Working capital needs rise in 2010-112 min read . Updated: 28 Jun 2011, 01:10 AM IST
Working capital needs rise in 2010-11
Working capital needs rise in 2010-11
One of the concerns voiced by the Reserve Bank of India is the apparent ease with which companies have been passing on higher costs to customers. This pricing power was a factor contributing to the central bank’s determination to hike interest rates and douse the inflationary fires, even if it lowered economic growth in the short run.
Pricing power is usually seen when supply is tight due to higher utilization levels (other factors also exist: an oligopolistic market or rising affordability, for example). So, have firms actually gone slow on the capital investment front, causing utilization levels to rise? And if they have, what are they doing with their cash?
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Normally, these questions can be answered only by the middle of the fiscal, when most annual reports for the previous year become available. But companies now publish a snapshot of their balance sheet along with the interim results, which gives an early though incomplete picture.
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Data from about 1,700 firms (excluding banks and financial services companies), show that net worth increased by 17% in 2010-11, reflecting good growth in profits. Debt-to-equity ratio fell by about 1.5 percentage points to 59%, as debt grew at a slower rate than net worth did. But fixed assets rose by 13.7% during 2010-11, which appears a reasonable level of growth. A smaller sample of companies, for which three-year data is available, shows that fixed asset growth in 2010-11 is higher than that in the previous year by about 2 percentage points.
Using the sectoral indices on the Bombay Stock Exchange as a proxy, key sectors such as capital goods, automobiles, metals, power have seen fixed assets grow by 15-20% in 2010-11. Fixed asset creation among oil and gas companies grew by just 9%, otherwise the overall growth would have been higher.
Firms have gone slow on their investments in securities, which grew by just 8% in 2010-11. This could signal lower investments for diversification or acquisitions via associates and subsidiaries. Treasury investments are also included under this head. Firms may be switching out of debt investments, as prices fall when interest rates go up. Companies have stocked up on cash in the bank, which rose by nearly 16% during the year. When interest rates are rising, a comfortable liquidity position is an important objective. An inflationary environment also means higher working capital needs. For the same volume of business, the investment in inventories and debtors rises.
Squeezing creditors for cash is one option, but there is a limit to that route since suppliers, too, will be faced with rising interest costs. Working capital does indicate some strain, with total net current assets (total current assets less current liabilities) rising by a sharp 29% in 2010-11. This is visible across sectors. Having enough cash in the bank allows companies to do business without excessive borrowing for short-term needs, which is more expensive compared with long-term loans. When margins are expected to be under pressure, an increase in interest costs is unwelcome.
Once the central bank’s inflation-fighting strategy shows results, inflation will slow; but unfortunately, growth is likely to fall, too. Companies may use that period to scout for acquisitions, as assets will become cheaper; their balance sheets also look strong, with relatively low debt-equity levels and comfortable cash reserves.
Graphic by Sandeep Bhatnagar/Mint
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