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The EY report concludes that based on the individual working capital cycle management, the efficiency levels of companies, they could have freed up between `2.7 trillion and `5.3 trillion of cash, or between 6% and 12% of their aggregate sales. Photo: Mint
The EY report concludes that based on the individual working capital cycle management, the efficiency levels of companies, they could have freed up between `2.7 trillion and `5.3 trillion of cash, or between 6% and 12% of their aggregate sales. Photo: Mint

Indian firms bad in working capital cycle management: EY report

The EY report analyses the latest published annual reports for the top 500 Indian firms by revenue across sectors

Mumbai: Top Indian firms could have had 5.3 trillion in cash at their disposal in the last fiscal year if they had efficiently managed their working capital cycle, a study by consulting firm EY has found.

The EY report, titled All Tied up India—Working Capital Management report 2014, analyses the latest published annual reports (for fiscal year 2012-13) for the top 500 Indian companies by revenue across sectors, including chemicals and fertilizers, food producers, information technology, oil and gas, steel, auto parts, pharmaceuticals, and machinery makers.

The report concludes that based on the individual working capital cycle management, the efficiency levels of companies, they could have freed up between 2.7 trillion and 5.3 trillion of cash, or between 6% and 12% of their aggregate sales. This could have then been used for capital expansion or even repaying debt, a problem that many companies are grappling with now.

A working capital cycle can be defined as the period in which there is a flow of liquid resources (the majority of which is in cash) into and out of a business. This period usually begins with investment in raw materials, work-in-progress and finished goods, and is followed by the monetisation of the assets that are created.

The longer this cycle takes, the lower the return on the capital employed.

The report states that compared with their global counterparts, Indian companies appear to be worse-off in working capital cycle management. Excluding oil and gas and metals and mining companies, the cash-to-cash cycle (a gauge of how long cash is tied up in the working capital cycle of the company, expressed in days of sales) for Indian companies lasts 67 days, compared with 42 days in the US, 41 in Europe, 57 in Japan, and 39 days in the rest of Asia.

Apart from the regional peculiarities in business environment, elements like supply chain infrastructure (logistics and distribution of goods) and “marked differences in the degree of management’s focus on cash and processes related to efficiency" are some of the reasons why the cash-to-cash cycle varied so widely between regions. One of the reasons cash is stuck longer in this cycle in India is evident from the World Bank ranking of the country in terms of performance of logistics. While countries like the US and Japan are among the top 10, India ranks 46 out of 155 countries.

“Not treating working capital as an operational issue, poor system data management, insufficient focus on continuously adapting business policies and processes to a rapidly changing environment appear to be the primary reason for the divergence in working capital trends between India and the US and Europe," the report states.

It is not just the smaller and relatively less organized companies that suffer from working capital management issues. Even larger entities like engineering conglomerate Larsen and Toubro Ltd (L&T) have been suffering from a similar problem of late.

A Barclays report dated 23 January says that L&T’s net working capital was 21% of total sales in the third quarter of the current fiscal year compared with 18% in the preceding quarter, “due to less customer advances and tighter vendor credit". The report was issued after L&T’s management met with analysts after declaring their October-December quarter results.

“Going forward, the execution part, cost reduction and working capital management are going to be our focus areas," K. Venkataramanan, chief executive officer at L&T, told reporters during the third quarter earnings press briefing. “However, we are still going to have a difficult period as far as the economy’s growth is concerned."

As a result of the long working capital cycle, the return on capital employed by companies has also suffered. It stood at 10.8% at the end of fiscal 2013, the lowest in five years.

To be sure, the working capital performance of India companies has shown a marginal improvement in 2012-13 over 2011-12, with the cash-to-cash cycle being shorter by 2%. But the report contends that this marginal improvement is hardly enough to offset the deterioration in the working capital management abilities of Indian companies from fiscal 2009 to fiscal 2013, during which the cash-to-cash cycle grew 21% longer.

Ankur Bhandari, partner (working capital advisory) at EY India, says that other factors like poorly defined contracts, inadequate due diligence of the credit worthiness of customers, and a more adversarial rather than collaborative relationship with suppliers are also some of the factors that lead to a longer duration between payables and receivables.

“At a time when banks are struggling with high levels of NPAs (non-performing assets) and their ability to fund is limited, companies are sitting on a huge potential resource of cash in their backyard, which they aren’t being able to utilize," Bhandari says.

Subba Rao Amarthaluru, chief financial officer of RPG Enterprises, says that what Indian companies need in a situation like this is a strong government that will “reignite the investments leading to higher GDP (gross domestic product), higher purchasing power and higher demand".

“Indian companies can and will certainly come out of this current challenge. Till the macroeconomic situation changes, companies have to keep their costs low and keep investing in processes and talent to take on the good times when they return shortly," he said.

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