OPEN APP
Home >Companies >Long working capital cycles a growing worry
Over the next three years, these Indian companies will need about `1.7 trillion to fund their working capital and capital expenditure requirements to achieve a revenue growth rate of 5%, the EY report said. Photo: Mint
Over the next three years, these Indian companies will need about `1.7 trillion to fund their working capital and capital expenditure requirements to achieve a revenue growth rate of 5%, the EY report said. Photo: Mint

Long working capital cycles a growing worry

Long working capital cycles are putting pressure on companies' cash flows and leading to higher debt and lower return

Mumbai: Indian companies are struggling with working capital cycles that are among the longest in the world, putting pressure on their cash flows and leading to higher debt and lower returns.

Although the top 500 Indian companies have seen a marginal improvement in their working capital cycles since 2013, the cash conversion cycles still remain longer than in 2009 and above all global averages, according to an EY study, All Tied up India—Working Capital Management report 2015, shared exclusively with Mint.

As a result, nearly 5.7 trillion is unnecessarily tied up in working capital cycles, creating a cash crunch for many companies, the study found. This is 11% of the aggregate sales of the top 500 publicly traded companies by revenue, which were analysed in the study. Longer cash conversion cycles force companies to borrow more and crimp profitability, experts say.

“If the working capital cycle keeps on lengthening, then the company will need to finance short-term obligations through either equity or debt," said Deep Mukherjee, senior director at India Ratings and Research Pvt. Ltd. “Raising equity may lower return on capital employed while debt will push up interest cost."

In India, the average cycle lasts 66 days for the top 500 companies (excluding oil and gas, and metals and mining companies), the study shows. In the US, the average cycle lasts just 42 days, while in Europe and Asia (excluding Japan) it is 40 days.

Over the next three years, these Indian companies will need about 1.7 trillion to fund their working capital and capital expenditure requirements to achieve a revenue growth rate of 5%, the EY report said.

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 monetization of the assets that are created. The longer this cycle takes, the lower the return on the capital employed.

Indian companies have not been focusing on effectively managing their working capital, according to Ankur Bhandari, partner, working capital advisory, EY.

“Corporates are more focused on the strategy and growth agenda rather than a cash and capital culture or return on capital employed framework," said Bhandari, adding that factors such as the changing regulatory environment and volatility in currency and commodity markets have all made it tougher to manage the working capital cycle.

On an average, the pharmaceuticals industry had a cash conversion cycle of 106 days in fiscal 2014, the longest, while the oil and gas sector saw the shortest cash conversion cycle of 18 days.

The cycle differs significantly across countries, said Ramesh Swaminathan, chief financial officer of drug maker Lupin Ltd. The company has businesses across regions including the US, Japan and India.

“There is no standard metric that can be followed. For instance, in the US business, the accounts receivable days are at 60," he said, adding that Lupin has worked on bringing down its working capital cycle over the past two years.

Companies that excelled in working capital management also had strong balance sheets and delivered higher margins and returns, the study found.

The top working capital performers who reported a 15-day cash conversion cycle achieved a 14% operating margin, a return on capital employed (ROCE) of 9% and a debt-to-equity ratio of 0.9 times. On the other hand, the bottom performers with a 59-day-long cycle reported an operating margin of 10%, an ROCE of 8% and a debt-to-equity ratio of 1.6 times. The study does not name the best and worst performers.

To be sure, some companies say the current market and economic conditions are to be blamed for the longer cash conversion cycles.

Working capital cycles have got longer in recent times, according to Seshagiri Rao, joint managing director and group chief financial officer, JSW Group. “In the current marketplace, liquidity pressures have increased and inventory levels have increased."

Jayant Acharya, director, commercial and marketing, JSW Steel Ltd, agrees.

“Cycles at the customer end have become longer. Although it depends on which industry one is referring to, typically in infrastructure, we have seen that the levels have elongated by 15-30 days," he said.

Promit Mukherjee contributed to this story.

Subscribe to Mint Newsletters
* Enter a valid email
* Thank you for subscribing to our newsletter.

Click here to read the Mint ePaperMint is now on Telegram. Join Mint channel in your Telegram and stay updated with the latest business news.

Close
×
Edit Profile
My Reads Redeem a Gift Card Logout