Nov 30, 2011|
Working capital management across industries
This is the second of the series of articles on Working capital.
Working capital cycle across industries
Working capital cycle plays a vital role in business productivity. It is a measure of the company's efficiency in managing its operational costs. However, every industry has its own set of dynamics that influences its working capital cycle. For example, aviation sector, real estate sector, gems & jewellery, engineering, power sector, sugar sector and textile sector are highly capital intensive. These companies realize proceeds from sales over a longer time-frame. This characteristic of a longer cycle between sales and realization of proceeds is reflected in their higher working capital requirements.
There are different reasons in each industry for the relatively longer working capital cycle. Real estate and engineering sectors involve projects which take a long time to complete, resulting in long inventory holding periods. The gems & jewellery industry imports rough diamonds, and exports the polished diamonds which translate into longer inventory and receivable days. Power distribution companies face difficulties in recovering dues from the cash-strapped State Electricity Boards and this stretches their debt holding period. The sugar and textile sectors longer working capital cycles are due to their dependence on commodity-based inputs which are seasonal in nature and necessitate their storage. Thus reasons ranging from time-consuming projects, higher levels of import/export, longer debt recovery and commodity-based seasonal inputs stretch working capital cycles. And this results in raising working capital requirements.
Even after taking into account the benefits of credit, sectors such as real estate and textile continue to have long working capital cycles. This adversely impacts their earnings as higher debt is required to service working capital. So, the return on equity (ROE) of these sectors is among the lowest. On the other hand, sectors such as FMCG, Mining, Oil & gas and IT produce higher returns by virtue of low or negative working capital cycles.
Source: Ace Equity database
|Net working cycle
|Gems & Jewellery
|Oil & gas
Rising working capital along with huge debts can create a precariously weak financial position threatening the survival of companies.
The Aviation industry has been in the eye of the storm battling with cash crunch. Airline companies such as Air India, Jet Airways and Kingfisher Airlines had borrowed heavily to expand air-fleet. However, the recent surge in crude price along with the weakening rupee left the over-leveraged companies high and dry. This coupled with exorbitant state fuel taxes, high maintenance charges and irrational ticket pricing have stretched working capital cycles creating a huge strain on the cash position of the companies. In fact Kingfisher Airlines was left with no cash to run its day-to-day operations and approached the government for a bail-out. In the case of Jet Airways, the auditors have raised a red flag on its going concern status, and asked it to raise funds to maintain its operations. This shows that increasing working capital cycle can spell havoc in a debt laden company putting its existence under cloud.
In the next article, we will study the most efficiently managed companies, and how companies can reduce this critical working capital cost component to become more profitable.
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