An attempt is made to study the fundamentals of working capital management and these are utilized to compare the working capital efficiency of public & private sector enterprises by taking cases of two disparate business firms.
Purpose of the study
The disclosure of factors which are responsible for formation of a disparity in the management of the current assets and liabilities between the private & the public sector business enterprises is a genuinely multifaceted charge. The research is an attempt to compare the working capital management of private sector and public sector business enterprises.
Significance of the study
Working capital for any business enterprise is the nervous system for its operations. None of the businesses can efficiently survive in the long run without maintaining a sufficient level of working capital. It is vital for its sole existence in the corporate environment. The management of working capital is one of the most pertinent functions of enterprise. Any business entity having sufficient level of working capital would always be in a better position to get advantages or benefits of any uncertain opportunity either to buy higher levels of raw materials or attain a special sort of a tender offer or to wait for the right moment to get back to the enhanced and improved market circumstances. Working capital can be employed for the lease payment, payroll of an employee of the organization, & all the everyday operating costs involved. This working capital is also an essential element when circumstances of unexpected elements arise. The growth of the organization on the whole depends on the efficient & effective management and utilization of working element. So, it should be dealt with properly. Working capital also proves to be an essential element to generate revenues, returns & dividends for the stakeholders. Inefficient handling and allocation of working capital would lead to poor results and would substantiate the benefits of financials on the short term basis. To attain objectives of profitability and sustained growth for the business enterprise, the efficient and effective management of the working capital becomes the most essential element. The management of this working capital is a tedious task, as it varies across businesses on the basis of elements like actual nature of the enterprise, the kind of raw materials utilized for operations, the technology deployed, finished goods maintained, level of inventory & its management, credit policy undertaken by the firm etc. Also, a noteworthy amount of finance is required for the lasting investment in dissimilar forms of current assets. In this paper, the management of working capital with respect to the private & public sector business enterprises will be discussed taking an example case. The sector for the comparison will be the iron & steel diligence. Some of the prominent features reflected are the following: The outline of alterations in the actual amount of the current assets is almost similar for both the enterprises. Utilization of short term financing to meet the lack of inventory or cash shortages is almost equal in both the private & public sector enterprises. These two sectors classify the sections of the current assets & current liabilities in a similar format. The sales revenues are improved by increased efficiency in the management of the working capital. The profitability and retained earnings therefore dividends paid to the company’s shareholders are improved by proper management of working capital.
The methodology for this paper is as follows: In review of literature, the theory on working capital management has been analyzed. The analysis of survey data section compares & contrasts the working capital ratios of both the public & private sector enterprises. In the later part of the paper, conclusion & recommendations have been discussed.
REVIEW OF LITERATURE
Working Capital Management
Working capital basically refers to the money value difference between the current assets & the current assets of a firm. It is equal to Net Working Capital. Some of the financial analysts like to consider just the current assets which include cash & marketable securities, inventory & the receivables. The administration enforced & deployed by the firm to manage the current assets & the actual financing needed by the firm to support the present needs is referred to as Working Capital Management. Working capital is one of the most essential elements of any firm’s financials. The current assets of a characteristic manufacturing company account for more than half of the total assets. It may even account for more for a distribution company. Excessive & disproportionate levels of current assets can easily lead to substandard levels of ROI (return on investment) realization. Also the other way round, maintaining very less current assets may lead to opportunity losses, shortages, & would face difficulty in maintaining & executing smooth operations. The current liabilities are the primary source of financing from external sources, if we consider smaller sized firms. The fast growing large sized companies also include financing based on current liabilities. It is the direct responsibility of the financial manager to manage the cash & marketable securities, accounts payables, accounts receivables, & other mechanisms to deploy short term financing. But the management of inventories isn’t under the discretion of the financial manager. Thus, a good proportion of the financial manager’ time should be dedicated for the management of the working capital as it is pertinent to a firms profitability.
Profitability & Risk
The two underlying fundamental decisions issues for a sound working capital management of a firm are: The optimum level of investment the current assets The correct blend of short term & long term financing which would be used to support this investment in current assets. The lessening in level of investment in current assets, while generating proper sales, would definitely increase the firms return on its assets. To the extent that the explicit costs of short term financing, the greater the proportion of short term debt as compared to total debt, the higher is the profitability of the firm. Although the interest rates for short term financing are higher than those involved in the long term financing. Nevertheless, the short term debt are going result in much higher returns as compared to long term debts as debts will be paid during the period when it is not required. These assumptions for profitability suggest us for maintaining a lower level of current assets & a greater proportion of current liabilities. This will result in negative level of the net working capital. Profitability means more risk. Risk here means threat to the firm for improper management to maintain sufficient current assets to Meet the cash obligations that the firm incurs Sustain the proper levels of sales for example running out of the inventory The two most basic principles involved in management of working capital can be listed as: Profitability varies inversely with liquidity Profitability moves together with risk. Permanent working capital may be defined as the amount of current assets required in order to meet a firm’s long term need on a minimum level. Temporary working capital may be defined as the sum of current assets that differ with seasonal needs. If a firm decides to adopt a hedging i.e. maturity matching approach to financing, each asset would be an offset, to a similar financial instrument of almost the same maturity levels. The seasonal variations short term in current assets should be financed with short term debts. The permanent component of the current assets, also the set of fixed assets should be financed with long term debt. If we try to generalise the facts, the longer the composite maturity schedule of the financials utilised by the firm, the less risk is associated with it. Nevertheless, the longer this maturity schedule, the costlier the finance is ought to be. Thus, there is a trade-off existing between profitability & risk. The working capital requirements of a firm are dependent on a number of factors. Some of the important ones are the following: Nature of the business enterprise The nature of the business enterprise & the working capital requirements of the firm are interlinked. The manufacturing sectors have a longer cycle of operation, the services sectors have a comparatively shorter cycle of working capital. This amount varies as business engaged in production activities would require more amount of working capital. Manufacturing Policies Every firm will have different set of manufacturing principles. For example, some of the firms would like to continuing to follow uniform policies even if there are fluctuations is demand, some would prefer to follow principle based on the varying demand. Thus, the working capital requirements for both the firms would be dissimilar. Market Conditions Market conditions like higher competition, need for faster delivery of goods & services, need for credit etc., the requirements of working capital would be higher. If there is lesser competition in the market, the requirements of working capital will be lesser. Availability of raw materials If there is constant & ready availability of raw material, concept of JIT may be implemented, and the need to maintain inventory warehouses diminishes. On the other way round, inventory has to be maintained thereby increasing the working capital requirements. Growth & Expansion When growths & expansions take place for an organization, the enhanced requirements of working capital arises. There is a need for larger set of working capital to fund the business activities. Price level changes If there is a trend of increasing price levels, a requirement of higher investment in the working capital arises. There is a need to enhance the investments in the current assets, thereby altering the working capital requirements. Manufacturing Cycle The manufacturing cycle basically may be defined as the period from the purchase of raw material to the fabrication of finished products. Longer the manufacturing cycle, the need for working capital increases. Some of the consequences of under-assessment of Working Capital are the following: The growth of the business firm may get stunted. Due to non-availability of adequate amount of working capital, undertaking of opportunistic profitable projects on the part of the firm becomes difficult. The implementation of strategic, tactical & operational plans becomes difficult, resulting in lower profitability. A crisis in cash may emerge because of scarcity of working capital. The fixed assets may not be utilised to optimum level capacity due to lower availability of funds. Te credibility of the business enterprise may be adversely affected as it would fail to tribute to its prior commitments. This may lead to future business relations closure. To obtain cash, the firm may be forced to purchase raw materials on credit & sell its finished products on cash. These quick actions may increase the purchase costs & reduce the selling costs because of possibility of discounts to be offered. These situations greatly hamper the profitability of the business enterprise. It may lead to stoppage or slow down of production process because of non-availability of working capital funds. Some of the consequences of over-assessment of Working Capital are the following: It may lead to pointless building up of inventory, thereby increasing carrying costs. The firm may become tolerant enough to provide liberal credit terms to the buyers, & may result in a poor management of cash & recovery mechanism. The management may become complacent & over satisfied, resulting in inefficient operations. The capital gets less productive & it may lead to reduction in ROI (return on investment).
The research methodology used for collecting the data was primarily of secondary nature. The data was collected from the annual reports of the two companies & provided by various web sites like moneycontrol.com were studied comprehensively and analysed to arrive at a result. Calculations for the regression analysis have been performed using the Microsoft Excel spreadsheets, by putting the values in the appropriate formulae.
The research has been conducted solely by the author. No other participants were involved in the research & no surveys were conducted. The data have been collected from the internet & analysis has been performed based on the results arising from the calculations performed.
The data collected have been depicted in relational format. Graphs and pie-charts have also been included to demonstrate the trends in market conditions and comparison of the same over the past years.
ANALYSIS OF DATA
The following tables show the various working capital ratios and other important functionalities for the financial years 2006-2010. The regression analysis is conducted & the results are presented in the 3rd table.
TISCO – Working Capital Management Ratios
Ratios Financial Years 2007 2008 2009 2010 Liquidity Ratios Current Ratio It measures the ability of the firm to meet the current liabilities with current assets. Current Assets Current Liabilities 1.203 1.113 2.513 5.461 Quick ratio It measure the ability of the firm to meet the current liabilities with the highly liquid current assets Current Assets less inventories Current Liabilities 0.597 0.542 2.085 5.075 Cash Proportion ratio It identifies the measured proportion of cash included in the assets 0.07 0.067 0.571 0.023 Working Capital Efficiency Working Capital Turnover It measure the usage of working capital to generate sales revenue over a given period of time. Sales Working Capital 41.41 39.33 2.394 0.735 Inventory Turnover It measures how many times the inventory has been turned over into cash during the year. Cost of Goods sold Inventory 6.094 4.94 2.385 4.896 Debtors Turnover It measures the no. of times the receivables have been turned over to cash during the year. Annual net credit sales Receivables 25.67 30.67 33.65 37.81 Creditors Turnover It measures the actual rate at which the firm pays off to its suppliers. Total Supplier Purchases Average Accounts Payable 3.61 2.97 2.85 2.42 Asset Turnover It is the amount of revenue created for unit worth of the assets. Revenue Assets 3.89 4.05 1.45 0.7 Working Capital Structure Ratios Current Assets to Total Net Assets Current Assets Total Net Assets 0.337 0.287 0.54 0.79 Current Liabilities to Total Liabilities Currents Liabilities Total Liabilities 0.305 0.273 0.231 0.146 Working Capital Leverage Current Assets/Total Assets – AŽ” Current Assets 0.365 0.287 0.858 1.571
RINL – Working Capital Management Ratios
Ratios Financial Years 2007 2008 2009 2010 Liquidity Ratios Current Ratio It measures the ability of the firm to meet the current liabilities with current assets. Current Assets Current Liabilities 6.171 5.182 4.85 3.712 Quick ratio It measure the ability of the firm to meet the current liabilities with the highly liquid current assets Current Assets less inventories Current Liabilities 4.891 4.45 4.45 3.245 Cash Proportion ratio It identifies the measured proportion of cash included in the assets 0.67 0.682 0.823 0.78 Working Capital Efficiency Working Capital Turnover It measure the usage of working capital to generate sales revenue over a given period of time. Sales Working Capital 1.64 1.22 1.08 1.23 Inventory Turnover It measures how many times the inventory has been turned over into cash during the year. Cost of Goods sold Inventory 4.67 4.55 5.09 4.64 Debtors Turnover It measures the no. of times the receivables have been turned over to cash during the year. Annual net credit sales Receivables 121.2 78.23 47.84 61.04 Creditors Turnover It measures the actual rate at which the firm pays off to its suppliers. Total Supplier Purchases Average Accounts Payable
Asset Turnover It is the amount of revenue created for unit worth of the assets. Revenue Assets 1.23 1.07 0.83 0.84 Working Capital Structure Ratios Current Assets to Total Net Assets Current Assets Total Net Assets 0.72 0.923 0.97 0.98 Current Liabilities to Total Liabilities Currents Liabilities Total Liabilities 0.123 0.17 0.19 0.27 Working Capital Leverage Current Assets/Total Assets – AŽ” Current Assets 1.65 1.23 1.25 1.11
D/P Ratio, DPS & EPS data
Financial Details TISCO RINL FY 1 FY 2 FY 3 FY 4 FY 1 FY 2 FY 3 FY 4 EPS 62.76 410.8 410.8 410.8 410.8 10.79 4.36 3.72 D/P 23.46
Company Regression equation y = c + dx, where x = sales, y = debtors Sales Turnover (in cr. Rs.) Debtors (in cr. Rs.) Debtors turnover ratio (in times) TISCO y = 713.945 – 0.0075x 20,000 570.768 35.05 RINL y = 22.446 + 0.0117x 22,000 25.467 785.8
Discussions on the basis of management of cash
TISCO has the range of composition of the cash & balance as compared to the total current assets is between 1% & 54%. RINL has the range of composition between 66% and 70%. In 2008-09, the cash balances of TISCO gets to it maximum value it tries to maintain the consistent level of operation. In case of RINL, the cash & balances have increased at a fast rate. In case of TISCO, the current ratios and the quick ratios demonstrate a pattern trend in the upward direction. The cash proportion ratios initially increase for the period of 2008-09, but then demonstrate a decreasing pattern. The possible reason in this case can be that the inflow of funds is higher and the loans & advances have been created in a greater proportion. In case of RINL, if we leave the cash proportion ratio, the liquidity ratios have tended to fall. The decrement is highest in the financial year 2009-10, as can be seen from the tables. In case of TISCO, the inflow of funds in the initial years of the research has been primarily through the operating activities. In the next couple of years, the inflow of funds is from both the operating and financing activities. The inflow of funds from the financing activities has increased through in the later part of this period. If we observe carefully, it can be seen that the outflow of cash in the initial couple of years has been primarily through the financing activities. There has been increase in the investment activities, thereby increasing the cash outflows. In case of RINL, the cash inflow is all the way by the operating activities but there is a decrease till 2008-09. The company had its inflow of cash through investing & financing activities for two years out of the 4 years. Cash outflows were also observed for the two years. In case of TISCO, there is an observable difference between the cash obtained from operations before and after the working capital changes because of adjustments. The rate of growth for TISCO has been slow & steady in the domain of depreciation. In case of RINL, the cash obtained from operations before there are alterations in working capital decrease till FY 2007-08 and then the values improve after that. In case of TISCO, the loans & advances remain at a higher level than the cash balances for the initial couple of years. The third year comes with an increase in cash balance. In the fourth year again the loans & advances exceed the cash balances as it declines with a greater rate. In case of RINL, the cash balances grow with a high rate, but decline in FY 2009-10. The cash balances increase steadily throughout the period. In TISCO, the cash outflows can be observed in the first & the fourth year, while cash inflows can be observed in the 2 years which are in between. The interest paid by the company has remained higher than the amount of dividends paid to the shareholders, & the amount continuously & gradually improves over time. In case of RINL, the cash inflow can be observed in all the 4 years. Nevertheless, there is decrease in the amount of cash inflow. The firm hasn’t declared dividends in these observed financial years. As the dividends haven’t been paid, the cash outflow because of this has been removed. Other measures of cash outflow such as the financial costs against the long term costs have gradually increased over the 4 years.
Discussions on the basis of management of inventory
TISCO has maintained a proper level of inventory for the observed period. When we observe the inventory composition, the raw materials & the inventory for finished goods have the highest proportion, & the values can be seen to be increasing for the complete period. The materials in store can be observed to systematically increase but the values remain below the raw materials & finished products. The inventory composition of work in progress has remained lowest for the observed period. In case of RINL, the highest composition is for the work in progress & finished products inventory. The raw materials composition comes next & the lowest composition is for the materials in store. If we compare the annual revenues & sales for TISCO, these have increased gradually for the period span. The annual cost of sales has a larger portion. The annual cost of production has remained low, but an increase can be observed in the year 2009-10. The annual cost of raw materials has remained lower as compared with the annual purchases if we leave the year 2006-07. In case of RINL, the annual sales have continuously increased for the period. A substantial difference can be observed between annual revenues and costs. The costs have also increased for the period. The cost of production has remained lower than the cost of production. The cost of raw materials has increased with a certain rate. The working capital to sales ratio for TISCO has remained high for the initial period, but has declined substantially in the next time span. The inventory turnover has remained steady for the period. The assets turnover ratio has the lowest value, and has decreased from the 2nd year. In case of RINL, inventory turnover has remained low. The working capital turnover ratio & the assets turnover ratio doesn’t show any noteworthy alterations.
Discussions on the basis of management of receivables
TISCO hasn’t been relying on customer advances in order to meet its short term obligations. The values of sundry debtors have increased over the period, but with a gradual degree, as some constancy can been seen. The sundry debtors have remained lower as & when compared to the advances from customers. For RINL, sundry debtors decrease in the year 2009-10, other than that there has been a gradual increase. The debtors turnover in case of TISCO has gone down, which symbolises growth & prosperity for the company. As the years have passed by, the asset turnover ratio & the payables turnover have increased. The creditors turnover has remained under the assets turnover ratio for the period of time. In case of RINL, the debtors turnover ratio has reached its peak value in 2006-07, but has reduced after that year. Based on regression analysis, receivables turnover ratio estimated & calculated for TISCO is around 35.04 times. The receivables turnover ratio based on regression analysis for RINL is around 785.8 times & is quite high.
TREND IN WORKING CAPITAL TO SALES RATIO
Chart demonstrating the Working Capital to Sales ratio for both companies:
CURRENT ASSET COMPOSITION
Current assets composition for TISCO over the 4 years:
Current assets composition for RINL over the 4 years:
Cash flows from diverse activities for RINL
Cash flows from diverse activities for TISCO
Some of the inferences that can be drawn are: RINL has been a lot conservative regarding the liquidity, as compared to TISCO. The cash producing ability for RINL declines for its operating activities. Therefore, the dependence on other sources for cash requirements is higher. RINL didn’t go for any king of acquisition or other action during the period of 4 years. RINL hasn’t engaged in payment of dividends to its shareholders. Thus, it can be seen that working capital for any commerce enterprise is the nervous system for its processes. None of the businesses can resourcefully continue to exist in the long run without maintaining a adequate level of working capital. It is vital for its only continuation in the corporate atmosphere. The organization of working capital is one of the most important functions of enterprise. Any business unit having adequate level of working capital would always be in a improved situation to get advantages or remuneration of any uncertain prospect either to buy superior levels of raw materials or achieve a special sort of a tender offer or to wait for the right second to get back to the enhanced and improved market conditions. Working capital can be engaged for the lease imbursement, payroll of an member of staff of the organization, & all the everyday operating expenses concerned. This working capital is also an essential constituent when circumstances of unforeseen fundamentals arise. The growth of the business on the entire level depends on the efficient & effective administration and deployment of working component. So, it should be dealt with appropriately. Working capital also establishes to be an vital element to produce revenues, returns & dividends for the stakeholders. Unproductive treatment and allotment of working capital would lead to reduced results and would authenticate the profits of financials on the short term basis. To attain goals of profitability and continued development for the business enterprise, the efficient and valuable management of the working capital becomes the most vital element. The management of this working capital is a dull task, as it varies athwart businesses on the basis of elements like real nature of the enterprise, the kind of raw materials utilized for operations, the expertise deployed, finished commodities maintained, level of inventory & its supervision, credit policy undertaken by the firm etc. Also, a noteworthy amount of investment is required for the lasting speculation in disparate forms of current assets. Thus, the management of working capital with respect to the private & public sector business enterprises has been discussed taking the example cases of RINL & TISCO. The sector for the comparison is the iron & steel diligence as it can be observed from the companies taken into consideration. Some of the important characteristics established are the following: The summarization of variations in the actual quantity of the current assets is almost parallel for both the firms. Deployment of short term financing to meet the need of inventory or cash deficiency is almost alike in both the private & public sector firms. These two sectors categorize the classes of the current assets & current liabilities in a analogous arrangement. The sales revenues are enhanced by increased effectiveness in the organization of the working capital. The profitability and retained earnings consequently dividends rewarded to the company’s shareholders are enhanced by proper administration of working capital. Based on the above inferences, it can said strongly that the working capital management policies of private sector enterprises are different than that of the public sector enterprises.
SUMMARY, RECOMMENDATIONS & CONCLUSION
Working capital basically refers to the money value difference between the current assets & the current assets of a firm. It is equal to Net Working Capital. Some of the financial analysts like to consider just the current assets which include cash & marketable securities, inventory & the receivables. The administration enforced & deployed by the firm to manage the current assets & the actual financing needed by the firm to support the present needs is referred to as Working Capital Management. The research was an attempt to compare the working capital management of private sector and public sector business enterprises. The disclosure of factors which are responsible for formation of a disparity in the management of the current assets and liabilities between the private & the public sector business enterprises is a genuinely multifaceted charge. The decision making prototypes at the various stages are quite different for the two. Also, the organisational culture, the working environment and atmosphere vary to a great degree when the two enterprise segments are compared. Thus, these impacts can be studied from the operational activities. The actual model of deployment of the current assets and the management of current liabilities varies when the two sector enterprises are simultaneously compared. The analysis is limited to the iron & steel industry segment in India. TISCO (Tata Iron & Steel Company) and RINL (Rashtriya Ispat Nigam Limited) correspond to the private sector and the public sector enterprises respectively. The financial data was extorted from the annual reports published by the companies and through various financial portals like moneycontrol.com between the years 2006-07 and 2009-10. From the analysis conducted, it can be inferred that the management of working capital of both the private & public sector firms is almost similar in the iron & steel industry. Based on the above inferences, it can said strongly that the working capital management policies of private sector enterprises are different than that of the public sector enterprises.