A hotel table-linen order: costing, working capital and which order to run first
A student who has completed the NSQF course runs a four-machine unit in a rented room in Hisar. Her monthly fixed costs are rent Rs 6,000, electricity Rs 2,500, her own salary Rs 8,000 and machine depreciation Rs 1,500. A hotel in Chandigarh orders 300 table-runner sets - one 150 cm runner plus six napkins - at Rs 380 per set, delivery within 30 days and payment 45 days after delivery. Each set uses 1.4 m of 150 cm poly-cotton at Rs 85 per metre plus Rs 12 of thread, zip and trim, and 40 minutes of machine time; she pays wages at Rs 45 per hour. Her normal rejection rate is 3%. She runs four machines for 8 hours a day, 25 days a month, at about 85% efficiency, and she has Rs 15,000 in the bank. A gift shop has separately offered 200 cushion covers at Rs 110 each, each needing Rs 58 of material and 12 minutes of stitching.
1. Calculate the variable cost per set, the contribution, the profit on the hotel order, and check whether she can deliver within 30 days.
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Material per set: 1.4 m x Rs 85 = Rs 119.00; plus thread, zip and trim Rs 12.00 = Rs 131.00. Labour per set: 40/60 hour x Rs 45 = Rs 30.00. Variable cost of a good set: Rs 131 + Rs 30 = Rs 161.00 before rejection.
Rejection: a 3% rejection rate means she must make more than 300 to deliver 300 good sets. 300 / 0.97 = 309.3, so about 310 sets must be cut and stitched. Spread over the order, variable cost per good set = Rs 161 x 310/300 = Rs 166.40 (equivalently 161/0.97).
Contribution: Rs 380 - Rs 166.40 = Rs 213.60 per set; for the order, 300 x 213.60 = Rs 64,080. Profit: contribution minus one month of fixed costs, Rs 64,080 - Rs 18,000 = Rs 46,080. Break-even quantity: Rs 18,000 / 213.60 = about 85 sets a month; 300 sets is far above that.
Capacity check: 310 sets x 40 minutes = 12,400 minutes = about 207 machine-hours. Available: 4 machines x 8 hours x 25 days x 0.85 = 680 machine-hours. The order needs about 30% of the month's capacity, roughly 8 working days, so the 30-day delivery is comfortable. Time is not the constraint - cash is.
2. Can she actually fund the order? Show the cash position and set out her options.
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Money going out before any money comes in:
- Material: 310 x Rs 131 = Rs 40,610.
- Wages: 310 x Rs 30 = Rs 9,300.
- Fixed costs over the period until payment (delivery at day 30, payment at day 75, so about 2.5 months): 2.5 x Rs 18,000 = Rs 45,000.
- Total outflow before receipt: roughly Rs 95,000.
Money coming in: 300 x Rs 380 = Rs 114,000, but only at about day 75.
Gap: she has Rs 15,000 in the bank and needs to carry something in the region of Rs 80,000 for two and a half months. As it stands the order is profitable on paper (Rs 46,080) and impossible to fund as written.
Options, in order of preference:
- Negotiate a 30-40% advance with the order - Rs 34,200 to Rs 45,600 - which covers material almost entirely.
- Negotiate shorter payment terms, for example 15 days after delivery instead of 45.
- Buy the fabric on 30-day credit from the supplier, matching her supplier credit to her customer credit. This is the classic fix for a growing unit and costs nothing if she pays on time.
- Reduce the risk by splitting the order into two deliveries, each invoiced and paid separately.
What she must not do is fund it from a moneylender at 3% a month. Borrowing Rs 80,000 at that rate costs Rs 2,400 a month and one late payment from the hotel wipes out the profit. Before signing, she should put the advance and payment terms in writing; a profitable order that runs out of cash still closes the unit.
3. Compare the gift-shop order with the hotel order and advise what she should do if both are available.
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Gift-shop order, per cover: material Rs 58 + labour (12/60 hour x Rs 45) Rs 9 = variable cost Rs 67. Contribution = Rs 110 - Rs 67 = Rs 43 per cover, or Rs 8,600 for 200 covers.
Per unit of scarce resource:
- Cushion covers: 12 minutes each, so 5 per machine-hour, contribution Rs 215 per machine-hour.
- Table-runner sets: 40 minutes each, so 1.5 per machine-hour, contribution Rs 213.60 x 1.5 = Rs 320 per machine-hour.
The hotel order earns about 50% more per machine-hour and is the better use of capacity. But the real constraint is not machine time - the hotel order uses only about 30% of the month's capacity, and the cushion covers would need 200 x 12 minutes = 40 machine-hours. Both fit comfortably inside 680 available machine-hours.
Advice: take both, but sequence them around cash. Run the gift-shop order first if it pays on delivery, because it generates cash quickly and funds the fabric purchase for the hotel order. Then run the hotel order against a negotiated advance. The binding constraint is working capital, not machines, so the decision rule is 'which order pays soonest', and the answer changes the moment the hotel agrees to an advance - at which point the hotel order goes first because it earns more per machine-hour. Write both quotations down with material, labour, overhead and a margin line, rather than pricing by feel.