• Submit by Syed Shah Hussain Naqvi

• HND RPL in Quantity Surveying Batch 12

Working Capital Management

Capital

capital is the keynote of economic development. In this modern age, the level of economic development is determined by the proportion of capital available.

Capital (economics), A factor of production that is not wanted for itself but for its ability to help in

producing other goods.

Definition of Working Capital

Working Capital refers to that part of the firm’s capital, which is required for financing short-term or current assets such a cash marketable securities, debtors and inventories. Funds thus, invested in

current assets keep revolving fast and are constantly converted into cash and this cash flow

out again in exchange for other current assets. Working Capital is also known as revolving or

circulating capital or short-term

KINDS OF WORKING CAPITAL

WORKING CAPITAL

BASIS OF CONCEPT

BASIS OF TIME

Gross Working Capital

Net Working Capital

Permanent / Fixed

WC

Temporary / Variable

WC

Regular WC

Reserve WC

Special WC

Seasonal WC

Components of Working CapitalThe working capital cycle is made up of four

core components:Cash & Cash equivalent.

Creditors/accounts payable.Inventory/stock in hand.

Debtors/accounts receivables.

Significance of Gross WC

• Optimum investment in CA Investment in CA must be adequate CA investment should not

be inadequate or excessive inadequate WC can disturb production and can also threaten the solvency of firm , if it fails to meet its current obligation excessive investment in CA should be avoided , since it impairs firms profitability

• Financing of CA Need for WC arises due to increasing level of business activity

& it is to provided quickly some time surplus fund may arises which should be invested in Short term securities , they should not be kept idle

Significance of Net Working Capital

• Maintaining Liquidity position For maintaining liquidity position there is a need to maintain CA sufficiently in excess of CL

• Judge Financial Soundness of a firm The Net working capital helps creditors and investors to judge financial soundness of a firm

BALANCE SHEET OF ABC COMPANY AS ON 31-3-2000

Liabilities R’s Assets R’s

Equity Shares20000

0 Goodwill 20000

8% Debentures10000

0Land and Building

150000

Reserve & Surplus 50000Plant and Machinery

100000

Sundry Creditors15000

0 Inventories  

Bills Payable 30000 Finished Goods 60000

Outstanding Expenses 20000 Work in process 40000

Bank Overdraft 50000 Prepaid Expenses 20000

Provision for Taxation 20000

Marketable Securities 60000

Proposed Dividend 30000 Sundry Debtors 90000

    Bills Receivables 20000

   Cash & Bank

Balance 90000

     

TOTAL65000

0 TOTAL65000

0

Difference between permanent & temporary working capital

Amount Variable Working Capitalof WorkingCapital

Permanent Working Capital

Time Permanent and temporary working capital for Stable firm

Variable Working CapitalAmount of WorkingCapital

Permanent Working Capital

Time Permanent and temporary working capital for Growing firm

• Operating cycle concept

• Maximization of share holder’s wealth of a firm is possible only when there are sufficient return from the operations

• Successful sales activity is necessary for earning profit sales do not convert into cash immediately

• There is invisible time lap between the sale of good and receipt of cash

• The time taken to convert raw material into cash is known as operating cycle

• Conversion of cash into raw material • Conversion of raw material into work in progress• Conversion of Work in progress into finished goods • Conversion of finished good into Sales ( Debtors and cash )

Operating Cycle in Manufacturing firm

Cash

RawMaterials

W I P

Finished Goods

Debtors SALES

Operating cycle of Non Manufacturing Firm

www.bcasqr.com

cash

Receivables

Stock of finished goods

Importance of Working Capital• It is important we work out the right level of

working capital you will need. If the working capital is too:– High - Business has surplus funds which are not earning a return; and – Low - May indicate that your business is facing financial difficulties.

• To Forecast the optimum working capital requirement the following formula may be used:– (Estimated cost of good sold x Operating cycle) + Desired cash balance.– Operating Cycle, O = R + W + F + D – C– Where, O = Duration of operating cycle.

R = Raw Material storage period.

W= Work-in-process period.

F = Finished Good Storage period.

D = Debtors collection period.

C = Creditors payment period.

Working Capital Financing• Fund Based:

– Cash Credit – Overdraft– Bills Discounting– Working Capital Demand Loan

• Non Fund Based:– Letter of Credit – Bank Guarantee

• Structured Product:– Factoring– Commercial Paper– Securitization of receivables– Buyers/Supplier credit.

Shah Tubes Ltd.• Among the 3 top manufacturer of the steel tubes, pipes and

hollow sections in India.• Delhi based with 5 manufacturing location at northern,

southern and western part of the India with installed capacities ½ Million MTPA.

• Despite a slowdown in the Indian economy Company has recorded a gross sales growth of 56% over 2010-11, EBIDTA growth of 26.19% and net profit growth of 13.83%.

• Intends to double production capacity to a million tonnes per annum by 2015 and generating revenues worth US$1 billion.

• Plan to increase presence in new geographies including Tier II & Tier III cities.

APL Apollo Tubes Ltd.• Among the 3 top manufacturer of the steel tubes, pipes and hollow

sections in India.• Delhi based with 5 manufacturing location at northern, southern

and western part of the India with installed capacities ½ Million MTPA.

• Despite a slowdown in the Indian economy Company has recorded a gross sales growth of 56% over 2010-11, EBIDTA growth of 26.19% and net profit growth of 13.83%.

• Intends to double production capacity to a million tonnes per annum by 2015 and generating revenues worth US$1 billion.

• Plan to increase presence in new geographies including Tier II & Tier III cities.

Working Capital CycleShah Tubes Ltd

Tubes Industry

30 Days

44 Days

60 Days 60 Days

30 Days

30 Days

40 Days

34 Days

Working Capital CycleAPL Apollo Tubes Ltd

Tubes Industry

30 Days

44 Days

60 Days 60 Days

30 Days

30 Days

40 Days

34 Days

Operating Cycle in number of days

Working Capital Cycle : No. of days F-2012 F-2011Inventory

Raw Material 14 22

Finished Goods 16 35

Debtors 44 46

Total 74 103

Creditors 34 36

Net Working Capital 40 68

Current Ratio - Analysis

Mar '12 Mar '11 Mar '10 Mar '09 Mar '080.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50

4.00

4.50

5.00

3.60

4.45

2.78

3.87

3.00

As per Tondon Committee

Current Assets : Mar '12 Mar '11

Inventories 93.00 97.22

Sundry Debtors 139.89 80.68

Cash and Bank Balance 3.15 1.20

Total 236.04 179.10 Current Liabilities 65.52 40.22

Net Current Assets 170.52 138.88

75% on current assets 177.03 134.33 Less: Current Liabilities 65.52 40.22

MPBF

111.51 94.11

Analysis of Peer CompaniesKEY RATIOS SHAH Man

IndMah

Seam

OPBDIT (% of Total operating Income) 6.7% 12.7% 20.5%

OPBIT (% of Sales) 6.1% 10.4% 19.6%

PBT (% of Sales) 4.0% 8.8% 19.4%

PAT (% of Sales) 2.7% 6.0% 13.6%

Analysis of Peer Companies’ Particulars SHAH Man Ind Mah Seam

Sources Of Funds

Total Share Capital 21.3 27.6 35.3

Equity Share Capital 21.3 27.6 35.3

Share Application Money 8.3 - -

Reserves 236.9 617.3 2,724.6

Networth 266.5 644.9 2,759.8

Secured Loans 192.5 230.2 1.6

Unsecured Loans - - 29.3

Total Debt 192.5 230.2 30.9

Total Liabilities 459.0 875.2 2,790.7 Application Of Funds

Gross Block 140.8 589.8 1,502.2

Less: Accum. Depreciation 16.7 241.8 179.5

Net Block 124.1 348.0 1,322.7

Capital Work in Progress 33.9 0.9 9.9

Investments 76.8 302.5 473.6

Inventories 93.0 160.2 717.2

Sundry Debtors 139.9 298.5 362.2

Cash and Bank Balance 3.2 107.8 20.1

Total Current Assets 236.0 566.5 1,099.6

Loans and Advances 85.0 284.5 261.1

Total CA, Loans & Advances 321.1 851.0 1,360.6

Current Liabilities 87.4 557.5 366.7

Provisions 9.6 69.7 9.4

Total CL & Provisions 96.9 627.2 376.1

Net Current Assets 224.1 223.8 984.6

Total Assets 459.0 875.2 2,790.7

KEY RATIOS SHAH Man Ind

Mah Seam

Current Ratio

3.6

1.4

3.4

Holding Days

Inventory

Raw Material 14.0

18.6

94.0

Finished Goods 16.0

13.8

24.6

Sundry Debtors 44.0

63.2

54.5

Sundry Creditors34.0

132.9 31.1

Recommendation

• The company should increase its creditors cycle to 60 days as per the industry benchmark.

• The company can also look for channel financing through contractual arrangement with its present lender.

• The company has recently shown tremendous growth towards trading goods. The company should reduce its inventory through efficient supply chain management .

• The company should also explore the possibilities of factoring keeping in mind the factoring cost ( both recourse and non- recourse) vis a vis collection cost and bad debt as a percentage of sale.

• The company has improved its rating from LBBB+ to A- ( long term) as per recent ICRA rating. The company can also go for financing its working capital through commercial paper, if accessible which is available at a lower cost.

Short term Borrowings v/s Credit Period

• The Company has obtained short term obligations at around 13.6 % .

• It is very important to understand that as per the credit policy of the company it offers around 2%( 0 days) cash discount to its debtors for payment upfront.

• The company needs to make an effective credit policy to ensure that the credit period offered is not at the cost of its earnings.

• The company also needs to ensure that the implicit cost imbedded in the credit period does not exceed market rate of competitive goods.

Recommendations

• The company has exports of 273million in the recent years. The same has reduced from 334 million in previous years.

• The company can search for innovative products such as forfeiting or pre shipment or post shipment finance

• Advantages:(1) Improved liquidity.(2) Convert credit sales into cash sales.(3) Credit limit does not get blocked

Pros Cons

• Signifies efficient working capital management.

• Saving in interest expenses.• Less risk of Bad-debt• For eg. Automobile Industry

• Risk of failure to meet short-term obligation.

• May result in lower credit rating because of failure/delay in payments.

• Bank may charge higher interest rate.

• For eg. Steel Industry

Negative Working Capital