhs (2.67 per cent).
The increase was found to be high in the case of land with 200 per cent variation
followed by pre-operative expenses (118 per cent) and buildings (37 per cent).
The cost of plant and machinery declined by Rs.27.15 lakhs (44.51 per cent). The
reason for escalation of cost of land was that it is located at the national highways.
With regard to cost of plant and machinery, no quotation from the industrial
supplier was enclosed. An approximate and average price was calculated at the
time of proposal preparation. But while implementing the project, the cost of plant
and machinery declined by 44.51 per cent whereas the pre-operative expenses
increased by 118 per cent. Cost of factoiy and non-factory buildings has also
increased by 37 per cent as the cost of cement, rod, bricks and other items has
1X3
Means of finance: The debt equity ratio proposed is 1:1. The actual debt equity
ratio is very near to the proposed one. However, there has been some minor
variations in the proportion of some components of equity capital which is due to
subsidy extended by SIPCOT which was not proposed at the time of preparation of
project proposal. A slight variation in the debt capital could be noticed
(Rs.4 lakhs). Actual debt raised was a bit more than the debt proposed. Share
capital as proposed has been raised. There has been no variation.
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Time Schedule for Project Implementation
The time schedule for implementation has been compared with the actual
time taken to complete the project. The work was not commenced and completed
as per the time schedule proposed for commencement and completion. The reason
was delay in clearing the project proposal by the government department and TLF1
(Table A 1.9).
The technical cell at the DHT makes an appraisal of the project proposal.
Then, it is forwarded to TLF.I for financial assistance. They, intum study and
appraise the proposals submitted. All these cause delay in appraising and
approving the proposals. This has resulted in delay in undertaking subsequent
activities. For instance, there was one and half years delay in acquisition and
development of lands. Similarly there was delay in construction and completion
of civil works by one year. Delivery and erection of plant and machinery was also
delayed by one year and two months. The actual commercial production
commenced on 6'1' June 1984 with 7000 spindles. The mill •with full licensed
capacity of 24,960 spindles started functioning only from April 1985.
Had the mill been given financial assistance on time, the delay in
commissioning of the projec t could have been avoided.
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Capacity Utilisation
Capacity utilisation determines the efficiency of the organisation. The
estimated capacity utilisation has been gradually enhanced from 85 per cent in the
first year- of the commencement of business to 95 per cent from the sixth year
onwards. 95 per cent utilisation of spindle capacity is the standard prescribed by
the SITRA. But then, the actual performance of capacity utilisation fell short of
the estimated capacity utilisation except the year 1987-88. There has been
negative variance between estimated and actual capacity utilisation.
There are several causes for the idleness of spindles or low capacity
utilisation. Some causes like power shortage, labour strike, cleaning and
maintenance as reported by the mill are uncontrollable. Whereas causes such as
want of back stuff, change of counts, absenteeism of workers are controllable.
Workers' absenteeism is the major reason for under utilisation of the capacity.
Repayment of Debt
The debt capital borrowed from the TLFI has to be repaid along with
interest. A repayment schedule was prepared for proposed debt. The rate of
interest is calculated at 14 per cent. The repayment period of the loan is eleven
years with a moratorium of first two years. The mill has been regular in
repayment of the debts. Further, the proposed schedule of repayment indicates
that the loan amount has to be repaid on equated monthly instalments.
But, in reality the instalment amount of repayment varies on the basis of
availability of funds. The term loan was sanctioned and released to the spinning
mills during 1983 and 1984. The mill started repaying interest from 1985
onwards.
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Net Profit
Net profit is the sign of sound financial health of the cooperative spinning
mills. Net profit facilitates the mill to distribute dividend on sharecapital to the
members on their business participation. It also helps the mill to provide for
cooperative education and development fund, reserve fund and other reserves.
The mill was expected to earn net profit in all the years excepting the first year,
being the initial period of the project. The actual performance showed a different
picture. The mill incurred loss in all the years excepting the 6th and 7th year of the
project. The prime reasons for the loss were: i) high cost of raw materials,
ii) high conversion cost, iii) lower capacity utilisation; iv) centralised price
fixation policy; v) absence of autonomy; vi) failure to modernise the machinery
and vii) lack of professional management. The loss was heavier especially in the
last two years of the project, due to escalation of cost of production.
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Conclusion
The Anna Cooperative Spinning mill has been selected to study the capital
budgeting practice with reference to 'establishment' decision. The origination of
the idea of establishment of the mill is based on several factors. But the prime
factor is political in nature. The project was formulated by the professional
chartered accountants after a detailed technical, market, financial and economic
analysis. A detailed analysis of the project cost and sources of finance have also
been undertaken. Pay Back period was the method used to a appraise the worth of
the project. A comparison between the projected and actual performance of the
implementation of the capital budgeting proposals indicates that the mill could not
execute many of its activities as planned.
Case A 2
The Mlsereor Cooperative Spinning Mill, Thirunagar
Introduction
The mill was registered on 8th August 1968 and commenced its commercial
production on 24lh August 1977. It started functioning with a meagre number of
896 spindles of second hand machinery for manufacturing of 10s yam from the
waste cotton procured from cooperative spinning mills. The membership of the
mill consists of individuals, the State Government, Weavers' Cooperative
Societies and other cooperative institutions. Having started working with a share
capital of Rs. 3.63 lakhs in 1977 the mill has been able to raise it to the tune of
Rs. 114.94 lakhs in 1997-98. A major chunk of share capital has, however, been
contributed by the Government (95.3 per cent) followed by other cooperative
institutions (4.10 per cent). Though the stakehold of individual weavers is high in
terms of membership (72 per cent), their contribution to the share capital of the
mill was very low (not even one per cent).
The raw materials are procured from cotton suppliers and through
TANSPIN. TANSPIN has been the major supplier of raw materials. But it could
not continue the supply of raw material, as the mills did not settle the accounts
promptly. The cotton samples are sent to laboratory of Thiayagaraja mill, a
nearby private mill, for testing the features jf cotton. Based on the results, the
cotton required for producing the 10s and 20s yam is purchased. Under the
decentralised pattern of cotton procurement, the daily market price of cotton at
important market centres is considered for fixing the price of cotton. The yam
produced is supplied to the COOPTEX at the rate fixed by DHT. The rate fixed by
the DHT is uniform and therefore, it affects the profitability of the spinning mills.
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The reason is the cost of production is many times higher than the sales price fixed
:y the DHT.
It is the only mill in the cooperative spinning sector in Tamil Nadu, which
meets the raw material demands of 10s yarn required by weavers' cooperative
societies. But then, the quality of yarn produced by the mill has not been up to the
mark. Steps have neither been taken to enhance the workmanship by giving
workers training nor to modernise the factory which is operating with "age old
machines". The mill has been continuously incurring heavy losses year after year.
Steps were taken to run the mill on successful line. One such effort was the
'expansion programme' for increasing the spindleage capacity of the mills.
Expansion Programmes
Expansion of the capacity is a capital expenditure programme designed to
expand the existing capacity. Such investments include proposals for adding more
machines of the type already in use, or the opening of another unit. 'Expansion
programme' is a kind of CBD which affects the revenue earning capacity of the
mill. This programme involves huge capital investment in plant and machinery
and building which would facilitate a major impact on the level as well as quality
of production. 'Expansion decision' is considered as a strategic decision. In the
words of Prasanna Chandra 'expansion programme' offers several advantages,
namely, familiarity with technology, production methods, and market condition,
reduction in unit overhead costs because of larger volume of production.
However, he cautioned that the advantages of expansion should be weighed
against the possibility of market saturation and risk of excessive dependence on
the existing product range. The mill, after considering the advantages of the
expansion programmes and the need for higher production levels, had expanded
the spindleage capacity three times at different periods since its inception.
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Justification for the Expansion programmes
Working with a meager number of 896 spindles has been a constraint for
the mill in earning profit. The size of the mill was uneconomic. The cost was high;
the revenue was less. As a result the mill incurred heavy loss. Hence the mill
decided to expand the capacity mainly to realise the advantages of largescale
operations. The intention was to make the mill economically viable. The scope for
reduction of unit cost is also wider, as the large scale production facilitates the
maximum utilisation of fixed assets.
Expansion programme: I
The mill commenced its production activities in 1977 with 896 spindles
which are second hand machinery. Due to heavy maintenance cost, the mill had
negative working results from the very inception. In order to improve its sales and
profit, the mill wanted to expand its capacity for which permission was granted by
the DHT. No separate project proposal was prepared. It was planned to buy four
frames each with 440 of spindles, from the excess machinery maintained by the
Salem Cooperative Spinning Mill. The amount required for the purchase of these
four frames was estimated to be around Rs. 10 lakhs. The amount was planned to
be borrowed from the Madurai District Central Cooperative Bank, Madurai and
Tamil Nadu Cooperative Union, Madras - Rs.5 lakhs, from each. However the
actual cost was Rs. 13 lakhs. Hence an excess amount of Rs.3 lakhs needed. It was
also borrowed from Tamil Nadu Cooperative Union. Both the financing
institutions provided financial assistance to mill on hypothecation of the existing
building and machinery. The 'expansion programme5 was planned to be carried
out during the period between August 1985 to December 1985. But it was
completed only in 1986. The 'expansion' did not require any additional
construction of new building, as the mill already had necessaiy building facilities
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to accommodate the four frames. No detailed proposal was required to be
prepared as both the financing institutions are cooperative organisation. They have
given their concurrence for sanctioning the required funds on the
recommendations of the DMT.
The financial assistance provided to the mill was on the following terms
and conditions; the amount must be repayable in ten half-yearly instalments of
Rs. 50,000 each, within a period of 5 years commencing from the date of receipt.
The entire amount had to be settled by the year 1992. The rate of interest charged
by DCCB was 11.5 per cent per annum. Of the term loan of Rs. 8 lakhs borrowed
from the State Cooperative Union, the mill repaid Rs. 3 lakhs and the balance
amount of Rs. 5 lakhs remains to be settled.
After 'expansion' of the spindle capacity, the mill started producing 20s in
addition to 10s yarn. The four frames installed as part of the 'expansion
programme' was used for producing 20s yam.
Expansion Programme: II
The second 'expansion programme' for increasing the spindleage capacity
from 2656 to 6000 spindles was proposed in 1986. The 'expansion programme'
consisted of the purchase of new machinery, additional factory building for
housing new machinery and construction of a godown for cotton storage. The
increase of spindleage capacity was expected to help spinning of doubled varieties
(2/20s and 2/17s) along with spinning of 10s and 20s of yarn. This second
'expansion' was mainly taken up with a view to meet the yam demands of
Weavers' Cooperative Societies at a reasonable price. The 'expansion programme'
would ensure additional employment opportunities to the eligible work force in
and around the mill.
1 %
The estimated cost of the project was Rs. 179.50 lakhs, whereas the actual
cost was Rs. 192.87 lakhs - 13 per cent increase over the projected cost. The mill
was depending heavily on the State Government for financial assistance for
carrying out the project. The shortage of funds was made up mainly by diverting
the working capital funds. The time schedule for completing the project was eight
months. However, the project was delayed by almost one year, as there was a
delay in getting the projects approved, and in getting the supply of machinery and
electricity. Of the total term loan of Rs. 52 lakhs, the mill repaid only one
instalment of Rs.0.21 lakhs. No instalment amount was repaid thereafter due to
erosion of working capital, financial crunch, poor marketing of yam on account of
inferior quality.
Expansion Programme: III
The third 'expansion programme' was planned to be taken up in the year
1988 - 89. This time the mill planned for 'expansion' with an additional
spindleage capacity of 6000 spindles. This proposal was considered to be the
major 'expansion programme'. The proposal was planned to enable the mill to
double the existing capacity. We have taken up the third 'expansion programme'
for our analysis because of three reasons: i) it is the major 'expansion programme'
the mill has ever taken up; ii) it is of recent one; and iii) data pertaining to the
project were also available for a detailed analysis.
Project Formulation
The idea of 'expansion investment programme' emerges from the top level
management of the mill which consists of the administrator and die factory
manager. The opinion of the middle level management and the lower level in this
regard, is not sought. The idea of 'expansion' of the spindleage capacity was
approved by the DHT. The mill then prepared the project report.
h>7
The responsibility of preparation of the project report was entrusted to the
accountant. He was assisted by his clerks and SQC. The process of project
formulation involves four major activities. They are described below.
Technical Analysis: The technical analysis considers spindle allotment,' capacity
utilisation, product mix, purchase of machinery, infrastructural facilities required
for the successful implementation of the project. The capacity utilisation of the
mill for the purpose of project formulation was fixed at 90 per cent, throughout the
life of the project. Based on the capacity utilisation the estimated production was
arrived at in consonance with SITRA norms. The spindle allotment and the
production mix proposed are given in table A2.1
The mill aimed at a production of 12.58 lakh kgs of different counts, which
when converted to 40s would amount to Rs. 10.89 lakh kgs of yarn. It is the
normal practice in the case of spinning mills to measure the production of
different counts of yam in terms of counts converted to 40s. The null had also
assumed that the different counts of yarn produced would be sold as and when the
production is over. The mill was initially concentrating only on the production of
two counts of yam viz., 10s and 20s though the mill had proposed the production
of 40s yam.
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Market Analysis : Major component in the market analysis is the estimation of
the sale of different counts of yarn. The estimation of sale of yam is normally
based on the proposed product mix. The major factor invariably considered by the
spinning mills under cooperative fold in the market analysis is that the 'partly
protected market' for their products. Since the mill has an assured market for the
yarn, the mills do not undertake elaborate market analysis. Major proportion of
yarn produced is sold to Weavers1 Cooperative Societies through (X)OPTEX on
the rate fixed by the Dl IT.
The estimated sales mix reveal that around three-fourth of the total sales
would be through the sale of 40s yam as there is a better demand for 40s yarn.
Financial Analysis: It is the core of the project formulation process. It covers the
various aspects such as estimation of the overall cost of the project, proposed
means of finance, expected production and sales, cash flow statements and profit.
Each of the aspect is described below.
Financial Projections : The mill has worked out projected profitability and
cash flow statement for ten years of the project period. It has described the
various financial aspects such as cost of production, sales, gross profit,
depreciation, repayment of term loans and available cash balance. All these
financial projections were based on certain assumptions. They are: i) the mill
would work with 12,000 spindles after expansion programme; ii) the mill would
aim at achieving 90 per cent capacity utilisation; iii) the mill would work for 350
days in a year; iv) estimation of production is determined based on S1TRA norms;
v) cost of cotton would be estimated based on the average of previous year's
(1988) cost maintained by the cotton purchase committee of TNTC; vi) sales price
would be fixed for yam based on previous year (1988) average price maintained
by the DHT. The mill did not; prepare the projected financial statements like the
hading account, profit and loss account and the balance sheet.
Loan Repayment : Of the total financial assistance provided by different
institutions for the 'expansion programme', the loan component accounts for
Rs. 51.25 lakhs provided by the Department of Adi-Dravidas and Tribal welfare
(Tamil Nadu Government). A sum of Rs. 75 lakhs was obtained as subsidy from
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the State Government which need not be repaid. Share capital to the tune of
Rs. 27.75 lakhs was also sanctioned by the Government, the repayment of which
normally does not arise in the recent future. Therefore the mill, while preparing
the repayment schedule had taken into consideration the loan component and the
interest thereof. The rate of interest chargeable by the institution on these loans
was 4 per cent per annum. The repayment schedule excludes repayment of
principal amount. The mill has been expected to pay an interest of Rs. 2.05 lakhs
every year. The repayment schedule as prepared by the mill is presented in
table A2.5.
The mill has been continuously incurring loss. It is categorised as a loss-
making organisation. The mill has incurred an accumulated net loss of Rs. 104.04
lakhs. The reasons for the perennial loss are: i) lower capacity utilisation;
ii) production of inferior quality of yarn; iii) erosion of working capital; iv) poor
workmanship; v) production cost is higher than tire yam price; vi) mounting of
overdues of principal as well as interest; vii) using age-old machinery and
equipments; and viii) low demand for yarn.
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Economic Analysis : The benefits to be extended to the society and to the
government were considered under economic analysis. The government exchequer
would benefit by sales tax and the excise duty derived from the project. 175
economically downtrodden people would be ensured of employment opportunity
from the project. This is the main aspect which helped in availing financial
assistance from the Department of Adi-Dravidas and Tribal welfare Board, Tamil
Nadu. Weavers' cooperatives were also ensured of getting yarn requirements
fulfilled by the 'expansion programme'.
Project Appraisal
After preparation, the project report is sent to DHT which makes a thorough
study. The DHT, is the controlling authority as far as the cooperative spinning
mills are concerned in Tamil Nadu. The major portion of financial requirements of
the 'expansion programme' was expected to be received from the State
Government in the form of subsidy and share capital loan. The null did not work
out the repayment schedule for the principal amount. Therefore, the question of
number of years to be taken to repay the amount did not arise. No appraisal
technique was adopted. The schedule of repayment indicates only the payment of
interest.
Project Implementation and Monitoring
As per the project proposal, the 'expansion programme' was scheduled to
be completed within one year period. The programme consists of purchase of
machinery and erection of the purchased machinery. The mill had enough space
and building facilities to house the proposed additional 6000 spindles. Therefore,
the question of construction of factory and office building, for the 'expansion
programme' did not arise. The mill has not prepared a comprehensive time
schedule for implementing the project.
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Commissioning of the Project
The project was commissioned in the year 1990 with a time lag of one year.
The time overrun was mainly due to delay in getting the financial assistance from
the TLFls and the State Government.
Evaluation of Capital Budgeting Proposal
We make an attempt here to evaluate the capital budgeting decision by
comparing the actuals against the projected figures. The key aspects considered
for evaluation are: i) project cost; ii) means and sources of finance; iii) rime
schedule for implementation; iv) loan repayment and v) anticipated net profit.
Cost of the Project - A Comparison : The1 actual cost incurred on the project is
compared with the proposed project cost. The proposed project cost was
Rs. 150 lakhs. But, the actual cost was lis. 179 lakhs. There was an increase of
Rs. 29 lakhs (19.33 per cent). The cost of every project item had increased. There
was an escalation of lis. 15.73 lakhs (12.48 per cent) on the plant and machinery
alone. The cost of stores and spares increased by Rs. 4.34 lakhs (86.80 per cent).
The reasons for increase in the cost of the project were: i) delay in getting the
proposal approval by the DHT and the State Government; ii) delay in getting
financial assistance; iii) delay in implementing the project; iv) increase in the
purchase price of the plant and machinery, spare parts and others (Table A2.6).
Sources of Finance - A Comparison : The means of finance proposed for the
project funding was the Government of Tamil Nadu. Accordingly, subsidy and
margin money loan assistance was availed to the extent of Rs. 112.50 lakhs from
the Government of Tamil Nadu. On behalf of the Government of Tamil Nadu,
Adi-Dravidas and Tribal welfare department has sanctioned the mill a sum of Rs.
112.50 (75 per cent of the total project cost). The mill approached the TIIC, for
the remaining 25 per cent (Rs.37.50 lakhs). TIIC refused to sanction financial
assistance to the mill, as the term loan borrowed from TIIC for the previous
'expansion programmes' remained unsettled (Table A2.7).
Time Schedule for Implementation - An Evaluation : The actual time taken for
completion of the project was compared with that of the proposed schedule. A
period of one year was proposed for completion of the project. But the actual
implementation of the project took two years for its completion. Therefore, the
actual commissioning of the project took place in the year of 1990 - 91 with a time
lag of two years. And again, instead of installing 12,000 spindles, only 9480
spindles were installed. The remaining 2520 spindles were never installed due to
paucity of funds.
207
Loan Repayment - A Comparison : The mill suffers from mounting dues. The
term loan borrowed from T1IC, TNCU, TNTC for the second 'expansion' remained
unsettled. In the mean-time, the loan borrowed for the third 'expansion
programme' has made the burden heavier. The mill found it veiy difficult to repay
the principal and pay the interest
The schedule of term loan outstanding and interest payable every year for
the 'expansion programme' was prepared by the mill. It shows that the interest
alone was expected to be paid every year. The principal amount stands
outstanding against the mill. The actual payment of interest was also very poor.
(Table A2.8).
208
Net Profit : The mill has been incurring heavy loss since its inceptions. It has
earned profit in none of the years in its life. However, the mill had positively
projected net profit during the project period. But the real picture remains
otherwise. The mill incurred heavy loss (Table A2.9). The reasons attributed for
loss are: lower capacity utilisation, out moded and out-dated machinery, inferior
quality of yarn, poor marketing and high cost of production.
Conclusion
The analysis of 'expansion' investment decision with reference to the
selected mill has indicated that the decision has not been scientifically taken. The
subsequent implementation has also not been followed with the required
seriousness. As a result the mill could not derive the advantages of the economy
of the scale of operations.
Case A 3
The Salem Cooperative Spinning IV!ill, Salem.
Introduction
The Salem Cooperative Spinning Mill was registered on 8tl1 June 1961 and
commenced its commercial production on 1st June 1964. The mill commenced its
functioning with 12320 spindles in 1964 and raised its spindleage capacity to
49960 in 1985. The mill is a 'weavers type' spinning mill. The total membership of
the mill in 1964 was 621, of which individual weavers and weavers cooperatives
constituted 605 (97 per cent). The mill over a period 37 years of its existence, has
earned profit for 15 years. The mill has frequently earned profit upto 1992.
Thereafter it has been continuously incurring loss. The mill was awarded for its
best performance by AIFCOSPIN in 1985. The mill retained the award for three
years upto 1988.
Like other Cooperative Spinning Mills, it also procures cotton from
TANSP1N, upcountry cotton markets namely Gujarat, Maharastra, and from the
local cotton markets in Tamil Nadu. The mill has been manufacturing 30s to 120s
of both cone and hank yarn. The mill, supplies yam to weavers cooperative
societies and also to the individual weavers in the open market. The management
of the mill, like other cooperative spinning mills, is vested with the
'Administrator'.
Significance of Modernisation in Cooperative Spinning Mills
The Cooperative Spinning Mill is a large sized industrial undertaking.
Production and sales activities are performed on a large scale basis. Large scale
operations lead to economy in its operations. Effective service at a reduced cost is
210
the maxim of the cooperative spinning mill. Cost minimisation in all possible
aspects is one strategy which would help the mill to prevent loss. Profitability of
spinning mills to a large extent is determined by its ability to reduce the
cost of production. This could be attained through modernisation of plant and
machinery combined with higher labour and machine productivity. Working with
age old machinery would not help achieving the above goals, perhaps it would
only give negative results. The root cause for poor working, low profit and
sickness of mill is the neglect of modernisation of plant and machinery for many
years.
Modernisation means an improved version of machinery installed in the
place of old machinery with the object of producing quality yam, with a view to
reducing the cost and increasing the machine productivity. Modernisation is not
something done today and forgotten for the next ten years. It must be a continuous
activity to maintain the productive system in a state of efficiency. It must be well
planned in order to improve the technical as well as organisational efficiency of a
mill . Modernisation is to be undertaken with three specific objectives, viz,
a) reduction in cost, b) improvement in quality, and e) diversification of existing
production partem. Before going for modernisation the management must define
which of these three objectives or combination is important from their point of
view. Such a clear definition of objectives is necessary both in the selection of
equipment and in the allocation of priorities for investment. Priority should be
given to those areas where profitability and quality improvements are immediate.
For example, conversion of an old ring frame by a modem one will not only lead
to immediate saving in labour cost, but also improving the quality of yam.
211
Capital Budgeting Practices in the Sample Mill
The mill commenced its production activity in 1964. The plant and
maehinery installed in the mill have served beyond their life. To enhance the level
of productivity and reduce the cost of production, modernisation programmes
were carried out. Two modernisation programmes were undertaken, since its
inception. One was completed in 1979-80. The project cost proposed was
Rs.132.02 lakhs. The mill was able to complete the modernisation programme
with a capital outlay of Rs. 123.04 lakhs which is seven percent lesser than the
original project cost. The mill repaid the debt borrowed from 1DBI, within the
stipulated repayment period. A detailed analysis could not be made on the
modernisation programme , as die project proposal of modernisation programme
was not made available for reference.
The second modernisation programme was taken up in the year 1988-89
and completed in 1990-91. It was the latest modernisation programme involving
an estimated outlay of Rs 224 Lakhs earned out by the mill. The programme has
been taken up for analysis because of the two reasons: i) it is of recent one
inolving huge capital outlay; and ii) data pertaining to the modernisation
prgramme was available in the mill.
Project Formulation
The idea of modernisation has emanated from the top administrative
authority of the mill. Top authority consists of administrator, general manager and
factory managers. The mill, after having got permission from the DHT, got into
the task of formulating the project. The project report was prepared by the chief
accountant assisted by clerk and statistical quality controller. The project
formulation covers the analysis of four major areas namely technical analysis,
market analysis, financial analysis and economic analysis. A brief description of
the four areas is given below.
Technical Analysis : It is concerned with the various aspects of availability of
infrastructure facilities, purchase of machinery, installation of machinery and
product mix. The mill faced no problem in getting infrastructure facilities, as it
possessed such facilities. Modernisation of machinery did not require any land and
additional building. Power and water supply and road facilities are already
available.
The mill for the purchase of machinery is guided by TNTC which serves as
a nodal and technical consultant for purchase of machinery. Decision on the
product mix is the crux of technical analysis based on which spindles are allotted
to different types of counts. The mill has been producing a range of counts from
20s to 80s both combed and carded yarn. Based on the yam requirements of the
COOPTEX on behalf of the weavers societies, spindles are allotted for production
of each count of yarn (Table A3.1). It is found that almost fifty per cent of spindles
were allotted for production of 40s and 60s.
Market Analysis: The sales volume of yam is estimated based on the various
counts of yarn manufactured, quantity of each count of yam manufactured, and the
scope for selling and demand for yarn in the market. The mill has good demand
for its yam. Salem, being a weaving town, the scope for marketing of yarn is
wider. "Primary Weavers Cooperative Societies" are the main customers to whom
the yam is sold through the COOPTEX at the rate fixed by the DHT. The excess
yam is proposed to be sold in the open market at a rate not less than the price fixed
by the DHT. Marketing of yam has never been a problem to the mill. The mill
estimated that the sale would be to the tune of Rs. 2043. 24 lakhs per annum over
the life of project. The share of 40s and 60s corded yam was estimated to be 45
per cent in the total sales (Table A3.1).
216
Financial projections : The mill has worked out the cost of production,
working results and cash flow statements for ten years. These statements describe
the expenditure to be inclined and returns to be earned for ten years after
commissioning of the project. The projections for ten years were based on certain
assumptions which are as follows: i) the repayment of loan amount would start
after one year from the date of receipt of the financial assistance; ii) loan would be
repaid over a period of five years in ten half yearly installments; iii) rate of interest
would be 21 per cent; iv) selling price and cost of cotton were to be forecasted
based on previous year average for the respective counts; v) 5 per cent increase on
sales and wages has to be considered eveiy year; vi) depreciation has to be
calculated under WDV method. Based on these assumptions the main aspects of
project report were analysed .
Economic Analysis: The economic analysis of modernisation project aims at
assessment of the contribution to be made by the mill to the government
exchequer, goods and services to be rendered by the mill to its members and the
capital formation. Modernisation had no effect on employment generation. The
contribution to government exchequer in the form of taxes has been worked out
and found to be ranging from Rs. 3.19 lakhs to Rs.68.56 lakhs during the project
period. Quality goods and services would be provided to the primary weavers
cooperative societies at a price which is reasonable.
Project Appraisal
Every project report of the cooperative spinning mill after its preparation, is
sent to the DHT for its appraisal and concurrence. The technical cell of DHT
carefully goes through the report. The project report at this stage could be revised,
modified and even retransmitted to the mill concerned, if necessary, as the DHT is
the controlling authority of the cooperative spinning mills.
217
After appraisal, the project: report on the modernisation programme submitted by
the mill was recommended to LDBI for necessary financial assistance.
Financial Assistance
The mill as per the original estimate has to get a term loan of Rs. 157 lakhs
from IDBI. At this stage, there was a proposal to modernise 13 Cooperative
Spinning Mills in Tamil Nadu of which Salem is one. The Government of Tamil
Nadu provided equity capital to all the 13 mills. The Salem Cooperative Spinning
Mills got an amount of Rs.94.46 lakhs of equity capital. The other sources of
funds are given in table A3.4.
Project Implementation
A time schedule for completing and commissioning the project was
prepared and enclosed along with the proposal. The time schedule describes the
sequence of works to be performed in order. The programme was scheduled to be
completed within a period of one year. This programme did not require
construction of any new building. It required only purchase of new machinery and
their installation. The schedule of implementation is given below.
Commissioning of the Project
The modernisation investment programme was commissioned in 1991 with ;
a timelag of one year. The time overrun was mainly caused by the state
government's intervention which resulted in the delayed implementation of the
project. '!
Evaluation of Capital Budgeting Decision
Having analysed the practice of capital budgeting system at the different
phases, we now make an attempt to evaluate the capital budget of the mill with
reference to i) project cost, ii) sources of finance, iii) time schedule for
implementation, iv) repayment of term loan, and v) the net profit.
Project Cost - Comparison : The project cost proposed for implementing the
modernisation programme was Rs.224.85 lakhs. But the actual cost of the
programme was Rs. 238.00 lakhs. There was an increase of Rs. 13.15 lakhs -an
increase of 6 per cent over the proposed project cost. The reason for cost overrun
was that the machinery cost, installation charges and transit charges had registered
a marginal increase at the time of implementation of the project.
Sources of Finance - Comparison: The source of finance proposed for
investment programme consists of debt as well as equity. Industrial Development
Bank of India was approached for a debt to the tune of Rs.157 lakhs. The
remaining financial requirement of Rs.67.85 lakhs was to be mobilised internally.
The internal sources of finance were in the form of equity as well as provisions
from working capital. The actual means of finance for investment programme was
Rs. 238.58 lakhs. The total equity accounted for Rs. 110.38 lakhs. Of which, the
state government has contributed a sum of Rs. 94.46 lakhs and the rest was
mobilised from the member societies.
Project Implementation - Evaluation: The modenisation programme was
scheduled to be commenced in 1989 and to be completed in 1990. Due to the
intervention of state Government, die actual implementation of the project
commenced in the year 1990 and it was completed in 1991. There was a delay of
one year in completing the modernisation programme.
Repayment of Term Loans - Comparison: A sum of Rs.41.80 lakh was
sanctioned by IDB1 for the modernisation programme. The amount was received
by the mill in the year 1990-91. The term loan was settled completely but not as
per schedule. The rate of interest was calculated at 21 per cent. The term loan
given by the Tamil Nadu Government has been converted into equity capital.
The actual borrowings made from the IDBI was Rs. 41.80 lakh in 1990-91.
The entire term loan was repaid in three installments, starting from 1995-96 to
1997-98. A comparison of actual repayment of term loan with the proposed one
makes a lot of difference. The gap in repayment of term loan is very wider as the
actual means of finance acquired was lesser than tire proposed means of finance.
Net Profit: Table A3.9 exhibits the projected and actual net profit of the mill. The
mill has projected net profit in all the years of the project period. But the actual
picture is different. The mill has earned profit only in two years which is also
very low when compared to projected net profit. The reasons for loss are: i) cost of
production is very high, ii) sales price is low, iii) centralised administration,
iv) failure to undertake modernisation at periodical interval.
Conclusion
The investment decision on 'modernisation' with reference to the mill has
not yielded the desired results. An analysis of the projected results against the
Actual outcome clearly indicates diat the organization has not properly and
Scientifically taken the decision of modernisation. This is clear from the fact that
the project delayed by one year. The returns from the modernisation programme
^tre also not upto the expectations.