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India Inc: Working capital check...

Sep 24, 2003

Over the years we have read that India inc. has consistently improved its efficiencies. Working capital is one such parameter, which is an important indicator of improving efficiency. In this article, we look at how the overall manufacturing sector has performed since the mid-1990's on this front. Working capital is basically the capital required by a business to manage the day-to-day operations of the company. Money is required to purchase raw materials and convert it into finished products, which are then sold to recover the amount invested along with some profits. In technical terms, working capital is basically the difference between current assets and current liabilities of the company. While the chief constituents of current assets include cash/bank balance, inventory, debtors and (short-term) loans and advances, current liabilities include provisions and short-term debt (creditors).

The graph below, indicates an improving working capital cycle (indicated by the fall in working capital to gross sales ratio of the Indian manufacturing sector). The main objective of any business is to cut down its working capital requirements in such a way that it can function with a minimal amount of the same. The graph below indicates that the Indian manufacturing sector has done well over the years to bring its working capital requirements under control. Efficient and minimal use of working capital ensures that cash is freed up, which can finance the company's other activities like expansion or payback of debt.

Source: CMIE

Over the years, Indian companies have employed efficient production methods to ensure that inventory levels are minimal. Methods like Just In Time (employed both on the production and supplier side) have ensured that inventory levels have been controlled significantly. This means that the company benefits both from its own streamlined operations as well as of its suppliers. However, one major factor that has led to the better usage of working capital has been the slowdown in the industry that has been witnessed in the last 3-4 years.

During a slowdown, manufacturers are forced to become conservative and they leverage more on their suppliers (potential creditors) as well as distributors (potential debtors). This leverage reduces the working capital requirements of the company. By leverage we mean that companies ask for larger credit period as well as faster payback from debtors. Also higher competition and affordability of better technology over the years has further aided the move towards lower working capital requirements by these companies.

Working capital trends are a good indicator of whether a particular company is moving up the efficiency scale, by using resources more efficiently, or not. While the Indian manufacturing sector has managed to improve on this front, the focus from here on should be on companies that are continually focusing on reducing their working capital requirements through intelligent systems looking for further efficiencies.

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