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Working capital reflects efficiency

Working capital reflects efficiency
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First Published: Fri, Feb 20 2009. 12 16 AM IST

Analytical view: Piyush Doshi says companies should start off by setting benchmarks against the best performers and look at how much cash they can release. Ramesh Pathania / Mint
Analytical view: Piyush Doshi says companies should start off by setting benchmarks against the best performers and look at how much cash they can release. Ramesh Pathania / Mint
Updated: Fri, Feb 20 2009. 12 16 AM IST
Mumbai: A new report from consulting firm Booz and Co. Inc. says part of the reason Indian companies are in dire straits is high working capital costs. Indian firms, like others around the globe, have been hit by a lack of credit, falling sales and shrinking profits.
Analytical view: Piyush Doshi says companies should start off by setting benchmarks against the best performers and look at how much cash they can release. Ramesh Pathania / Mint
According to the report, the money required to manage daily operations at Indian firms is extremely high. Higher working capital signals inefficiency, increases cost of capital, adds to debt and eats into profit. In a recent interview, D.D. Rathi, chief financial officer for yarn maker Grasim Industries Ltd, said: “Working capital cycle has extended and its management is (a) top priority.”
The Booz study focused on 80 companies in sectors such as power, steel, cement and consumer goods, and is a precursor to a more definitive study to be conducted on all listed Indian firms. In an interview with Mint, Booz principal Piyush Doshi, one of the authors of the study, explained the findings. Edited excerpts:
Why this study?
The most important reason is that this is the time to seriously worry about working capital, given the cash crunch. We looked at some of the numbers, and the opportunities companies have in this space of easing the pain is tremendous. In a downturn...cash is king. In India particularly, there is an even bigger opportunity than we previously thought—from the perspective of benchmarks as well as from the perspective of some of the practices that we observed. Globally also, very few companies get it right because it’s not so easy; it’s complicated.
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What are the key things you looked for?
We wanted to see two things. One, we wanted to understand how every company is doing within a sector and who are the leaders and the laggards, and how big is the gap. And the second thing we wanted to look at was how have companies done over a period of time.
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How have things changed over (the) 2005-2008 period. And then we supplemented this with our recent interactions with companies in India. This data plus the global insight we have—we combined this to bring out the report.
What did you find?
The amount of working capital is really big. This is very often the measure of inefficiency in the system, (there is) Rs330,000 crore in just inventories and receivables. This is just 80 leading companies. To put this in perspective, this number is higher than the net profit in 2007-08 of the companies we studied. If we look at all listed companies and extrapolate the numbers, it could come close to Rs600,000 crore, or Rs700,000 crore.
What does this indicate?
Very often, inventories and receivables are cushions, or ways in which companies try to hide their inefficiencies. So basically, if supply side is inefficient, inventories provide them the cushion so that they don’t default on the delivery date.
Why we believe this is an opportunity is because in the period 2005-08, sales of these companies grew by 21%. So obviously, as sales grow some of your investments in inventories grow, too, but it has gone up much faster than sales. If companies were managing this with proper care and attention, it could have been reduced, because as you become bigger you are able to manage your working capital deployment efficiently. This suggests that in the good times, companies lost focus on this issue.
There is a also a big gap between the leaders and lags. For example, in consumer products, the best performer (Colgate-Palmolive (India) Ltd) is minus 52 days (net working capital) while for the laggard Nirma Ltd, it is 126 days.
Why did working capital needs grow faster than sales?
That is something we really need to understand more... From outside in, we don’t see any natural reason for this to happen. It’s not as if a few companies are suddenly facing more complexities. I would say that there are not many reasons. Only when we go and talk to individual companies we can know why this happened... When the market was growing and liquidity was available, you didn’t worry about it. When the cycle turns, you start thinking how we can get tight on this one.
What would be the normal levels of working capital?
It depends very much on the sector and the kind of product we are looking at. For example, if you look at consumer product companies, the distributors are dependent on the companies.
So these companies take payment in advance, and consequently their receivables tend to be very low. So, if you look at a particular sector, say steel, if you are in the 45-60 (days) range, that would be good. These are in line with global averages. If you look at the global best, who configure their supply chain in particular ways, then it can go down to 35-40 days.
What should companies be doing to tackle this?
First of all, companies should start off by setting benchmarks against the best performers and look at how much cash they can release. Then look at each component of working capital and manage it at the level of detail required. The problem is usually at lower levels of details—and you should not pass off decision-making to system tools. You should also incentivize the sales force to make the right trade-off between price and payment terms. Often salespeople push through deals by agreeing to easy credit terms.
Graphics by Sandeep Bhatnagar / Mint
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First Published: Fri, Feb 20 2009. 12 16 AM IST