Working Capital

Management
Opening Story

2
THE EMPEROR WAS……..

3
Let me tell you the story of the profit
that never was. A Company showed a
good profit. A question was then asked
where the profit was. All searched high
and low, but the profit was not to be
found. The cash balance was nil.

4
“ But we made a profit,” said the sales
manager. “No money,” was the
laconic reply, from the finance head.
The finance head’s fund flow statement
revealed that profits were there all
right, but they were used up in adding
to debtors.
5
“Well,” said the sales chief, sheepishly ,
“ I think there is a cash crunch, but it is a
temporary phase. As soon as I liquidate
my debtors, You will get your profit”.

6
A closer look at the figures showed that
accretion to debtors came largely from
old outstanding and from retention on
projects which would take a year or
more to complete, and, if we were
lucky, to liquidate. But the story does
not end here.

7
“Well done,” said the bankers, whose
consortium cheered the profit that never
was, while endorsing their enhanced
borrowing limits - with interest at 14.5
percent : “the more the merrier”

8
“Come all ye faithful, giving and
rejoicing,” sang the taxman,
clapping his hands with unabashed
glee. At 35% tax, paid in advance
on a profit that never was he had a
great deal to rejoice about.

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 And so ends the story of the profit
that never was. The sales
Manager earned his increment; the
banker got his business; the
taxman picked up his bonanza.
The only loser in the game was the
Emperor - the Emperor was stark
naked.

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 ARE WE TOO TO KEEP THE EMPEROR
NAKED???

Let’s manage the Working Capital better

12
What is Working Capital

Sources - External /
Internal ?
13
 Working Capital
Capital required by business can be
classified into two categories:
 Money required for investment in long
term assets, e.g.,
* Land & Buildings
* Plant, Machinery & Equipment
* Vehicles

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 Working Capital

 Money required for investment in short

term assets, e.g.,
* Materials
* Spares
* Consumables
* Day-to-day expenses
* Credit sales to customers etc.

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Concepts

 Capital is classified as:

 LONG TERM CAPITAL – LONG TERM

REQUIREMENTS

 SHORT TERM CAPITAL / WORKING CAPITAL

– SHORT TERM NEEDS
 Current Assets (Short Term)
Such assets which are in the process of
production, distribution during the natural
course of business until they become cash or
equivalent.
Cash & Bank
Inventory
Debtors
Loans & Advances
Current Liabilities (Short term)

Liabilities falling due within a period of 12

months

Creditors for Goods & Services

Overdraft facilities
Provisions made
Advances received from Customers
CONCEPTS:

Working capital – Short Term – Current …..

GROSS WORKING CAPITAL – The current assets which

represent the proportion of investment that circulates
from one form to another in the ordinary conduct of
business.
NET WORKING CAPITAL – The portion of current
assets financed with long term funds or current assets –
current liabilities
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 WORKING CAPITAL MANAGEMENT

Working capital management is concerned with the

problems that arise in managing the current assets,
current liabilities and the interrelationships between
them.
GOAL:
To manage the firm’s current assets and liabilities in
such a way that a satisfactory level of working capital
is maintained.

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 FACTORS DETERMINING AMOUNT OF WORKING CAPITAL

Purchase Payment for Sell product Receive

resources resource purchase on credit cash

Inventory Receivable
conversion conversion
period period

Payables Cash
period Conversion
period
Operating cycle
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 Operating
Cycle
Working Capital Cycle
(or) Operating Cycle is
the duration of time
when the Company’s
Cash enters into the
business process and
again gets converted
into cash (and earning
a profit in the
process).
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 Operating Cycle

The way working capital moves around the

business is modeled by the working capital
cycle. This shows the cash coming into the
business, what happens to it while the
business has it and then where it goes.
Working Capital Cycle (or) Operating Cycle
is the duration of time when the
Company’s Cash enters into the business
process and again gets converted into cash
(and earning a profit in the process). A
simple working capital cycle may look
something like…………...
Operating Cycle

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 So, What is Working Capital ?
 Circulating Capital (Life-Blood)

 Current Assets are the ‘Gross Working Capital’.

 Net Working. Capital =

Current. Assets - Current.Liabilities

 Working Capital is the excess of Current

Assets over Current Liabilities.

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 Classification of Working
Capital
Permanent Variable
Permanently needed Fluctuates with the
for the enterprise to level of business
carry out minimum activities. Hence
level of activities. may be financed
Hence should be from Short Term
financed from Long Sources.
Term Sources. Eg. Bank overdraft,
Eg. Debentures commercial papers
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Working Capital Management - Why?

 It is costly
 Current assets do not earn any return
 Profitability of Business can be improved
 Materials must be stocked to meet the
requirements of the customers

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 Significance of Working Capital
Management
 Management of Working Capital Means
management of its key components i.e.,
Cash, Debtors, Inventory & Creditors

 Working Capital should be managed with

care because profitability and liquidity are
inversely related and hence lead towards
opposite directions

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Working Capital in L&T Construction

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 Working Capital in ECC (L&T Construction)

Current Assets:
 Stock at Sites/Main depot - A
 Outstanding (including retention) - B
 Excess of work done over - C
Invoicing (SOI)
 Other Current Assets - D
 Cash & Bank Balance - E

Current Liabilities:
 Unadjusted advance - F
 Vendor Credit - G
 Other Current Liabilities - H

Net Working Capital = [A+B+C+D+E] – [F+G+H]

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Key Areas identified for L&T Construction
• Concentrate on Gross Working Capital rather than
Net WC

Three thrust areas :-

• Stock optimization / reduction of inventory.
• Movement of debtors – How to reduce / control it.
• Control on Sales over invoicing.
 Profit Vs Cash

Profit
Profitrepresents
representsthe
theexcess
excessof
ofRevenue
Revenueover
overExpenses
Expenses
for
foraaparticular
particularperiod
period

Cash
Cashrepresents
representsthe
theexcess
excessof
ofReceipts
Receiptsover
overPayments
Payments
during
duringthe
theBusiness
Businesscycle
cycle

Profit
Profitmay
maybe
bein
inany
anyform
form-- Debtors
Debtors//Stock
Stock//Cash
Cash

Cash
Cashisis“CASH”
“CASH”
 WC Management – Our Role
Monitoring
Monitoring the
the Three
Three Essentials
Essentials

Receivables
Receivables from
from
Customers
Customers

Payables
Payables to
toVendors
Vendors

Stock
Stock
 WC Management – Receivables

For
ForNew
NewJobs,
Jobs,initialize
initializethe
the Adv.
Adv.Pre-requirement
Pre-requirementprocess
process in
in
Co-ordination
Co-ordinationwith
withthe
theBU.
BU.

Timely
Timelysubmission
submissionof
ofInvoices
Invoicesto
toCustomers
Customers

Follow
Followup
upfor
forCertification
Certification

Ultimate
UltimateGoal
Goalisisto
tocollect
collectthe
the outstanding
outstandingas
asfast
fastas
aswe
wecan
can
 WC Management – Payments

Payments
Payments to
to S/C
S/C
Prioritize
Prioritizethe
theSub-Contractors
Sub-Contractorsto
tobe
bepaid
paid
Back
Backto
toBack
BackS/C
S/Cto
tobe
bepaid
paidas
asper
perWO
WOconditions
conditions

Payments
Payments to
to Suppliers
Suppliers
Avoid
AvoidCash
CashPurchases
Purchases
Negotiate
Negotiate for
forthe
themaximum
maximumcredit
creditperiod
periodand
andpay
payon
on
Due
Duedate
date
 WC Management – Stock

Plan
Planin
inaccordance
accordancewith
withthe
theInvoice
Invoiceforecast.
forecast.

Monitoring
Monitoringthe
theMoving
Moving&&Non-Moving
Non-Movingstock
stock

Avoid
Avoidaccumulating
accumulatingStock.
Stock.Stock
Stockisisidle
idleCash
Cashwith
withzero
zeroreturn
return
 Effective Management

Effective
EffectiveWorking
Working Capital
Capital Management
Management involves
involves

-Forecasting
-Forecasting the
the Invoice
Invoice on
on customer
customer

-- Forecasting
Forecasting the
the Collection
Collection from
from customers
customers

-- Forecasting
Forecasting the
the Disbursements
Disbursements to
toVendors
Vendors

-- Forecasting
Forecasting the
the other
othercontrollable
controllable payables
payables
 Ultimate Aim ………….
To
Tohave
haveaaPositive
PositiveCash
CashFlow
Flow

Liquidation
Liquidationof
ofOutstanding
Outstanding

Follow
Followup
upfor
forthe
theOutstanding
Outstanding

Follow
Followup
upand
andcollect
collectthe
theOutstanding
Outstanding

Follow
Followup
upand
andcollect
collectthe
theOutstanding
Outstandingat
atan
anearliest
earliestdate
date
 Mind it….

Sale
Sale isis really
really not
not aa Sale
Sale when
when OS
OS not
not collected
collected

Profit
Profit earned
earned isis not
not Cash
Cash earned
earned

CASH
CASH isis REALITY
REALITY
 Ratio
Analysis

40
 Ratio Analysis

 Compare the performance of the

company for past successive years

 The absolute numbers change so

comparison is required

 Compare two companies of differing

size but from the same industry
 Profitability Ratios

 Gross Profit Margin = GP / Sales

(This ratio indicates the average spread
between the Cost of Goods sold and the
Sales revenue)

 Net Profit Margin = NP / Sales

(This ratio shows that earnings left for
shareholders as % of Net Sales)
Return
On
Capital
Employed
 ROCE

ROCE - a measure of profitability

ROCE = Profit (or Net Earnings)

Average Net Funds Employed
 Net Earnings

Sales
Less : Cost
Gross Margin
Less : RO, HQ & A& M OH
PBIT
Less : Interest & Taxes
PAT or NE
 Average Net Funds Employed

Avg. Net Funds Employed = ANFA + AWC

ANFA - Average Fixed Assets (net of

depreciation)

WC - Current Assets - Current Liabilities

AWC - Average Working Capital

 Advantages of ROCE concept

Simple to compute & easy to understand

Possible to compare with different kinds of projects

with unequal…….
- Life Periods
- Different kinds of Capital employed

Comparable with results obtained from

accounting records
 How to Improve
ROCE ..??
 Improve Profit
- By cost reduction
- By increasing sales
- By reduction of contract execution time
- By realising all possible extra claims

Reduce ANFE
-By reduction of Avg. Working Capital
Economic
Value
Addition
 EVA – the concept
Opportunity Cost of
EVA Operating Profit Running the Business

Net Earnings Capital Charge

 Sales
– Cost of Sales
 Charge for using capital
– Overhead  The return foregone by not
-------- investing in comparably risky
 PBIT
businesses
 Capital employed * WACC
– Tax
 -------- [Weighted Average Cost of
 PAT
Capital ( debt as well as equity)]
 ====
 EVA
Sales
Less : Cost
Gross Margin
Less : Overheads
PBIT
Less : Interest & Taxes
PAT or NE
Less : Capital Charge
EVA
Another way of looking at EVA

EVA Rate of Cost of X Capital

Return capital used

Efficiency Size

EVA is an integrated measure of growth and profitability that

captures value creation !
 Which project is doing good ?
` . crore

Element Project 1 Project 2 Project 3 Project 4 Project 5

Stock 13 2 8 10 7

OS 199 2 48 27 -

WIP > Inv 34 (6) 9 19 (4)

OCA 5 1 1 - 2

GWC 251 (1) 66 56 5

Vendor Credit 95 2 8 4 6

Unadj Adv 52 1 22 - 19

OCL 13 - 1 1 1

NWC 91 (4) 35 51 (21)

 B&F IC
WC % on Sales – 7 yrs trend
50
GWC % to
Sales
40 37
36
34
30
30
24
21
19
20
16
12
10
5

1
0
Mar'07 Mar'08 Mar'09 Mar'10 Mar'11 Mar'12 Jun'12 Sep'12 Dec'12
Mar’13
-6 -6 -2
-2 -7
-10 -11 -10

-20
 Review of Working Capital (Avg. numbers)
B&F IC ` . crore

Mar’10 Mar’11 Mar’12 Parameters Jun’12 Sep’12 Mar'13

317 258 681 Stock 774 919 976

1017 1233 1839 Outstanding 2019 2222 2636
-632 32 414 Cost Over Invoice 568 685 823

60 121 113 Other Current Assets 134 83 194

762 1644 3047 Gross Working Capital 3495 3909 4629

12% 21% 30% % of Sales 34% 37% 36%
407 963 1383 Vendor Credit 1365 1522 1512
807 1263 1930 Advances 1983 2014 2082
256 227 362 Other Current Liabilities 347 277 333
-708 -809 -628 Net Working Capital -200 96 702
-11% -10% -6% % of Sales -2% 1% 5%
Any Questions….?

THANK
YOU

Uday Sindiri
us@lntecc.com

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