Cash Working Capital vs Balance Sheet Working Capital: An Analysis Based on Four Cases

Author(s): S. K. Chakraborty
Source: Economic and Political Weekly, Vol. 9, No. 10 (Mar. 9, 1974), pp. M11+M13+M15-
M17+M19-M22
Published by: Economic and Political Weekly
Stable URL: http://www.jstor.org/stable/4363469
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 Cash Working Capital vs Balance Sheet
Working Capital
An Analysis Based on Four Cases
S K Chakraborty

The conventional definition of working capital adopts a balance sheet view of resources for'sustain.
ing the current operations of the firm. However, the balance sheet is a static position statement of the firm
on a certain date. It fails to indicate the dynamic flow of values occurring in the firm throughout a
period.
The real dynamics of the pressures on cash flows are contained in the firnm's income or profit and
loss statement. This statement contains all the operational inflows and outflows of values-cash or credit
-during a period.
The operating cycle concept of working capital a'iscussed here is basically a profit and loss acc
based tool.

I trade creditors the current assets, less sion, sale of finished goods and realisa-
current liabilities (including bank over-tion of debtors. Part of material and
Working Capital in Common labour resources may be used Qn credit
draft) calculation would simply leave
Parlance
working capital at its previous figure. terms. Similarly, sales could be partly
THE conyentional definition of work- Liquidation of debtors and inventory in cash and the rest on credit. In the ulti-
ing capital in terms of offsetting the into cash would also leave the working mate analysis, however, it is cash flows
current claims against the firm against capital level unchanged. And so would which will keep the firm going in the
the curr'ent claims of the firm seems payment of current liabilities in cash. long-term. Creditors and debtors and
somewhat confusing. The surplus left Similarly, a relatively large amount of similar items are merely transient stop-
after such offsetting is in fact equivalentworking capital according to this defini- gaps. The firm will keep itself working
to a portion of the long-term claims tion may produce a false sense of secu- and solvent so long as cash flows are
against the firm. One has only to rity at a time wrhen cash resouirces may not undutily upset. And the real dyna-
visualise, the Balance Sheet layout to be negligible, or wvhen these may be mlics of the pressures on cash flows
appreciate this point. Working Capital provided increasingly by long-term fund are contained in the firm's Income or
so dlefined is thus really a part of long- sources in the absence of adequate pro- Profit and Loss Statement. This state-
term finance used to support current fits. ment (or account) contains all the opera-
activities-. This is the working capital Three points seem to emerge from tional inflows and outflows of values
margini money which is treated as fixed above. First, the Balance Sheet defini- cash or credit - during a period. The
investment for project appraisals. The tion of working capital is perhaps not conventional definition of working capi-
following simple illustration will make meaningful, except for indicating the tal adopts a Balance Sheet view of re-
the point clear: firm's current solvency in repaying its sources for stustaining current operations.
Period 1 Period 2 creditors. Second, when firms speak of The operating cycle concept- to be
(Rs) (Rs) shortage of working capital, they in fact developed below is, however,; basically
Sales 1,000 1,500 imply scarcity of cash resources. Third- a Profit and Loss Account-based tool.
WorkIng Capital
say, 34 of sales 250 375.
ly, in fut:ds flow analyses increase in
Constituted as working capital, as conventionally II
Cnrrent Assets 350 525 defined, represents emnployment or
Less, Cturrent application of ftunds. Conceptually, a Operating Cycle Concept
Liabilities 100_ _150 rise in working capital is thus at par If we shift away from the Balance
250 375 Nwith an increase in, say, fixed assets or. Sheet (lefinition of working capital, we
Financed' by repayment of loans. With the cash have to focus attention on the Income
Bank 'Overdraft
definition of wvorking capital, however, Statement and on the cash version of
(70 per' cent) 175 262
L-ong-Term' it is difficult to see how an increase:inworking capital. The transition to this
Finance 75 113 cash is an application of funds. There vantage point is achieved, t-hrough the
250 375 seems, therefore, to exist the need for operating cvcle concept (OG.%- In do-
a more direct and relevant measure of ing so, however, the Bala,6e`.Sheet is
Thtis larger the amount of working cash working capital needs. not completely cast aside.t. ' '.As we
capital so *derived, greater the propor- The Balance Sheet is a static posi- shall examine below, the 641~ulation of
tion of kIng-term capital soutrces siphon-tion statement of the firm on a certain
the OC period in itself actsg'as a link
ecl off to short-term activities. It is date. It fails to indicate the dynamic between the Balance Sheet- and the
(litficult to say whether -this is right or
flow of values occurring in the firm Income Statem t. Underlying the
not. Apparently, when firms are worriedthroughout a period. These value flows
application'if Qf:h - O concept is a
abllut tigyht working capital situation,in a going concern centre mainly around
more functionalM interpretation '" of the
the logic of the above definition would the operational activities of the business role of working capital. It is argued
perhaps indicate diversion of long-term in any period. For a manufacturing here that the basic function of working
finances for short-term purposes. For, concern these operations are related to capital is to support all opera-tional
if bank overdraft were substituted for procurement of materials, their conver-
activities of the firm, and costs thereof,

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ECONOMIC AND POLITICAL WEEKLY Review of Management March 1974
over a period. It is only a part of this
function to be able to meet the current
liabilities as and when these fall due.
The cash version of working capital
fits appropriately in this wider perspec-
tive.'
The systematic exposition of the OC
concept is contained in Park and Glad-
son's work.2 The main thrust of their
work has been in using the OC period
for a business to define its current liabi-
lities and current assets. This defini-
tion, quite logically, is suggested as a
finer criterion to judge the funds flow
pattern through working capital items,
than the conventional one-year time-
span. Calculation of the OC period by
following through the successive stages
of committing cash in the operations and
finally getting it back into the stream
again to l)egin another cycle, is quite
tailor-made to the individual characteri-
stics of a firm. All specific technological
as wvell as commercial features of an
enterprise are provided with a sharper
analytical focus while deriving the dura-
tion of the OC. Thus, the nature, age,
and mix of technical processes employ-
ed in a firm shall be the dominant
influence on the conversion period of
manufacture. Similarly, the credit
periocl allowed to and by the firm for
purchases and sales will determine the
length of materials acquisition and
storage and debtors' collection periods.
In all these phases, the firm will have
its owvn specific strengths and/or weak-
(a) Materials consumed during the
nesses, quite apart from some general
intra-industry uniformities. It is such
specificities which get highlighted in
the OC period.
Having derived the OC period for a
firm, those items of assets or liabilities
alone which liquidate themselves into
or l)y cash within that period are classi-
fied as 'current' ones. Working capital
computed from such items will be very
different - and more relevant - from
the one based on items classified as cur-
rent on a one-year basis. It is surely
more ulsefutl for a firm to know how
soon a unit of money put into opera-
tion is going to be recouped again in
cash for use in a fresh cycle of opera-
tions. The OC period indicates precisely
this time-interval. In other words, the
OC concept has a built-in stress on the
cash interpretation of working capital
for ongoing operations. Thus, Sagan's
'money manager' could gainfully use
the OC tool as one means to escape the
(liscomfiture of being presented with "a
satisfactory working capital ratio when
he does not have funds to meet an
immediately due payment".3 Since
many of the valuation bases adopted for
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current asset items are subjective assess- will go opening w i p, materials consurn-
ments flowing from accrual income ed and all manufacturing expenses in-
accoLnting, the OC approach to cash cluding wages, less closing w i p. The
forecasting (as demonstrated later) manufacturing expenses may have to
should provide a stronger focus on the be unearthed from schedules attached
key resource of cash.4 to the Profit and Loss Account. The
Another point should be mentioned pace of the conversion process is de-
here. The concept of cash working termined largely by the state of tech-
capital is being employed for the four nological efficiency and supervisory abi-
case studies below to indicate cash lities in the firm.
needed for manufacturing and selling The degree of completion of work-
operations only. Cash outlays involving in-progress on the opening and clos-
capital expenditures, dividend payments, ing dates wvill influence the number of
etc, are being ignored. days for this phase of the operating
cycle. This is illustrated below with
III simple figures where the same quanti-
ties of opening and closing w ip's are
Computation of Operating Cycle assumed 50 per cenit and 25 p-er cent
Period
complete, for the first period, and for
In the study presented below the the second period 25 per cent and 50
following methodology has been used in per cent complete, respectively.
determining the length of the operat- Year 1 Year 2
ing cycle period. The calculations are Opening w i p 100 50
all based on published account figures. Manufacturing
In all cases we shall be dealing with expenses 600 600_
manufacturing concerns. (Instead of 700 650
taking 365 days in each year as below, Closing v i p 50 100
it may be more realistic to assume a Cost of finished
goods produced 650 550
figure between 250 and 330 working
days a year.) .- Conversion period
(1) Materials in Storage Period: This
measures the average time bought, items 75z: 5 75-: 5
* 365 * 365
remain in store prior to being released
into the production stream. The fol- i e, 42 days i e, 50 days
lowing steps are involved in calculating This difference of 8 days reflects the
it.
relative efficiencies of conversion in the
two years.
year, say, M.
(3) Fintished Goodls in Storage Period:
(b) Average daily rate of materials Some time usually elapses before
consumption, M/365.
finished goods move ouit of the manu-
(c) Average materials inventory facturers' warehouse to the customer.
during the year, i e, (opening
This is particularly so for firms which
inventory + closing inventory)/
produice for stock and not against
2, say, I.
orders. How speedily this movement
(d) - Ntumber of days materials re-takes place depends upon the nature of
main in store = I/(M/365). the product(s), market(s), the season of
Materials consumed during the year the year, the effectiveness of sales and
could be readily found out with the muarketing tactics, etc. Calculation of
help of opening and closing stock and this period follows the sequence given
raw materials purchase figures. below:
(2) Conver&sion Process Period: This (a) Cost of finished goocls sold dur-
measures the time taken on average to ing the year, say, F..
carry out the basic manufacturing pro- (b) Average daily cost of finished
cesses, converting material inputs into goods sold = F/365.
finished goods. The steps involved are: (c) Average finished goods inven-
(a) Cost of finished goods produc- tory during the year ie, (open--
tion during the year, say, C. ing stock finished goods + c10s--
(b) Average daily cost of finished ing stock of finished goods)/2,.
goods produced = C/365. say, G,
(c) Average work-in-process during (d) .. Average period duLring which!
the year i e, (opening w i p + finished goods remain in ware-
closing w i p)/2, say W. hotuse = G/(F/365).
(d) * Average conversion time = Cost of finished goods sold during'
W/(C/365). the year is obtained by adding to cost
Into cost of finished goods produced of finished goods producedl in the year
M-1-3.
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 ECONOMIC AND POLITICAL WEEKLY Review of Management March 1974
[already calculated in 2(a) above], the
opening stock of finished goods and all
administrative and selling expenses, and
deducting the closing stock of finished
goods at the end of the year. The
splitting of administrative expenses into calculations, the operating cycle period
manufacturing and selling expense
categories has been regarded as not
being practically very meaningful in +this
context. It is also assumed that finish-
ed goods inventory valuation is done on
full cost or absorption cost basis.
(4) Debtors' Coll.ection Period:
Depeniding on the commercial conven-
tions of trade for an industry in vary-
ing economic environments, and also on
the firm's ownla credlit policies, the con- strate the use of the OC concept based
version of debtors into cash (stage 3
above being that of conversion of finish-
edl goods into debtors) will consume
somne timte. Since published accounts
(lo not usually show the break-up of
sales into credit and cash categories,
we shiall assumlle for our purposes all
sales to be on credit. The calculation
then is as below:
(a) Average daily sales during the
year, i e, (total net sales during
the year/365), say, S.
(b) Average debtors' balance during
the year, i e (opening balance +
closing balance)/2, say, D.
(c) .-. Average collection period of
debtor's balance = D/S.
for all these firms for the 5-year period
Since excise duty is payable by the
provided all data used below.
firm on its sales, which is later on re-
covered from customers, two alternatives
are possible. Either sales net of excise
duty vbe considered, in which case the
excise duty amount should be excluded
in compuiting cost of goods sold. Or,
gross sales valtue including excise duty
be taken, in which case the duty
amount should be adcded to cost of
goods sold. There will be some varia-
tion in both the finished goods in
storage and debtors' collection periods
according to the particular alternative
adopted.
(5) Cr,editors' Liquiidation Period: The Particulars
same mix of commercial and policy
considerations as in stage (4) above
also governs the period of credit obtain-
ed from the suppliers of the firm. The
computation is as follows:
(a) Axrage daily purchases during
the vear, ie, (total net purchases
in the year/.365), say, P.
(b) Average creditors' balance dur-
ing the year, i e, (opening
balance + closing balance)/2,
say, C.
(c) .-. Average credit period obtain-
ed from suppliers = C/P. This
period goes to the advantage of-
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the firm, and to that extent is tion. Although depreciation is a non-
to be offset against the sub-total cash charge, yet it goes into the valua-
of the first four phases of the tion of work-in-progress because of the
operating cycle period. absorption-costing basis assumed earlier.
Thus taking together the above five But since this is an expense not re-
quiring cash outlay, we are excluding
is derived as follows: it in computing operational expenses.
I/(M/365) + W/(C+365) Other administrative and selling ex-
G/(F/.365) penses are included. Taxes and divid-
+ D/S - C/P = OC. ends are not considered however in
computing operational expenses because
these are appropriations subsequent to
IV
the accrual of profits from operations.
Four Cases These outlays are not meant for support-
As already mentioned, the analysis ing the operations of the business. The
reported below is intended to demon- next step is to divide the total opera-
tional expenditure for each year calcu-
on published annual reports of the firms. lated above, by the number of operat-
In this section the analysis alone will ing cycles for the relevant year already
be presented. The next section will figured out in step two earlier. The
draw attention towards some of the resultant amount indicates on an ex
post basis the cash workitng capital that
highlights and limitations of the analy-
sis done here. should have been required to sustain
The study covers four companies over the year's operations. This figure will
a five-year period from 1965 to 1969. in all probability not equal the average
These companies are Union Carbide of working capital amount as convention-
India Ltd, Hindustan Lever Ltd, Dun- ally derived from Balance Sheet items
lop (India) Ltd, and Guest, Keen and of opening and closing cumrent assets
Williams Ltd. The first and the third and current liabilities. Let us examine
firms belong mainly to the consumer Table 1.
durable goods industry. The second The follow^ing points emerging from-
is a consumer goods producing firm. Table 1 are significant:
The f ourth one is in the producers' (1) The year 1967 seems to be the.
goods industry. Published final accounts 'hump' year for nearly all phases of the
operating cycle. This is reflected in
the longest OC period - 159.5 days
In each case the length of the OC - in that year during the 5-year period
period has been computed for each of covered. And following from this, the
the five years. This, in turn, has been number of OC's completed in 1967 is
converted into the number of operat- also the least, i e, 2.5 approximately.
ing cycles completed by each unit of The years 1968 and 1969 have register-
money in a year. In the third step we ed consistent reductions in all the first
have computed from the Profit and four phases of the OC. The credit
Loss Accounts the total operational period allowed to suppliers has, how-
expenses on account of materials, wages, ever, shown a slight rise in 1969 over
etc, for each year, excluding deprecia- 1968. Consequently, the O*C duration
TABLE 1: UNION CARBIDE (INDIA) LIMITE.n
Years
1965 1966 1967 1968 1969
Days Days Days Days Days
(1) Raw materials in store 134.4 127.3 147.2 117.9 102.8
(2) Conversion period 18.5 18.4 21.7 16.0 15.2
(3) Finished goods in store 31.5 29.1 30.3 25.8 25.8
(4) Debtors' collection period 24.4 22.6 24.2 24.1 19.1
Less 208.8 197.4 223.4 183.8 162.9
(5) Creditors' payment period 58.7 44.3 63.9 61.4 62.0
(6) Operating cycle period 150.1 153.1 159.5 122.4 100.9
(7) Number of operating cycles
per year (365 " Row 6) 2.431 2.?84 2.288 2.982 3.617
Rs/mil Rs/mil Rs/mil Rs/mil Rs/mil
(8) Cash wvorking capital
requirement 65.0 86.4 107.3 104.1 102.7
(9) Average working capital
as per balance sheet 51.7 72.2 87.9 105.5 116.6
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 Beview of Management March 1974 ECONOMIC AND POLITICAL WEEKLY

for 1969 is the shortest in the five the help of information contained in of future changes affecting sales in
years - 101 days only. This, in turn, Table 1. It has been suggested earlier 1970 would also be used to refine the
gives the greatest number of operating that cash working capital requirements forecast based on past average beha-
cycles for this year - 3.6 times. The are a function of. the volume of acti- viour of sales. Assuming, however, that
preliminaiy inference from this situa- vity, given a certain duration of the a 15 per cent rise is expected in 1970
tion is: relatively less cash working operating cycle. If sales volume is re- in the final analysis, sales would be
capital should be needed in 1968 and garded as an indicator of level of acti- around 435.4 million.
1969 to sustain the same volume of vity, then it may be hypothesised that
In 1969 the number of operating
business. cash working capital needs would be cycles completed by each unit of mo-
(2) The difference between cash a positive function of sales volume. In ney wvas 3.617. Assuming this could
working capital requirement and the absence of a common denominator
be marginally improved upon to 3.7 in
Balance Sheet working capital may of physical sales for a vide variety of
1970, then cash working capital re-
also be investigated by examining the products, we have to accept sales value
quirement is established at (Rs 435.4
pattern of working capital behaviour as a surrogate measure of activity level. million/3.7), i e, Rs 118 million appro-
luring the year. The averaging of open- This will, however, cause distortions
ximately for 1970. As the rate of in-
ing and closing working capital figures (lue to changes in selling prices which
flation per annum is of the order of 6
could very well obscure the seasonalor mnay not necessarily have any impact onper cent now, an additional 6 per cent
other periodic influences like pre- cash working capital needs. A regres- margin on Rs 118 million would yield
budget buying, procurements against sion equation could be fitted to, say, an estimate of cash requirement at Rs
import licences, etc. Possessing internal the past 10-15 years' sales figures with
125 million. The benefit of this calcula-
information, one could also adjust Ba- those of corresponding operational ex-
tion is that it focuses clearly on the de-
lance Sheet working capital for obso- pense amounts. With the help of this
mand for liquid money for next year's
lete stocks, old debtors, doubtful claims, equation, for the forecast sales level
manufacturing and selling operations
etc, which should not influence the for a particular yeai, the corresponding
(not capital expenditure, however).
operating cycle. These points would be operational expense figure could be
Such an estimate, we feel, is crucial be-.
equally applicable to the three following readily obtained. Although the amount
cause the conventional working capital
cases as well. so obtained would by itself have cover-
figure by itself may be misleading, des-
ed the inflationary factor to some ex-
(3) By dividing the total operational pite the fact that cash resources are ge-
tent, quite apart from reflecting the
expenses during each year by the nerated through the realisation of cur-
direct correlation between activity level
respective number of operating cycles,. rent assets. In fact, non-cash current
and operational expenses, we may add
we arrive at figures of required cash assets could be managed better if we
a further margin to allow for anticipat-
working capital shown against row 8 know the amount of cash working capi-
ed inflationary price increases.
in the Table. It is interesting to observe Thus, sales, less excise duty, for tal needs. Decisions about overdraft
that upto 1967 there has been a sub- facilities could also be better taken if
Union Carbide increased steadily from
stantial excess of cash working capital Rs 165.4 million in 1965 to Rs 387.3 the extent of gap between direct cash
needed over the average working capital realisation through sales plus through
amount derived from the Balance Sheet. million in 1969. This represents an realisation of current assets, and opera-
This leads to a preliminary hypothesis average 27 per cent increase in acti- tional cash requirements could be more
that upto 1967 the OC periods were too vity level per annum over the quin- rationally forecast in advance.
long with the result that more cash was quennium. If we allow for the fact We have mentioned above the pos-
necessary to carry on business. In that during 1968 and 1969 - just fol- sibility of improving upon the number
1968, when the number of OCs corn- lowing the recession - the rates of in- of operating cycles per year to 3.7 in
pleted during the year showed marked crease were much more than normal, 1970. More explicitly, it implies a re-
improvement, the gap between cash then we might assume that sales would duction in the duration of the OC pe-
working capital and Balance Sheet work-register a rise of around 15 per cent in riod. It may be observed from Table
ing capital is almost nil. And in 1969, 1970 over 1969. Of course, estimates 1 that except in 1967, the durations of
with further sharp reduction in the
TABLE 2: HINDUSTAN LEVER AMITE D
OC period duration, the Balance Sheet
working capital substantially exceeds Y ear

cash working capital. This comparision 1965 1966 1967 1968 1969
Particulars
may be better understood if we con-
sider the 'cash value' of Balance Sheet Days Days Days Days Days
working capital, i e, all non-cash cur- (1) Raw materials in store 46.6 47.8 44.5 50.5 40.9
rent assets realised at their full money (2) Conversion period 8.3 7.4 6.7 7.3 7.4
value, less cash payment of all current (3) Finished goods in store 26.7 29.7 26.5 23.9 22.6
(4) Debtors' collection period 3.9 5.0 5.9 6.6 7.0
liabilities in full.
Less 85.5 89.9 83.6 88.3 77.9
If excess cash working capital were (5) Creditors' payment period 21.2 24.9 23.0 24.7 23.8
needed for three years upto 1967, where (6) Operating cycle period 64.3 65.0 60.6 63.6 54.1
could it have been drawn from? A
(7) Number of operating cycles
prima Jaaie answer probably lies in that per vear (365 Row 6) 5.676 5.615 6.023 5.739 6.746
such additional needs were met out of
Rs /mil Rs/mil Rs/mil Rs/mil Rs/mil
long-term fund sources of the firm. (8) Cash working capital
(4) The two preceding points are a requirement 127.9 139.8 142.9 153.0 149.5
sort of post mortem. But a forward- (9) Average working capital as
looking analysis is also possible with per balance sheet 114.6 152.2 166.2 165.3 167.0

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ECONOMIC AND POLITICAL WEEKLY Review of Management March 1974

each of the first four phases have shown
a falling trend. It is for management
to go deeper into each phase and to
try to look for possible further econo-
mies in any or some of these phases.
And, of course, attempts may be made
to prolong creditors' repayment period
without jeopardising goodwill.
The following points need highlight-
ing from Table 2:
(1) The difference in the nature of
industries to which Union Carbide and
Hindustan Lever respectively belong.
seems to be clearly demonstrated by
the marked variation in the length of
their OC periods, and hence the ntun-
ber of operating cycles completed each
>-ear by them. Union Carbide manu-
factures mainly dry cells and torches
of various specifications under the fa-
mous brand name of 'Eveready'. Hin-
dustan Lever, on the other hand, pro-
duces consumer goods like soaps, baby
foods, beverages, etc. Viewed in this
light, lesser time-spans involved in
each and every phase of the OC period
for Hindustan Lever, compared to
those of Union Carbide, seems inherent
in their respective product ranges. A
tentative hypothesis could thus be sug-
gested: firms belonging to the consu-
mer goods indu-stry are likely to have
shorter OC periods than those belong-
ing to the consumer durable goods in-
dustry - at least for the sale-of-finish- would be maintained for the next year
ed-goods and realisation-of-debtors cy-
cles. Sometimes, however, bulk-buying
of seasonal crops may cause the raw
materials-in-store period to be relative- level of operating cycle efficiency is
ly long for consumer goods firms, e g,maintained for 1970 also, then the
tobacco or tea.
(2) The range of fluctuation in the
length of the OC period between 1965
and 1969 is much less for Hindustan
Lever (17 per cent, i e,65 x l00
65-
than for Union Carbide (36 per cent, i e,
be contrasted to the changing relation-
ship of these two amounts for Union
Carbide shown in Table 1. It was
argued there that such changes were
possibly due to too long an OC period
for Union Carbide until 1967 which
caused more cash resources to be de-
ployed to run the business. When in
the last two years the efficiency of the
OC improved we found relatively less
cash resources w ere needed to sustain
higher levels of activity. Following
this line of reasoning, it seems Hindus-
than Lever has been able throughout
the period to maintain such a minimum
level of OC efficieincy that there has
been no occasion when cash require-
mnents exceeded Balance Sheet working
capital (except in 1965). This is per-
haps a healthy sign because it indicates
that the rate of conversion or realisa-
tion of non-cash current assets ade-
quately meets the cash requirements of
business operations.
(4) Sales, less excise duty, for Hin-
dustan Lever stepped up from Rs
662.1 million in 1965 to Rs 1,020.0
million in 1969. This represents an
annual average rate of increase of
about 11 per cent. Since this firm be-
longs to the consumer goods category,
and hence is liable to a lesser degree
of fluctuation in activity level, we as-
sume that 11 per cent r ate of increase
also. Based on this prognosis, estimat-
ed sales for 1970 is Rs 1,132 million
approximately. Assuming that the 1969
number of operatinig cycles for 1970
will remain at 6.75. Dividing Rs 1,132
million into 6.75, we get an estimated
figure of cash requirements at Rs 168
million nearly. Adding a margin of 6
TABLE 3: DUNLOP (INDIA) LIMITED
per cent for inflation, the final estimate
is Rs 178 million.
Comparison of Table 3 with Tables
1 and 2 throws uIp the following inte-
resting points:
(1) The lengths of the OC periods of
Dunlop are more in line with those of
Union Carbide, whereas their disparity
with the OC period of Hindustan
Lever is substantial indeed. The most
plausible explanation for this seems to
be the fact that Dunlop and Union
Carbide fall in the same industrial ca-
tegory, ie, consumer durable goods.
Hindustari Lever is in an altogether
different kind of business.
(2) Pursuing the comparison between
Union Carbide and Dunlop a bit fur-
ther, it is noticeable that except for
the finished goods in store period, all
the other four phases of the OC are
of quite disparate lenigths for the two
firms. This only substantiates the point
that the technological and commercial
characteristics of the firms are quite dif-
ferent. A tailor-made OC period is,
therefore, a more precise guide to cash
needs. However, that the two firms
belong to a common industrial category
is shown by the overall closeness of
their net OC periods (row 6), particu-
larly in the year 1969.
(3) Compared to Union Carbide, the
range of fluctuation in the duration of
OC periods for Dunlop is very much
less - only about 8.6 per cent
(111.7-102.3
111.7- x 100) over the f
period. However, this is also half the ex-
tent of fluctuation experience by Hin-
dustan Lever during the same years.
Apparently the argument made earJier
that such differences may be attribut-
able to the greater sensitivity of coan-

159.5-10? x 100). Although ~Xea-s 1965 1966 1967 1968 1969

Particulars
we are not here going to suggest an
answer to it, yet a question may be
raised: is this difference in amplitude
of fluctuation attributable to the greater
sensitivity of consumer durable goods
industry to business cycles, compared
to that of consumer goods industry?
For, the Indian economy suffered a re-
cession between 1965 and 1968, follow-
ing the Indo-Pak war of 1965 and
crop failures.5
(3) It will be noticed from Table 2
that cash working capital requirements
are consistently less than average work-
ing capital as per Balance Sheet for
all the years except 1965. This may
Days Days Days Days Days
(1) Raw materials in store 67.7 70.8 76.4 73.5 77.1
(2) Conversion period 6.4 5.4 5.9 6.8 6.6
(3) Finished goods in store 23.0 20.2 19.4 23.2 24.5
(4) Debtors' collection period 50.6 44.2 45.7 44.4 41.7
Less 147.7 140.6 147.4 147.9 149.9
(5) Creditors' payment period 36.0 37.4 44.3 43.3 47.6
(6) Operating cycle period 111.7 103.2 10.3.1 104.6 102.3
(7) Number of operating cycles
per year (365 - Row 6) 3.267 3.536 3.540 3.489 3.567
Rs /mil Rs/mil Rs/mil Rs/mil Rs/rnil
(8) Cash working capital
requirement 141.4 154.9 166.7 189.8 208.8
(9) Average working capital as
per balance sheet 128.4 137.1 159.6 169.7 .184.8

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ECONOMIC AND POLITICAL WEEKLY Review of Management March 1974

sumer durable goods firms to business ness fluctuations than Hindustan Lever, even more sensitive to business cycles
fluctuations in contradicted by the be- it may not be possible for Dunlop to than a firm in the consumer durables
haviour of OC period in Dunlop. The maintain the average rate of 12.5 per industry.
answer to this riddle may lie in a cent, wvhich bears the impact of rela- (2) The gap between cash working
closer analysis of the relative impact of tively high growth rates in 1968 and capital and Balance Sheet working ca-
the 1965-68 recession on a firm like 1969 immediately following the reces- pital for GKW has not, however, be-
Union Carbide compared to that on a sion, into 1970. Let us, then, assume haved the way it has done for Union
firm like Dunlop, even though both of it to be 10 per cent for 1970. Estimat- Carbide corresponding to changes in
them belong to the consumer durable ed sales is, therefore, Rs 709 nmillion. the OC period. Like Hindustan Lever,
grouip of indutstries. As the OC period is showing very slow GKW's cash resource needs seem to
(4) The cash working capital require- improvement, let us also assume that have remained consistently less than Ba-
ments of Duinlop have consistently ex- for 1970 the efficiency achieved is such lance Sheet working capital for the five-
ceeded the average Balance Sheet as to yield 3.75 operating cycles in the year period. For GKW too, therefore,
working capital in all the years. This year. The corresponding cash working it could be suggested that the rate of
is so despite the fact that it has had capital estimate is therefore Rs 709 conversion of non-cash current assets
each year a bigger number of operat- mil/3.75, i e, Rs 189 million approxi- has been more than sufficient to satisfy
ing cycles except in 1969, than those mately. Topping it up with a 6 per cent the cash needs of business. This line
of Union Carbide. The reasons may inflation margin, the final figure is Rs of argument seems to have some weight
200 million. when judged against the reverse si-
again be specifically firm-oriented. In
other words, there is possibly scope for The imnportant points to emerge from tuation where cash working capital
Table 4 are: needs are greater than Balance Sheet
further reductions in some or all phases
of the operating cycle for betterment (1) GKW belongs to the engineering working capital, e g, Dunlop's case. In
in the efficiency of operating cycle producers goods indusstry which weath-the latter instance it would appear that
turnover. The excess of cash needs ered the worst blast of the 1965-1968 net non-cash current assets are by
over Balance Sheet working capital recession. This fact is worth bearing themselves inadequate to meet the level
also indicates that such excess is like- in mind wvhile interpreting data con- of cash requirements dictated by the
ly to have been supported from long- tained in the above Table. Thus, for existing state of efficiency of the operat-
term sources of funds. Howvever, from GKW too, like Union Carbide, the ing cycle.
the standpoint of computing the con- 'hump' year for th, duration of the (3) The fact that average Balance
ventional 'return on capital employed', OC period is 1967. Preceding and fol- Sheet working capitals are far in excess
which includes working capital in the lowing this year, the OC periods be- of cash working capital requirements
denominator, lower Balance Sheet have in a similar pattern for both thesefor both GKW and Hindustan Lever
working capital figure indicates relati- firms. This similarity lends again some has another implication. This could
vely efficient employment of resources. support to the point made earlier that, mean that return On capital employed
And following this reasoning, Hindus- as we move up the scale from consu- measurcs for judging managerial effi-
tan Lever should be bearing an unfa- mer goods industry to producers' goods ciency in managing the firms assets are
vourable comparison with Dunlop. industry, there is an overall tendency shown in a poorer light due to larger-
(5) Dunlop's sales (less excise duty) for the respective OC periods to be than-necessary working capital appear-
increased from Rs 397.2 million to Rs more sensitive to cyclical fluctuations ing in the Balance Sheet. In other
644.4 million over the five-year period, in economic activity. But the range of words, sharper focus is thrown on the
ie, by nearly 62 per cent. This means variation for GKW is almost 50 per need for effective management of cur-
cent
an average annual growth rate of 12.4 rent assets against the background of
per cent. Considering the fact that this '. 190-95.9 estimated cash requirements. And the
firm belongs to the consumer durable e, --190 xlO x0. This latter estimate is made possible on an
goo.ds group, and that therefore it had possibly reflects that a firm in the pro-
overall basis by computing the operat-
responded to a greater extent to b-uci- ducers' goods industry will tend to be ing cycle period.
(4) Sales (the product mix of GKW
TABLE 4: GUEST, KEEN AND WILuAIs LIMITED is such that excise duty on its sales is
Years almost negligible) for this firm, increas-
1965 1966 1967 1968 1969 ed from Rs 285 million in 1965 to Rs
PartiCUlarS 320 million in 1969, i e, a 12.5 per cent
Days Days Days Davs Days rise in 5 years. The annual average
(1) Raw materials in store 90.5 126.4 141.4 127.3 71.0 rate has, therefore, been of the order
(2) Conversion period 13.6 14.5 15.8 14.1 17.9 of only 2.5 per cent. Since GKW was
(3) Finished goods in store 25.4 34.6 41.2 39.9 22.8
worst hit by the recession, and since
(4) Debtors' collection period 63.9 5.7 78.9 87.8 70-8
the producer goods industry group
Less 193.4 251.2 277.3 269.1 182.5
takes longer time to pick uip momen-
(5) Creditors' payment period 80.6 93.2 87.0 119.7 86.6
tum, we may assume that next year's
(6) Operating cycle period 112.8 158.0 190.3 149.4 95.9
rate of sales will be more in line with
(7) Number of operating cycles the rates experienced in 1968 and
per year (365 * Row 6) 3.235 2.310 1.921 2.443 3.806 1969 which were about 4 per cent and
8 per cent respectively, rather than
Rs /mil Rs/mil Rs/mil Rs/mil Rs/mil
(8) Cash working capital with those of the earlier years. On top
reqUirement 82.1 117.8 141.2 94.2 73.2 of that, with industrial activity picking
(9) Average working capital as up, it may be presumed that 1970 sales
per balance sheet 105.8 142.2 171.7 161.6 126.4 will register a 10 per cent improve-

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 Review of Management March 1974 ECONOMIC AND POLITICAL WEEKLY

ment over 11969. Based on this pre- First, the level of OC efficiency has (4) It is generally recognised that
mise, next year's sales estimate is always been at a consistently high pitch. firms tend to suffer cash shortages du-
around Rs 352 million. If the nunber Second, as this unit in our sample was ring periods of growth and expansion.
of aperating cycles for 1970 is improv- most affected by the recession, the Correspondingly, due to lagged effects,
ed to 4.0, then the estimated cash scale of operations clicl not expan-id as onsets of decline in btusiness activity
working capital need for the year is much as it did for the other three firmns, are likely to be associated with surplus
Rs 88 million. A 6 per cent addition anid so called for relatively less stretch cash. We, therefore, tried to interpret
for inflation makes the estimate ap- in cash resources. the calculations for the four firms cho-
proximately Rs 93 million. sen for this study in terins of the in-
(2) The principal theme of this arti-
dustrial recession during 1965-68. In
cle has been the stress on the signifi-
our sample, Guest, Keen and Williams
cance of cash requirements for business
Consolidating Comments was the worst hit firm, while Hindus-
operations, relatively to that of conven-
(1) In the workings presented above, tan Lever was perhaps the least affect-
tional working capital. Some modera-
we have incltuded cash in Balance ed by the recession. Both firms exhibit
tion is, however, called for in this em-
Sheet working capital computations. It lesser cash requirements than Balance
phasis too. In times of continu.ous in-
may have been more appropriate to ex- Sheet working capital, except in 1965
flation it is not wise to hold high cash
clude cash from such calculations be- for Hindustan Lever. But the signifi-
balances than necessary. Quite apart
cause we were comparing cash require- cant fact is that the gap between the
from being a sign of inept management
ments with current assets, less cuirrent of the firm's growth, continually sur- two figures is consistently very much
liabilities. The implication in conven- larger for GKW - both in absolute
plus cash balances are bound to suffer
tional working capital computations amounts and in percentages - than for
erosion in real valuie dtue to persistent
just mentioned is that current assets Lever. This seems to lend support to
inflation. Paton argues in this context
get converted into cash during the fin-that a 1: 1 ratio (insteadl of the u.sual the phenomenon of surplus liquid funds
ancial period which, after paying off (via withheld capital replacements,
2: 1) between cash and near cash
the current liabilities, provides for scaled dowZn purchases and inventories
itelmis and culrrent liabilities should be
meeting other operational expenses. etc) during declining business activity.&
striven for in most business situation,s. 6
The paradox, however, is that suich cur- The computation of the OC period, and In comiiparing Dunlop with Lever,
rent assets as are lelied upon to yield its application in the manner indicated however, we find that explanation
cash, themselves need to be supported above, seenms to provide an even clearerthrough recession loses some force.
by funds until conlversion into cash. It and firm - relevant measure of the Dunlop belongs to the consumer durable
is worthwhile to remember that increase zone of tolerance for holding judicious goods (or intermecliate goods, accord-
in working capital represents an appli- cash balanices on a continuing basis. ing to RBI) indtustry, while Hindustan
cation of funds, and not a source. In This is not to suggest that current as- Lever is a consumer goods firm. The
other words, large amounts of current sets are to be or can be eliminate(l. impact of recession on Dunlop should,
assets need not necessarily be a rational The point is that having estimated an- therefore, have been more pronounced
source of financial comfort. The me- nual cash requiirements on a more sys- than that on Lever. Duinlop should,
thod of computing the operating cycle tematic basis, the management and accordingly, have produced evidence of
period outlined above in fact leads to conversiotn of non-cash current assets cash surplus (i e, lesser cash, require-
longer OC periods for larger invento- could be effected in such a manner as ments than working capital) to a greater
ries, debtors, etc. This, in tum, im- to ensure that the cash level norm is extent than Hinclustan Lever. The
plies slower turnover rates, dictating maintained fairly consistently. figtures, howvever, produce a very con-
more cash requirements, to support in- (3) The estimation procedure for cash trary picture. Dunlop's cash require-
tervening operations. Unless, therefore, requirements outlined above relates ments have always been in excess of
the length of the OC period is short- only to the operating aspects of the working capital. The average increase
ened, increasing balance sheet working business, i e, buying, manufacturing, in sales over 1965-1969 for Dunlop and
capital could induce cash requirements selling, etc. Cash is required for at least Lever were nearly equial, i e, 12.4 per
which exceed such capital. This hypo- three other major activities namely, re-cent and 11 per cent respectively. It
thesis seems to be corroborated in the payment of loans, investments in capi- cannot possibly be forcefully argued,
case of Union Carbide. Until 1967 tal items, and dividen(d payments. Pro-therefore, that Du-nlop's operations ex-
when the OC period ranged between visions for these have to be super-im- panded at a mtuch faster rate than
150 and 159 clays, cash requiirements posed on cash needs for operations. Lever's (although one would have ex-
consistently exceeded Balance Sheet And the proper context for doing this pected Dunlop's sales to have grown
working capital, despite the steady rise is the overall fun(ds flow analysis car- in fact at a smwlaller rate than Lever's).
in the latter amount too. When, how- rie(l out at the beginning of each pe- A better explanation may, therefore,
ever, in 1968 an(d 1969,. the OC per- riod. While dividend payouts and lie in the relative efficiencies of the OC
riods came down- sharply, cash require- loan repayments could be known fairly periods for the two firms. g;iven the
ments were almost equal to and less correctly the former being based on industrial categories to which the-y
than (respectively) conventional work- standard company policy, and the lat- respectively belong, the OC period for
ing capital despite continuing increase ter being governed bv contract terms Dunlop is perhaps so high as to require
in the latter. Guest, Keen and Williams, the capital expenditture programme excess cash than warranted by working
however, presents a different picture. is a matter of careful decision-making. capital - even during recession. Cor
Although the OC periods variecl from Total cash budgeting shall have to respondingly, Lever's OC efficiency
a high of 190 days to a lowv of 96 days, awvait the capital expenditure decisions being high, it is able to do with less
cash requirements seemed always to be which may in turn have significant fin- cash than indicated by the cash value
less than Balance Sheet working capi- ancing implications - both short and of its working capital. This may indi-
tal. There could be two reasons for this. long term. 7 cate lowering the amoulnt of working

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ECONOMIC AND POLITICAL WEEKLY Review of Management March 1971

capital investment for improving the derived by netting the same current over that period. Otherwise, inore
rate of return on capital employed. item grotips. A little reflection xvill show recent years couild have been considered
(5) We have used sales forecast (the that no suich anomaly exists in fact. as Mwell.
method for deriving it coulcl of course be Balance Sheet working capital (interim (9) Baniks in India are reported to
much more refined in practice than here)9 or annual) is a static picture of the net miake use of the OC calculations for
as the independent causal variable in -sti- current assets position, includinig cash. seasonal industries like tea, tobacco,
mating cash requirements for the year When the opening and closing balances sugar, etc. They do not rely upon the
1970 in each case. In fact, it is in of these itemiis are linked with the rele- annual Balance Sheet figures to ensturo
the projection of cash requirement, vant operational activities of the firm in security of over(drafts in relation to
along with sales forecast, for the next the process of computing the O(C period, these industries. Many well managed
period that the OC period should prove these figtures get re-interpreted in a firms themiselves also employ these cal-
more useful than in performing the kind dvnamic context. And an estimation of cullations to watch their own cash move-
of post nmortem analysis outlined above. cash needs for operational purposes is ments. However, it does not seem to
How does working capital, as conven- feasible only throtugh such linking of cur- be a wvile'y used approach in industrial
tionally computed, relate to sales or rent items to the technological and com- houses. The simple presentation of the
tturnover in comparison w ith the cas'h mercial (dy namics of the firm. method in this paper may contribute to
requirement-tumover relationship? Work- (7) The foregoing analysis is subject to a better monitoring and managing of
ing capital is the net resultant of balanc- the basic limitations of an external in- cash wvorking capital.
ing betwveen several items, and of vary- vestigator havinig to rely on ptublished
ing valuation bases for some of them. informatioan alone. Thus, the use of (10) Finally, in our computation of
Grass has listed several points why average w-orking capital on the basis of the OC periods above, we have assuim-
w%orking capital may not vary directly opening and closing balances only is e(l collectioni of debtors to result direct-
with sales, some of which are mention- liable to errors because the levels of ly in cash-inflowv. In most cases in
ed below 10 working capital dturing the year could practice,
be however, this is not so. For,
(1) Level of wvork-in-progress de- (llite different from the opening and clos- much of stuch realisations constitute
pends on the length of the manu-
izng figuires. This may be especially true cash-in-trans-t, che(Itues to be cashed
facturing time-cycle, and there- of seasonal businesses.12 But for the and the like. In consumer goods indus-
fore on the producits and the pro- tries this may be an important factor.
kind of firms analvsed in this paper ignor-
duct mix.
ing the seasonalitv factor seems reali- A calculation of cvcle period for cash
(2) Work-in-progress is geared to out- stic. There is no apparent reason to inflow on the same l)asis as for debtors'
put at manufacturing cost, not think that the year-end Balance Sheet collection shown above may, therefore,
turnover. l)e made and added as a sixth element
figures for these firms represent the
(.3) Finished stock levels depend upon culmination of a 'natural' business year in the OC period.
commercial factors. wifh rock-bottom inventories and
(4) Debtors levels depend on credit accounts receivables and high liquidity. Notes
terms and liquidity of customers. [This paper has benefited from the
Again, different product lines within
(5) Creditors are geared to purchases the same firm might exhibit distinct comments and suggestions made
rather than turnover, etc. by A Sen. Any shortcomings are
operating eycle characteristics. Cash this auithor's.]
It is precisely such factors as Grass has estimates coulll be more refined and
I Some w7riters, however, prefer not
highlighted which have been explicitly accurate if the OC calculations are done to include cash in vorking capital
incorporated in the operating cycle separatelv for each product line. How- since cash is the effect rather than
methodology elaborated above. Each ever, the basic intention in the article the cause of working capital
step in the OC period computation has
leacds
been fo demonstrate the uise of Ihe changes. For example, see "Con-
trol of Working Capital", (ed) M
to the assessment of- the impact of the OC concept, and not to throxv up defini-
Crass, Goower Press, Essex, 1972,
transformation process of each current tive concltusions about the management p 6. Btit the ca.sh view of work-
asset item on the firm's casbh resources. of cash working capital or cturrent items ing capital seems most effectively
The operating expenses for the next year, in the fotur firms analysed. supported for a firm wvhich is plan-
derived from sales forecasts and adjust- (8) It may be suggested that after ning to start its operations for the
first time. Evidence for this inter-
ments for inventories an(d wvork-in-pro- having forecasted 1970 cash working
pretation seems also to be contained
gress, are then used to estimate cash, capital needs above, xx'hy not compare in assertions like "working capital
and not so-called working capital require- these with actuials as available from is to be provided for to the extent
ments. The derivation of cash require- 1970 published accouints. This has not of 6 mornths' works cost of produc-
ments through this process seems to be been done for the simple reason that the tion". OIIly a cash view of this
amount can carry clear conviction.
more obviously linke(d to sales or turan-
blanket assuimptions made by uis abotit See Report on The Fair Ex-Works
over, than is the link of conventional various elernents of the OC computa- Retention Prices of Steel for the
wvorking capital to sales, although over
tions andl sales projections, without Period 1st April 1960 to 31st
the long term the latter relationship entering into any dialogtue wvith the March 1962, Tariff Commission,
Government of India, Bombay
should also broadly hold good. It firms, are onlv illtustrative in natture.
1962, p 43. Correct comparison
(6) It may be arguted that it is an Comparisons of forecasts in this paper seems possil)!e only wbhen we have
anomaly to use the same cuirrent assetwith the acttuals xvouild, therefore, con- azn estimate of total cash require-
and current liability figuires from the vey little meaning. It is, hi)wvever, ments for operations during a
balance sheet for computing the length likely to be a uisefuil exercise for the period, as dist.nct from conven-
t.onally dlfined working capital.
of each phase of the operating cycle, internal analyst. Besides. the period
2 Park. C and Gladson, J W, "Work
calculating the OC turnover riate from 1965-69 was chosen to cover the reces- ing Capital", Macmillan Co, NewN
thence and finally the cash estimates, and sion spell and to relate Balance Sheet York, 1963, Chapter 3.
then comparing it w7ith wzorking capital andl casha working capital movements 3 Sagan, J, "Tow ard a Theory o

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Review of Managemenit March 1974 ECONOMIC AND POLITICAL IVEEKLY

Working Capital Management", in say that the size of working capital same poiiit, op cit, p 72.
"Financial Management - Policies ... is usually a function of sales, as 12 This point has also been highlight-
and Practices", (eds) F J Corrigan are fixed assets", "Business Fin- ed by Jaedicke, R K, and Sprouse,
and H A Ward, Houghton Mifflin, ance: Theory and Management", R T, in "Accounting Flows: In-
Boston, 1963, p 186. Collier Macmillan International, comes, Funds and Cash", Prentice
4 Lee, T A, "A Case for Cash Flow New York, 1972, p 31.3. Weston Hall, Englewood Cliffs, New Jersey,
Reporting", Joutrnial of Business and Brigham also emphasise the 1965, pp 109-114.
Finance, Volume 4, Number 2,
Summer, 1972, pp 27-36.
5 See "On Recent Recessionary Trend
in Organised Industry", Reserve
Bank of Itndia Bulletin, July 1968,
pp 862-69. The RBI industrial
classification is different from ours:

Psmare
its categorisation being Basic
Industries, Capital Goods Industries.
Intermediate Goods Industries and
Consumer Goods Industries. The
study has contrasted the wide fluc-
tuations in growth rates of output of
basic and capital goods induistries
gained the nearly steady declining
rates of the last two groups. GKW,
which falls in the capital (our pro-
ducers') goods industry, has thus
shown the widest fluctuations.
Dunlop and UCIL fall in RBI's
intermediate goods group, although
a distinction based on durability
is also logical.
6 Paton, W A, "Observations on In-
flation from an Accounting Stand",
Journal of Accounting Research,
Volume 6, Number 1, Spring 1968.
p 84,
7 For a simple methodology of asses-
sing overall cash surplus (or short-
age) situation in the context of funds
flow analysis see Jackson, A S, and
Townsend, E C, "Financial Man-
agement", George Harrap, London,
1970, pp 157-62.
8 See for example, Cohen J B and
Robbins, S M, "The Financial Man-
ager" Harper and Weatherhill
International, Tokyo, 1968, p 300:
"(The] tendency for companies to
become cash-poor as the tide ot
economic prosperity rises and cash-
rich as it runs out is a well known
economic phenomenon."
9 See Weston, J F and Brigham,
E F: "Managerial Finance" HoIt,
Rinehart and Winston, New York,
1972, pp 73-77. They have refined
the 'percentage of sales method' by
computing the ratio of each item of
current asset and current liability SCI caters to Daried requirements
to sales. The use of these ratios
for forecasting working capital operating a uniquely diversified
needs is suggested after duly tem-
pering them with an understanding modern fleet comprising cargo liner
of basic technology and the logic
of sales-to-current items relation- carriers, tankers, colliers, oreloil/gr
ships for the firm. We have, how-
ever, suggested only one relation- carriers, timber carrier,
ship in the OC concept above
cash to sales. All current asset and passenger-cum-cargo ships.
items are transformed into cash as
it were. Weston and Brigham sug-
gest more refined forecasting techni-
ques also, e g, linear regression,
multiple regression, etc.
0 Grass, op cit, p 7. Shipping House, Madam Cama Road, Bombay 400 001.
1 Most authors seem to hold the Agents at all principal ports of the world.
sales-to-working capital causal rela-
tionship to be true. Thus, Archer,
S H and D'Ambrosio, C A, state:
"In general it is possibly safe to

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