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.

I S3

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.

203

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.