A STUDY OF WORKING CAPITAL MANAGEMENT AND ITS IMPACT ON

PROFITABILTY AND NETWORTH OF CNX FMCG INDEX COMPANIES

Paper by: Riyazahmed.K, Assistant Professor, Department of MBA, Sona College of technology, Salem.

ABSTRACT

Optimal management of working capital is an important financial decision and

contributes positively to the value creation of business. Every business needs investment to
procure fixed assets, which remain in use for a longer period. Money invested in these assets is
called ‘Long term Funds’ or ‘Fixed Capital’. Business also needs funds for short-term purposes
to finance current operations. Investment in short term assets like cash, inventories, debtors etc
is called ‘Short-term Funds’ or ‘Working Capital’. The ‘Working Capital’ can be categorized, as
funds needed for carrying out day-to-day operations of the business smoothly. The
management of the working capital is equally important as the management of long-term
financial investment. It is also concerned with maintaining liquidity in the business to ensure
smooth running of day to day operations and to meet its financial obligations. The role of finance
manager, therefore, is a very vital and vested with responsibility of maintaining the business
operations in an efficient and profitable manner. Mismatch, if any in effective management of
current assets and current liabilities would not only result negative impact of profitability and
firm’s growth but also financial distress and bankrupt of business entity. This study considering
the significance of the above, shall make an attempt to investigate the efficiency of working
capital management of FMCG companies listed in CNX FMCG INDEX and its relationship with
profitability and net worth. Further, the study would also overcome limitation of scholastic
knowledge due to dearth of research in financial management at the FMCG sector.

1. Introduction
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 (i) adequate supply
of raw materials for processing; (ii) cash to pay for wages, power and other costs; (iii) creating a
stock of finished goods to feed the market demand regularly; and, (iv) 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 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:
i. Decision regarding management of the working capital has to be taken frequently
and on a repeat basis.
ii. The various components of the working capital are closely related and
mismanagement of any one component adversely affects the other components too.
iii. 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

The working capital needs of a business are influenced by numerous factors.

The important ones are discussed in brief as given below:
i. Nature of Enterprise
The nature and the working capital requirements of an enterprise are interlinked.
While a manufacturing industry has a long cycle of operation of the working capital, the same
would be short in an enterprise involved in providing services. The amount required also varies
as per the nature; an enterprise involved in production would require more working capital than
a service sector enterprise.

ii. Manufacturing/Production Policy

Each enterprise in the manufacturing sector has its own production policy, some follow
the policy of uniform production even if the demand varies from time to time, and others may
follow the principle of 'demand-based production' in which production is based on the demand
during that particular phase of time. Accordingly, the working capital requirements vary for both
of them.

iii. Operations
The requirement of working capital fluctuates for seasonal business. The working capital
needs of such businesses may increase considerably during the busy season and decrease
during the slack season. Ice creams and cold drinks have a great demand during summers,
while in winters the sales are negligible.

iv. Market Condition

If there is high competition in the chosen product category, then one shall need to offer
sops like credit, immediate delivery of goods etc. for which the working capital requirement will
be high. Otherwise, if there is no competition or less competition in the market then the working
capital requirements will be low.

v. Availability of Raw Material

If raw material is readily available then one need not maintain a large stock of the same,
thereby reducing the working capital investment in raw material stock. On the other hand, if raw
material is not readily available then a large inventory/stock needs to be maintained, thereby
calling for substantial investment in the same.
vi. Growth and Expansion
Growth and expansion in the volume of business results in enhancement of the working
capital requirement. As business grows and expands, it needs a larger amount of working
capital. Normally, the need for increased working capital funds precedes growth in business
activities.

vii. Price Level Changes

Generally, rising price level requires a higher investment in the working capital. With
increasing prices, the same level of current assets needs enhanced investment.

viii. Manufacturing Cycle

The manufacturing cycle starts with the purchase of raw material and is completed with
the production of finished goods. If the manufacturing cycle involves a longer period, the need
for working capital would be more. At times, business needs to estimate the requirement of
working capital in advance for proper control and management. The factors discussed above
influence the quantum of working capital in the business.
The assessment of working capital requirement is made keeping these factors in view.
Each constituent of working capital retains its form for a certain period and that holding period is
determined by the factors discussed above. So for correct assessment of the working capital
requirement, the duration at various stages of the working capital cycle is estimated. Thereafter,
proper value is assigned to the respective current assets, depending on its level of completion.
The basis for assigning value to each component is given below:

CONSEQUENCES OF UNDER ASSESSMENT OF

WORKING CAPITAL

 Growth may be stunted. It may become difficult for the enterprise to undertake profitable
projects due to non-availability of working capital.
 Implementation of operating plans may become difficult and consequently the profit
goals may not be achieved.
 Cash crisis may emerge due to paucity of working funds.
 Optimum capacity utilization of fixed assets may not be achieved due to non-availability
of the working capital.
  The business may fail to honor its commitment in time, thereby adversely affecting its
credibility. This situation may lead to business closure.
 The business may be compelled to buy raw materials on credit and sell finished goods
on cash. In the process it may end up with increasing cost of purchases and reducing
selling prices by offering discounts. Both these situations would affect profitability
adversely.
 Non-availability of stocks due to non-availability of funds may result in production
stoppage.
 While underassessment of working capital has disastrous implications on business; over
assessment of working capital also have its own dangers.

CONSEQUENCES OF OVER ASSESSMENT OF

WORKING CAPITAL
 Excess of working capital may result in unnecessary accumulation of inventories.
 It may lead to offer too liberal credit terms to buyers and very poor recovery system and
cash management.
 It may make management complacent leading to its inefficiency.
 Over-investment in working capital makes capital less productive and may reduce return
on investment. Working capital is very essential for success of a business and,
therefore, needs efficient management and control.
 Each of the components of the working capital needs proper management to optimize
profit.

Rationale of the study:

Every business intends to maximize their shareholders worth through several financial
management techniques. This objective of business enterprise will be achieved only when it
earns reasonable profits from its operations. As profits are depending upon the volume of sales,
these sales may not result in immediate conversion of stock into cash. The business
enterprises, therefore, should maintain reasonable working capital for smooth running of its day
to day operations. This short term financing decision should be accurately match between
profitability and liquidity. Any mismatch in effective management of current assets and current
liabilities would not only result negative impact of profitability and firm’s growth but also financial
distress as well as bankrupt of business entity. This study, considering the significance of
above, shall make an attempt to study the management of working capital management of
FMCG companies in CNX FMCG INDEX and tries to investigate the relationship between
working capital and profitability of the FMCG companies. This study expected to contribute to
existing literature on working capital and FMCG companies in India.

The objectives of the study are designed to examine the working capital management at
selected companies and in particular
 The ascertain the efficiency of working capital management of FMCG companies
 To analyze the impact of working capital components on profitability.
 To examine the effect of working capital on net worth

Review of literature:
. JP singh and shishir pandey (2008) studied on the impact of working capital on
profitability through correlation between liquidity, profitability and profit before tax (PBT) of
hindalco industries limited based on secondary data from annual reports for the period 1990 to
2007. F Samiloglu and K Demirgunes (2008) analysed the effect of working capital
management on firm profitability by considering significant relationship between firm profitability
and the components of cash conversion cycle. The study used regression model to measure
statistical significance. Empirical findings of the study showed that, the accounts receivable
period, inventory period and leverage affect firm negatively. While growth affect firm
profitability positively. Pedro Juan Garcia terurel and pedro Martinez Solano (2007) studied on
the effects of working capital management on profitability of small and medium sized Spanish
firms.
The study found that managers can create value by reducing the inventories and the
number of days for which their accounts are outstanding. Further, it is found that shortening the
cash conversion cycle as the firm’s profitability. Marc Deloof (2003) investigated the relationship
between working capital management and corporate profitability at Belgian non financial firms
through measuring trade credit policy and inventory policy by number of days account
receivable, account payable and inventories, and the cash conversion cycle. This study found
that less profitable firms wait longer to pay their bills. S Benjamin Christopher studied on
sensitivity of profitability to working capital management using dependent variable, as a return
on investment to measure profitability and to ascertain relationship between working capital
Management and profitability. The study found significant relationship with ROI through
correlation analysis. Further empirical data through regression analysis found that and increase
of one unit in current ratio, cash turnover ratio, current assets to operating income and
leverages decreases profitability. Further the path analysis of study reveals that, the effect of
quick ratio has the highest direct effect o profitability while current ratio has the least direct
effect. Zariawathi , MA Annuar M.N Abdul Rahim observed the effect of working capital
management on profitability of the firms in Malaysia. The study used the regression analysis
and revealed the strong negative relationship between cash conversion cycle and firm
profitability.
The study found that reducing cash conversion period would result in increase of
profitability. The above literature of working capital management facilitates the study to
understand methodology and findings on different aspects. The study also noted lack of
scholastic work in FMCG sector. Based on the same, the study developed methodology of its
own for the specific research.

Research Methodology:
The study focused to address the efficiency of working capital management of FMCG
companies listed in CNX NSE FMCG Index. The companies included in FMCG index are listed
below;
 Brittania Industries
 Colgate polmolive
 Dabur India
 Emami Ltd
 Glaxosmithkline consumer
 Godrej consumer
 Hindustan unilever
 ITC lmt
 Jubiliant foodworks
 Marico Ltd
 Mcleod russel
 Rei Agri ltd
 Tata global beverages
 United breweries
 United spirits
 The above mentioned 15 companies are listed in National Stock Exchange (NSE). The
study used secondary data from published financial statements for a period of five years
i,e from 2006-07 to 2010-2011.

Variables used for data analysis:

The study identified independent and dependent variables based on the earlier
research studies in the area of working capital management. These are used tot test hypothesis
of the study.
 Current ratio establishes the relationship between current assets and current liabilities.
Normally, high current ratio is considered to be a sign of financial strength. It is the
indicator of the firm’s ability to promptly meet its short term liabilities.
 Quick ratio (Acid test ratio) establishes a relationship between quick or liquid assets
and current liabilities. Liquid assets can be converted into cash immediately without ay
loss of value. Cash is the most liquid assets.
 Inventory turnover ratio is the number of times inventory turned over in a year. It is the
relationship between cost of goods sold and average inventory at cost.
 Fixed assets turnover ratio is the ratio of sales to the value of fixed assets. It indicates
how well the business is using its fixed assets to generate sales. Generally, the higher
the ratio, the better, because a high ratio indicates the business has less money tied up
in fixed assets for each rupee of sales revenue. A declining ratio may indicate that the
business is over invested fixed assets.
 Return on Net worth (Return on Equity) measures the rate of return on the ownership
interest (shareholder’s equity) of the common stock owners. It measures a firm’s
efficiency at generating profits from every unit of shareholder’s equity (also known as net
assets or assets minus liabilities). ROE shows how well a company uses investment
funds to generate earning growth.
 Net profit margin refers to measure of profitability. It is calculated by finding the net
profit as a percentage of revenue. The profit margin is mostly used for internal
comparison. It is difficult to accurately compare the net profit ratio for different entities.
Individual business’ operating and financing arrangements vary so much that different
entities are bound to have little meaning. A low profit margin indicates a low margin of
safety; higher risk that a decline in sales will erase profits and results in a net loss.
 Analysis & Interpretation:
1. Working Capital management efficiency:
The following are the working capital ratios of the 15 companies in the CNX
FMCG Index:

Inventory
NP Turnover Debtors turn
CNX FMCG INDEX Margin RONW FATR CR QR ratio ratio
Brittania Industries 4.94 25.554 7.482 1.156 0.574 13.318 77.298
Colgate polmolive 16.214 25.554 4.408 0.99 0.738 15.674 15.972
Dabur India 14.842 55.926 5.344 0.998 0.732 10.906 26.312
Emami Ltd 14.834 30.078 2.354 1.502 1.782 12.278 14.976
Glaxosmithkline
consumer 11.716 26.046 3.432 1.666 1.116 8.556 49.264
Godrej consumer 16.624 59.754 5.814 1.26 0.83 7.522 73.616
Hindustan unilever 12.692 97.054 7.578 0.806 0.398 8.276 30.436
ITC limited 21.658 27.286 1.744 1.222 0.528 5.324 22.152
Jubiliant foodworks 6.21 32.13 2.26 0.79 0.69 76.83 23.23
Marico Ltd 9.948 45.886 7.698 1.17 1.16 7.486 30.674
Mcleod russel 13.592 17.414 0.576 0.48 0.612 35.726 41.436
Rei Agri ltd 5.728 16.154 5.674 0.652 4.696 1.102 4.252
Tata global
beverages 18.46 14.892 7.17 0.692 0.754 5.424 17.324
United breweries 4.342 9.404 2.718 1.63 2.736 16.752 5.004
United spirits 9.682 15.462 5.34 1.82 3.784 12.952 7.404

From the above mentioned ratios, in Net profit margin ITC limited have a highest net profit
margin followed by Tata global beverages. In return on net worth (RONW) Godrej consumer
comes second next to Hindustan lever (97.054). Fixed assets turnover for Marico and Britannia
industries are found to be higher than the industry competitors. Current ratio and quick ratio of
united spirits and Rei Agri ltd are higher than the industry competitors. Inventory turnover and
debtors turnover higher In Jubilian food works are higher than the industry counter parts.
 2. Ratios of the selected companies for the period of 5 years:

2011 2010 2009 2008 2007

Net profit Margin 12.61266667 13.08 10.20866667 11.86333333 11.90133333
Return on Net worth 35.44533333 29.036 37.73533333 44.12533333 36.31666667
Fixed Assets turnover
ratio 4.67 4.326666667 4.468666667 4.377333333 5.053333333
Current ratio 1.102 1.153333333 1.132666667 0.993333333 1.125333333
Quick ratio 1.471333333 1.749333333 1.302666667 1.212666667 1.215333333
Inv. Turnover ratio 15.47 17.786 16.53333333 10.73733333 8.605333333
Debtors Turnover ratio 45.54933333 54.03066667 56.45 36.90333333 38.21933333

Net profit margin considerably increased till the year 2010 and slightly decreased in 2011.
Return on net worth increased till 2009 and decreased in 2010, started increasing in 2011.Fixed
assets turnover ratio showing decreasing trend over 5 years. Current ratio, Quick ratio, debtor’s
turnover ratio showing stable trend the past 5 years. Inventory turnover ratio is showing a
raising trend over the five years.

3. Relationship between profitability, net worth and working capital:

Pearson Correlations

NPM RONW FATR CR QR INV DEB

NPM Pearson Correlation 1

Sig. (2-tailed)
N 5
RONW Pearson Correlation -.507 1

Sig. (2-tailed) .383

N 5 5
FATR Pearson Correlation -.030 .004 1

Sig. (2-tailed) .962 .995

N 5 5 5
CR Pearson Correlation .047 -.865 .223 1

Sig. (2-tailed) .941 .058 .718

N 5 5 5 5
QR Pearson Correlation .643 -.858 -.450 .541 1

Sig. (2-tailed) .241 .063 .446 .346

 N 5 5 5 5 5
INV Pearson Correlation .080 -.592 -.642 .501 .776 1

Sig. (2-tailed) .899 .293 .243 .390 .123

N 5 5 5 5 5 5
DEB Pearson Correlation -.212 -.596 -.482 .686 .608 .910* 1

Sig. (2-tailed) .732 .289 .411 .201 .276 .032

N 5 5 5 5 5 5 5

*Correlation is significant at the 0.05 level (2 tailed)

From the above correlation analysis Net profit margin is highly correlated with Quick
ratio (0.643), and Return on Net worth is highly negatively correlated with Quick ratio
and Current ratio. Current ratio is highly correlated (0.776) with Inventory turnover
ratio. Debtors’ turnover ratio is highly correlated (0.910) with Inventory turnover ratio.

Conclusion:
The study therefore reveals that, Indian FMCG companies should give due
importance for the short term asset management for improving the net profit margin.
Further Return on net worth does not influenced by any of the short variables in the
chosen companies. However, Inventory turnover is highly correlated with quick ratio,
so improving inventory management efficiency will give improvement in profit; since
quick ratio is highly correlated with Inventory and Net profit margin for the selected
companies.
In addition to the above, it is found from the empirical studies that, working
capital management is an important tool to measure a company’s operational and
financial efficiency. This should form a part of company’s operational and strategic
plans. Further, every effort should be made to improve the working capital position
and it will not only yield greater efficiency but also improve financial efficiency.
References
 Bhattacharya, Hrishikes (2001), working capital management – strategies
and techniques, prentice hall of india private limited New Delhi,2001
 Christopher,S. Benjamin & A.L Kamalavalli: Sensitivity of profitability to
working capital management in Indian corporate hospitals.
 Deloof, Marc (2003-04), Journal of Business Finance and Accounting, Vol.30,
issue 3-4, pp 573-588
 Since JP & shisher pandey (2008), Impact of working capital management in
the profitability of Hindalco Industries Limited, The ICFAI university journal of
Financial Economics, volume VI, pp 62 – 72.
 A.N.Vijayakumar,(2010) Impact of working capital management on
profitability and net worth – A study on selected Indian Tea plantations
companies, Sona global management research, volume 4,issue 3,pp 71-83.