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Working capital management: Some aspects - Views on News from Equitymaster
 
 
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  • Oct 8, 2003

    Working capital management: Some aspects

    India Inc has been pursuing cost cutting measures with more seriousness now than ever before. As a result foreign concepts like JIT (Just In Time inventory management), BPR (Business Process Re-engineering) have entered the Indian corporate domain. Against this backdrop let us have a look at the best and worst performers in the corporate sector in terms of debtor days and inventory days for the year FY03.

    Before we analyse India Inc. based on debtor and inventory days, we shall first look at the relevance of the two in the operations of any company.
    The top 5
    FY03 Debtor
    days
      Inventory
    days
    Hindustan Construction 1 Container Corporation 1
    Container Corporation 2 Engineers India Ltd 1
    Trent Limited 3 Hero Honda 14
    Nestle India Limited 4 Bajaj Auto 16
    I.B.P.Co.Limited 5 Munjal Showa 17
    The laggards…
    FY03 Debtor
    days
      Inventory
    days
    Neyveli Lignite 333 Hindustan Construction 235
    Television Eighteen 269 Balrampur Chini 158
    Punjab Tractors 268 Cipla Limited 139
    Penta Media Graphics 264 Bharat Electronics 137
    Zee Telefilms 237 Bata India 122

    Debtor days: Debtor days is nothing but a measure of how fast a company is able to recover money from its customers in exchange for the goods sold or services rendered by the company. Thus, for e.g. if the debtor days were 60, it would mean that the company takes around two months to recover the amount. The faster the company is able to recover the amount or in other words the lower the debtor days, the better it is for company as it will not have to rely on borrowed funds to further its operations and would lead to savings in interest costs on short term borrowings. Lower debtor days could also mean that the company has a strong clout in the market (mainly due to dominant market share) and is therefore in a position to demand quick settlements.

    Inventory days: Companies usually build up inventories to meet any unexpected increase in demand or inventory might also pile up during periods of recession when demand for goods slackens. Inventory days give us an idea on how fast the company is able to utilise its inventory. If for e.g. the inventory days for a company are 30, this indicates that the company has inventories, which lasts for a month. Built up of excess inventories is bad for the company since carrying inventory involves costs in the form of funds, which are tied up.

    Similar to debtor days, the lower the inventory days the better it is for the company as it will have to bear the inventory carrying cost for a shorter period of time and will have lesser liquidity problems. Companies might have high current ratio (current assets/current liabilities) but can still run into liquidity problems on account of excess build up of inventory. Lending institutions are likely to mete out harsher treatments to these companies and can impose higher interest rates on such companies. Therefore, in order to avoid higher interest rates and liquidity problems companies should have sound inventory management.

    As far as India’s best performing companies in inventory days are concerned, it is heartening to know that companies from the auto sector (Hero Honda and Bajaj) figure in the list since traditionally the auto sector has been notorious for its high inventories. Strong growth in the two-wheeler segment in FY03 has meant that the inventory of auto majors get exhausted at a faster rate. However, we would want the investors to recognize the fact that going forward we do not expect the industry to grow at the FY03 levels and hence inventory days may revert back to their high levels seen in the past.

    If one were to look at the debtors days among the companies that have the lowest debtors days the observation is that a few of them are leaders in their industry while for the rest, by virtue of the industry dynamics they have lower debtor days. For example, Nestle which is one of the dominant players in the culinary segment, commands enough clout to ensure that its debtors days are low. On the other hand in the case of IBP, direct retail sales ensure that debtors days are very low. Similarly, Container Corporation, which has a monopolistic position in its sector has high bargaining power and hence the low level of debtors days.

    Among the companies that have performed poorly on the debtors days front, media companies are in majority. This is because media companies have very less bargaining power as compared to their clients (that spend on advertising) that are the main source of revenues. Thus, we see that media companies take longer to realise revenues, leading to higher debtors days.

    Debtors and inventory days are unavoidable features of any sector. However from the analysis done above we can gauge the importance of these parameters and the fact that they are very much dependent on the nature of industry, a particular company operates in as well as the relative standing (leader or laggard) of the company in the industry.

     

     

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