Description
Working capital is one of the vital parameters of financial management function. Profitability and working capital relationship is frequently emphasized for deciding on the level of investment in working capital. All manufacturing firms need to understand the association between these two variables to arrive at optimal financial decisions. Though theories exist on the topic, empirical methods are inadequately focused in arriving at conclusions. Use of statistical methods in understanding the relationship is systematic and scientific, which may provide better insight for decision making. This project is an endeavor to understand the relationship between working capital and profitability in a detailed manner.
Working Capital Management at NALCO
Contents
LIST OF TABLES.................................................................................................................................................................. 5 LIST OF FIGURES................................................................................................................................................................ 5 ABBREVIATIONS ................................................................................................................................................................ 5 EXECUTIVE SUMMARY ...................................................................................................................................................... 8 OBJECTIVES ................................................................................................................................................................... 8 RESULTS ........................................................................................................................................................................ 8 RECOMMENDATIONS ................................................................................................................................................... 9 1. INTRODUCTION....................................................................................................................................................... 10 1.1 The Indian Aluminium Industry- A Snapshot ........................................................................................................ 10 1.2 SALIENT FEATURES OF INDIAN ALUMINIUM INDUSTRY ....................................................................................... 11 1.3 Nalco and it’s Financial performance in a nutshell ............................................................................................. 12 1.3.1 NALCO PROFILE .............................................................................................................................................. 12 1.3.2 CORPORATE STRENGTH ................................................................................................................................. 13 1.3.3 FINANCIAL PERFORMANCE OF THE COMPANY ............................................................................................. 13 1.4 Objectives ............................................................................................................................................................. 16 1.5 Assumptions ......................................................................................................................................................... 16 2. Methodology .............................................................................................................................................................. 16 3. Working Capital management of NALCO.................................................................................................................... 16 3.1 Cash Management of NALCO ............................................................................................................................... 16 3.2 Inventory Management of NALCO........................................................................................................................ 19 3.2.1 Types of Inventories: ..................................................................................................................................... 19 3.2.2 Need to hold Inventories: .............................................................................................................................. 19 3.2.3 Functions of Inventory in NALCO ................................................................................................................... 20 3.2.4 Objectives of Inventory Management in NALCO ........................................................................................... 20 3.2.5 Effective Inventory Management .................................................................................................................. 20 3.2.6 INVENTORY MANAGEMENT TECHNIQUES ADOPTED BY NALCO .................................................................. 21
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Working Capital Management at NALCO
3.3 RECEIVABLE MANAGEMENT ................................................................................................................................. 22 3.3.1 Receivable Management in NALCO ............................................................................................................... 22 4. CALCULATION OF GROSS OPERATING CYCLE PERIOD FOR 2010-2011 ...................................................................... 23 4.1 Raw material conversion period ........................................................................................................................... 23 4.2 Work-in-progress conversion period= .................................................................................................................. 23 4.4 Debtor Conversion Period .................................................................................................................................... 25 4.5 Payment Deferred Period ..................................................................................................................................... 25 5. CALCULATION OF GROSS OPERATING CYCLE PERIOD FOR 2009-10 .......................................................................... 26 5.1 Raw material conversion period ........................................................................................................................... 26 5.2 Work-in-progress conversion period .................................................................................................................... 27 5.3 Finished Goods Conversion Period ....................................................................................................................... 27 5.4 Debtor Conversion Period .................................................................................................................................... 28 5.5 Payment Deferred Period ..................................................................................................................................... 28 5.6 Interpretation ....................................................................................................................................................... 29 6. NALCO’S FINANCIAL RATIOS ....................................................................................................................................... 30 6.1 Liquidity Ratios :.................................................................................................................................................... 30 6.1.1 Current Ratio.................................................................................................................................................. 30 6.1.2 Quick ratio...................................................................................................................................................... 31 6.2 Cash Ratio ............................................................................................................................................................. 32 6.3 ACTIVITY RATIOS: .................................................................................................................................................. 33 6.3.1 Debtors Turn over Ratio ................................................................................................................................ 33 6.3.2 Average Collection period (ACP) .................................................................................................................... 34 6.3.3 Inventory Turnover Ratio (ITR) ...................................................................................................................... 34 6.3.4 Working Capital Turnover Ratio (WCTR) ....................................................................................................... 36 7. Relationship between Working capital and Profitability – A statistical Analysis ..................................................... 37 7.1 Regression Analysis............................................................................................................................................... 38 7. 2 Correlation between various measures of working capital and Profitability ...................................................... 40 8. LIMITATIONS ............................................................................................................................................................... 43 9. CONCLUSIONS AND RECOMMENDATIONS................................................................................................................. 43
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Working Capital Management at NALCO
10. ANNEXURE- 1 ............................................................................................................................................................ 45 11. Annexure- 2 .............................................................................................................................................................. 51 12. Annexure – 3 ............................................................................................................................................................. 61 13. Bibliography .............................................................................................................................................................. 77
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Working Capital Management at NALCO
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Working Capital Management at NALCO
LIST OF TABLES
Table Number 7.1 Table Name Theoretical relationship between measures of working capital and profitability Year wise data on PBT and corresponding Inventory Year wise data on PBT and corresponding Sundry debtors Year wise data on PBT and corresponding Cash and Bank Balance Year wise data on PBT and corresponding Loans and other current assets Year wise data on PBT and corresponding Loans and advances Page Number 36
7.2.1 7.2.2 7.2.3
40 40 41
7.2.4
41
7.2.5
42
LIST OF FIGURES
Figure number 1.1 1.2 3.1 7.1.1 11.1 11.2 11.3 11.4 12.1 12.2 12.3 Figure Name Financial Performance Net Worth in Crores Cash Management Cycle PBT Line Fit Plot Porter’s Generic Model The Conversion of Bauxite to Aluminium Organizational Chart of NALCO Organizational Structure of NALCO Working Capital Cycle Temporary and Permanent Working Capital- A Diagrammatic View 3D Nature of Working Capital Page Number 14 14 16 39 53 54 56 58 61 68 73
ABBREVIATIONS
WC FG Working Capital Finished Goods
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CR QR DTR ACP ITR WCTR
Current Ratio Quick Ratio Debtors Turn Over Ratio Average Collection Period Inventory Turn Over Ratio Working Capital Turn Over Ratio
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Working Capital Management at NALCO
EXECUTIVE SUMMARY
Working capital is one of the vital parameters of financial management function. Profitability and working capital relationship is frequently emphasized for deciding on the level of investment in working capital. All manufacturing firms need to understand the association between these two variables to arrive at optimal financial decisions. Though theories exist on the topic, empirical methods are inadequately focused in arriving at conclusions. Use of statistical methods in understanding the relationship is systematic and scientific, which may provide better insight for decision making. This project is an endeavour to understand the relationship between working capital and profitability in a detailed manner.
OBJECTIVES
1. To find out the working capital of NALCO and understand its significance. 2. To find out the Financial Ratios of Nalco and understand their interpretation. 3. Examining the efficiency of NALCO in the managing it’s working capital. 4. Use of Statistical analysis ( to find out a relation between Working Capital and PBT. 5. Use of Correlation analysis to find out the impact of various measures of Working Capital on Profitability.
RESULTS
1. The Gross working capital cycle of NALCO was found to be lengthier in 2010-11 as compared to 2009-10 due to increase in raw material conversion period and increase in finished goods conversion period. 2. Although Nalco has been maintaining a healthy current ratio, its quick ratio has taken a beating due to increase in inventory. The cash ratio also suggests that there has been a greater increase in sundry creditors which forms a part of its current liabilities as compared to its current assets. While its debtors turnover ratio and average collection period showed improvement indicating Nalco’s efficient debt management, its Inventory turnover ratio showed a decline suggesting a decrease in profitability and decrease in return of its investment in its stocks. 3. Statistical analysis using tools like Regression analysis helped us in finding an equation, incorporating Working capital and PBT , to help us predict the optimum level of working capital required for a projected value of PBT. 4. Correlation analysis helped us to find that there exists a negative correlation between some measures of working capital like inventory, sundry debtors and Loans and advances & PBT.
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Working Capital Management at NALCO
RECOMMENDATIONS
1. Nalco should try to improve its raw material conversion period and finished goods conversion period to reduce its working capital cycle. Finished goods conversion period can be improved by better marketing of Nalco’s products and extension of better credit facilities to its customers. 2. Nalco should perform statistical analysis ( e.g Regression analysis) using parameters like PBT to gauge the optimum working capital requirement. 3. Nalco should reduce the amount of sundry creditors or seek a wider credit repayment duration from its creditors to make sure that it can meet its obligations properly and remain profitable at the same time.
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1. INTRODUCTION
Two essential aspects of financial soundness of a firm are the financial position and economic performance. Working capital management is most crucial aspect of economic performance of a firm. Effective working capital decisions contribute to the profitability and attainment of overall objectives of an organization on one hand and provide liquidity to the firm on the other. For several reasons, capital budgeting decisions are influenced by operating managers to larger extent and the day to day management of liquidity, short term obligations, uninterrupted operations calls for effective working capital decisions that forms the domain of finance function. Theoretically, leaving other things constant, level of investment in current assets has a bearing on the profitability of the firm. Excess of investment in working capital casts a negative impact on the profitability of a firm and positive impact on the liquidity. Before I get into the concept of Working Capital Management at Nalco, I would like to give a snapshot of the Indian Aluminium Industry and Nalco.
1.1 The Indian Aluminium Industry- A Snapshot
The biggest trait of the aluminium industry, being a commodity, is the cyclicality of the industry, wherein there are periodic ups and downs. That said, when compared with cement and steel, aluminium is a value-add commodity. It is a highly capital intensive sector (Rs 200 bn required for a 1 million tonne green field capacity expansion). Cost efficiency plays a critical role in the survival of a company in the sector for which, control over inputs (say raw material) is of utmost importance. India has large resources of high grade bauxite (the basic alumina ore) deposits placing it fifth in the world after Australia, Guinea, Brazil and Jamaica. Major bauxite reserves are concentrated on the East Coast along Orissa and Andhra Pradesh. Today, India's per capita consumption of aluminium is below 1 kg. And while globally there are about 3,000 applications of aluminium, India has only around 300.The capacity for producing aluminium has increased consistently over the past few years. Fortunately, the advantage of having the 5th largest bauxite reserves in the world coupled with cheap and abundant labor helps the Indian companies to retain the distinction of being the lowest cost producers in the world. Globally, the industry is less fragmented when compared with steel and cement. On basis of scale of operations and level of integration, aluminium producers can be categorized into the following two types:
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?
Integrated producers/Primary producers: Integrated producers have presence right from the mining of bauxite (raw material) to producing aluminium ingots (finished product). Some companies may even go a step further and have downstream manufacturing facilities such as manufacturing of semi-fabricated products (foils). Primary producers could either be a company that is just into mining of bauxite and alumina production or pure aluminium ingot manufacturing. For companies, which have restricted themselves from venturing into the downstream segment, the user industries are basically the secondary producers.
?
Secondary producers: For this segment of producers, which are involved in the production of semi-fabricated products, the raw material is acquired from primary producers, which is in the form of aluminium ingots and billets. The user industries for this segment would be the packaging industry (foils), auto ancillary (wheels), to name a few.
Aluminium products can be classified under three categories. Rolled products find applications in automobiles, consumer durable, construction and engineering sectors. Extrusions include bars, pipes and tubes that find usage in the electrical and the transportation sectors. Finally, foils are used in the packaging sector, which are high-value products and have higher margins.
1.2 SALIENT FEATURES OF INDIAN ALUMINIUM INDUSTRY
? ? ? ? ? Highly concentrated industry with only five primary plants in the country. Controlled by two private groups and one public sector unit. Bayer – Hall-Herault technology used by all producers. Electricity, coal and furnace oil are primary energy inputs. All plants have their own captive power for cheaper and un-interrupted power
supply. ? ? ? ? ? ? Energy cost is 40% of manufacturing cost for metal and 30 % for rolled products. Plant have set internal target of 1-2% reduction in specific energy consumption in the next 5-8 years. Energy management is a critical focus energy policy. Two plants have declared formal energy policy. Each plant has an energy management cell Achievements in energy conservation are highlighted in the Annual Report of the company.
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Working Capital Management at NALCO
?
Energy target are based on the best energy figures achieved in their sector/region and by the plant itself in the past.
? ? ?
Generally, government policies are related as conducive to energy management. ‘Task force’ formed by BEE in their sector to work as catalyst in promoting energy efficiency. High cost of technology is the main barrier in achieving high-energy efficiency.
1.3 Nalco and it’s Financial performance in a nutshell
NALCO is considered to be a turning point in the history of Indian aluminum industry. Nalco has not only has addressed the need for self-sufficiency in aluminum but also given the country a technological edge in producing this strategic metal to the best of world standard. NALCO was incorporated in 1981 as a public sector. This has emerged as the largest integrated bauxite alumina aluminum complex in Asia. By considering its capacity utilization, technology absorption, quality assurance, export performance & earning profit, Nalco is a bright example of India’s industrial development. Today, as an ISO9001, ISO 14001, OHSAS 18001 co. with its products registered in London Metal Exchange, Nalco has emerged as the largest in integrated bauxite alumina aluminum complex in Asia.
1.3.1 NALCO PROFILE
? ? ? Modern updated technology Integrated operation 9th largest producer of aluminum in the world
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? ? ?
Efficient logistic in transportation International linkage in technology & market Environment friendly operation
1.3.2 CORPORATE STRENGTH
? ? ? ? ? ? ? ? ? ? Captive resources Advanced technology Integrated operation World-class products Well-trained manpower Sound financial mgt Care for Ecology & Environment Self-funded expansion Expertise in project mgt International linkage Technology & Market
1.3.3 FINANCIAL PERFORMANCE OF THE COMPANY
NALCO has remained the forerunner with the best quality of products over the years. Financial results of the company reflect the country’s robust performance in production and marketing. Sales turnover and net profit have grown over the years. The salient features of the financial performances are highlighted below: ? ? Since the inception of the company NALCO is running in profits. Highest profit has been Rs. 614.55 crores in the year 1995-96 as the Aluminium prices remained buoyant. ? From 1992-93 to 1995-96 there has been growth in sales, profit book value, earning per share and net worth. But in 1996-97 the profit was dipped due to dip in international Aluminium prices.
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Working Capital Management at NALCO
?
Though the gross sales, profit and other financial parameters have shown improvement in 1997-98, there has been again dip in the production figure, sales, profit etc. in 1998-99 due to internal problem again introduction of MAT has also affected the bottom line of the company.
?
The debt to equity ratio reduced over the years and the company became a Zero Debt company in the year 1998-99 repaying all its debt. This has prompted the company to appeal government of India for Capital restructuring.
? ?
The return on capital employed and return on net worth have been impressive. Nalco earned a net profit (after tax) of Rs 1,096 crore for the year 2010-11 as compared to Rs 814 crore in the previous year, recording an increase of 31%.
?
The operating cost in 2010-11 was higher by Rs 399 crore, an increase of over 10% from the previous year due to increase in prices of coal, fuel oil and provisioning for wage revision.
?
The profit before tax for 2010-11 was higher because of higher sales realization as compared to the previous year
?
The results of 2010-11 would have been still better, but for the adverse impact of exchange rate of rupee on sales, which made a dent of Rs 159 crore during the year.
?
The depreciation was higher by Rs 103 crore due to commissioning of one more czptive power unit during the year and provision for impairment.
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Fig 1.1 FINANCIAL PERFORMANCE
7000 6000 5000 4000 3000 2000 1000 0
NET PROFIT
TOTAL INCOME
Fig 1.2 Net Worth In Crores
Net Worth
12000 10000 8000 6000 4000 2000 0 2006-07 2007-08 2008-09 2009-10 2010-11
Net Worth
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1.4 Objectives
i. ii. iii. iv. v. To find out the working capital of NALCO and understand its significance. To find out the Financial Ratios of Nalco and understand their interpretation.
Examining the efficiency of NALCO in the managing it’s working capital. Use of Regression analysis to find out a relation between Working Capital and PBT.
Use of Correlation to find out the impact of various measures of Working Capital on Profitability.
1.5 Assumptions
i. Financial data used in this report has figures which have been rounded to the nearest decimal points hence might not tally at some places.
2. Methodology
Secondary data, especially the annual reports of NALCO has been used in all financial analysis and certain information recorded in the report has been through the interactions with my coordinator, senior employees at the branch and professionals with rich experience in the field. In my assessment, both qualitative and quantitative have been used, to draw conclusions. I have divided my project work into the following sections to have a better understanding of my work at Nalco. a) Finding of the working capital of NALCO and understand its significance. b) Finding of various Financial ratios of NALCO. c) Use of Statistical tools to better understand the relationship between working capital and profitability. d) Providing Interpretations, suggestions and drawing conclusions.
3. Working Capital management of NALCO
3.1 Cash Management of NALCO
Cash management is concerned with the managing of: i) ii) iii) Cash flows into & out of the firm Cash flows within the firm Cash balance held by the firm at a point of time by financing deficit or investing surplus of cash.
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The Organization needs cash for the following reasons: 1) Transaction Motive
2) Precaution Motive
3) Speculative Motive
It can be represented by a cash management cycle
Cash collection
Business Operation
Deficit
Information & Control
Borrows Invest
Surplus
Cash payments
Fig 3.1 Cash Management Cycle
Cash management of NALCO, focuses on the following aspects: ? ? ? Cash Budgeting Long-term cash forecasting Monitoring collections & receivables
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? ?
Optimal cash balance Option for investing surplus of funds
Cash budgeting or short-term cash forecasting is the principal tool of cash management. Cash budget, routinely prepared by NALCO, are helpful in: ? ? ? ? ? ? Estimating cash requirements Planning short-term financing Scheduling payments in connections with capital expenditure project Planning purchases of materials Developing credit policies Checking the accuracy of long-term forecasts.
The key areas of effective cash management of NALCO are:
a)
Identifying the requirements of funds at various units
b)
Investment of surplus funds productively
c)
Repayment of Loans
d)
Proper capital expenditure
e)
Standardized reporting system
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3.2 Inventory Management of NALCO
Inventory constitutes the most significant part of the current assets of large majority of companies in India. On an average, inventories are approximately 60% of current asset in public limited companies in India. Because of the large size of the inventories maintained by firms, a considerable amount of funds are required to be committed to them. It is, therefore very necessary to manage inventories efficiently & effectively in order to avoid unnecessary investments. A firm neglecting the management of inventories will be jeopardizing its long run profitability & may fail ultimately. The purpose of inventory management is to ensure availability of materials in sufficient quantity as and when required and also to minimize investment in inventories. It is possible for a company to reduce its level of inventories of a considerable degree, without any adverse effect on production & sales, by using simple inventory planning & control techniques. The reduction is excessive inventories which carries a bad impact on a company’s profitability.
3.2.1 Types of Inventories:
1. 2. 3. 4. Raw Materials Work in progress Finished Goods Cash and marketable securities.
3.2.2 Need to hold Inventories:
There are four general motives for holding inventory: ? ? ? ? Transaction Motive Precautionary Motive Speculative Motive Contractual requirements
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3.2.3 Functions of Inventory in NALCO
? ? ? ? ? ? ? ? To meet anticipated demand To smooth production requirement To decouple operations To protect against stock-outs To take advantage of order cycle To help hedge against price increases To permit operations To take advantage of quantity discounts
3.2.4 Objectives of Inventory Management in NALCO
? ? ? ? ? ? ? To ensure continuous supply of materials, spares & finished goods. To avoid both over-stocking & under-stocking of inventory. To maintain investments in inventories & the optimal level as required by the operational & sales activities. To keep material cost under control so that they contribute in reducing cost of production & overall costs. To eliminate duplications in order or replenishing stocks. This is possible with the help of centralizing purchases. To minimize loses through deterioration, pilferage wastage and damages. Clear cut accountability should be fixed at various level of organization.
3.2.5 Effective Inventory Management
? ? ? ? A system to keep track of inventory A reliable forecast of demand Knowledge of lead times Reasonable estimates of a) Holding cost b) Ordering costs c) Shortage costs
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?
A classification system
3.2.6 INVENTORY MANAGEMENT TECHNIQUES ADOPTED BY NALCO
In managing inventories the firm’s objectives should be in consonance with the wealth maximization principle. To achieve this firm should determine the optimum level of inventory. A proper invention control not only serves the acute problem of liquidity but also increases profits & cause substantial reduction in the working capital of the concern. Following are the tools & techniques of inventory management adopted by NALCO: ? ? ? ? ? Economic order quantity ABC Analysis XYZ Analysis FSN Analysis Perpetual Inventory system I. Raw materials – that consists of CP coke, CT pitch, aluminum fluoride, Pig iron, HFO Alumina and anodes for smelter and coal, HFO, LDO for NALCO and caustic Soda, Alum, Lime, CGM etc. for Alumina plant and it has not faced a situation like out of stock of raw materials during the recent past. II. Stores & Spares – At the time of procurement of the machinery, generally some spares are procured for immediate maintenance, which is directly linked to different equipments. These spares are known as instance spares and most of these items are of high value. III. Intermediary goods – It consists of Green Anodes, Banked Anodes, Rodded Anode, Anode Stem, etc. for which NALCO has installed its own plants for producing the Green and Baked Anodes and imports them only when there is shortage. IV. Finished Goods – That consists of Bauxite, Aluminum Hydrate, Alumina, Aluminum Ingots, Sow Ingots, Billets, Wire rods sheets etc. the finished products of NALCO move fast hence the stock of finished goods are very less in company. The company also effectively reduces the rejected inventory. The rejected inventory in NALCO comprises of anode butts and rejected finished products. Anode rejects are recycled and reused in the process while finished stocks rejects are either recycled or sold at lower prices. The company is exercising good control to minimize the rejects.
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3.3 RECEIVABLE MANAGEMENT
? ? ? ? ? ? ? ? ? It refers to the decisions taken by the management, when a firm sells its products or services on credit. In formulating an optional credit policy, finance manager must analyze the following aspects of credit management: Terms of payment Credit policy variables Credit evaluation Credit grating decision Control of accounts receivable In this project, we will investigate the techniques, which a company may employ to determine an optimum credit policy. Once an optimum credit policy is determined, the finance manager must ascertain the effect it will have on the company’s current asset requirements.
3.3.1 Receivable Management in NALCO
Nalco has set up its marketing office in India i.e. Mumbai, Kolkata, New Delhi, Chennai, Bangalore and Pondichery. These marketing offices obtain sale order from aluminum users in India as well as globally. On the basis of order received for different products it makes product planning of different products i.e. sow, Ingots, billets, wire etc and accordingly advices production planning at production units. Marketing office also sends dispatch instruction to dispatch section, which indicates various commercial terms i.e., product requirement, mode of dispatch, payment terms etc. The function of Dispatch department is to receive finished products from production department and segregate it on the basis of its laboratory analysis and grade. It keeps account of the various grades of finished products received by them. As per the sale order dispatch instruction received from the marketing office for export/domestic sale the dispatch department segregates and prepares the materials for dispatching the same by Rail. The material is handed over to the transporter. On the completion of dispatch of the consignment as per dispatch advice, the dispatch department sends the entire dispatch department sends all the dispatch documents with delivery invoice& copy of L.R to the finance department. On the basis of this finance department makes commercial invoice which takes care of taxes and other duties over and above the cost of product and sends it to the marketing office which may be in the form of Banker’s cheque, bank draft or in the form of letter of credit
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Working Capital Management at NALCO
opened by the buyer. The buyer opens a letter of credit with its banker. On completion of dispatch, on the basis of commercial invoice and proof of dispatch, on the basis of commercial invoice and proof of the dispatch the money is realized by the NALCO’S banker from the buyer’s bank.
4. CALCULATION OF GROSS OPERATING CYCLE PERIOD FOR 2010-2011.
4.1 Raw material conversion period
Raw material Inventory * 365
Raw material consumptions
=
614.56 * 365 766.12
= 292 days Raw material Inventory = Raw materials + Coal & fuel oil + Stores and spares
92.16+95.88+426.52 = 614.56
4.2 Work-in-progress conversion period=
Work-in-progress Inventory * 365 Cost of Production
Cost of Production = Op. FG + Factory Cost + Administration Exp. – Closing FG
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Working Capital Management at NALCO
Factory Cost = Op. WIP+ Raw material Consumed+ Power & Fuel + Repairs & Maintenance + Manufacturing Exp. – Cl. WIP Cost Of Production = Rs. 3373.88
WIP conversion period =
141.50*365 3373.88 = 15 days
4.3 Finished Goods Conversion Period = Finished goods inventory * 365 Cost of goods sold
Cost of goods sold = Cost of production + Op. Finished goods inventory- Cl. Finished goods inventory = 3373.88+142.06-214.72 = Rs. 3301.21 Finished Goods Conversion Period = 214.72 * 365 3301.21 = 35 Days
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Working Capital Management at NALCO
4.4 Debtor Conversion Period
Debtors *365 Credit sales
=
112.40 * 365 6369.88
= 6 Days
4.5 Payment Deferred Period
Creditors *365 / Credit Purchase
Payment Deferred Period =
2170.8* 365 3341.31 = 237 days
Net Operating Cycle = Gross Operating Cycle- Payment Deferred Period
Gross Operating Cycle = Inventory Conversion Period + Debtors Conversion Period
Inventory Conversion Period = Raw material+ Work-in- progress+ Finished goods
For 2010-11 = (292+15+35+06-237) = 111 Days
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Working Capital Management at NALCO
5. CALCULATION OF GROSS OPERATING CYCLE PERIOD FOR 2009-10
5.1 Raw material conversion period
Raw material Inventory * 365
Raw material consumptions
=
576.11 * 365 782.30
= 268 Days
Raw material Inventory = Raw materials + Coal & fuel oil + Stores, Spares & Others
= 64.57 + 88.64 + 422.90 = 782.30 units
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Working Capital Management at NALCO
5.2 Work-in-progress conversion period
Work-in-progress Inventory * 365 Cost of Production
Cost of Production = Op. FG + Factory Cost + Administration Exp. – Closing FG Factory Cost = Op. WIP+ Raw material Consumed+ Power & Fuel + Repairs & Maintenance + Manufacturing Exp. – Cl. WIP
= 114.74+782.30+1601.14+296.37+210.78-146.32 = Rs. 2859.01 Cost Of Production = 131.91 + 2859.01 + 115.29 – 142.06 = Rs 2964.15
WIP conversion period =
146.32 *365 2964.15
=
18 days
5.3 Finished Goods Conversion Period
Finished goods inventory * 365 Cost of goods sold
Cost of goods sold = Cost of production + Op. Finished goods inventory- Cl.Finished goods inventory
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Working Capital Management at NALCO
= 2964.15+131.91-142.06 = Rs.2954 Finished Goods Conversion Period 142.06 * 365 2954 = 17 Days
5.4 Debtor Conversion Period
Debtors *365 / Credit Sales Debtors conversion period = = 181.66 * 365 5311.40 = 12 Days
5.5 Payment Deferred Period
Creditors *365 / Credit Purchase Payment Deferred Period = 1757.03* 365 3018.14 = 212 Days
For 2009-10 = (268+18+17+12-212) = 103 Days For 2010-11 = (292+15+35+06-237) = 111 Days
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Working Capital Management at NALCO
5.6 Interpretation
The gross operating cycle period in the year 2010-11 is comparatively longer than the year 2009-10 which is not good for the business. It implies that locking up of funds in current assets is for a relatively longer duration and NALCO can obtain greater mileage for each rupee invested in current assets. The longer the duration of operating cycle period, slower is the transformation of current asset into cash. Here raw materials include raw materials along with stores & spares. The Raw material conversion period has increased from 268 days in 2009-10 to 292 days in 2010-11 which shows a poor raw materials management by NALCO in the 2010-11. Work-in-progress conversion has decreased from 18 to 15 days. Finished goods conversion period is increased from 17 days in 2009-10 to 35days in 2010-11. Debtors’ conversion period decreases from 12 days in 2009-10 to 6 days in 2010-11. NALCO gives its debtor a period of 15 days to repay the debt. This shows that Nalco has shown improvement in getting back money from its debtors. The payment-deferred period is increased from 212 days in 2009-10 to 237 days in 2010-11 indicating that NALCO is able to get a wider time window to pay back to its creditors. From the above data we can interpret that NALCO is managing its operating cycle in an efficient manner. But we can also see that the finished goods are lying in the go-down or stores for along period of time which results in blocking the money for that number of days. NALCO should concentrate more in that area so that the finished goods get sold off quickly.
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6. NALCO’S FINANCIAL RATIOS
RATIO ANALYSIS Ratio Analysis is one of the powerful tools for financial analysis. I have studied and analyzed the following ratio of NALCO. a) Liquidity Ratios
b)
Cash Ratio
c)
Activity Ratios
6.1 Liquidity Ratios :
6.1.1 Current Ratio
Current Ratio = Current Assets Current Liabilities
2004-05 CR =
1,811.04 806.39
= 2.246
2005-06 CR =
3,297.88 940.15
= 3.50
2006-07 CR =
4794.08 1218.61
= 3.9340
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Working Capital Management at NALCO
2007-08 CR =
5041.33 1540.88
= 3.2720
2008-09 CR= 2009-10CR=
4224.06 /1216 5022.03 /1342
= 3.4737 =3.7421 = 2.2055
2010-11CR= 6045.17/2740.95
We can state that the ratio has been increased. Current assets are more than current liabilities, although 2011 has shown a slight decrease in current assets, hence we can state that NALCO has greater margin of safety. NALCO is in a better position to meet the obligations.
6.1.2 Quick ratio
Quick Ratio = Current assets- Inventories Current liabilities
3,297.88-591.58 2005-06 QR = 940.15
2,706.30 = 940.15 = 2.88
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Working Capital Management at NALCO
4974.08- 634.96 2006-07 QR = 1218.61 5041.33- 1318.31 2007-08 QR = 1540.88 2008-09QR= 4224.06- 646/ 1216 2009-10QR= 5022.03- 450 /1342 2010-11QR= 6045.17-1058.47/2740.95 = 2.94 = 3.4 =1.81 = 2.826 = 3.56
Inventory is a slow moving item. It does not get converted into cash quickly. Therefore it is left out of the fast moving assets and then the liquidity of the company is calculated. We can see that the company did not have a good liquid position during 2003-04 but it improved in the year 2009-10. But 2010-2011 saw a drastic reduction in the ratio due to huge rise in the level of inventory.
6.2 Cash Ratio
Cash Ratio = Cash + Marketable Securities Current liabilities 2,193.71 + 0 2005-06 CR = 940.15 = 2.333
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Working Capital Management at NALCO
3686.53 + 0 2006-07 CR = 1218.61 = 3.025
3516.46 + 0 2007-08 CR = 1218.61 2008-09 CR= 3224.35 + 0 /1216 2009-10 CR= 3321.78 +0 / 1342 2010-11CR= 3795.23+0/2740.95 = 2.651 = 2.475 =1.384 = 2.885
Cash ratio is useful in measuring the capability of the company in meeting its current liabilities. We can see that the company is quite able to meet the obligations of the liabilities effectively. In 2010-11, the ratio has decreased due to increase in current liabilities (Increase in lending to micro enterprises).
6.3 ACTIVITY RATIOS:
6.3.1 Debtors Turn over Ratio
Debtors Turnover Ratio = Net Sales Debtors 4988.80 2007-08 DTR = 60.65 = 82.24
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Working Capital Management at NALCO
2008-09 DTR = 2009-10 DTR = 2010-11 DTR=
5094.52 /26.50 5055.66 /181.78 5958.98/112.40
=192.24 =27.81 =53.015
This ratio indicates the velocity of debt collection of a firm. In simple words it indicates the number of times average debtors (receivable) are turned over during a year. In 2009-10 there was a drastic fall in the figure due to many fold increase in debtors while net sales was more or less constant but in 2010-11 there has been an improvement in this figure.
6.3.2 Average Collection period (ACP)
This gives the number of days it takes to get back all the debt amount from the debtors. ACP = 365/ DTR 2007-08=365/82.24 = 4.43days 2008-09=365/192.24=1.89days 2009-10=365/27.81=13.12 days 2010-11=365/53.015=6.88 days The ACP has reduced in 2010-11 from that of previous years, from which we can state that NALCO has adopted a good cash collection system.
6.3.3 Inventory Turnover Ratio (ITR)
Stock turn over ratio/Inventory turn over ratio indicates the number of time the stock has been turned over during the period and evaluates the efficiency with which a firm is able to manage its inventory. Cost of goods sold ITR = Average inventory
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Working Capital Management at NALCO
1,766.97 2005-06 = 529.06+591.58/2 1,766.97 = 560.32 1,766.97 2006-07 = 529.06+591.58/2 1,766.97 = 560.32 = 3.15 2,497.53 2007-08 = 686.65+634.96/2 = 3.78 = 3.15
2008-09 = 6514.51 /634.96 = 10.26 2009-10 = 5474.45 /686.65 = 7.98
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Working Capital Management at NALCO
2010-11 =4199.8/1001.695=4.192 The ITR shows a decline in 2009-10 and 2010-11 signifying decrease in profitability and decrease in the return form every rupee invested in inventory. Nalco should try and increase its ITR by either reducing inventory levels or by increasing its sales through marketing and providing more credit to its customers to boost sales.
6.3.4 Working Capital Turnover Ratio (WCTR)
It indicates the velocity of the utilization of net working capital. This ratio represents the number of times the working capital is turned over in the course of year. Sales WCTR = Net Working Capital
4,851.90 2005-06 WCTR = 2,357.73 5940.19 2006-07 WCTR = 3755.47 4988.80 2007-08 WCTR = 3500.45 = 1.42 = 1.58 = 2.05
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Working Capital Management at NALCO
2008-09 WCTR= 2009-10 WCTR = 2010-11 WCTR=
5094.52/2595.57 5055.66/2998.3
=1.96 =1.68
5958.98/3304.22 =1.80
Hence, WCTR has increased in 2010-11 as compared to 2009-10 indicating better working capital management by NALCO.
7. Relationship between Working capital and Profitability – A statistical Analysis
Theoretically, leaving other things constant, level of investment in current assets has a bearing on the profitability of the firm. Excess of investment in working capital casts a negative impact on the profitability of a firm and positive impact on the liquidity. Studies on the association of level of investment in current assets and the profitability have always claimed inverse relationship in the research on the degree of association both at micro and macro levels. Let us have a glance on the impact of investment in various current assets on the profitability theoretically. TABLE 7.1 Theoretical relationship between measures of working capital and profitability Current Assets Cash Excess As non earning assets reduces profitability. Shortage Causes liquidity crisis by lagging in payments, disruption of operations, ultimately affecting the overall turnover and profits. Receivables Cost of Collection efforts, Default risks, low profitability . Inventory Opportunity cost of funds, price declines, carrying costs adversely affect profits Interrupted production schedules, limited supplies, lower turnover and profits Lower turnover, lower profitability
Theoretically working capital decision affects both liquidity and profitability. Excess of Investment in working capital may result in low profitability and lower investment may result in poor liquidity. Management need to trade-off
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Working Capital Management at NALCO
between liquidity and profitability to maximize shareholders wealth. To understand the impact of working capital on profitability, one needs to establish the relationship between these two. Statistical Measures such as correlation and regression models can be used to understand such relationship. The level of working capital needed by a firm is a function of nature of the industry, size of the firm, availability of raw materials, production cycle of the firm, Production policy of the firm, nature of demand for the products, competition in the industry etc. ,f(WC) = {N, Q, R, Pc, Pp, D, and C….n} Where WL is the level of working capital Q = Size of firm R= Availability of Raw-material Pc= Production Cycle of the firm Pp= Production policy of the firm D= Nature of demand for the products of the firm C= competition in the industry The list of factors is exemplary but not exhaustive. There can be differences in the investment in various types of current assets. For example, firms in services industry have negligible size of investment in stores but considerable size of investment in cash and receivables whereas manufacturing firms invest comparatively large sums in inventories. Optimum level of working capital is investment decision in current assets that varies with the risk-return preferences of firms. Conservative firms are risk averse and satisfy with the available profitability at lowest risk and aggressive firms prefer high profitability even for higher risk.
7.1 Regression Analysis
Let us subject Working capital and PBT (Profit Before Tax) to a linear regression model to find out a relation between them and determine an equation to find out the optimal level of working capital required for a particular projection of sales.
Y=a+bX.
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Working Capital Management at NALCO
Where Y=working capital. X=PBT. a=the intercept of line on the Y-axis. I.e., the Amount of working capital required when sales are Nil. 7.1.1 Year wise data on PBT and corresponding Working capital
Year 2011—2010 2010-2009 2009-2008 2008-2007 Working Capital in Crores 3304.22 2998.32 2595.57 3500.45 PBT in Crores 1524.7 1154.86 1272.27 1631.52
Upon doing regression analysis we get the following output: Regression Statistics Multiple R R Square Adjusted R Square Standard Error Observations 0.451114 292.2611 4 0.796289 0.634076
Standard Coefficients Error t Stat P-value
Lower 95% -
Upper 95%
Lower 95.0% -
Upper 95.0%
Intercept
1108.608 1079.455 1.027008 0.412394
3535.91 5753.127 -
3535.91 5753.127 1.87037 4.723182
Pbt
1.426406 0.766219 1.861616 0.203711
1.87037 4.723182
This suggests that their exists a ‘R’ value of 0.634076 between Working Capital and PBT.
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Working Capital Management at NALCO
The equation comes out to be: Working Capital= 1108.608 + 1.4264065 *PBT Using this equation we can predict the optimum amount of working capital required for a particular projected value of PBT so that neither there is a blockage of cash in the operating cycle, lowering of profitability, increase in opportunity costs neither there is a shortage of working capital.
PBT Line Fit Plot
4000 3500 Working Capital 3000 2500 2000 1500 1000 500 0 1524.7 1154.86 PBT 1272.27 1631.52 Working Capital Predicted Working Capital
Fig 7.1.1 PBT Line Fit Plot The above plot shows that there was an excess of working capital in the year 2008 and 2010 while there was a shortage of working capital in 2009. But the amount of working capital seems to be optimum during the year 2011.
7. 2 Correlation between various measures of working capital and Profitability
To understand the correlation between profitability and Working capital we will consider 1. 2. 3. 4. Inventory ( As a percentage of total current assets) Sundry debtors ( As a percentage of total current assets) Cash and Bank Balance ( As a percentage of total current assets) Other current assets ( As a percentage of total current assets)
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Working Capital Management at NALCO
5.
Loans and advances (As a percentage of total current assets)
For the purpose of finding the correlation between the previously mentioned measures of working capital and PBT, as a measure of profitability, we will consider the data of previous four financial years namely 2010-11,2009-2010, 2008-09,2007-08. i) Inventory year 2010-11 2009-10 2008-09 2007-08 Inventory 1058.47 944.92 841.9 686.65 PBT 1524.7 1154.86 1272.27 1631.52
Table 7.2.1 Year wise data on PBT and corresponding Inventory Correlation = -0.321055656 ii) Sundry debtors year 2010-11 2009-10 2008-09 2007-08 Sundry debtors 112.4 181.78 26.5 60.65 PBT 1524.7 1154.86 1272.27 1631.52
Table 7.2.2 year wise data on PBT and corresponding Sundry debtors Correlation = -0.409842187
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Working Capital Management at NALCO
iii)
Cash and Bank Balance
Cash and Bank year 2010-11 2009-10 2008-09 2007-08 balance 3795.23 3152.35 2869.04 3516.46 PBT 1524.7 1154.86 1272.27 1631.52
Table 7.2.3 Year wise data on PBT and corresponding cash and Bank balance Correlation = 0.758762 iv) Other Current Assets Other current year 2010-11 2009-10 2008-09 2007-08 assets 163.84 145 175.35 236.47 PBT 1524.7 1154.86 1272.27 1631.52
Table 7.2.4 Year wise data on PBT and corresponding other current assets Correlation= 0.77411463
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Working Capital Management at NALCO
v)
Loans and advances Loans and year 2010-11 2009-10 2008-09 2007-08 advances 915.23 785.59 616.02 541.1 PBT 1524.7 1154.86 1272.27 1631.52
Table 7.2.5 Year wise data on PBT and corresponding Loans and Advances Correlation = -0.179395163
8. LIMITATIONS
1. This study is carried on the basis of the data available for NALCO Ltd, during the period 2005-2011. The study is confined to understanding the relationship between working capital and profitability of the case using Profit Before Tax (PBT) as a measure of profitability and the most common measures of working capital. Results of the tests cannot be generalized to other companies in the manufacturing industry . 2. In regression analysis we have found an equation relating working capital and Profit before tax. This model does not incorporate many other qualitative factors which are hard to quantify on which Working capital depends like size of firm, availability of Raw-materials, production Cycle of the firm, production policy of the firm,
nature of demand for the products of the firm, competition in the industry .
9. CONCLUSIONS AND RECOMMENDATIONS
1. The current ratio has increased. Current assets are more than current liabilities, although 2011 has shown a
slight decrease in current assets, hence we can state that NALCO has greater margin of safety. NALCO is in a better position to meet the obligations. Hence Nalco should maintain this ratio to be able to meet its obligations.
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Working Capital Management at NALCO
2. 2010-11 saw a drastic decrease to 1.81 in the quick ratio due to huge rise in the level of inventory. Nalco
should improve its quick ratio by decreasing its level of inventory to a desired level as unnecessary inventory chokes cash.
3. Nalco’s cash ratio has been quite healthy in the previous years but 2010-11 saw a decrease in it due to
increase in current liabilities of which small enterprise lending formed a major part. Unless the return on its lending is good, Nalco should reduce lending to small and micro enterprises.
4. In 2009-10 there was a drastic fall in the DTR due to many fold increase in debtors while net sales was more
or less constant but in 2010-11 there has been an improvement in this figure.
5. The ACP has reduced in 2010-11 from that of previous years, from which we can state that NALCO has
adopted a good cash collection system.
6. The ITR shows a decline in 2009-10 and 2010-11 signifying decrease in profitability and decrease in the return form every rupee invested in inventory. Nalco should try and increase its ITR by either reducing inventory levels or by increasing its sales through marketing and providing more credit to its customers to boost sales.
Using Regression analysis we were able to find out an equation which can be used to find out the optimum level of working capital required considering a projected PBT. Since the equation has used historical data, therefore while forecasting Working capital requirements other qualitative aspects should be taken into consideration like competition in the market, availability of raw materials, nature of demand in the market etc.
7. Correlation analysis showed that there existed a negative correlation between inventory, sundry debtors
and loans and advances with that of PBT, while a positive correlation existed between cash and bank, other current assets with that of PBT. Hence, NALCO should refrain from investing too much in inventory or lending to small and micro enterprises to prevent reduction in its profitability.
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Working Capital Management at NALCO
10. ANNEXURE- 1 The Indian Aluminium Industry- A detailed View
INDIAN INDUSTRY PLAYERS The Indian aluminum sector is characterized by large integrated players like Hindalco and National Aluminum Company (Nalco). The other producers of primary aluminum include Indian Aluminum (Indal), now merged with Hindalco, Bharat Aluminum (Balco) and Madras Aluminum (Malco) the erstwhile PSUs, which have been acquired by Sterlite Industries. Consequently, there are only three main primary metal producers in the sector. Hindalco Industries Limited, a prestigious part of Aditya Birla Group, enjoys a leadership position in Indian aluminium and copper industry. It is the world's largest aluminium rolling company and not to forget one of the biggest producers of primary aluminium in Asia with a market share of 48%. The group differentiated as one of the lowest cost producers of aluminum in the world. They excel in the premium category as they hold 58% of sales in the value added category. They have an installed capacity of 445,000 t pa. Incorporated in 1981, as a public sector enterprise of the Government of India, National Aluminium Company Limited (Nalco) is Asia's largest integrated aluminium complex, encompassing bauxite mining, alumina refining, aluminium smelting and casting, power generation, rail and port operations. Commissioned during 1985-87, Nalco has emerged to be a star performer in production and export of alumina and aluminium, and more significantly, in propelling a self-sustained growth. It had an installed capacity of 3,45,000 T of Aluminum metal and produced 3, 58,954 T of the same. Bharat Aluminium Co. Ltd. (BALCO) was incorporated in the year 1965 as a Public Sector Undertaking (PSU). It is the first public sector enterprise in the country which started producing aluminium in 1975. In the year 2001, GoI divested 51% equity and management control in favor of Sterlite Industries (I) Limited which had capacity of 200,000 tpa of calcined alumina, 350,000 tpa of aluminium metal and 810MW power plants. The company has an integrated Aluminium complex at Mettur comprising 40,000 tpa of Aluminium smelter, 80,000 tpa refinery, CPP of 75 MW and associated metal casting and fabrication facilities.
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Working Capital Management at NALCO
.Madras Aluminium Company Ltd. (MALCO) has its own Bauxite reserves in the state of Tamil Nadu – 1.7 million tones. The company has an integrated Aluminium complex at Mettur comprising 40,000 tpa of Aluminium smelter, 80,000 tpa refinery, CPP of 75 MW and associated metal casting and fabrication facilities.
The consolidation process in the aluminium industry which commenced four years ago, crystallized further in 2000-01 with Hindalco acquiring Indian Aluminium (Indal) and Sterlite Industries absorbing Bharat Aluminium Company (Balco). In the earlier round, Indal acquired Orissa Extrusions and Annapurna Foils, India Foils annexed Light Metal, Century Extrusions took over Sangam Aluminium and Malco Sterlite absorbed India Foils.
? ? ? HINDALCO is expanding its capacity by 100,000 per annum. NALCO is expanding its capacity by 460,000 per annum. NALCO is expanding its capacity by 2.1 million tpa.
BACKGROUND Hindalco's consolidation: After deciding to shelve the green field aluminium project in May 1999, Hindalco's seemed close to losing its pre-eminent position in the industry to Nalco. But in less than a year, it made two key initiatives that pushed it to the top. These were: ? Brownfield expansion: Obviously, the first response after shelving the green field project was to look at Brownfield expansion at its existing plant at Renukoot, UP. After examining the feasibility of such an expansion, Hindalco decided to expand its smelter capacity by 1 lakh tpa to 3.42 lakh tpa, the alumina refining capacity by 2.10 lakh tpa to 6.60 lakh tpa, and a matching increase in captive power generation facilities. ? Acquisition of Indal: Hindalco delivered its masterstroke in the third quarter of March 2000, when it unveiled an agreement to pick up a 54.6 per cent equity stake held by Alcan Aluminium, Canada, in Indian Aluminium (Indal) for Rs 738 crore. It was the largest all-cash acquisition in Corporate India. Nalco's relative strength: As a public sector major, Nalco has not moved as aggressively as its private sector peers Hindalco and Sterlite. But within its limitations, Nalco has created three drivers to earnings growth. Unlike Hindalco, Nalco has all along contemplated the brown field expansion model for growth. The first driver is the expansion of
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Working Capital Management at NALCO
the bauxite mines and alumina refinery to provide inputs to its expansion project for primary metal. The first phase of expansion of alumina refinery was completed in June 2000. The company has also doubled bauxite mining capacity from 2.40 million tones to 4.80 million tones. 2Its second driver was the expansion project involving the enhancement of its smelting capacity from 2.30 lakh tpa to 3.45 lakh tpa, along with an increase in captive power from 720 MW to 840 MW. Since Nalco had no downstream production to create scope for value addition, it decided to create its third engine of growth by taking over International Aluminium Products, a joint venture originally promoted by Mukand, FATA Hunter and Global Emerging Markets, a foreign investor.
Sterlite's acquisition of Balco in March 2001 was in the news and the company paid Rs. 552 crores for 51 per cent stake in the PSE. It is expected that the aluminium business (consisting of Malco and Balco) could be spun off into a separate company. Sterlite stands to gain the bauxite reserves of Balco estimated to be around 12 million tones and 1L ton of primary metal capacity. The acquisition makes Sterlite an integrated player right from bauxite mining (Balco) stage to downstream products such as foils (India Foils).
DOMESTIC MARKET OUTLOOK – CURRENT CONDITIONS Domestic aluminum consumption has been witnessing strong growth spurred by investments and industrial growth. The outlook for future demand remains upbeat as economic activity in key aluminum consuming sectors continue to be fast paced. The electric sector demand growing at 23% during FY06 provided a major push. Aluminum consumption will get further boost from the mega power projects as well as the initiatives announced by the government in the budget for rural electrification. There is substantial investment needed in the sector to meet the country’s current and projected future power requirements which bodies well for aluminium demand. Aluminum consumption in transportation segment expanded at an even higher rate of 32%. Rapidly increasing household income has provided a significant life to the passenger vehicles segment growing at around 20% in the last couple of years. Reduction in the excise duty of small cars will further enhance growth. Improvement in the road infrastructure and increasing economic activity bodes well for commercial vehicles demand. The strong growth of the Indian automobile industry is backed by a vibrant auto component sector which is emerging as a hub for global manufacturing. This has significant potential for domestic aluminum consumption.
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Working Capital Management at NALCO
The building and consumption sector has been witnessing an unprecedented growth all over the country. The broad based economic growth has resulted in rapid urbanization and development of smaller towns. This along with strong business sentiment is boosting demand for commercial properties. Experts forecast shortfall of 19 million houses every year, which can lead to a substantial demand creation for aluminum products. Growing consumer demand has led to shift growth in consumer durables and packaging sectors. This posse’s significant potential for future aluminum consumption. Aluminum prices have risen significantly over the past year and reached 17-year highs of $ 2,634/ MT in Feb. 2006. This has been accompanied by falling inventories and rising costs across the world. Reported primary aluminum stocks have declined to a mere 5 weeks of consumption, while reported total aluminum inventories stand at 8 weeks of consumption, close to the multi-year lows. Importantly, aluminum smelters world wide have been under tremendous cost pressure from rising key input costs like alumina, power, carbon and oil. These factors, along with rising global demand, are anticipated to support aluminum prices above historical levels over the long run. The key consumer industries in India are electrical (power), transportation, consumer durables, packaging and construction. Of this, power is the biggest consumer (about 44% of total) followed by infrastructure (17%) and transportation (about 10%-12%). However, internationally, the pattern of consumption is in favor of transportation, primarily due to large-scale aluminum consumption by the aviation industry. REVENUES Revenues = Volumes * Realizations Volumes Growth prospects of the aluminium industry are a function of economic growth. In the Indian context, economic progress does influence the demand for aluminium, as its user industries like infrastructure, transportation; consumer durables and housing get affected. It must be noted that the consumption pattern of aluminium in India is tilted largely in favor of power and electricity (over 1/3rd of total consumption), as against the world consumption pattern, wherein transportation, especially airlines, have a major role to play. The key application of aluminium across sectors is in products like power transformers, railways, auto industry (components and body building), housing (furnishing), packaging (competition is from tin and plastic) and consumer
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Working Capital Management at NALCO
durable sector (body parts). The industry is also looking at increasing volume sales by presenting itself to the steeluser industries as a good substitute option on the basis of its qualities of strength and lesser weight. Competition On the domestic front, protection from competition is in the form of tariffs, which makes the landed cost of aluminium into the country comparatively expensive vis-à-vis the domestic produce. Investors have to keep in mind that when customs duty falls, threat of imports increases unless domestic producers are competitive. Competition is more global in nature for the sector, similar to other sectors. However, since Indian companies are among the lowest cost producers in the world, pressure of imports is negated to that extent. Indian companies are also protected in the domestic markets from international competition, owing to tariffs imposed on aluminium imports. However, with the government committed to bringing down the tariff levels, companies will have to improve cost efficiencies to protect margins Realizations some factors, which determine the realizations for the company, are: ? London Metal Exchange (LME)
Unlike steel and cement, pricing for aluminium is determined at a global exchange called LME. This serves as a benchmark. Prices are determined depending upon the demand-supply mismatch, which in turn is dependent on the economic cycle. When aluminium prices start firming, in order to cash in on the rise in price, manufactures increase the capacity utilization, which ultimately distorts the demand-supply picture and prices start to weaken. If demand fails to match production, the consequent rise in inventory impacts prices and vice-versa. Domestic prices closely track international price movements. However the volatility on the domestic front is reduced to a certain extent owing to factors like import tariff protection and the absence of fragmentation in the domestic aluminium industry.
?
Player positioning 49
Working Capital Management at NALCO
This factor plays a crucial role in determining the profitability of a company. Since a company can be largely present in the upstream segment or the downstream segment or be an integrated player, the cyclicality of the industry has a varying effect on the performance of the company. For example, a company, which is largely present in the upstream segment, will be prone to volatility. This is because raw material prices increase or decrease depending upon aluminium production. Whereas, a company, which has a significant presence in the downstream segment, margins will be squeezed in a cyclical upturn, as aluminium prices strengthen. The ability to pass on the rise in input costs is relatively less. However, an integrated player is best placed as he has the advantage of captive mining, which will protect its input costs, while its presence in the downstream segment will help it to keep a check on the realization aspect. ? Value added products
Realizations are also dependant to a large extent on the product profile of the company. Companies with a larger presence in value added segments (downstream segment) like extrusions, foils and aluminium wheels are able to realize higher value for their products, which assists margin improvement. EXPENSES As pointed above, in the face of increasing competition, survival would depend on cost efficiency, more so given the commodity nature of the business. Some of the key expense heads pertain to raw material, power, employees and interest cost. Since raw material and power constitute over 50% of the total operating expenses, companies with captive facilities have an added advantage. Employee expense is the next big contributor with a share of 12%-15% of the total operating expenses. If the company has presence in mining, employee requirements tend to be on the higher side. Freight is another important cost, which is dependent on the company's proximity to the raw material source and also to customers. Finally, as aluminium companies are capital-intensive in nature and have significant exposure to debt, managing interest cost is of utmost importance.
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Working Capital Management at NALCO
11. Annexure- 2
NALCO- A Holistic View
VISION TO BE A COMPANY OF GLOBAL IN THE ALUMINIUM SECTOR. MISSION TO ACHIEVE GROWTH IN BUSINESS WITH GLOBAL COMPETITIVE EDGE PROVIDING SATISFACTION TO THE CUSTOMER, EMPLOYEES, SHAREHOLDERS & COMMUNITY AT LARGE Environment Nalco assigns high importance to promotion & maintenance of a pollution-free environment in all its activities. The environment Mgt system in all production units conform to the ISO 14001 norms. Among numerous recognitions, the two highest national awards viz. Indira Priyadarshini Vrikhamitra for a forestation & Indira Gandhi Paryavaran Puraskar for environment Mgt, conferred on the co. by the ministry of environment & forests, Govt of India, bear further testimony to Nalco’s commitment towards the environment. Nalco assigns high importance to promotion & maintenance of a pollution free environment in all its operation
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Working Capital Management at NALCO
Nalco has set the following objectives regarding the environment management:? ? ? ? To use non-polluting & environment friendly technology in all its industrial activities. To monitor regularly air, water, land, noise & other environmental condition. To constantly improve the standards of pollution control & provide a leadership in management. To develop an awareness of environmental responsibilities among the employees. environmental
To work with Govt. & local authorities to help, prevent & minimize the adverse consequences of the industrial activities on the environment.
Community care The co. has adopted a policy of playing a catalytic role in improving the of life of the people living in the peripheral villages, in collaboration with local Govt. authorities. The activities include—creation of infrastructure for communication, education, and health care, water supply, apart from undertaking social forestry, organizing rural sports & supporting cultural activities.
MILE STONES OF NALCO 1981 – Foundation of Company 1985 – Start of Commissioning 1987 – Commencement of scale of Metal 1988 – Commencement of Alumina Export 1992 – Commencement of metal export. 1995 – An ISO 900 Company
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Working Capital Management at NALCO
Achievements of NALCO 1. 2. 1st MINES SAFETY AWARDED IN 1988. Best eco-friendly award for the year 1994-95 to the mines & refinery complex by the state of Orissa Safety Award Committee. 3. 4. 5. 6. 7. 8. 9. 10. Indira Priyadarshini Vrikshyarnitra Award 1994 from MOFF, Govt of India to the company for eco-friendliness. FICCI Environment Award for environment conservation 1996-1997. WEC-IIEE-IAENP Environment Award for contributing towards environment protection around NALCO. Gem-Granite Environment Award 1997-98 by FIMI N.D. Pollution control excellence award by the state of Orissa Pollution Control Board. Special Commendation Award under Golden Peacock Environment Management Award. 1998 scheme by World Environment Foundation. EEPC (All India) Star performance Award for outstanding contribution to Engineering Exports in Large Enterprise Group. 11. 12. 2010 IIM-Non-ferrous best performance award in category of large integrated production organization. 1st prize in the aluminium sector at the National Energy Conservation Awards-2010, instituted by the Ministry of power, Govt. of India. 13. 14. 15. CSR Award for the Best Practices under the ‘Global HR Excellence’ category at the world HR congress. DPE Best listed CPSE Award for its excellent performance in significant value addition to its shareholders. EEPC(Eastern Region’s) Gold Trophy, as top exporter in the large Enterprise category.
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Working Capital Management at NALCO
M Inbound Logistics Operations Outbound Logistics Marketing & Sales Service A R M Fig 11.1 FIRM INFRASTRUCTURE HUMAN RESOURCE MANAGEMENT TECHNOLOGY DEVELOPMENT PROCUREMENT A R G I n
PORTER’S GENERIC VALUE CHAIN
Based on the Porter’s value chain I have tried to analyze the value chain of Nalco. The value chain is a systematic approach to examining the development of competitive advantage. The chain consists of a series of activities that create and build value. They culminate in the total value delivered by an organization. The organization is split into 'primary activities' and 'support activities.' I would be discussing the entire value chain of Nalco in the following heads. PRIMARY ACTIVITIES Inbound Logistics – it involves procuring the raw materials from the supplier’s and distributing it to the manufacturing departments respectively. The basic raw material that is Bauxite comes from the Captive mines itself. Bulk of the purchase of raw materials is from India and sometimes they outsource materials from foreign countries like China, Australia, America, and France. All imports land in their private ports at
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Working Capital Management at NALCO
Kolkata and Vizag. They transport the bauxite from mines to production houses in 15 km automatic conveyor belts. Operations – it emphasizes on the methods and processes involved in conversion of raw materials to finished goods. The process of reaching to aluminum involves the following steps: Fig 11.2 The conversion of Bauxite to Aluminium
REFINERY BAUXITE ALUMINA SMELTER ALUMINIUM
2.9 Tones of Bauxite give us 1 Tone of Alumina and 1.9 Tones of Alumina gives 1 Ton of Aluminum. So the ratio becomes 2.9: 1.9: 1 respectively. ? ? ? ? ? Nalco has bauxite mines at Panchpatmalli It has Alumina Refinery at Damanjodi It has Smelter plant at Angul It has Captive Power Plant at Angul It has port facilities at Vishakhapatnam
Outbound Logistics – Nalco has warehouses in all of its various regional offices like Mumbai, Chennai, Bangalore, Jaipur, Vizag, Kolkata, and Daman and other places. They send mostly bulk Alumina and that goes by train. Aluminum is transported to warehouses both by train and road carriage facility. Marketing and sales – they believe in and rather the product requires bulk marketing system for Alumina. They call in for tenders and thus the process of sales follows. For Aluminum they go in for spot and long term contacts. For long term contracts they again call in for tenders Service – Nalco as such doesn’t have in after sales department but they believe in maintaining a good relationship with their customers. They give in assured guarantee of product purity of 99.7 % in Aluminum and alumina below 45
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Working Capital Management at NALCO
microns. They never hesitate in replacing any product if defaulted but they assure rare chances of it also as the products are always tested before release. The company has also achieved zero discharge of industrial effluents.
SECONDARY ACTIVITIES Firm infrastructure – the company has been allotted with mining lease of Pottangi Bauxite deposits with estimated reserves of 69 million tones. Government has provisionally allotted Utkal E – Coal Block at Talcher, Orissa. Nalco has a aluminum capacity of 48 L tones. They have their own processing plant which is known as Aluminum Refinery, Smelting plant and Power supply through their CPP units. Human Resource Management – HRD is the key to the success of NALCO. With a total manpower of 7406 employees it is being able to meet its new expansions. Targets are set, functional and developmental training needs are identified from multiple sources, primary being, the competency related needs, secondly, needs arising from organizational requirements and finally departmental / sectional imperatives. Technology Development – technology has been imported from Pechiney, a France based company which is now a part of the Canadian Alcan group. ERP, VPN and e-Governance have been embarked upon. RAMCO Maintenance Mgt. Packages have been successfully implemented at CPP, Bauxite mines, Damanjodi and port facilities. Statistical Process Control methods were also introduced for better control of production processes.
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Fig 11. 3
ORGANIZATIONAL CHART OF NALCO
ED (M&R)
GM (AR)
GM (MINES)
GM (H&A)
GM (MATLS)
GM (FINANCE)
GM (O&M)
FUNCTIONAL HOD
FUNCTIONAL HOD
FUNCTIONAL HOD
FUNCTIONA L HOD
FUNCTIONAL HOD
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ED (M&R)
:
Overall in charge of M&R Complex and all Functional level GMs are reporting
GM(AR)/GM : (O&M) GM (Mines) GM (H&A) GM (MATLS.) : : :
In charge of Alumina Plant operation & maintenance In charge of Mines operation & maintenance In charge of HRD & Admn. of M&R Complex In charge of Purchase & stores Functions of M&R Complex In charge of Finance & Accounts of M&R Complex In charge for respective area of operation and i.e. Production, Mechanical, Electrical, Steam Generation Plant, Electronic &
GM (FINANCE) : FUNCTIONAL :
HEAD OF DEPARTMENT
Instrumentation, Civil, Purchase, Stores, Finance, Human Resource Development, Administration, Horticulture, Training, Peripheral Development.
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Fig 11.4
ORGANIZATIONAL STRUCTURE OF FINANCE DEPARTMENT DIRECTOR
EXECUTIVE DIRECTOR
GENERAL MANAGER
GENERAL MANAGER
DEPUTY GENERAL MANAGER
CHIEF MANAGER
SENIOR MANAGER
MANAGER
DEPUTY MANAGER
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ASSITANT MANAGER OFFICER The entire finance dept. works in synchronization where tasks are interchangeable and everyone is accountable for their tasks. The Corporate Office performs centralized function where all regional offices act as collection centres. All units are decentralized. Apart from performing routine tasks the corporate office also performs specific tasks like: ? ? ? ? ? ? Financial policy making for entire organization. Sales realization and debtors account. Corporate budgeting. Corporate financial planning. Corporate centralized accounts. Forex transactions.
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12. Annexure – 3 Working Capital Management
Working capital management is concerned with the problems that arise in attempting to manage the current assets, the current liabilities and the inter relationship that exists between them. The current assets refer to those assets which in the ordinary course of business can be, or will be, converted into cash within one year without undergoing a diminution in value and without diminution in value and without disrupting the operations of the firm. The major current assets are cash, marketable securities, accounts receivables and inventory. Current liabilities are those liabilities which are intended, at their inception, to be paid in the ordinary course of business, within a year, out of the current assets or earnings of the concern. The basic current liabilities are accounts payable, bills payable, bank overdraft, and the outstanding expenses. The goal of working capital management is to manage the firm’s current assets and liabilities in such a way that a satisfactory level of working capital is maintained. This is so because if the firm cannot maintain a satisfactory level of working capital. It is likely to become insolvent and may even be forced into bankruptcy. The current assets should be large enough to cover its current liabilities in order to ensure that they are obtained and used in the best possible way. The interaction between current assets and current liabilities is therefore, the main theme of the theory of working capital management. In the words of Shubin,”Working capital is the amount of funds necessary to cover the cost of operating the enterprise.” According to Genestenberg,”Circulating capital means current assets of a company that are changed in the ordinary course of business from one form to another, as for example, from cash to inventories, inventories to receivables, receivables into cash.”
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Working capital management
Fig 12.1 Working Capital cycle Every running business needs working capital. Even a business which is fully equipped with all types of fixed assets required is bound to collapse without adequate supply of raw materials for processing, cash to pay for wages, power and other costs creating a stock of finished goods to feed the market demand regularly. The ability to grant credit to its customers. All these require working capital. Working capital is thus like the lifeblood of a business. The business will not be able to carry on day-to-day activities without the availability of adequate working capital. Working capital cycle involves conversions and rotation of various constituents/ components of the working capital. Initially ‘cash’ is converted into raw materials. Subsequently, with the usage of fixed assets resulting in value
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additions, the raw materials get converted into work in process and then into finished goods. When sold on credit, the finished goods assume the form of debtors who give the business cash on due date. Thus ‘cash’ assumes its original form again at the end of one such working capital cycle but in the course it passes through various other forms of current assets too. This is how various components of current assets keep on changing their forms due to value addition. As a result, they rotate and business operations continue. Thus, the working capital cycle involves rotation of various constituents of the working capital. While managing the working capital, two characteristics of current assets should be kept in mind viz. (i) short life span, and (ii) swift transformation into other form of current asset. Each constituent of current asset has comparatively very short life span. Investment remains in a particular form of current asset for a short period. The life span of current assets depends upon the time required in the activities of procurement; production, sales and collection and degree of synchronization among them. A very short life span of current assets results into swift transformation into other form of current assets for a running business. These characteristics have certain implications: Decision regarding management of the working capital has to be taken frequently and on a repeat basis. The various components of the working capital are closely related and mismanagement of any one component adversely affects the other components too. The difference between the present value and the book value of profit is not significant. The working capital has the following components, which are in several forms of current assets: ? ? ? ? ? Stock of Cash Stock of Raw Material Stock of Finished Goods Value of Debtors Miscellaneous current assets like short term investment loans & advances
DEFINITION: There are two concepts of working capital: gross and net. The term gross working capital, also referred to as working capital, means the total current assets.
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The term net working capital can be defined in two ways
i)The most common definition of net working capital(NWC) is the difference between current assets and current liabilities; and (ii)Alternate definition of NWC is that portion of current assets which is financed with long term funds. The gross working capital concept is financial or going concern concept whereas net working capital is an accounting concept of working capital. These two concepts of working capital are not exclusive; rather both have their own merits. The gross concept is sometimes preferred to the net concept of working capital for the following reasons: It enables the enterprise to provide correct amount of working capital at the right time. Every management is more interested in the total current assets with which it has to operate than the sources from where it is made available. The gross concept takes into consideration the fact that every increase in the funds of the enterprise would increase in its working capital The gross concept of working capital is more useful in determining the rate of return on the investments in working capital. The net working capital concept however is also important for the following reasons: The qualitative concept which indicates the firm’s ability to meet its operating expenses and short term liabilities. It indicates the margin of protection available to the short term creditors, i: e, the excess of current assets over current liabilities. It is an indicator of the financial soundness of an enterprise. It suggests the need for financing a part of the working capital requirements out of the permanent sources of funds. To conclude, it may be said that, both, gross and net, concepts of working capital are important aspects of the working capital management. The net concept of working capital may be suitable only for proprietary form of organizations such as sole trader or partnership firms. But the gross concept is very suitable to the company form of organization where there is divorce between ownership, management and control. NET WORKING CAPITAL: But the net working capital refers to the difference between current assets and current liabilities. Current liabilities are those claims of outsider, which are expected to mature
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for payment within an accounting year & include creditors, bills payable & the outstanding expenses. In other words you can say that this is the excess of current assets over current liabilities. CURRENT ASSETS constitute the following: 1. Inventories: Inventories represent raw materials and components, work-in-progress and finished goods. 2. Trade Debtors: Trade Debtors comprise credit sales to customers. 3. Prepaid Expenses: These are those expenses, which have been paid for goods and services whose benefits have yet to be received. 4. Loan and Advances: They represent loans and advances given by the firm to other firms for a short period of time. 5. Investment: These assets comprise short-term surplus funds invested in government securities, shares and short-terms bonds. 6. Cash and Bank Balance: These assets represent cash in hand and at bank, which are used for meeting operational requirements. One thing you can see here is that this current asset is purely liquid but non-productive. Current liabilities form part of working capital that represents obligations which the firm has to clear to the outside parties in a short-period, generally within a year. CURRENT LIABILITIES comprise the following: I. Sundry Creditors: These liabilities stem out of purchase of raw materials on credit terms usually for a period of one to two months. II. Bank Overdrafts: These include withdrawals in excess of credit balance standing in the firm’s current accounts with banks III. Short-term Loans: Short-terms borrowings by the firm from banks and others form part of current liabilities as short-term loans. IV.Provisions: These include provisions for taxation, proposed dividends and contingencies.
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Working capital Current assets Cash Accounts receivable Notes receivable Marketable securities Inventory Prepaid expenses Total current assets Total current liabilities Current liabilities Accounts payable Notes payable Accrued expenses Taxes payable
Net working capital is current assets minus current liabilities. Gross working capital concept focuses on two aspects: 1. How to optimize investment in current assets? 2. How should current assets be financed? The planning should be done keeping in mind two danger point’s i.e. excessive and inadequate investment in current assets. Investment in current assets needs to be adequate as it affects the profitability, solvency and liquidity. Why this issue comes up because it ultimately affects the objectives of financial management.
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Danger points to be kept in mind while planning 1. Excessive investment (Profitability) a. It results in unnecessary accumulation of inventories. Thus, chances of inventory mishandling, waste, theft & losses increase. b. It is an indication of defective credit policy & slack collection period. c. Excessive WC makes management complacent, which degenerates into managerial inefficiency. d. Tendencies of accumulating inventories tend to make speculative profits grow. 2. Inadequate investment (Liquidity) a. It stagnates growth. b. It becomes difficult to implement operating plans and achieve the firm’s operating profit target. c. Operating inefficiencies creep in when it becomes difficult even to meet day-to-day commitments. d. Fixed assets are not efficiently utilized for the lack of working capital funds. Thus, the firm’s profitability would deteriorate. e. Paucity of WC funds render the firm unable to avail attractive credit opportunities. f. The firm loses its reputation when it is not in a position to honour its short-term obligations. TYPES OF WORKING CAPITAL Working capital may be classified as: Permanent or Fixed working capital Temporary or variable working capital Permanent working capital: These components represent the value of current assets required on a continuing basis over the entire year and for several years. Permanent working capital is the minimum amount of current assets which is needed to conduct a business even during the dullest season of the year. The minimum level of current assets is called permanent or fixed working capital as this part is permanently blocked in current assets. This amount varies from year to year, depending upon the growth of the company and the stage of the business cycle in which it operates. It is the amount of funds required to produce the goods and services, which are necessary to satisfy demand at a particular point of time. It represents the current assets, which are required on a
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continuing basis over the entire year. It is maintained as the medium as to continue the operations at any time. Characteristics of permanent working capital It is classified on the basis of the time period. It constantly changes from one asset to another and continues to remain in the business process. Its size increases with the growth of business operations. Temporary working capital Contrary to the above you will find that temporary working capital represents a certain amount of fluctuations in the total current assets during a short period. These fluctuations are increased or decreased and are generally cyclical in nature. Additional current assets are required at different times during the operating year. Variable working capital is the amount of additional current asset that are required to meet the seasonal needs of a firm, so is also called as the seasonal working capital. For example: additional inventory will be required for meeting the demand during the period of high sales When the peak period is over variable working capital starts decreasing or very little during the normal period. It is temporarily invested in current assets. Say for an example a shopkeeper invests more money during winter season because he/ she require to keep more amount of stock of woolen cloths. The same happens in a sugar factory how: the factory manager buys more quantity of sugarcane during the harvesting season and they continuously stops for some time.
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Characteristics of temporary working capital It is not always gainfully employed, though it may change from one asset to another asset, as permanent working capital does. It is particularly suited to business of a seasonal or cyclical nature.
Fig 12.2 Determinants of working capital: We can explain the determinants of working capital as follows: Nature of business: The working capital requirements are basically related to the conduct of the business. Public utility undertakings like Electricity, Water supply, Railways etc need very limited working capital because they offer cash sales only and supply services, not products and as such no funds are ties up in inventories and receivables .But at the same time have to invest fewer amounts in fixed assets .The manufacturing concerns on the other hand require sizeable working capital along with fied investments, as they have to build up the inventories. Terms of sale and purchases: Credit sales are granted by the concerns too its customers as well as credit terms granted by the suppliers also affect the working capital. If the credit terms of the purchases are more favorable and at the same time those of sales less liberal, less cash will be invested in the inventory. With more favorable credit terms, working capital requirements can be reduced.
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Manufacturing cycle: The length of manufacturing cycle influences the quantum of working capital needed. Manufacturing process always involves a time lag between the time when raw materials are fed into the production line and finished goods are finally turned out by it. The length of the period of manufacture in turn depends o the nature of product as well as production technology used by a concern. Shorter the manufacturing cycle, lesser the working capital required. Rapidity of turnover: If the inventory turnover is high, the working capital requirements will be low. With a better inventory control, a firm is able to reduce its working capital requirements. When a firm has to carry on a large slow moving stock, it needs a larger working capital as against another whose turnover is rapid. A firm should determine the minimum level of stock, which it will have to maintain throughout the period of its operation. Business cycle: Cyclical changes in the economy also influence quantum of working capital. In a period of boom i.e. when the business is in prosperous, there is a need of larger amount of working capital due to increase in sales, rise in price etc and vice versa during period of depression. Changes in technology: Changes in technology may lead to improvements in processing of raw materials, savings in wastage, greater productivity, and more speedy production. All these improvements may enable the firm to reduce investments in inventory. Seasonal variation: The inventory of raw materials spares and stores depend on the condition of supply. If the supply is prompt and adequate the firm can manage with small inventory. However, if the supply were unpredictable and scant then the firm, to ensure the continuity of production, would have to acquire stocks as and when they are available and carry larger inventory on an average. Market conditions: The degree of competition prevailing in the market place has an important bearing on working capital needs. When the competition is keen, a larger inventory of finished goods is required to promptly serve the customers who may not be inclined to wait because other manufacturers are ready to meet their needs.
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Seasonality of operations: Firms, which have marked seasonality in their operation usually, have highly fluctuating working requirements. Let us take an example to illustrate this point. Consider firm manufacturing fans. The sale of fans reaches a peak during the summer months and drops sharply during the winter period. The working capital need of such a firm is likely to increase considerably in summer months and decrease significantly during winter season. Dividend policy: It has a dominant influence on the working capital position of a firm. If the firm is following a conservative dividend policy, the need for working capital can be met with retained earnings. Working capital cycle: Larger the working capital cycle, more is the requirement of working capital. Price level changes: Changes in the price level also affect the working capital requirements. Generally, the rising prices will require the firm to maintain a larger amount of working capital as more funds will be required to maintain the same current assets. The effect of rising prices may be different for different firms. Some firms may be affected much while some others may not be affected at all by the rise in prices. Other factors: Certain other factors such as operating efficiency, management ability, irregularities of supply, import policy, asset structure, importance of labour, banking facilities, etc; also influence the requirements of working capital. Importance or advantages of adequate working capital Working capital is the lifeblood and nerve centre of a busiess.Just as circulation f blood is essential in the human body for maintaining life, working capital is very essential to maintain the smooth running of a business. No business can run successfully without an adequate amount of working capital. The main advantages of maintaining adequate amount of working capital are as follows: 1. Solvency of the business: Adequate working capital helps in maintaining solvency of the business by providing uninterrupted flow of production. 2. Goodwill: Sufficient working capital enables a business concern to make prompt payments and hence helps in creating and maintaining goodwill.
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3. Easy loans: A concern having adequate working capital, high solvency,and good credit standing can arrange loans from banks and ohers on easy and favourable terms. 4. Cash discounts: Adequate working capital also enables a concern to avail cash discounts on the purchases and hence it reduces costs. 5. Regular supply of raw materials: Sufficient working capital ensures regular supply of raw materials and continuous production. 6. Regular payment of salaries, wages, and other day to day commitments: A company which has ample working capital can make regular payments of salaries, wages and other day to day commitments which raises the morale of its employees, increase their efficiency, reduces the wastage and costs and enhances production and profits. 7. Exploitation of favorable market conditions: Only concerns with adequate working capital can exploit favorable market conditions such as purchasing its requirements in bulk when the prices are lower and by holding its inventories for higher prices. 8. Quick and regular return on investments: Every investor wants a quick and regular return on his investments. Sufficiency of working capital enables a concern to pay quick and regular dividends to its investors as there may not be much pressure to plough back profits. This gains the confidence of its investors and creates a favorable market to raise additional funds in the future. 9. High morale: Adequacy of working capital creates and environment of security, confidence, higher morale and creates overall efficiency in a business. Excess or inadequate working capital: Every business concern should have adequate working capital to run its business operations. It should have neither redundant or excess working capital nor inadequate nor shortage of working capital. Both excess as well as short working capital positions are ba for any business. However, out of the two it is the inadequacy of working capital which is more dangerous from the point of view of the firm. Disadvantages of Redundant or Excessive Working Capital 1. Excessive Working Capital means idle funds which earn no profits for the business and hence the business cannot earn a proper rate of return on its investments. 2. When there is a redundant working capital, it may lead to unnecessary purchasing and accumulation of inventories causing more chances of theft, waste and losses.
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3. Excessive working capital implies excessive debtors and defective credit policy which may cause higher incidence of bad debts. 4. It may result into overall efficiency in the organization. 5. When there is excessive working capital, relations with banks and other financial institutions may not be maintained. 6. Due to lower rate of return on investments, the value of shares may also fall. Disadvantages or Dangers of Inadequate Working Capital 1. A concern which has inadequate working capital cannot pay its short term liabilities in time. Thus, it will lose its reputation and shall not be able to get good credit facilities. 2. It cannot buy its requirements in bulk and cannot avail of discounts, etc. 3. It becomes difficult for the firm to exploit favorable market conditions and undertake profitable projects due to lack of working capital. 4. The firm cannot pay day to day expenses of its operations and it creates inefficiencies, increases costs and reduces the profits of the business. 5. It becomes impossible to utilize efficiently the fixed assets due to non availability of liquid funds. 6. The rate of return on investments also falls with the shortage of working capital. Management of Working Capital Working Capital, in general practice, refers to the excess of current assets over current liabilities. Management of working capital therefore, is concerned with the problems that arise in attempting to manage the current assets, the current liabilities and the inter-relationship that exists between them. In other words it refers to all aspects of administration of both current assets and current liabilities. The basic goal of working capital management is to manage the current assets and current liabilities of affirm in such a way that a satisfactory level of working capital is maintained i.e. it is neither inadequate nor excessive. This is so because both inadequate as well as excessive working capital positions are bad for any business. Inadequacy of working capital may lead the firm to insolvency and excessive working capital implies idle funds which earn no profits for the business. Working capital management policies of a firm have a great effect on its profitability, liquidity and
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structural health of the organization. In this context, working capital management is three dimensional in nature: I. Dimension I is concerned with the formulation of policies with regard to profitability, risk and liquidity. II. Dimension II is concerned with the decisions about the composition and level of current assets. III. Dimension III is concerned with the decisions about the composition and level of current liabilities.
3D Nature of Working Capital Management
Dimension Dimension II Profitability, Profitability, Risk, & Liquidity Risk, & Liquidity
n II son I Level iio Level ns een Dim ion & Dim stton & ii po i CA os A omp o Com offC C
D ComD im Com pimeensio o n n possiti sion IIII itio n II o o Cn & L offC L& Leevel vel L
Fig 12.3 3D Nature of Working Capital PRINCIPLES OF WORKING CAPITAL MANAGEMENT/ POLICY The following are the general principles of a sound working capital management policy: 1. Principle of Risk Variation: Risk here refers to the inability of a firm to meet its obligations as and when they become due for payment. Larger investments in current assets with less dependence on short term borrowings increase liquidity, reduces risk and thereby decreases the opportunity for gain or loss. On the other hand less investment in current assets with greater dependence on short term borrowings increases risk, reduces liquidity and increases profitability. In other words, there is a definite direct relationship between the degree of risk and profitability. A conservative
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management prefers to minimize risk by maintaining a higher level of current assets or working capital while a liberal management assumes greater risk by reducing working capital. However, the goal of the management should be to establish a suitable trade off between profitability and risk. 2. Principle of Cost of Capital: The various sources of raising working capital finance have different cost of capital and the degree of risk involved. Generally, higher the risk lower is the cost and lower the risk higher is the cost. A sound working 3. Principle of Equity Position: This principle is concerned with planning the total investment in current assets. According to this principle, the amount of working capital invested in each component should be adequately justified by a firm’s equity position. Every rupee invested in the current assets should contribute to the net worth of the firm. The level of current assets may be measured with the help of two ratiosi)current assets as a percentage of total assets and (ii)current assets as a percentage of total sales. While deciding about the composition of current assets, the financial manager may consider the relevant industrial averages. 4. Principle of Maturity of Payment: This principle is concerned with planning the sources of finance for working capital. According to this principle, a firm should make every effort to relate maturities of payment to its flow of internally generated funds. Maturity pattern of various current obligations is an important factor in risk assumptions and risk assessments. Generally, shorter the maturity schedule of current liabilities in relation to expected cash inflows, the greater the inability to meet its obligations in time. To sum up, working capital management should be considered as an integral part of corporal management. In the words of Louis Brand, “We need to know when to look for working capital funds, how to use them and how to measure, plan and control them.” To achieve the above mentioned objectives of working capital management, the financial manager has to perform the following basic functions: ? ? ? Estimating the working capital requirements. Financing of working capital needs. Analysis and control of working capital
Factors Requiring Consideration While Estimating Working Capital Total costs incurred on material, wages and overheads.
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The length of time for which raw materials are to remain in stores before they are issued for production. The length of the production cycle or work-in-process, i.e., the time taken for conversion of raw material into finished goods. The length of sales cycle during which finished goods are to kept waiting for sales. The average period of credit allowed to customers. The amount of cash required to pay day-to-day expenses of the business. The average amount of cash required to make advance payments, if any. The average credit period expected to be allowed by suppliers. Time lag in the payment of wages and other expenses.
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13. Bibliography
? Financial Management ? Financial Management ? Financial Management ? Annual Reports of NALCO ? www.nalcoindia.com ? www.moneycontrol.com ? www.accounting4management.com I M Pandey Khan and Jain Prasanna Chandra
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Working capital is one of the vital parameters of financial management function. Profitability and working capital relationship is frequently emphasized for deciding on the level of investment in working capital. All manufacturing firms need to understand the association between these two variables to arrive at optimal financial decisions. Though theories exist on the topic, empirical methods are inadequately focused in arriving at conclusions. Use of statistical methods in understanding the relationship is systematic and scientific, which may provide better insight for decision making. This project is an endeavor to understand the relationship between working capital and profitability in a detailed manner.
Working Capital Management at NALCO
Contents
LIST OF TABLES.................................................................................................................................................................. 5 LIST OF FIGURES................................................................................................................................................................ 5 ABBREVIATIONS ................................................................................................................................................................ 5 EXECUTIVE SUMMARY ...................................................................................................................................................... 8 OBJECTIVES ................................................................................................................................................................... 8 RESULTS ........................................................................................................................................................................ 8 RECOMMENDATIONS ................................................................................................................................................... 9 1. INTRODUCTION....................................................................................................................................................... 10 1.1 The Indian Aluminium Industry- A Snapshot ........................................................................................................ 10 1.2 SALIENT FEATURES OF INDIAN ALUMINIUM INDUSTRY ....................................................................................... 11 1.3 Nalco and it’s Financial performance in a nutshell ............................................................................................. 12 1.3.1 NALCO PROFILE .............................................................................................................................................. 12 1.3.2 CORPORATE STRENGTH ................................................................................................................................. 13 1.3.3 FINANCIAL PERFORMANCE OF THE COMPANY ............................................................................................. 13 1.4 Objectives ............................................................................................................................................................. 16 1.5 Assumptions ......................................................................................................................................................... 16 2. Methodology .............................................................................................................................................................. 16 3. Working Capital management of NALCO.................................................................................................................... 16 3.1 Cash Management of NALCO ............................................................................................................................... 16 3.2 Inventory Management of NALCO........................................................................................................................ 19 3.2.1 Types of Inventories: ..................................................................................................................................... 19 3.2.2 Need to hold Inventories: .............................................................................................................................. 19 3.2.3 Functions of Inventory in NALCO ................................................................................................................... 20 3.2.4 Objectives of Inventory Management in NALCO ........................................................................................... 20 3.2.5 Effective Inventory Management .................................................................................................................. 20 3.2.6 INVENTORY MANAGEMENT TECHNIQUES ADOPTED BY NALCO .................................................................. 21
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3.3 RECEIVABLE MANAGEMENT ................................................................................................................................. 22 3.3.1 Receivable Management in NALCO ............................................................................................................... 22 4. CALCULATION OF GROSS OPERATING CYCLE PERIOD FOR 2010-2011 ...................................................................... 23 4.1 Raw material conversion period ........................................................................................................................... 23 4.2 Work-in-progress conversion period= .................................................................................................................. 23 4.4 Debtor Conversion Period .................................................................................................................................... 25 4.5 Payment Deferred Period ..................................................................................................................................... 25 5. CALCULATION OF GROSS OPERATING CYCLE PERIOD FOR 2009-10 .......................................................................... 26 5.1 Raw material conversion period ........................................................................................................................... 26 5.2 Work-in-progress conversion period .................................................................................................................... 27 5.3 Finished Goods Conversion Period ....................................................................................................................... 27 5.4 Debtor Conversion Period .................................................................................................................................... 28 5.5 Payment Deferred Period ..................................................................................................................................... 28 5.6 Interpretation ....................................................................................................................................................... 29 6. NALCO’S FINANCIAL RATIOS ....................................................................................................................................... 30 6.1 Liquidity Ratios :.................................................................................................................................................... 30 6.1.1 Current Ratio.................................................................................................................................................. 30 6.1.2 Quick ratio...................................................................................................................................................... 31 6.2 Cash Ratio ............................................................................................................................................................. 32 6.3 ACTIVITY RATIOS: .................................................................................................................................................. 33 6.3.1 Debtors Turn over Ratio ................................................................................................................................ 33 6.3.2 Average Collection period (ACP) .................................................................................................................... 34 6.3.3 Inventory Turnover Ratio (ITR) ...................................................................................................................... 34 6.3.4 Working Capital Turnover Ratio (WCTR) ....................................................................................................... 36 7. Relationship between Working capital and Profitability – A statistical Analysis ..................................................... 37 7.1 Regression Analysis............................................................................................................................................... 38 7. 2 Correlation between various measures of working capital and Profitability ...................................................... 40 8. LIMITATIONS ............................................................................................................................................................... 43 9. CONCLUSIONS AND RECOMMENDATIONS................................................................................................................. 43
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10. ANNEXURE- 1 ............................................................................................................................................................ 45 11. Annexure- 2 .............................................................................................................................................................. 51 12. Annexure – 3 ............................................................................................................................................................. 61 13. Bibliography .............................................................................................................................................................. 77
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LIST OF TABLES
Table Number 7.1 Table Name Theoretical relationship between measures of working capital and profitability Year wise data on PBT and corresponding Inventory Year wise data on PBT and corresponding Sundry debtors Year wise data on PBT and corresponding Cash and Bank Balance Year wise data on PBT and corresponding Loans and other current assets Year wise data on PBT and corresponding Loans and advances Page Number 36
7.2.1 7.2.2 7.2.3
40 40 41
7.2.4
41
7.2.5
42
LIST OF FIGURES
Figure number 1.1 1.2 3.1 7.1.1 11.1 11.2 11.3 11.4 12.1 12.2 12.3 Figure Name Financial Performance Net Worth in Crores Cash Management Cycle PBT Line Fit Plot Porter’s Generic Model The Conversion of Bauxite to Aluminium Organizational Chart of NALCO Organizational Structure of NALCO Working Capital Cycle Temporary and Permanent Working Capital- A Diagrammatic View 3D Nature of Working Capital Page Number 14 14 16 39 53 54 56 58 61 68 73
ABBREVIATIONS
WC FG Working Capital Finished Goods
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CR QR DTR ACP ITR WCTR
Current Ratio Quick Ratio Debtors Turn Over Ratio Average Collection Period Inventory Turn Over Ratio Working Capital Turn Over Ratio
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EXECUTIVE SUMMARY
Working capital is one of the vital parameters of financial management function. Profitability and working capital relationship is frequently emphasized for deciding on the level of investment in working capital. All manufacturing firms need to understand the association between these two variables to arrive at optimal financial decisions. Though theories exist on the topic, empirical methods are inadequately focused in arriving at conclusions. Use of statistical methods in understanding the relationship is systematic and scientific, which may provide better insight for decision making. This project is an endeavour to understand the relationship between working capital and profitability in a detailed manner.
OBJECTIVES
1. To find out the working capital of NALCO and understand its significance. 2. To find out the Financial Ratios of Nalco and understand their interpretation. 3. Examining the efficiency of NALCO in the managing it’s working capital. 4. Use of Statistical analysis ( to find out a relation between Working Capital and PBT. 5. Use of Correlation analysis to find out the impact of various measures of Working Capital on Profitability.
RESULTS
1. The Gross working capital cycle of NALCO was found to be lengthier in 2010-11 as compared to 2009-10 due to increase in raw material conversion period and increase in finished goods conversion period. 2. Although Nalco has been maintaining a healthy current ratio, its quick ratio has taken a beating due to increase in inventory. The cash ratio also suggests that there has been a greater increase in sundry creditors which forms a part of its current liabilities as compared to its current assets. While its debtors turnover ratio and average collection period showed improvement indicating Nalco’s efficient debt management, its Inventory turnover ratio showed a decline suggesting a decrease in profitability and decrease in return of its investment in its stocks. 3. Statistical analysis using tools like Regression analysis helped us in finding an equation, incorporating Working capital and PBT , to help us predict the optimum level of working capital required for a projected value of PBT. 4. Correlation analysis helped us to find that there exists a negative correlation between some measures of working capital like inventory, sundry debtors and Loans and advances & PBT.
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Working Capital Management at NALCO
RECOMMENDATIONS
1. Nalco should try to improve its raw material conversion period and finished goods conversion period to reduce its working capital cycle. Finished goods conversion period can be improved by better marketing of Nalco’s products and extension of better credit facilities to its customers. 2. Nalco should perform statistical analysis ( e.g Regression analysis) using parameters like PBT to gauge the optimum working capital requirement. 3. Nalco should reduce the amount of sundry creditors or seek a wider credit repayment duration from its creditors to make sure that it can meet its obligations properly and remain profitable at the same time.
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Working Capital Management at NALCO
1. INTRODUCTION
Two essential aspects of financial soundness of a firm are the financial position and economic performance. Working capital management is most crucial aspect of economic performance of a firm. Effective working capital decisions contribute to the profitability and attainment of overall objectives of an organization on one hand and provide liquidity to the firm on the other. For several reasons, capital budgeting decisions are influenced by operating managers to larger extent and the day to day management of liquidity, short term obligations, uninterrupted operations calls for effective working capital decisions that forms the domain of finance function. Theoretically, leaving other things constant, level of investment in current assets has a bearing on the profitability of the firm. Excess of investment in working capital casts a negative impact on the profitability of a firm and positive impact on the liquidity. Before I get into the concept of Working Capital Management at Nalco, I would like to give a snapshot of the Indian Aluminium Industry and Nalco.
1.1 The Indian Aluminium Industry- A Snapshot
The biggest trait of the aluminium industry, being a commodity, is the cyclicality of the industry, wherein there are periodic ups and downs. That said, when compared with cement and steel, aluminium is a value-add commodity. It is a highly capital intensive sector (Rs 200 bn required for a 1 million tonne green field capacity expansion). Cost efficiency plays a critical role in the survival of a company in the sector for which, control over inputs (say raw material) is of utmost importance. India has large resources of high grade bauxite (the basic alumina ore) deposits placing it fifth in the world after Australia, Guinea, Brazil and Jamaica. Major bauxite reserves are concentrated on the East Coast along Orissa and Andhra Pradesh. Today, India's per capita consumption of aluminium is below 1 kg. And while globally there are about 3,000 applications of aluminium, India has only around 300.The capacity for producing aluminium has increased consistently over the past few years. Fortunately, the advantage of having the 5th largest bauxite reserves in the world coupled with cheap and abundant labor helps the Indian companies to retain the distinction of being the lowest cost producers in the world. Globally, the industry is less fragmented when compared with steel and cement. On basis of scale of operations and level of integration, aluminium producers can be categorized into the following two types:
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Working Capital Management at NALCO
?
Integrated producers/Primary producers: Integrated producers have presence right from the mining of bauxite (raw material) to producing aluminium ingots (finished product). Some companies may even go a step further and have downstream manufacturing facilities such as manufacturing of semi-fabricated products (foils). Primary producers could either be a company that is just into mining of bauxite and alumina production or pure aluminium ingot manufacturing. For companies, which have restricted themselves from venturing into the downstream segment, the user industries are basically the secondary producers.
?
Secondary producers: For this segment of producers, which are involved in the production of semi-fabricated products, the raw material is acquired from primary producers, which is in the form of aluminium ingots and billets. The user industries for this segment would be the packaging industry (foils), auto ancillary (wheels), to name a few.
Aluminium products can be classified under three categories. Rolled products find applications in automobiles, consumer durable, construction and engineering sectors. Extrusions include bars, pipes and tubes that find usage in the electrical and the transportation sectors. Finally, foils are used in the packaging sector, which are high-value products and have higher margins.
1.2 SALIENT FEATURES OF INDIAN ALUMINIUM INDUSTRY
? ? ? ? ? Highly concentrated industry with only five primary plants in the country. Controlled by two private groups and one public sector unit. Bayer – Hall-Herault technology used by all producers. Electricity, coal and furnace oil are primary energy inputs. All plants have their own captive power for cheaper and un-interrupted power
supply. ? ? ? ? ? ? Energy cost is 40% of manufacturing cost for metal and 30 % for rolled products. Plant have set internal target of 1-2% reduction in specific energy consumption in the next 5-8 years. Energy management is a critical focus energy policy. Two plants have declared formal energy policy. Each plant has an energy management cell Achievements in energy conservation are highlighted in the Annual Report of the company.
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Working Capital Management at NALCO
?
Energy target are based on the best energy figures achieved in their sector/region and by the plant itself in the past.
? ? ?
Generally, government policies are related as conducive to energy management. ‘Task force’ formed by BEE in their sector to work as catalyst in promoting energy efficiency. High cost of technology is the main barrier in achieving high-energy efficiency.
1.3 Nalco and it’s Financial performance in a nutshell
NALCO is considered to be a turning point in the history of Indian aluminum industry. Nalco has not only has addressed the need for self-sufficiency in aluminum but also given the country a technological edge in producing this strategic metal to the best of world standard. NALCO was incorporated in 1981 as a public sector. This has emerged as the largest integrated bauxite alumina aluminum complex in Asia. By considering its capacity utilization, technology absorption, quality assurance, export performance & earning profit, Nalco is a bright example of India’s industrial development. Today, as an ISO9001, ISO 14001, OHSAS 18001 co. with its products registered in London Metal Exchange, Nalco has emerged as the largest in integrated bauxite alumina aluminum complex in Asia.
1.3.1 NALCO PROFILE
? ? ? Modern updated technology Integrated operation 9th largest producer of aluminum in the world
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Working Capital Management at NALCO
? ? ?
Efficient logistic in transportation International linkage in technology & market Environment friendly operation
1.3.2 CORPORATE STRENGTH
? ? ? ? ? ? ? ? ? ? Captive resources Advanced technology Integrated operation World-class products Well-trained manpower Sound financial mgt Care for Ecology & Environment Self-funded expansion Expertise in project mgt International linkage Technology & Market
1.3.3 FINANCIAL PERFORMANCE OF THE COMPANY
NALCO has remained the forerunner with the best quality of products over the years. Financial results of the company reflect the country’s robust performance in production and marketing. Sales turnover and net profit have grown over the years. The salient features of the financial performances are highlighted below: ? ? Since the inception of the company NALCO is running in profits. Highest profit has been Rs. 614.55 crores in the year 1995-96 as the Aluminium prices remained buoyant. ? From 1992-93 to 1995-96 there has been growth in sales, profit book value, earning per share and net worth. But in 1996-97 the profit was dipped due to dip in international Aluminium prices.
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Working Capital Management at NALCO
?
Though the gross sales, profit and other financial parameters have shown improvement in 1997-98, there has been again dip in the production figure, sales, profit etc. in 1998-99 due to internal problem again introduction of MAT has also affected the bottom line of the company.
?
The debt to equity ratio reduced over the years and the company became a Zero Debt company in the year 1998-99 repaying all its debt. This has prompted the company to appeal government of India for Capital restructuring.
? ?
The return on capital employed and return on net worth have been impressive. Nalco earned a net profit (after tax) of Rs 1,096 crore for the year 2010-11 as compared to Rs 814 crore in the previous year, recording an increase of 31%.
?
The operating cost in 2010-11 was higher by Rs 399 crore, an increase of over 10% from the previous year due to increase in prices of coal, fuel oil and provisioning for wage revision.
?
The profit before tax for 2010-11 was higher because of higher sales realization as compared to the previous year
?
The results of 2010-11 would have been still better, but for the adverse impact of exchange rate of rupee on sales, which made a dent of Rs 159 crore during the year.
?
The depreciation was higher by Rs 103 crore due to commissioning of one more czptive power unit during the year and provision for impairment.
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Working Capital Management at NALCO
Fig 1.1 FINANCIAL PERFORMANCE
7000 6000 5000 4000 3000 2000 1000 0
NET PROFIT
TOTAL INCOME
Fig 1.2 Net Worth In Crores
Net Worth
12000 10000 8000 6000 4000 2000 0 2006-07 2007-08 2008-09 2009-10 2010-11
Net Worth
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Working Capital Management at NALCO
1.4 Objectives
i. ii. iii. iv. v. To find out the working capital of NALCO and understand its significance. To find out the Financial Ratios of Nalco and understand their interpretation.
Examining the efficiency of NALCO in the managing it’s working capital. Use of Regression analysis to find out a relation between Working Capital and PBT.
Use of Correlation to find out the impact of various measures of Working Capital on Profitability.
1.5 Assumptions
i. Financial data used in this report has figures which have been rounded to the nearest decimal points hence might not tally at some places.
2. Methodology
Secondary data, especially the annual reports of NALCO has been used in all financial analysis and certain information recorded in the report has been through the interactions with my coordinator, senior employees at the branch and professionals with rich experience in the field. In my assessment, both qualitative and quantitative have been used, to draw conclusions. I have divided my project work into the following sections to have a better understanding of my work at Nalco. a) Finding of the working capital of NALCO and understand its significance. b) Finding of various Financial ratios of NALCO. c) Use of Statistical tools to better understand the relationship between working capital and profitability. d) Providing Interpretations, suggestions and drawing conclusions.
3. Working Capital management of NALCO
3.1 Cash Management of NALCO
Cash management is concerned with the managing of: i) ii) iii) Cash flows into & out of the firm Cash flows within the firm Cash balance held by the firm at a point of time by financing deficit or investing surplus of cash.
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Working Capital Management at NALCO
The Organization needs cash for the following reasons: 1) Transaction Motive
2) Precaution Motive
3) Speculative Motive
It can be represented by a cash management cycle
Cash collection
Business Operation
Deficit
Information & Control
Borrows Invest
Surplus
Cash payments
Fig 3.1 Cash Management Cycle
Cash management of NALCO, focuses on the following aspects: ? ? ? Cash Budgeting Long-term cash forecasting Monitoring collections & receivables
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Working Capital Management at NALCO
? ?
Optimal cash balance Option for investing surplus of funds
Cash budgeting or short-term cash forecasting is the principal tool of cash management. Cash budget, routinely prepared by NALCO, are helpful in: ? ? ? ? ? ? Estimating cash requirements Planning short-term financing Scheduling payments in connections with capital expenditure project Planning purchases of materials Developing credit policies Checking the accuracy of long-term forecasts.
The key areas of effective cash management of NALCO are:
a)
Identifying the requirements of funds at various units
b)
Investment of surplus funds productively
c)
Repayment of Loans
d)
Proper capital expenditure
e)
Standardized reporting system
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Working Capital Management at NALCO
3.2 Inventory Management of NALCO
Inventory constitutes the most significant part of the current assets of large majority of companies in India. On an average, inventories are approximately 60% of current asset in public limited companies in India. Because of the large size of the inventories maintained by firms, a considerable amount of funds are required to be committed to them. It is, therefore very necessary to manage inventories efficiently & effectively in order to avoid unnecessary investments. A firm neglecting the management of inventories will be jeopardizing its long run profitability & may fail ultimately. The purpose of inventory management is to ensure availability of materials in sufficient quantity as and when required and also to minimize investment in inventories. It is possible for a company to reduce its level of inventories of a considerable degree, without any adverse effect on production & sales, by using simple inventory planning & control techniques. The reduction is excessive inventories which carries a bad impact on a company’s profitability.
3.2.1 Types of Inventories:
1. 2. 3. 4. Raw Materials Work in progress Finished Goods Cash and marketable securities.
3.2.2 Need to hold Inventories:
There are four general motives for holding inventory: ? ? ? ? Transaction Motive Precautionary Motive Speculative Motive Contractual requirements
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Working Capital Management at NALCO
3.2.3 Functions of Inventory in NALCO
? ? ? ? ? ? ? ? To meet anticipated demand To smooth production requirement To decouple operations To protect against stock-outs To take advantage of order cycle To help hedge against price increases To permit operations To take advantage of quantity discounts
3.2.4 Objectives of Inventory Management in NALCO
? ? ? ? ? ? ? To ensure continuous supply of materials, spares & finished goods. To avoid both over-stocking & under-stocking of inventory. To maintain investments in inventories & the optimal level as required by the operational & sales activities. To keep material cost under control so that they contribute in reducing cost of production & overall costs. To eliminate duplications in order or replenishing stocks. This is possible with the help of centralizing purchases. To minimize loses through deterioration, pilferage wastage and damages. Clear cut accountability should be fixed at various level of organization.
3.2.5 Effective Inventory Management
? ? ? ? A system to keep track of inventory A reliable forecast of demand Knowledge of lead times Reasonable estimates of a) Holding cost b) Ordering costs c) Shortage costs
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Working Capital Management at NALCO
?
A classification system
3.2.6 INVENTORY MANAGEMENT TECHNIQUES ADOPTED BY NALCO
In managing inventories the firm’s objectives should be in consonance with the wealth maximization principle. To achieve this firm should determine the optimum level of inventory. A proper invention control not only serves the acute problem of liquidity but also increases profits & cause substantial reduction in the working capital of the concern. Following are the tools & techniques of inventory management adopted by NALCO: ? ? ? ? ? Economic order quantity ABC Analysis XYZ Analysis FSN Analysis Perpetual Inventory system I. Raw materials – that consists of CP coke, CT pitch, aluminum fluoride, Pig iron, HFO Alumina and anodes for smelter and coal, HFO, LDO for NALCO and caustic Soda, Alum, Lime, CGM etc. for Alumina plant and it has not faced a situation like out of stock of raw materials during the recent past. II. Stores & Spares – At the time of procurement of the machinery, generally some spares are procured for immediate maintenance, which is directly linked to different equipments. These spares are known as instance spares and most of these items are of high value. III. Intermediary goods – It consists of Green Anodes, Banked Anodes, Rodded Anode, Anode Stem, etc. for which NALCO has installed its own plants for producing the Green and Baked Anodes and imports them only when there is shortage. IV. Finished Goods – That consists of Bauxite, Aluminum Hydrate, Alumina, Aluminum Ingots, Sow Ingots, Billets, Wire rods sheets etc. the finished products of NALCO move fast hence the stock of finished goods are very less in company. The company also effectively reduces the rejected inventory. The rejected inventory in NALCO comprises of anode butts and rejected finished products. Anode rejects are recycled and reused in the process while finished stocks rejects are either recycled or sold at lower prices. The company is exercising good control to minimize the rejects.
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Working Capital Management at NALCO
3.3 RECEIVABLE MANAGEMENT
? ? ? ? ? ? ? ? ? It refers to the decisions taken by the management, when a firm sells its products or services on credit. In formulating an optional credit policy, finance manager must analyze the following aspects of credit management: Terms of payment Credit policy variables Credit evaluation Credit grating decision Control of accounts receivable In this project, we will investigate the techniques, which a company may employ to determine an optimum credit policy. Once an optimum credit policy is determined, the finance manager must ascertain the effect it will have on the company’s current asset requirements.
3.3.1 Receivable Management in NALCO
Nalco has set up its marketing office in India i.e. Mumbai, Kolkata, New Delhi, Chennai, Bangalore and Pondichery. These marketing offices obtain sale order from aluminum users in India as well as globally. On the basis of order received for different products it makes product planning of different products i.e. sow, Ingots, billets, wire etc and accordingly advices production planning at production units. Marketing office also sends dispatch instruction to dispatch section, which indicates various commercial terms i.e., product requirement, mode of dispatch, payment terms etc. The function of Dispatch department is to receive finished products from production department and segregate it on the basis of its laboratory analysis and grade. It keeps account of the various grades of finished products received by them. As per the sale order dispatch instruction received from the marketing office for export/domestic sale the dispatch department segregates and prepares the materials for dispatching the same by Rail. The material is handed over to the transporter. On the completion of dispatch of the consignment as per dispatch advice, the dispatch department sends the entire dispatch department sends all the dispatch documents with delivery invoice& copy of L.R to the finance department. On the basis of this finance department makes commercial invoice which takes care of taxes and other duties over and above the cost of product and sends it to the marketing office which may be in the form of Banker’s cheque, bank draft or in the form of letter of credit
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Working Capital Management at NALCO
opened by the buyer. The buyer opens a letter of credit with its banker. On completion of dispatch, on the basis of commercial invoice and proof of dispatch, on the basis of commercial invoice and proof of the dispatch the money is realized by the NALCO’S banker from the buyer’s bank.
4. CALCULATION OF GROSS OPERATING CYCLE PERIOD FOR 2010-2011.
4.1 Raw material conversion period
Raw material Inventory * 365
Raw material consumptions
=
614.56 * 365 766.12
= 292 days Raw material Inventory = Raw materials + Coal & fuel oil + Stores and spares
92.16+95.88+426.52 = 614.56
4.2 Work-in-progress conversion period=
Work-in-progress Inventory * 365 Cost of Production
Cost of Production = Op. FG + Factory Cost + Administration Exp. – Closing FG
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Working Capital Management at NALCO
Factory Cost = Op. WIP+ Raw material Consumed+ Power & Fuel + Repairs & Maintenance + Manufacturing Exp. – Cl. WIP Cost Of Production = Rs. 3373.88
WIP conversion period =
141.50*365 3373.88 = 15 days
4.3 Finished Goods Conversion Period = Finished goods inventory * 365 Cost of goods sold
Cost of goods sold = Cost of production + Op. Finished goods inventory- Cl. Finished goods inventory = 3373.88+142.06-214.72 = Rs. 3301.21 Finished Goods Conversion Period = 214.72 * 365 3301.21 = 35 Days
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Working Capital Management at NALCO
4.4 Debtor Conversion Period
Debtors *365 Credit sales
=
112.40 * 365 6369.88
= 6 Days
4.5 Payment Deferred Period
Creditors *365 / Credit Purchase
Payment Deferred Period =
2170.8* 365 3341.31 = 237 days
Net Operating Cycle = Gross Operating Cycle- Payment Deferred Period
Gross Operating Cycle = Inventory Conversion Period + Debtors Conversion Period
Inventory Conversion Period = Raw material+ Work-in- progress+ Finished goods
For 2010-11 = (292+15+35+06-237) = 111 Days
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Working Capital Management at NALCO
5. CALCULATION OF GROSS OPERATING CYCLE PERIOD FOR 2009-10
5.1 Raw material conversion period
Raw material Inventory * 365
Raw material consumptions
=
576.11 * 365 782.30
= 268 Days
Raw material Inventory = Raw materials + Coal & fuel oil + Stores, Spares & Others
= 64.57 + 88.64 + 422.90 = 782.30 units
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Working Capital Management at NALCO
5.2 Work-in-progress conversion period
Work-in-progress Inventory * 365 Cost of Production
Cost of Production = Op. FG + Factory Cost + Administration Exp. – Closing FG Factory Cost = Op. WIP+ Raw material Consumed+ Power & Fuel + Repairs & Maintenance + Manufacturing Exp. – Cl. WIP
= 114.74+782.30+1601.14+296.37+210.78-146.32 = Rs. 2859.01 Cost Of Production = 131.91 + 2859.01 + 115.29 – 142.06 = Rs 2964.15
WIP conversion period =
146.32 *365 2964.15
=
18 days
5.3 Finished Goods Conversion Period
Finished goods inventory * 365 Cost of goods sold
Cost of goods sold = Cost of production + Op. Finished goods inventory- Cl.Finished goods inventory
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Working Capital Management at NALCO
= 2964.15+131.91-142.06 = Rs.2954 Finished Goods Conversion Period 142.06 * 365 2954 = 17 Days
5.4 Debtor Conversion Period
Debtors *365 / Credit Sales Debtors conversion period = = 181.66 * 365 5311.40 = 12 Days
5.5 Payment Deferred Period
Creditors *365 / Credit Purchase Payment Deferred Period = 1757.03* 365 3018.14 = 212 Days
For 2009-10 = (268+18+17+12-212) = 103 Days For 2010-11 = (292+15+35+06-237) = 111 Days
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Working Capital Management at NALCO
5.6 Interpretation
The gross operating cycle period in the year 2010-11 is comparatively longer than the year 2009-10 which is not good for the business. It implies that locking up of funds in current assets is for a relatively longer duration and NALCO can obtain greater mileage for each rupee invested in current assets. The longer the duration of operating cycle period, slower is the transformation of current asset into cash. Here raw materials include raw materials along with stores & spares. The Raw material conversion period has increased from 268 days in 2009-10 to 292 days in 2010-11 which shows a poor raw materials management by NALCO in the 2010-11. Work-in-progress conversion has decreased from 18 to 15 days. Finished goods conversion period is increased from 17 days in 2009-10 to 35days in 2010-11. Debtors’ conversion period decreases from 12 days in 2009-10 to 6 days in 2010-11. NALCO gives its debtor a period of 15 days to repay the debt. This shows that Nalco has shown improvement in getting back money from its debtors. The payment-deferred period is increased from 212 days in 2009-10 to 237 days in 2010-11 indicating that NALCO is able to get a wider time window to pay back to its creditors. From the above data we can interpret that NALCO is managing its operating cycle in an efficient manner. But we can also see that the finished goods are lying in the go-down or stores for along period of time which results in blocking the money for that number of days. NALCO should concentrate more in that area so that the finished goods get sold off quickly.
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Working Capital Management at NALCO
6. NALCO’S FINANCIAL RATIOS
RATIO ANALYSIS Ratio Analysis is one of the powerful tools for financial analysis. I have studied and analyzed the following ratio of NALCO. a) Liquidity Ratios
b)
Cash Ratio
c)
Activity Ratios
6.1 Liquidity Ratios :
6.1.1 Current Ratio
Current Ratio = Current Assets Current Liabilities
2004-05 CR =
1,811.04 806.39
= 2.246
2005-06 CR =
3,297.88 940.15
= 3.50
2006-07 CR =
4794.08 1218.61
= 3.9340
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Working Capital Management at NALCO
2007-08 CR =
5041.33 1540.88
= 3.2720
2008-09 CR= 2009-10CR=
4224.06 /1216 5022.03 /1342
= 3.4737 =3.7421 = 2.2055
2010-11CR= 6045.17/2740.95
We can state that the ratio has been increased. Current assets are more than current liabilities, although 2011 has shown a slight decrease in current assets, hence we can state that NALCO has greater margin of safety. NALCO is in a better position to meet the obligations.
6.1.2 Quick ratio
Quick Ratio = Current assets- Inventories Current liabilities
3,297.88-591.58 2005-06 QR = 940.15
2,706.30 = 940.15 = 2.88
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Working Capital Management at NALCO
4974.08- 634.96 2006-07 QR = 1218.61 5041.33- 1318.31 2007-08 QR = 1540.88 2008-09QR= 4224.06- 646/ 1216 2009-10QR= 5022.03- 450 /1342 2010-11QR= 6045.17-1058.47/2740.95 = 2.94 = 3.4 =1.81 = 2.826 = 3.56
Inventory is a slow moving item. It does not get converted into cash quickly. Therefore it is left out of the fast moving assets and then the liquidity of the company is calculated. We can see that the company did not have a good liquid position during 2003-04 but it improved in the year 2009-10. But 2010-2011 saw a drastic reduction in the ratio due to huge rise in the level of inventory.
6.2 Cash Ratio
Cash Ratio = Cash + Marketable Securities Current liabilities 2,193.71 + 0 2005-06 CR = 940.15 = 2.333
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Working Capital Management at NALCO
3686.53 + 0 2006-07 CR = 1218.61 = 3.025
3516.46 + 0 2007-08 CR = 1218.61 2008-09 CR= 3224.35 + 0 /1216 2009-10 CR= 3321.78 +0 / 1342 2010-11CR= 3795.23+0/2740.95 = 2.651 = 2.475 =1.384 = 2.885
Cash ratio is useful in measuring the capability of the company in meeting its current liabilities. We can see that the company is quite able to meet the obligations of the liabilities effectively. In 2010-11, the ratio has decreased due to increase in current liabilities (Increase in lending to micro enterprises).
6.3 ACTIVITY RATIOS:
6.3.1 Debtors Turn over Ratio
Debtors Turnover Ratio = Net Sales Debtors 4988.80 2007-08 DTR = 60.65 = 82.24
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Working Capital Management at NALCO
2008-09 DTR = 2009-10 DTR = 2010-11 DTR=
5094.52 /26.50 5055.66 /181.78 5958.98/112.40
=192.24 =27.81 =53.015
This ratio indicates the velocity of debt collection of a firm. In simple words it indicates the number of times average debtors (receivable) are turned over during a year. In 2009-10 there was a drastic fall in the figure due to many fold increase in debtors while net sales was more or less constant but in 2010-11 there has been an improvement in this figure.
6.3.2 Average Collection period (ACP)
This gives the number of days it takes to get back all the debt amount from the debtors. ACP = 365/ DTR 2007-08=365/82.24 = 4.43days 2008-09=365/192.24=1.89days 2009-10=365/27.81=13.12 days 2010-11=365/53.015=6.88 days The ACP has reduced in 2010-11 from that of previous years, from which we can state that NALCO has adopted a good cash collection system.
6.3.3 Inventory Turnover Ratio (ITR)
Stock turn over ratio/Inventory turn over ratio indicates the number of time the stock has been turned over during the period and evaluates the efficiency with which a firm is able to manage its inventory. Cost of goods sold ITR = Average inventory
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Working Capital Management at NALCO
1,766.97 2005-06 = 529.06+591.58/2 1,766.97 = 560.32 1,766.97 2006-07 = 529.06+591.58/2 1,766.97 = 560.32 = 3.15 2,497.53 2007-08 = 686.65+634.96/2 = 3.78 = 3.15
2008-09 = 6514.51 /634.96 = 10.26 2009-10 = 5474.45 /686.65 = 7.98
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Working Capital Management at NALCO
2010-11 =4199.8/1001.695=4.192 The ITR shows a decline in 2009-10 and 2010-11 signifying decrease in profitability and decrease in the return form every rupee invested in inventory. Nalco should try and increase its ITR by either reducing inventory levels or by increasing its sales through marketing and providing more credit to its customers to boost sales.
6.3.4 Working Capital Turnover Ratio (WCTR)
It indicates the velocity of the utilization of net working capital. This ratio represents the number of times the working capital is turned over in the course of year. Sales WCTR = Net Working Capital
4,851.90 2005-06 WCTR = 2,357.73 5940.19 2006-07 WCTR = 3755.47 4988.80 2007-08 WCTR = 3500.45 = 1.42 = 1.58 = 2.05
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Working Capital Management at NALCO
2008-09 WCTR= 2009-10 WCTR = 2010-11 WCTR=
5094.52/2595.57 5055.66/2998.3
=1.96 =1.68
5958.98/3304.22 =1.80
Hence, WCTR has increased in 2010-11 as compared to 2009-10 indicating better working capital management by NALCO.
7. Relationship between Working capital and Profitability – A statistical Analysis
Theoretically, leaving other things constant, level of investment in current assets has a bearing on the profitability of the firm. Excess of investment in working capital casts a negative impact on the profitability of a firm and positive impact on the liquidity. Studies on the association of level of investment in current assets and the profitability have always claimed inverse relationship in the research on the degree of association both at micro and macro levels. Let us have a glance on the impact of investment in various current assets on the profitability theoretically. TABLE 7.1 Theoretical relationship between measures of working capital and profitability Current Assets Cash Excess As non earning assets reduces profitability. Shortage Causes liquidity crisis by lagging in payments, disruption of operations, ultimately affecting the overall turnover and profits. Receivables Cost of Collection efforts, Default risks, low profitability . Inventory Opportunity cost of funds, price declines, carrying costs adversely affect profits Interrupted production schedules, limited supplies, lower turnover and profits Lower turnover, lower profitability
Theoretically working capital decision affects both liquidity and profitability. Excess of Investment in working capital may result in low profitability and lower investment may result in poor liquidity. Management need to trade-off
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Working Capital Management at NALCO
between liquidity and profitability to maximize shareholders wealth. To understand the impact of working capital on profitability, one needs to establish the relationship between these two. Statistical Measures such as correlation and regression models can be used to understand such relationship. The level of working capital needed by a firm is a function of nature of the industry, size of the firm, availability of raw materials, production cycle of the firm, Production policy of the firm, nature of demand for the products, competition in the industry etc. ,f(WC) = {N, Q, R, Pc, Pp, D, and C….n} Where WL is the level of working capital Q = Size of firm R= Availability of Raw-material Pc= Production Cycle of the firm Pp= Production policy of the firm D= Nature of demand for the products of the firm C= competition in the industry The list of factors is exemplary but not exhaustive. There can be differences in the investment in various types of current assets. For example, firms in services industry have negligible size of investment in stores but considerable size of investment in cash and receivables whereas manufacturing firms invest comparatively large sums in inventories. Optimum level of working capital is investment decision in current assets that varies with the risk-return preferences of firms. Conservative firms are risk averse and satisfy with the available profitability at lowest risk and aggressive firms prefer high profitability even for higher risk.
7.1 Regression Analysis
Let us subject Working capital and PBT (Profit Before Tax) to a linear regression model to find out a relation between them and determine an equation to find out the optimal level of working capital required for a particular projection of sales.
Y=a+bX.
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Working Capital Management at NALCO
Where Y=working capital. X=PBT. a=the intercept of line on the Y-axis. I.e., the Amount of working capital required when sales are Nil. 7.1.1 Year wise data on PBT and corresponding Working capital
Year 2011—2010 2010-2009 2009-2008 2008-2007 Working Capital in Crores 3304.22 2998.32 2595.57 3500.45 PBT in Crores 1524.7 1154.86 1272.27 1631.52
Upon doing regression analysis we get the following output: Regression Statistics Multiple R R Square Adjusted R Square Standard Error Observations 0.451114 292.2611 4 0.796289 0.634076
Standard Coefficients Error t Stat P-value
Lower 95% -
Upper 95%
Lower 95.0% -
Upper 95.0%
Intercept
1108.608 1079.455 1.027008 0.412394
3535.91 5753.127 -
3535.91 5753.127 1.87037 4.723182
Pbt
1.426406 0.766219 1.861616 0.203711
1.87037 4.723182
This suggests that their exists a ‘R’ value of 0.634076 between Working Capital and PBT.
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Working Capital Management at NALCO
The equation comes out to be: Working Capital= 1108.608 + 1.4264065 *PBT Using this equation we can predict the optimum amount of working capital required for a particular projected value of PBT so that neither there is a blockage of cash in the operating cycle, lowering of profitability, increase in opportunity costs neither there is a shortage of working capital.
PBT Line Fit Plot
4000 3500 Working Capital 3000 2500 2000 1500 1000 500 0 1524.7 1154.86 PBT 1272.27 1631.52 Working Capital Predicted Working Capital
Fig 7.1.1 PBT Line Fit Plot The above plot shows that there was an excess of working capital in the year 2008 and 2010 while there was a shortage of working capital in 2009. But the amount of working capital seems to be optimum during the year 2011.
7. 2 Correlation between various measures of working capital and Profitability
To understand the correlation between profitability and Working capital we will consider 1. 2. 3. 4. Inventory ( As a percentage of total current assets) Sundry debtors ( As a percentage of total current assets) Cash and Bank Balance ( As a percentage of total current assets) Other current assets ( As a percentage of total current assets)
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Working Capital Management at NALCO
5.
Loans and advances (As a percentage of total current assets)
For the purpose of finding the correlation between the previously mentioned measures of working capital and PBT, as a measure of profitability, we will consider the data of previous four financial years namely 2010-11,2009-2010, 2008-09,2007-08. i) Inventory year 2010-11 2009-10 2008-09 2007-08 Inventory 1058.47 944.92 841.9 686.65 PBT 1524.7 1154.86 1272.27 1631.52
Table 7.2.1 Year wise data on PBT and corresponding Inventory Correlation = -0.321055656 ii) Sundry debtors year 2010-11 2009-10 2008-09 2007-08 Sundry debtors 112.4 181.78 26.5 60.65 PBT 1524.7 1154.86 1272.27 1631.52
Table 7.2.2 year wise data on PBT and corresponding Sundry debtors Correlation = -0.409842187
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Working Capital Management at NALCO
iii)
Cash and Bank Balance
Cash and Bank year 2010-11 2009-10 2008-09 2007-08 balance 3795.23 3152.35 2869.04 3516.46 PBT 1524.7 1154.86 1272.27 1631.52
Table 7.2.3 Year wise data on PBT and corresponding cash and Bank balance Correlation = 0.758762 iv) Other Current Assets Other current year 2010-11 2009-10 2008-09 2007-08 assets 163.84 145 175.35 236.47 PBT 1524.7 1154.86 1272.27 1631.52
Table 7.2.4 Year wise data on PBT and corresponding other current assets Correlation= 0.77411463
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Working Capital Management at NALCO
v)
Loans and advances Loans and year 2010-11 2009-10 2008-09 2007-08 advances 915.23 785.59 616.02 541.1 PBT 1524.7 1154.86 1272.27 1631.52
Table 7.2.5 Year wise data on PBT and corresponding Loans and Advances Correlation = -0.179395163
8. LIMITATIONS
1. This study is carried on the basis of the data available for NALCO Ltd, during the period 2005-2011. The study is confined to understanding the relationship between working capital and profitability of the case using Profit Before Tax (PBT) as a measure of profitability and the most common measures of working capital. Results of the tests cannot be generalized to other companies in the manufacturing industry . 2. In regression analysis we have found an equation relating working capital and Profit before tax. This model does not incorporate many other qualitative factors which are hard to quantify on which Working capital depends like size of firm, availability of Raw-materials, production Cycle of the firm, production policy of the firm,
nature of demand for the products of the firm, competition in the industry .
9. CONCLUSIONS AND RECOMMENDATIONS
1. The current ratio has increased. Current assets are more than current liabilities, although 2011 has shown a
slight decrease in current assets, hence we can state that NALCO has greater margin of safety. NALCO is in a better position to meet the obligations. Hence Nalco should maintain this ratio to be able to meet its obligations.
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Working Capital Management at NALCO
2. 2010-11 saw a drastic decrease to 1.81 in the quick ratio due to huge rise in the level of inventory. Nalco
should improve its quick ratio by decreasing its level of inventory to a desired level as unnecessary inventory chokes cash.
3. Nalco’s cash ratio has been quite healthy in the previous years but 2010-11 saw a decrease in it due to
increase in current liabilities of which small enterprise lending formed a major part. Unless the return on its lending is good, Nalco should reduce lending to small and micro enterprises.
4. In 2009-10 there was a drastic fall in the DTR due to many fold increase in debtors while net sales was more
or less constant but in 2010-11 there has been an improvement in this figure.
5. The ACP has reduced in 2010-11 from that of previous years, from which we can state that NALCO has
adopted a good cash collection system.
6. The ITR shows a decline in 2009-10 and 2010-11 signifying decrease in profitability and decrease in the return form every rupee invested in inventory. Nalco should try and increase its ITR by either reducing inventory levels or by increasing its sales through marketing and providing more credit to its customers to boost sales.
Using Regression analysis we were able to find out an equation which can be used to find out the optimum level of working capital required considering a projected PBT. Since the equation has used historical data, therefore while forecasting Working capital requirements other qualitative aspects should be taken into consideration like competition in the market, availability of raw materials, nature of demand in the market etc.
7. Correlation analysis showed that there existed a negative correlation between inventory, sundry debtors
and loans and advances with that of PBT, while a positive correlation existed between cash and bank, other current assets with that of PBT. Hence, NALCO should refrain from investing too much in inventory or lending to small and micro enterprises to prevent reduction in its profitability.
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Working Capital Management at NALCO
10. ANNEXURE- 1 The Indian Aluminium Industry- A detailed View
INDIAN INDUSTRY PLAYERS The Indian aluminum sector is characterized by large integrated players like Hindalco and National Aluminum Company (Nalco). The other producers of primary aluminum include Indian Aluminum (Indal), now merged with Hindalco, Bharat Aluminum (Balco) and Madras Aluminum (Malco) the erstwhile PSUs, which have been acquired by Sterlite Industries. Consequently, there are only three main primary metal producers in the sector. Hindalco Industries Limited, a prestigious part of Aditya Birla Group, enjoys a leadership position in Indian aluminium and copper industry. It is the world's largest aluminium rolling company and not to forget one of the biggest producers of primary aluminium in Asia with a market share of 48%. The group differentiated as one of the lowest cost producers of aluminum in the world. They excel in the premium category as they hold 58% of sales in the value added category. They have an installed capacity of 445,000 t pa. Incorporated in 1981, as a public sector enterprise of the Government of India, National Aluminium Company Limited (Nalco) is Asia's largest integrated aluminium complex, encompassing bauxite mining, alumina refining, aluminium smelting and casting, power generation, rail and port operations. Commissioned during 1985-87, Nalco has emerged to be a star performer in production and export of alumina and aluminium, and more significantly, in propelling a self-sustained growth. It had an installed capacity of 3,45,000 T of Aluminum metal and produced 3, 58,954 T of the same. Bharat Aluminium Co. Ltd. (BALCO) was incorporated in the year 1965 as a Public Sector Undertaking (PSU). It is the first public sector enterprise in the country which started producing aluminium in 1975. In the year 2001, GoI divested 51% equity and management control in favor of Sterlite Industries (I) Limited which had capacity of 200,000 tpa of calcined alumina, 350,000 tpa of aluminium metal and 810MW power plants. The company has an integrated Aluminium complex at Mettur comprising 40,000 tpa of Aluminium smelter, 80,000 tpa refinery, CPP of 75 MW and associated metal casting and fabrication facilities.
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Working Capital Management at NALCO
.Madras Aluminium Company Ltd. (MALCO) has its own Bauxite reserves in the state of Tamil Nadu – 1.7 million tones. The company has an integrated Aluminium complex at Mettur comprising 40,000 tpa of Aluminium smelter, 80,000 tpa refinery, CPP of 75 MW and associated metal casting and fabrication facilities.
The consolidation process in the aluminium industry which commenced four years ago, crystallized further in 2000-01 with Hindalco acquiring Indian Aluminium (Indal) and Sterlite Industries absorbing Bharat Aluminium Company (Balco). In the earlier round, Indal acquired Orissa Extrusions and Annapurna Foils, India Foils annexed Light Metal, Century Extrusions took over Sangam Aluminium and Malco Sterlite absorbed India Foils.
? ? ? HINDALCO is expanding its capacity by 100,000 per annum. NALCO is expanding its capacity by 460,000 per annum. NALCO is expanding its capacity by 2.1 million tpa.
BACKGROUND Hindalco's consolidation: After deciding to shelve the green field aluminium project in May 1999, Hindalco's seemed close to losing its pre-eminent position in the industry to Nalco. But in less than a year, it made two key initiatives that pushed it to the top. These were: ? Brownfield expansion: Obviously, the first response after shelving the green field project was to look at Brownfield expansion at its existing plant at Renukoot, UP. After examining the feasibility of such an expansion, Hindalco decided to expand its smelter capacity by 1 lakh tpa to 3.42 lakh tpa, the alumina refining capacity by 2.10 lakh tpa to 6.60 lakh tpa, and a matching increase in captive power generation facilities. ? Acquisition of Indal: Hindalco delivered its masterstroke in the third quarter of March 2000, when it unveiled an agreement to pick up a 54.6 per cent equity stake held by Alcan Aluminium, Canada, in Indian Aluminium (Indal) for Rs 738 crore. It was the largest all-cash acquisition in Corporate India. Nalco's relative strength: As a public sector major, Nalco has not moved as aggressively as its private sector peers Hindalco and Sterlite. But within its limitations, Nalco has created three drivers to earnings growth. Unlike Hindalco, Nalco has all along contemplated the brown field expansion model for growth. The first driver is the expansion of
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Working Capital Management at NALCO
the bauxite mines and alumina refinery to provide inputs to its expansion project for primary metal. The first phase of expansion of alumina refinery was completed in June 2000. The company has also doubled bauxite mining capacity from 2.40 million tones to 4.80 million tones. 2Its second driver was the expansion project involving the enhancement of its smelting capacity from 2.30 lakh tpa to 3.45 lakh tpa, along with an increase in captive power from 720 MW to 840 MW. Since Nalco had no downstream production to create scope for value addition, it decided to create its third engine of growth by taking over International Aluminium Products, a joint venture originally promoted by Mukand, FATA Hunter and Global Emerging Markets, a foreign investor.
Sterlite's acquisition of Balco in March 2001 was in the news and the company paid Rs. 552 crores for 51 per cent stake in the PSE. It is expected that the aluminium business (consisting of Malco and Balco) could be spun off into a separate company. Sterlite stands to gain the bauxite reserves of Balco estimated to be around 12 million tones and 1L ton of primary metal capacity. The acquisition makes Sterlite an integrated player right from bauxite mining (Balco) stage to downstream products such as foils (India Foils).
DOMESTIC MARKET OUTLOOK – CURRENT CONDITIONS Domestic aluminum consumption has been witnessing strong growth spurred by investments and industrial growth. The outlook for future demand remains upbeat as economic activity in key aluminum consuming sectors continue to be fast paced. The electric sector demand growing at 23% during FY06 provided a major push. Aluminum consumption will get further boost from the mega power projects as well as the initiatives announced by the government in the budget for rural electrification. There is substantial investment needed in the sector to meet the country’s current and projected future power requirements which bodies well for aluminium demand. Aluminum consumption in transportation segment expanded at an even higher rate of 32%. Rapidly increasing household income has provided a significant life to the passenger vehicles segment growing at around 20% in the last couple of years. Reduction in the excise duty of small cars will further enhance growth. Improvement in the road infrastructure and increasing economic activity bodes well for commercial vehicles demand. The strong growth of the Indian automobile industry is backed by a vibrant auto component sector which is emerging as a hub for global manufacturing. This has significant potential for domestic aluminum consumption.
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Working Capital Management at NALCO
The building and consumption sector has been witnessing an unprecedented growth all over the country. The broad based economic growth has resulted in rapid urbanization and development of smaller towns. This along with strong business sentiment is boosting demand for commercial properties. Experts forecast shortfall of 19 million houses every year, which can lead to a substantial demand creation for aluminum products. Growing consumer demand has led to shift growth in consumer durables and packaging sectors. This posse’s significant potential for future aluminum consumption. Aluminum prices have risen significantly over the past year and reached 17-year highs of $ 2,634/ MT in Feb. 2006. This has been accompanied by falling inventories and rising costs across the world. Reported primary aluminum stocks have declined to a mere 5 weeks of consumption, while reported total aluminum inventories stand at 8 weeks of consumption, close to the multi-year lows. Importantly, aluminum smelters world wide have been under tremendous cost pressure from rising key input costs like alumina, power, carbon and oil. These factors, along with rising global demand, are anticipated to support aluminum prices above historical levels over the long run. The key consumer industries in India are electrical (power), transportation, consumer durables, packaging and construction. Of this, power is the biggest consumer (about 44% of total) followed by infrastructure (17%) and transportation (about 10%-12%). However, internationally, the pattern of consumption is in favor of transportation, primarily due to large-scale aluminum consumption by the aviation industry. REVENUES Revenues = Volumes * Realizations Volumes Growth prospects of the aluminium industry are a function of economic growth. In the Indian context, economic progress does influence the demand for aluminium, as its user industries like infrastructure, transportation; consumer durables and housing get affected. It must be noted that the consumption pattern of aluminium in India is tilted largely in favor of power and electricity (over 1/3rd of total consumption), as against the world consumption pattern, wherein transportation, especially airlines, have a major role to play. The key application of aluminium across sectors is in products like power transformers, railways, auto industry (components and body building), housing (furnishing), packaging (competition is from tin and plastic) and consumer
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Working Capital Management at NALCO
durable sector (body parts). The industry is also looking at increasing volume sales by presenting itself to the steeluser industries as a good substitute option on the basis of its qualities of strength and lesser weight. Competition On the domestic front, protection from competition is in the form of tariffs, which makes the landed cost of aluminium into the country comparatively expensive vis-à-vis the domestic produce. Investors have to keep in mind that when customs duty falls, threat of imports increases unless domestic producers are competitive. Competition is more global in nature for the sector, similar to other sectors. However, since Indian companies are among the lowest cost producers in the world, pressure of imports is negated to that extent. Indian companies are also protected in the domestic markets from international competition, owing to tariffs imposed on aluminium imports. However, with the government committed to bringing down the tariff levels, companies will have to improve cost efficiencies to protect margins Realizations some factors, which determine the realizations for the company, are: ? London Metal Exchange (LME)
Unlike steel and cement, pricing for aluminium is determined at a global exchange called LME. This serves as a benchmark. Prices are determined depending upon the demand-supply mismatch, which in turn is dependent on the economic cycle. When aluminium prices start firming, in order to cash in on the rise in price, manufactures increase the capacity utilization, which ultimately distorts the demand-supply picture and prices start to weaken. If demand fails to match production, the consequent rise in inventory impacts prices and vice-versa. Domestic prices closely track international price movements. However the volatility on the domestic front is reduced to a certain extent owing to factors like import tariff protection and the absence of fragmentation in the domestic aluminium industry.
?
Player positioning 49
Working Capital Management at NALCO
This factor plays a crucial role in determining the profitability of a company. Since a company can be largely present in the upstream segment or the downstream segment or be an integrated player, the cyclicality of the industry has a varying effect on the performance of the company. For example, a company, which is largely present in the upstream segment, will be prone to volatility. This is because raw material prices increase or decrease depending upon aluminium production. Whereas, a company, which has a significant presence in the downstream segment, margins will be squeezed in a cyclical upturn, as aluminium prices strengthen. The ability to pass on the rise in input costs is relatively less. However, an integrated player is best placed as he has the advantage of captive mining, which will protect its input costs, while its presence in the downstream segment will help it to keep a check on the realization aspect. ? Value added products
Realizations are also dependant to a large extent on the product profile of the company. Companies with a larger presence in value added segments (downstream segment) like extrusions, foils and aluminium wheels are able to realize higher value for their products, which assists margin improvement. EXPENSES As pointed above, in the face of increasing competition, survival would depend on cost efficiency, more so given the commodity nature of the business. Some of the key expense heads pertain to raw material, power, employees and interest cost. Since raw material and power constitute over 50% of the total operating expenses, companies with captive facilities have an added advantage. Employee expense is the next big contributor with a share of 12%-15% of the total operating expenses. If the company has presence in mining, employee requirements tend to be on the higher side. Freight is another important cost, which is dependent on the company's proximity to the raw material source and also to customers. Finally, as aluminium companies are capital-intensive in nature and have significant exposure to debt, managing interest cost is of utmost importance.
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Working Capital Management at NALCO
11. Annexure- 2
NALCO- A Holistic View
VISION TO BE A COMPANY OF GLOBAL IN THE ALUMINIUM SECTOR. MISSION TO ACHIEVE GROWTH IN BUSINESS WITH GLOBAL COMPETITIVE EDGE PROVIDING SATISFACTION TO THE CUSTOMER, EMPLOYEES, SHAREHOLDERS & COMMUNITY AT LARGE Environment Nalco assigns high importance to promotion & maintenance of a pollution-free environment in all its activities. The environment Mgt system in all production units conform to the ISO 14001 norms. Among numerous recognitions, the two highest national awards viz. Indira Priyadarshini Vrikhamitra for a forestation & Indira Gandhi Paryavaran Puraskar for environment Mgt, conferred on the co. by the ministry of environment & forests, Govt of India, bear further testimony to Nalco’s commitment towards the environment. Nalco assigns high importance to promotion & maintenance of a pollution free environment in all its operation
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Nalco has set the following objectives regarding the environment management:? ? ? ? To use non-polluting & environment friendly technology in all its industrial activities. To monitor regularly air, water, land, noise & other environmental condition. To constantly improve the standards of pollution control & provide a leadership in management. To develop an awareness of environmental responsibilities among the employees. environmental
To work with Govt. & local authorities to help, prevent & minimize the adverse consequences of the industrial activities on the environment.
Community care The co. has adopted a policy of playing a catalytic role in improving the of life of the people living in the peripheral villages, in collaboration with local Govt. authorities. The activities include—creation of infrastructure for communication, education, and health care, water supply, apart from undertaking social forestry, organizing rural sports & supporting cultural activities.
MILE STONES OF NALCO 1981 – Foundation of Company 1985 – Start of Commissioning 1987 – Commencement of scale of Metal 1988 – Commencement of Alumina Export 1992 – Commencement of metal export. 1995 – An ISO 900 Company
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Achievements of NALCO 1. 2. 1st MINES SAFETY AWARDED IN 1988. Best eco-friendly award for the year 1994-95 to the mines & refinery complex by the state of Orissa Safety Award Committee. 3. 4. 5. 6. 7. 8. 9. 10. Indira Priyadarshini Vrikshyarnitra Award 1994 from MOFF, Govt of India to the company for eco-friendliness. FICCI Environment Award for environment conservation 1996-1997. WEC-IIEE-IAENP Environment Award for contributing towards environment protection around NALCO. Gem-Granite Environment Award 1997-98 by FIMI N.D. Pollution control excellence award by the state of Orissa Pollution Control Board. Special Commendation Award under Golden Peacock Environment Management Award. 1998 scheme by World Environment Foundation. EEPC (All India) Star performance Award for outstanding contribution to Engineering Exports in Large Enterprise Group. 11. 12. 2010 IIM-Non-ferrous best performance award in category of large integrated production organization. 1st prize in the aluminium sector at the National Energy Conservation Awards-2010, instituted by the Ministry of power, Govt. of India. 13. 14. 15. CSR Award for the Best Practices under the ‘Global HR Excellence’ category at the world HR congress. DPE Best listed CPSE Award for its excellent performance in significant value addition to its shareholders. EEPC(Eastern Region’s) Gold Trophy, as top exporter in the large Enterprise category.
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M Inbound Logistics Operations Outbound Logistics Marketing & Sales Service A R M Fig 11.1 FIRM INFRASTRUCTURE HUMAN RESOURCE MANAGEMENT TECHNOLOGY DEVELOPMENT PROCUREMENT A R G I n
PORTER’S GENERIC VALUE CHAIN
Based on the Porter’s value chain I have tried to analyze the value chain of Nalco. The value chain is a systematic approach to examining the development of competitive advantage. The chain consists of a series of activities that create and build value. They culminate in the total value delivered by an organization. The organization is split into 'primary activities' and 'support activities.' I would be discussing the entire value chain of Nalco in the following heads. PRIMARY ACTIVITIES Inbound Logistics – it involves procuring the raw materials from the supplier’s and distributing it to the manufacturing departments respectively. The basic raw material that is Bauxite comes from the Captive mines itself. Bulk of the purchase of raw materials is from India and sometimes they outsource materials from foreign countries like China, Australia, America, and France. All imports land in their private ports at
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Working Capital Management at NALCO
Kolkata and Vizag. They transport the bauxite from mines to production houses in 15 km automatic conveyor belts. Operations – it emphasizes on the methods and processes involved in conversion of raw materials to finished goods. The process of reaching to aluminum involves the following steps: Fig 11.2 The conversion of Bauxite to Aluminium
REFINERY BAUXITE ALUMINA SMELTER ALUMINIUM
2.9 Tones of Bauxite give us 1 Tone of Alumina and 1.9 Tones of Alumina gives 1 Ton of Aluminum. So the ratio becomes 2.9: 1.9: 1 respectively. ? ? ? ? ? Nalco has bauxite mines at Panchpatmalli It has Alumina Refinery at Damanjodi It has Smelter plant at Angul It has Captive Power Plant at Angul It has port facilities at Vishakhapatnam
Outbound Logistics – Nalco has warehouses in all of its various regional offices like Mumbai, Chennai, Bangalore, Jaipur, Vizag, Kolkata, and Daman and other places. They send mostly bulk Alumina and that goes by train. Aluminum is transported to warehouses both by train and road carriage facility. Marketing and sales – they believe in and rather the product requires bulk marketing system for Alumina. They call in for tenders and thus the process of sales follows. For Aluminum they go in for spot and long term contacts. For long term contracts they again call in for tenders Service – Nalco as such doesn’t have in after sales department but they believe in maintaining a good relationship with their customers. They give in assured guarantee of product purity of 99.7 % in Aluminum and alumina below 45
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Working Capital Management at NALCO
microns. They never hesitate in replacing any product if defaulted but they assure rare chances of it also as the products are always tested before release. The company has also achieved zero discharge of industrial effluents.
SECONDARY ACTIVITIES Firm infrastructure – the company has been allotted with mining lease of Pottangi Bauxite deposits with estimated reserves of 69 million tones. Government has provisionally allotted Utkal E – Coal Block at Talcher, Orissa. Nalco has a aluminum capacity of 48 L tones. They have their own processing plant which is known as Aluminum Refinery, Smelting plant and Power supply through their CPP units. Human Resource Management – HRD is the key to the success of NALCO. With a total manpower of 7406 employees it is being able to meet its new expansions. Targets are set, functional and developmental training needs are identified from multiple sources, primary being, the competency related needs, secondly, needs arising from organizational requirements and finally departmental / sectional imperatives. Technology Development – technology has been imported from Pechiney, a France based company which is now a part of the Canadian Alcan group. ERP, VPN and e-Governance have been embarked upon. RAMCO Maintenance Mgt. Packages have been successfully implemented at CPP, Bauxite mines, Damanjodi and port facilities. Statistical Process Control methods were also introduced for better control of production processes.
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Fig 11. 3
ORGANIZATIONAL CHART OF NALCO
ED (M&R)
GM (AR)
GM (MINES)
GM (H&A)
GM (MATLS)
GM (FINANCE)
GM (O&M)
FUNCTIONAL HOD
FUNCTIONAL HOD
FUNCTIONAL HOD
FUNCTIONA L HOD
FUNCTIONAL HOD
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Working Capital Management at NALCO
ED (M&R)
:
Overall in charge of M&R Complex and all Functional level GMs are reporting
GM(AR)/GM : (O&M) GM (Mines) GM (H&A) GM (MATLS.) : : :
In charge of Alumina Plant operation & maintenance In charge of Mines operation & maintenance In charge of HRD & Admn. of M&R Complex In charge of Purchase & stores Functions of M&R Complex In charge of Finance & Accounts of M&R Complex In charge for respective area of operation and i.e. Production, Mechanical, Electrical, Steam Generation Plant, Electronic &
GM (FINANCE) : FUNCTIONAL :
HEAD OF DEPARTMENT
Instrumentation, Civil, Purchase, Stores, Finance, Human Resource Development, Administration, Horticulture, Training, Peripheral Development.
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Fig 11.4
ORGANIZATIONAL STRUCTURE OF FINANCE DEPARTMENT DIRECTOR
EXECUTIVE DIRECTOR
GENERAL MANAGER
GENERAL MANAGER
DEPUTY GENERAL MANAGER
CHIEF MANAGER
SENIOR MANAGER
MANAGER
DEPUTY MANAGER
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ASSITANT MANAGER OFFICER The entire finance dept. works in synchronization where tasks are interchangeable and everyone is accountable for their tasks. The Corporate Office performs centralized function where all regional offices act as collection centres. All units are decentralized. Apart from performing routine tasks the corporate office also performs specific tasks like: ? ? ? ? ? ? Financial policy making for entire organization. Sales realization and debtors account. Corporate budgeting. Corporate financial planning. Corporate centralized accounts. Forex transactions.
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12. Annexure – 3 Working Capital Management
Working capital management is concerned with the problems that arise in attempting to manage the current assets, the current liabilities and the inter relationship that exists between them. The current assets refer to those assets which in the ordinary course of business can be, or will be, converted into cash within one year without undergoing a diminution in value and without diminution in value and without disrupting the operations of the firm. The major current assets are cash, marketable securities, accounts receivables and inventory. Current liabilities are those liabilities which are intended, at their inception, to be paid in the ordinary course of business, within a year, out of the current assets or earnings of the concern. The basic current liabilities are accounts payable, bills payable, bank overdraft, and the outstanding expenses. The goal of working capital management is to manage the firm’s current assets and liabilities in such a way that a satisfactory level of working capital is maintained. This is so because if the firm cannot maintain a satisfactory level of working capital. It is likely to become insolvent and may even be forced into bankruptcy. The current assets should be large enough to cover its current liabilities in order to ensure that they are obtained and used in the best possible way. The interaction between current assets and current liabilities is therefore, the main theme of the theory of working capital management. In the words of Shubin,”Working capital is the amount of funds necessary to cover the cost of operating the enterprise.” According to Genestenberg,”Circulating capital means current assets of a company that are changed in the ordinary course of business from one form to another, as for example, from cash to inventories, inventories to receivables, receivables into cash.”
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Working capital management
Fig 12.1 Working Capital cycle Every running business needs working capital. Even a business which is fully equipped with all types of fixed assets required is bound to collapse without adequate supply of raw materials for processing, cash to pay for wages, power and other costs creating a stock of finished goods to feed the market demand regularly. The ability to grant credit to its customers. All these require working capital. Working capital is thus like the lifeblood of a business. The business will not be able to carry on day-to-day activities without the availability of adequate working capital. Working capital cycle involves conversions and rotation of various constituents/ components of the working capital. Initially ‘cash’ is converted into raw materials. Subsequently, with the usage of fixed assets resulting in value
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additions, the raw materials get converted into work in process and then into finished goods. When sold on credit, the finished goods assume the form of debtors who give the business cash on due date. Thus ‘cash’ assumes its original form again at the end of one such working capital cycle but in the course it passes through various other forms of current assets too. This is how various components of current assets keep on changing their forms due to value addition. As a result, they rotate and business operations continue. Thus, the working capital cycle involves rotation of various constituents of the working capital. While managing the working capital, two characteristics of current assets should be kept in mind viz. (i) short life span, and (ii) swift transformation into other form of current asset. Each constituent of current asset has comparatively very short life span. Investment remains in a particular form of current asset for a short period. The life span of current assets depends upon the time required in the activities of procurement; production, sales and collection and degree of synchronization among them. A very short life span of current assets results into swift transformation into other form of current assets for a running business. These characteristics have certain implications: Decision regarding management of the working capital has to be taken frequently and on a repeat basis. The various components of the working capital are closely related and mismanagement of any one component adversely affects the other components too. The difference between the present value and the book value of profit is not significant. The working capital has the following components, which are in several forms of current assets: ? ? ? ? ? Stock of Cash Stock of Raw Material Stock of Finished Goods Value of Debtors Miscellaneous current assets like short term investment loans & advances
DEFINITION: There are two concepts of working capital: gross and net. The term gross working capital, also referred to as working capital, means the total current assets.
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The term net working capital can be defined in two ways
i)The most common definition of net working capital(NWC) is the difference between current assets and current liabilities; and (ii)Alternate definition of NWC is that portion of current assets which is financed with long term funds. The gross working capital concept is financial or going concern concept whereas net working capital is an accounting concept of working capital. These two concepts of working capital are not exclusive; rather both have their own merits. The gross concept is sometimes preferred to the net concept of working capital for the following reasons: It enables the enterprise to provide correct amount of working capital at the right time. Every management is more interested in the total current assets with which it has to operate than the sources from where it is made available. The gross concept takes into consideration the fact that every increase in the funds of the enterprise would increase in its working capital The gross concept of working capital is more useful in determining the rate of return on the investments in working capital. The net working capital concept however is also important for the following reasons: The qualitative concept which indicates the firm’s ability to meet its operating expenses and short term liabilities. It indicates the margin of protection available to the short term creditors, i: e, the excess of current assets over current liabilities. It is an indicator of the financial soundness of an enterprise. It suggests the need for financing a part of the working capital requirements out of the permanent sources of funds. To conclude, it may be said that, both, gross and net, concepts of working capital are important aspects of the working capital management. The net concept of working capital may be suitable only for proprietary form of organizations such as sole trader or partnership firms. But the gross concept is very suitable to the company form of organization where there is divorce between ownership, management and control. NET WORKING CAPITAL: But the net working capital refers to the difference between current assets and current liabilities. Current liabilities are those claims of outsider, which are expected to mature64
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for payment within an accounting year & include creditors, bills payable & the outstanding expenses. In other words you can say that this is the excess of current assets over current liabilities. CURRENT ASSETS constitute the following: 1. Inventories: Inventories represent raw materials and components, work-in-progress and finished goods. 2. Trade Debtors: Trade Debtors comprise credit sales to customers. 3. Prepaid Expenses: These are those expenses, which have been paid for goods and services whose benefits have yet to be received. 4. Loan and Advances: They represent loans and advances given by the firm to other firms for a short period of time. 5. Investment: These assets comprise short-term surplus funds invested in government securities, shares and short-terms bonds. 6. Cash and Bank Balance: These assets represent cash in hand and at bank, which are used for meeting operational requirements. One thing you can see here is that this current asset is purely liquid but non-productive. Current liabilities form part of working capital that represents obligations which the firm has to clear to the outside parties in a short-period, generally within a year. CURRENT LIABILITIES comprise the following: I. Sundry Creditors: These liabilities stem out of purchase of raw materials on credit terms usually for a period of one to two months. II. Bank Overdrafts: These include withdrawals in excess of credit balance standing in the firm’s current accounts with banks III. Short-term Loans: Short-terms borrowings by the firm from banks and others form part of current liabilities as short-term loans. IV.Provisions: These include provisions for taxation, proposed dividends and contingencies.
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Working capital Current assets Cash Accounts receivable Notes receivable Marketable securities Inventory Prepaid expenses Total current assets Total current liabilities Current liabilities Accounts payable Notes payable Accrued expenses Taxes payable
Net working capital is current assets minus current liabilities. Gross working capital concept focuses on two aspects: 1. How to optimize investment in current assets? 2. How should current assets be financed? The planning should be done keeping in mind two danger point’s i.e. excessive and inadequate investment in current assets. Investment in current assets needs to be adequate as it affects the profitability, solvency and liquidity. Why this issue comes up because it ultimately affects the objectives of financial management.
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Danger points to be kept in mind while planning 1. Excessive investment (Profitability) a. It results in unnecessary accumulation of inventories. Thus, chances of inventory mishandling, waste, theft & losses increase. b. It is an indication of defective credit policy & slack collection period. c. Excessive WC makes management complacent, which degenerates into managerial inefficiency. d. Tendencies of accumulating inventories tend to make speculative profits grow. 2. Inadequate investment (Liquidity) a. It stagnates growth. b. It becomes difficult to implement operating plans and achieve the firm’s operating profit target. c. Operating inefficiencies creep in when it becomes difficult even to meet day-to-day commitments. d. Fixed assets are not efficiently utilized for the lack of working capital funds. Thus, the firm’s profitability would deteriorate. e. Paucity of WC funds render the firm unable to avail attractive credit opportunities. f. The firm loses its reputation when it is not in a position to honour its short-term obligations. TYPES OF WORKING CAPITAL Working capital may be classified as: Permanent or Fixed working capital Temporary or variable working capital Permanent working capital: These components represent the value of current assets required on a continuing basis over the entire year and for several years. Permanent working capital is the minimum amount of current assets which is needed to conduct a business even during the dullest season of the year. The minimum level of current assets is called permanent or fixed working capital as this part is permanently blocked in current assets. This amount varies from year to year, depending upon the growth of the company and the stage of the business cycle in which it operates. It is the amount of funds required to produce the goods and services, which are necessary to satisfy demand at a particular point of time. It represents the current assets, which are required on a
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continuing basis over the entire year. It is maintained as the medium as to continue the operations at any time. Characteristics of permanent working capital It is classified on the basis of the time period. It constantly changes from one asset to another and continues to remain in the business process. Its size increases with the growth of business operations. Temporary working capital Contrary to the above you will find that temporary working capital represents a certain amount of fluctuations in the total current assets during a short period. These fluctuations are increased or decreased and are generally cyclical in nature. Additional current assets are required at different times during the operating year. Variable working capital is the amount of additional current asset that are required to meet the seasonal needs of a firm, so is also called as the seasonal working capital. For example: additional inventory will be required for meeting the demand during the period of high sales When the peak period is over variable working capital starts decreasing or very little during the normal period. It is temporarily invested in current assets. Say for an example a shopkeeper invests more money during winter season because he/ she require to keep more amount of stock of woolen cloths. The same happens in a sugar factory how: the factory manager buys more quantity of sugarcane during the harvesting season and they continuously stops for some time.
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Characteristics of temporary working capital It is not always gainfully employed, though it may change from one asset to another asset, as permanent working capital does. It is particularly suited to business of a seasonal or cyclical nature.
Fig 12.2 Determinants of working capital: We can explain the determinants of working capital as follows: Nature of business: The working capital requirements are basically related to the conduct of the business. Public utility undertakings like Electricity, Water supply, Railways etc need very limited working capital because they offer cash sales only and supply services, not products and as such no funds are ties up in inventories and receivables .But at the same time have to invest fewer amounts in fixed assets .The manufacturing concerns on the other hand require sizeable working capital along with fied investments, as they have to build up the inventories. Terms of sale and purchases: Credit sales are granted by the concerns too its customers as well as credit terms granted by the suppliers also affect the working capital. If the credit terms of the purchases are more favorable and at the same time those of sales less liberal, less cash will be invested in the inventory. With more favorable credit terms, working capital requirements can be reduced.
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Manufacturing cycle: The length of manufacturing cycle influences the quantum of working capital needed. Manufacturing process always involves a time lag between the time when raw materials are fed into the production line and finished goods are finally turned out by it. The length of the period of manufacture in turn depends o the nature of product as well as production technology used by a concern. Shorter the manufacturing cycle, lesser the working capital required. Rapidity of turnover: If the inventory turnover is high, the working capital requirements will be low. With a better inventory control, a firm is able to reduce its working capital requirements. When a firm has to carry on a large slow moving stock, it needs a larger working capital as against another whose turnover is rapid. A firm should determine the minimum level of stock, which it will have to maintain throughout the period of its operation. Business cycle: Cyclical changes in the economy also influence quantum of working capital. In a period of boom i.e. when the business is in prosperous, there is a need of larger amount of working capital due to increase in sales, rise in price etc and vice versa during period of depression. Changes in technology: Changes in technology may lead to improvements in processing of raw materials, savings in wastage, greater productivity, and more speedy production. All these improvements may enable the firm to reduce investments in inventory. Seasonal variation: The inventory of raw materials spares and stores depend on the condition of supply. If the supply is prompt and adequate the firm can manage with small inventory. However, if the supply were unpredictable and scant then the firm, to ensure the continuity of production, would have to acquire stocks as and when they are available and carry larger inventory on an average. Market conditions: The degree of competition prevailing in the market place has an important bearing on working capital needs. When the competition is keen, a larger inventory of finished goods is required to promptly serve the customers who may not be inclined to wait because other manufacturers are ready to meet their needs.
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Seasonality of operations: Firms, which have marked seasonality in their operation usually, have highly fluctuating working requirements. Let us take an example to illustrate this point. Consider firm manufacturing fans. The sale of fans reaches a peak during the summer months and drops sharply during the winter period. The working capital need of such a firm is likely to increase considerably in summer months and decrease significantly during winter season. Dividend policy: It has a dominant influence on the working capital position of a firm. If the firm is following a conservative dividend policy, the need for working capital can be met with retained earnings. Working capital cycle: Larger the working capital cycle, more is the requirement of working capital. Price level changes: Changes in the price level also affect the working capital requirements. Generally, the rising prices will require the firm to maintain a larger amount of working capital as more funds will be required to maintain the same current assets. The effect of rising prices may be different for different firms. Some firms may be affected much while some others may not be affected at all by the rise in prices. Other factors: Certain other factors such as operating efficiency, management ability, irregularities of supply, import policy, asset structure, importance of labour, banking facilities, etc; also influence the requirements of working capital. Importance or advantages of adequate working capital Working capital is the lifeblood and nerve centre of a busiess.Just as circulation f blood is essential in the human body for maintaining life, working capital is very essential to maintain the smooth running of a business. No business can run successfully without an adequate amount of working capital. The main advantages of maintaining adequate amount of working capital are as follows: 1. Solvency of the business: Adequate working capital helps in maintaining solvency of the business by providing uninterrupted flow of production. 2. Goodwill: Sufficient working capital enables a business concern to make prompt payments and hence helps in creating and maintaining goodwill.
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3. Easy loans: A concern having adequate working capital, high solvency,and good credit standing can arrange loans from banks and ohers on easy and favourable terms. 4. Cash discounts: Adequate working capital also enables a concern to avail cash discounts on the purchases and hence it reduces costs. 5. Regular supply of raw materials: Sufficient working capital ensures regular supply of raw materials and continuous production. 6. Regular payment of salaries, wages, and other day to day commitments: A company which has ample working capital can make regular payments of salaries, wages and other day to day commitments which raises the morale of its employees, increase their efficiency, reduces the wastage and costs and enhances production and profits. 7. Exploitation of favorable market conditions: Only concerns with adequate working capital can exploit favorable market conditions such as purchasing its requirements in bulk when the prices are lower and by holding its inventories for higher prices. 8. Quick and regular return on investments: Every investor wants a quick and regular return on his investments. Sufficiency of working capital enables a concern to pay quick and regular dividends to its investors as there may not be much pressure to plough back profits. This gains the confidence of its investors and creates a favorable market to raise additional funds in the future. 9. High morale: Adequacy of working capital creates and environment of security, confidence, higher morale and creates overall efficiency in a business. Excess or inadequate working capital: Every business concern should have adequate working capital to run its business operations. It should have neither redundant or excess working capital nor inadequate nor shortage of working capital. Both excess as well as short working capital positions are ba for any business. However, out of the two it is the inadequacy of working capital which is more dangerous from the point of view of the firm. Disadvantages of Redundant or Excessive Working Capital 1. Excessive Working Capital means idle funds which earn no profits for the business and hence the business cannot earn a proper rate of return on its investments. 2. When there is a redundant working capital, it may lead to unnecessary purchasing and accumulation of inventories causing more chances of theft, waste and losses.
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3. Excessive working capital implies excessive debtors and defective credit policy which may cause higher incidence of bad debts. 4. It may result into overall efficiency in the organization. 5. When there is excessive working capital, relations with banks and other financial institutions may not be maintained. 6. Due to lower rate of return on investments, the value of shares may also fall. Disadvantages or Dangers of Inadequate Working Capital 1. A concern which has inadequate working capital cannot pay its short term liabilities in time. Thus, it will lose its reputation and shall not be able to get good credit facilities. 2. It cannot buy its requirements in bulk and cannot avail of discounts, etc. 3. It becomes difficult for the firm to exploit favorable market conditions and undertake profitable projects due to lack of working capital. 4. The firm cannot pay day to day expenses of its operations and it creates inefficiencies, increases costs and reduces the profits of the business. 5. It becomes impossible to utilize efficiently the fixed assets due to non availability of liquid funds. 6. The rate of return on investments also falls with the shortage of working capital. Management of Working Capital Working Capital, in general practice, refers to the excess of current assets over current liabilities. Management of working capital therefore, is concerned with the problems that arise in attempting to manage the current assets, the current liabilities and the inter-relationship that exists between them. In other words it refers to all aspects of administration of both current assets and current liabilities. The basic goal of working capital management is to manage the current assets and current liabilities of affirm in such a way that a satisfactory level of working capital is maintained i.e. it is neither inadequate nor excessive. This is so because both inadequate as well as excessive working capital positions are bad for any business. Inadequacy of working capital may lead the firm to insolvency and excessive working capital implies idle funds which earn no profits for the business. Working capital management policies of a firm have a great effect on its profitability, liquidity and
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structural health of the organization. In this context, working capital management is three dimensional in nature: I. Dimension I is concerned with the formulation of policies with regard to profitability, risk and liquidity. II. Dimension II is concerned with the decisions about the composition and level of current assets. III. Dimension III is concerned with the decisions about the composition and level of current liabilities.
3D Nature of Working Capital Management
Dimension Dimension II Profitability, Profitability, Risk, & Liquidity Risk, & Liquidity
n II son I Level iio Level ns een Dim ion & Dim stton & ii po i CA os A omp o Com offC C
D ComD im Com pimeensio o n n possiti sion IIII itio n II o o Cn & L offC L& Leevel vel L
Fig 12.3 3D Nature of Working Capital PRINCIPLES OF WORKING CAPITAL MANAGEMENT/ POLICY The following are the general principles of a sound working capital management policy: 1. Principle of Risk Variation: Risk here refers to the inability of a firm to meet its obligations as and when they become due for payment. Larger investments in current assets with less dependence on short term borrowings increase liquidity, reduces risk and thereby decreases the opportunity for gain or loss. On the other hand less investment in current assets with greater dependence on short term borrowings increases risk, reduces liquidity and increases profitability. In other words, there is a definite direct relationship between the degree of risk and profitability. A conservative
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management prefers to minimize risk by maintaining a higher level of current assets or working capital while a liberal management assumes greater risk by reducing working capital. However, the goal of the management should be to establish a suitable trade off between profitability and risk. 2. Principle of Cost of Capital: The various sources of raising working capital finance have different cost of capital and the degree of risk involved. Generally, higher the risk lower is the cost and lower the risk higher is the cost. A sound working 3. Principle of Equity Position: This principle is concerned with planning the total investment in current assets. According to this principle, the amount of working capital invested in each component should be adequately justified by a firm’s equity position. Every rupee invested in the current assets should contribute to the net worth of the firm. The level of current assets may be measured with the help of two ratios
i)current assets as a percentage of total assets and (ii)current assets as a percentage of total sales. While deciding about the composition of current assets, the financial manager may consider the relevant industrial averages. 4. Principle of Maturity of Payment: This principle is concerned with planning the sources of finance for working capital. According to this principle, a firm should make every effort to relate maturities of payment to its flow of internally generated funds. Maturity pattern of various current obligations is an important factor in risk assumptions and risk assessments. Generally, shorter the maturity schedule of current liabilities in relation to expected cash inflows, the greater the inability to meet its obligations in time. To sum up, working capital management should be considered as an integral part of corporal management. In the words of Louis Brand, “We need to know when to look for working capital funds, how to use them and how to measure, plan and control them.” To achieve the above mentioned objectives of working capital management, the financial manager has to perform the following basic functions: ? ? ? Estimating the working capital requirements. Financing of working capital needs. Analysis and control of working capitalFactors Requiring Consideration While Estimating Working Capital Total costs incurred on material, wages and overheads.
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The length of time for which raw materials are to remain in stores before they are issued for production. The length of the production cycle or work-in-process, i.e., the time taken for conversion of raw material into finished goods. The length of sales cycle during which finished goods are to kept waiting for sales. The average period of credit allowed to customers. The amount of cash required to pay day-to-day expenses of the business. The average amount of cash required to make advance payments, if any. The average credit period expected to be allowed by suppliers. Time lag in the payment of wages and other expenses.
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13. Bibliography
? Financial Management ? Financial Management ? Financial Management ? Annual Reports of NALCO ? www.nalcoindia.com ? www.moneycontrol.com ? www.accounting4management.com I M Pandey Khan and Jain Prasanna Chandra
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