Working Capital Management

A SUMMER TRAINING PROJECT REPORT ON WORKING CAPITAL MANAGEMENT AT HINDALCO INDUSTRIES LTD.

Submitted in partial fulfillment of the two years (F/T) PGDM programme 2008-10

Under the guidance of

BY AMIT KUMAR SINGH PG/14/012 Submitted to

Industrial Guide

Academic Guide

Mr. VIMAL RAHEJA

Mr. Shyam Lal Dev Panday

DY.MANAGER (Accounts Dept.) HINDALCO INDUSTRIES LTD.

Sr.Lecturer SCHOOL OF MANAGEMNT SCIENCES

SCHOOL OF MANAGEMENT SCIENCES, VARANASI

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DECLARATION I, hereby state that the Project Report titled” Working Capital Management of Hindalco Industries Ltd.”Is an original work done entirely by me and is based on my own observations. The facts presented here are true to the best of my knowledge Amit kr. Singh Place: Date:

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PREFACE It is a great privilege for me to place this report before the readers. The report is concerned with “Working Capital Management Of Hindalco Industries Ltd.”This report is proposed in a very simple and understandable language. I would also like to state that although every possible care has been taken to make this report error free but still the possibility of some errors creeping in inadvertently cannot be ruled out. I shall feel highly obliged to all the readers if the same are brought to my notice. Critical evaluation and suggestions for improvement are most welcome and shall be greatly acknowledged. I sincerely express my gratefulness to all those who have directly or indirectly helped us in preparing this report. I firmly believe that this direction from all readers which will be thankful acknowledged.

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ACKNOWLEDGEMENT This project is an authenticated work on Summer Training Project at Hindalco Industries Limited, Renukoot, Uttar Pradesh. I would like to take this opportunity to thank all the people, who extended their immense help to complete my project. I would like to express our gratitude to Mr. Vimal Raheja, DY.Manager, Accounts Dept., Hindalco Industries Limited who spent his valuable time to discuss about the project and his continuous co- operation helped to get on with the project on a full swing without much hassles.

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TABLE OF CONTENTS • Introduction-----------------------------------1-12 • Company Profile -----------------------------13-22 • Objectives --------------------------------------23 • Research Methodology ----------------------24 • Working Capital Management-------------35-60 • Data Analysis and Interpretation--------- 61-72 • Conclusions-------------------------------------73-74 • Suggestions and Limitations----------------75 • Bibliography ----------------------------------76 • Annexure

----------------------------------77-78

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Global Aluminium Market Background: Aluminium is a lightweight, durable and corrosion resistant metal that can be extruded, rolled, formed and painted for use in a wide range of applications. According to the International Aluminium Institute, approximately 66% of global consumption is used in the construction, transportation and packaging sectors while the remaining 34% is used in consumer, capital goods and electricity transmission. Aluminium is produced from alumina, which is refined from bauxite, a mineral found in various parts of the world. There are several types of bauxite with alumina content ranging from 35% to 60%. Bauxite is refined to produce alumina predominantly through what is known as the Bayer process, although this process varies depending on the type and quality of bauxite. Alumina is then converted into aluminium metal using an electrolytic process. The global aluminium industry has experienced Global demand for primary aluminium has grown consistently at a compounded annual growth rate of 5.1% between 1999 and 2004. Global primary aluminium consumption was approximately 30.3 million metric tons in 2004 as compared to 27.5 million metric tons in 2003. Driven by strong demand in end-use markets, global demand is expected to rise to 31.7 million metric tons by 2005, before increasing further to 37.8 million metric tons in 2009. Significant consolidation in recent years, including the recent merger of Pechiney with Alcan. In 2004, the top five producers accounted for approximately 42% of world primary aluminium production, with the largest producer, Alcan, accounting for 12% of global production. The other large producers are Alcoa, Russian Aluminium, Norsk Hydro and BHP Billiton, who together accounted for 30% of global primary aluminium production in 2004. Increasing Asian Aluminium Consumption: The following table sets forth the actual and estimated regional consumption of aluminium from 2003 to 2009.

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In the above table: In the 2004, North America, Western Europe and China together accounted for approximately 66% of global primary aluminium consumption. North American demand has been led by the United States, which in 2004 accounted for 21% of global

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demand. Asia has shown the largest annual increases in consumption of primary aluminium over the last five years, driven largely by increased demand from China and Japan, which have emerged as the second and third largest aluminium consuming nations, accounting for 20% and 8%, respectively, of global primary aluminium demand in 2004. Increasing Deficit in Asian market: According to the International Aluminium Institute, primary aluminium production has grown at a compounded annual growth rate of 4.7% per annum between 1999 to 2004. Historically, industrialized nations accounted for a large share of global production. However, changing dynamics in energy availability and the rising cost of alumina have resulted in a shift in aluminium production to countries with access to greater bauxite supplies and affordable sources of power. One region which is emerging as an attractive destination for aluminium smelting is Asia. From 1997 to 2004, the proportion of global primary aluminium production carried out in Asia (excluding the Middle East) increased from 13% to 26%, while the proportion of global primary aluminium production carried out in North America and Western Europe in aggregate declined from 43% to 33%. Notwithstanding the rise in aluminium production and capacities in the region, aluminium supplies in Asia have lagged behind demand, resulting in a supply deficit of 4.2 million metric tons during 2004. During this period, China witnessed a marginal surplus and the rest of Asia witnessed a deficit of 4.8 million metric tons. Given expectations of continued strong growth in China and other Asian markets, the demand-supply gap is likely to widen and

is

estimated

to

reach

a

high

of

5.5

million

metric

tons

by

2

8

According to Metal Bulletin Research, the global deficit of alumina in 2004 was 338,000 metric tons, which was approximately 0.6% of global alumina consumption for the same period. However, the overall deficit was larger in Asia primarily due to the demand and supply dynamics in China. While Asia Accounted for 26% of global metallurgical grade alumina production during the same period, according to Metal Bulletin Research. This indicates a sharp rise in aluminium smelting capacity in Asia without a commensurate increase in alumina refining capacities. More significantly, alumina imports accounted for approximately 45% of total metallurgical grade alumina consumption in China in 2004, with approximately 56% of the total imports being sourced from Australia. Going forward, China will remain the key driver of demand growth in the region with a projected demand of approximately 18.0 million metric tons for metallurgical grade alumina in 2007, growing at a compounded annual growth rate of 10.9%. Furthermore, China will continue to be primary aluminium production in 2004, it accounted for only 16.5% of global dependent on imports to meet its domestic alumina consumption. Pricing: Aluminium is traded on the LME. While prices are determined by LME price movements, producers also charge a regional premium that generally reflects the cost of obtaining the metal from an alternative sourceThe following table sets forth the movement

in

the

aluminium

price

from

1995

to

2004.

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Alumina, however, is priced on the basis of negotiations, but usually determined with reference to the LME price for aluminium. Negotiated agreements generally take the form of long-term contracts, but fixed prices can be negotiated for shorter periods and a relatively small spot market also exists.

Indian Aluminium Market Background: The aluminium industry in India has grown progressively, tracking the country’s economy over the years. According to CRU estimates, domestic primary aluminium production will increase to a high of 943,000 metric tons in calendar 2005, compared to 860,000 metric tons in calendar 2004. CRU estimates production to reach 1,113,000 metric tons by calendar 2006. According to the Indian Minerals Yearbook 2003, India is home to the sixth largest bauxite deposit in the world with a reserve base of 1,400 million metric tons. Bauxite deposits are spread across the states of Orissa, Andhra Pradesh, Jharkhand, Chhattisgarh, Gujarat and Maharashtra. Indian bauxite is of superior Quality and is largely located on a single plateau, thus making bulk mining possible and resulting in significant cost advantages. In the past, Indian producers suffered from high power costs, but with privatization of coal mines by the government of India, new avenues have opened up for securing cost effective power for Indian producers. Backed by abundant, good quality bauxite and coal, as well as lower cost labour, Indian companies have emerged as low cost producers of aluminium. The domestic aluminium industry consists of three primary producers: Hindalco, National Aluminium Company Limited, or NALCO, and Vedanta Resources Plc, which controls Bharat Aluminium Company Limited, or BALCO, and Madras Aluminium Company Limited, or MALCO, all of whom are integrated producers with a presence ranging from bauxite mining to aluminium metal production. In fiscal 2005, Hindalco was the market leader with a 40% market share in India, while NALCO and Vedanta Resources Plc accounted for approximately 23% and 15%, respectively.

Domestic Demand and Consumption Pattern Domestic demand for aluminium has grown at a compounded annual growth rate of 9.8% between fiscal 2002 and fiscal 2005 to reach a high of 897,000 metric tons in fiscal 2005, which also includes scrap and metal imports of 201,000 metric tons. More

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importantly, the last two years have witnessed even stronger growth with annual growth rates of 20.6% and 9.5% for in fiscal 2004 and 2005 respectively. The power sector is the largest user segment of aluminium, accounting for 45% of domestic consumption in fiscal 2005. Historically, the power sector has accounted for a significant portion of aggregate domestic demand as high voltage current is usually transmitted through aluminium cables in India. However, as a result of the changing growth dynamics and increasing acceptance of new applications, the proportion of aluminium consumed by other user sectors such as transportation, construction and packaging has increased in recent years. The transportation sector accounted for 21% of domestic demand in fiscal 2005, benefiting from higher volumes and increased per vehicle usage of aluminium. The construction and packaging sectors accounted for 8% and 5%, respectively, of domestic demand in fiscal 2005. Pricing and Tariff: Domestic aluminium prices track the global price trends as producers usually price the metal at a marginal discount to the landed cost of imported metal. Though valueadded product prices also track metal price movement, they usually witness relatively less volatility and command a premium reflecting the degree of value addition and quality, as indicated by the brand. Aluminium imports are subject to a customs duty of 10% and an additional surcharge on the customs duty at a rate of 2%. This represents a significant reduction from the 25% customs duty charged as recently as fiscal 2001, bringing India more in line with customs duties charged by other countries in Southeast Asia. Market Outlook: The domestic aluminium industry is expected to grow in the coming years, supported by growth in the Indian economy and increased domestic demand in end-user markets. CRU estimates that primary aluminium consumption in India will increase to 1,209,000 metric tons by 2009.In addition; the government of India is planning to significantly increase power generation capacity in the next few years. The Ministry of Power plans to double power capacity to 200,000 MW by 2012. As part of this plan, cumulative capacity of the transmission links will be enhanced from 4,800 MW to 30,000 MW by 2012. Coupled with the increased demand resulting from the privatization of electricity transmission

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And distribution and a greater emphasis on improving the existing electricity distribution infrastructure in India, especially in rural areas, the power sector is expected to boost domestic aluminium demand. This growth is also likely to be supported by increased use of aluminium in automobile and two-wheeler manufacturing as well as a potential growth in automotive component exports as major automotive manufacturers begins to look to India as a sourcing base for their operations. The construction sector is also expected to witness continued growth for the foreseeable future. While the Housing segment has benefited from improved availability of more affordable financing; this sector is likely to get a further boost from the opening up of the real estate sectors to foreign direct investment in India. Backed by increasing acceptance of aluminium as an alternative to wood, demand from this sector is Poised to grow in the coming years. Moreover, the long term potential for the domestic markets is encouraging with the Indian per capita consumption growing from approximately 627 grams in fiscal 2002 to 830 grams in fiscal 2005, as compared to 4,598 grams in China and 21,286 grams in the United States in calendar 2004.

Global Copper Market Background: Copper is a non-magnetic metal with high conductivity, tensile strength and resistance to corrosion. Copper consumption can be divided into three main product groups: copper wire rods, copper products and copper alloy products. According to Brook Hunt, over the last 10 years, the predominant intermediate use of copper has been the production of copper wire rods, which accounted for approximately half of total copper production in 2004. Copper wire rods are used in wire and cable products such as energy cables, building wires and magnet wires. Copper alloy products were the next largest users of copper in 2004, accounting for 17% of total demand, followed by copper tubes at 11%. In addition, copper has several non-electrical applications such as tubes for air conditioners and refrigerators, foils for printed circuit boards and other industrial and consumer applications. In 2004, the construction sector accounted for 37% of copper consumption, followed by the electrical and electronic sectors at 26%, industrial machinery and equipment at 15%, transportation equipment at 11% and consumer products at 11%. In addition to direct applications, copper is also used in a

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number of alloys, including brass (copper and zinc), bronze (copper and tin), nickel silver, phosphor bronze and aluminium bronze. The copper industry can be divided into three broad categories: • Copper mining which uses mined ore to produce copper concentrates, usually containing 25% to 40%copper; • Copper custom smelting which smelts and refines copper from the concentrates obtained from copper mines; and • Integrated copper producers, who undertake mining, smelting, and refining or leaching to produce copper. Integrated copper producers account for a large part of the copper capacity in the world. Copper Consumption: Global consumption of refined copper has grown consistently at a compounded annual growth rate of 3.8% between 1994 and 2004. The consumption of 16.8 million metric tons in 2004 reflects an increase of 8.8% over 2003. The key growth drivers are the continuing demand from the construction and power sectors. Global demand for refined copper is expected to reach 17.0 million metric tons in 2005, and to increase gradually to an estimated 19.6 million metric tons by 2009. Western Europe, China, North America and the rest of Asia (including Japan and the Middle East) together accounted for nearly 88% of global refined copper consumption. Europe and North America accounted for over 50% of refined copper consumption during the 1980s, but robust growth in Asia, led by China and Japan, has resulted in a significant change in global consumption patterns during the last decade. With a compounded annual growth rate of 6.6% between 1994 and 2004, Asia has been amongst the fastest growing copper market in the world. Driven by continuing growth in China and other regional markets, Asia is likely to witness continued strong growth over the next five years with regional consumption of refined copper estimated to reach 10.1 million metric tons by 2009. The following table sets forth the regional consumption pattern of refined copper from 2003 to 2009 (estimated):

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Copper Supply: Global mine production is the principal source of copper, with scrap recycling accounting for only 11% to 13% of aggregate supplies. The five largest copper mining countries are Chile, USA, Peru, Australia and Indonesia, which together accounted for 64% of global copper mine production in 2004. Nearly one third of global mine production is sold in the custom smelting market, with the rest being used for integrated production. Integrated copper production is concentrated in countries such as Chile, Peru, Canada and Australia, which together account for 25% of global smelter copper production and 29% of global refined copper production. The major custom smelting locations include China, Japan, South Korea, India, and Western Europe, which together accounted for 42% of global smelter production in 2004 and thus are major importers of copper concentrate. Refined copper production has grown at a compounded annual growth rate of 3.5% between 1995 and 2004. Global production currently stands at 15.9 million metric tons, reflecting a growth of 4.5% in 2004. Traditionally, the Americas and Western Europe accounted for a majority of copper production, though their share has been on the decline in recent years. Asian markets have witnessed strong growth in capacities during this period. In 2004, China and the rest of Asia (including Japan and the Middle East) accounted for 13% and 19%, respectively, of global refined copper production while the Americas and Western Europe accounted for 37% and 12%, respectively. In spite of strong production growth, Asian markets witnessed a supply

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deficit of 2.3 million metric tons in 2004. Of this, the supply deficit in China was 1.4 million metric tons. The following table sets forth the actual and estimated regional demand - supply balance from 2003 to 2009:

Pricing: Copper is traded on the LME. Although prices are determined by LME price movements, producers normally charge a regional premium that is market driven. The following table sets forth the movement in copper prices from 1995 to 2004.

For custom smelters, TcRc has a significant impact on profitability as prices for copper concentrate and prices of finished products are LME price net of TcRc or plus a premium, respectively. A significant proportion of concentrates are sold under frame contracts and TcRc is negotiated annually. The TcRc rates are influenced by the

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demand-supply situation in the concentrate market, prevailing and forecasted LME prices and mining and freight costs.

Indian Copper Market Background: The Indian copper industry primarily consists of custom smelters as there are limited quality copper deposits in the country. The available deposits are owned by the government-owned Hindustan Copper Limited, which was the only producer in India until 1995. However, the industry has transformed significantly since then with the entry of Birla Copper, now owned by Hindalco Industries Limited, and Sterlite Industries, part of Vedanta Resources Plc., who together accounted for 89% of domestic production in calendar 2004. Reflecting this transformation, over the last 8 years, industry capacity has also grown approximately 8 times from a modest 72,000 metric tons in 1997 to 566,000 metric tons in 2004. Consumption Pattern: Domestic refined copper consumption has grown at a compounded annual growth rate of only 7.2% between 1999 and 2004. Overall growth has been hampered due to a sharp decline in domestic demand from the jelly filled telecom cables, or JFTC, sector, the largest user of copper in India. The deeper penetration of the cellular industry as well as a decrease in optic fiber prices led to a slowdown in JFTC demand from government-owned purchasers, which in turn impacted copper consumption adversely. Supported by strong growth in other user segments such as winding wires, power cables and other user applications, industry demand has rebounded strongly during the last few years. CRU has estimated the aggregate refined copper consumption at 325,000 metric tons in 2004, a growth of 5.9% from 307,000 metric tons reported in 2003. Pricing and Tariff: Domestic copper prices track the global prices as the metal is priced on the basis of the landed costs of imported metal. Copper imports are subject to a customs duty of 10% and an additional surcharge of 2% of the customs duty. The customs duty has been reduced from 15% to 10% in 2005. Domestic producers are also able to charge a regional premium, which is market driven.

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Market Outlook The Indian market outlook is expected to remain positive with strong growth in key user segments such as power, construction and engineering. According to CRU, domestic consumption of refined copper is expected to increase from 325,000 metric tons in 2004 to an estimated 378,000 metric tons by 2009, reflecting a compounded annual growth rate of 3.1% between 2004 and 2009. This growth is significantly lower than the historical averages, largely on account of negative growth in the telecom cable segment which continues to suffer from increasing penetration of the cellular telecommunication and low prices of optic fibers in the international markets. Indian producers, however, benefit from attractive opportunities in the regional markets, which had reported an aggregate supply deficit of 2.8 million metric tons in 2004. According to CRU, the Asian deficit is likely to widen further over the next few years, which offers promising prospects for exports.

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Hindalco-Overview ‘Hindalco’ was set up in collaboration with Kaiser Aluminium & Chemicals Corporation USA, in a record time of 18 month. The plant started its commercial production in the year 1962 with a capacity of 20,000 TPA. It has since grown to become the largest integrated aluminium producer in India. The company has grown manifold and is managed by board of directors, with shri Kumar Mangalam Birla as the chairman of the board of directors. Hindalco Industries Limited, the metals flagship company of the Aditya Birla Group, is an industry leader in aluminium and copper. A metals powerhouse with a consolidated turnover in excess of US$ 14 billion, Hindalco is the world's largest aluminium rolling company and one of the biggest producers of primary aluminium in Asia. Its Copper smelter is the world's largest custom smelter at a single location. Company's principal products comprise of Aluminium Ingots, Aluminium Billets, Aluminium Wire Rods, Sheet Products, Extrusions, Aluminium Foils and Aluminium Alloy Wheels. The Company's by products include Gallium Metal, Vanadium Sludge and Aluminium Dross Established in 1958, Hindalco commissioned its aluminium facility at Renukoot in Eastern U.P. in 1962. Later acquisitions and mergers, with Indal, Birla Copper and the Nifty and Mt.Gordon copper mines in Australia, strengthened the company's position in value-added alumina, aluminium and copper products, with vertical integration through access to captive copper concentrates. In 2007, the acquisition of Novelis Inc. a world leader in aluminium rolling and can recycling marked a significant milestone in the history of the aluminium industry in India. With Novelis under its fold Hindalco ranks among the global top five aluminium majors, as an integrated producer with low cost alumina and aluminium facilities combined with high-end rolling capabilities and a global footprint in 12 countries outside India. Its combined turnover of US$ 14 billion, places it in the Fortune 500 league. Hindalco, at Renukoot, houses a fully integrated plant, comprising of 3 main plants i.e. the Alumina, Smelter & Fabrication Plants. Each plant employs varying Technology. With integrated facilities, output from various plants is used by next, along with varying raw materials. Company has its own captive power plant at Renusagar (30 Km away from Renukoot ) with installed capacity of 741.7 MW and 78 MW of Co Generation Plant at Renukoot itself.

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Alumina Plant: It was commissioned with an initial capacity of 40,000 MTPA, which has now increased, to 700000 MTPA. The plant has been expanded in phases using new technology from time to time for energy efficiency and capacity enhancement. It employs the basic Bayer’s process and the major raw materials for the plant are Bauxite, Steam, Caustic Soda and Furnace oil. Aluminium Smelter: It has 11 Pot lines with 2067 Pots installed with annual production capacity of 3,45,000 MT. The Smelter employs the Hall Heroult Electrolysis Process for the extraction of Aluminium from Alumina. Basic raw materials for the smelter are Alumina, Power, Anodes and Aluminium Fluoride. Fabrication Plant: The Fabrication Plant at Renukoot comprises of 4 Main Sections Remelt Shop, Cast House, Rolling Mills, Extrusion & Conform which produce Wire Rod, Sheets, Coils and Extruded Products. Hindalco, an ISO 14001, ISO 9001:2000 and OHSAS 18001 Company. Recently these three systems have integrated as IMS (Integrated Management System). Today Hindalco occupies a place of pride in the global aluminium scenario with its most efficient working in all areas of operations. The company has kept pace all along with latest development in aluminium technology and has occupied its manufacturing facilities. Hindalco has bagged 14 prestigious International & National Awards for Business Excellence, Quality, Energy Conservation and its efforts for preserving the Environment in FY 05-06.

Hindalco Today Aluminium has turned out to be the wonder metal of the industrialized World. No other single metal can do so many job’s so well, and so Economically also. Aluminium growth rate is the highest amongst the major basic metals today. Hindalco ranks as the largest aluminium producer in India and contributes about 40 % share in total production of the country. The company’s fully integrated aluminium operations consists of the Mining of bauxite, conversion of bauxite in to alumina, production of primary aluminium from alumina by electrolysis and production of Properzi redraw roads, rolled products, extructions and value added products like foil wheel at silvasa. Hindalco integrated operations and operational efficiency has enabled the company to be one of world’s lowest cost producers of

aluminium. The company’s cost

efficiency has helped it to record an outstanding performance in the face of adverse

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market conditions. Hindalco also owns a large captive thermal power plant at renusager that Meets the power requirment of the company very efectively, has a current Generation units . Hindalco currently has primary aluminium capicity of 3, 50,000 MTPA. Some recent milestones:


In May 2007, Novelis became a Hindalco subsidiary with the completion of the acquisition process. The transaction makes Hindalco the world's largest aluminium rolling company and one of the biggest producers of primary aluminium in Asia, as well as being India's leading copper producer.
In May 2006, the company signed an MoU with the Government of Madhya Pradesh for setting up a greenfield aluminium smelter and a captive power plant. The company also entered into a joint venture with Essar Power (M.P.) Ltd. to develop and operate coal mines at Mahan, Madhya Pradesh. The joint venture will supply coal to the proposed aluminium smelter and power complex in Madhya Pradesh
In May 2006, the company's copper mining subsidiary Aditya Birla Minerals Limited (formerly Birla Mineral Resources Pty Ltd.) came out with an equity offering and subsequent listing on the Australian Stock Exchange (ASX)
In March 2006, the company acquired an aluminium rolling mill and wire rods facility, from Asset Reconstruction Company (India) Limited (ARCIL), belonging to Pennar Aluminium Company Limited
In January 2006, the company concluded 4:1 rights issue of its shares on partly paid basis. It was the largest ever rights issue in the history of corporate India and first one to issue partly paid instruments
In September 2005, the company split its shares in ratio of 10:1 in order to enhance liquidity and to encourage participation from retail investors
In April 2005, the company signed an MoU to establish a world class integrated aluminium project in the state of Orissa

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In April 2005, the company entered into MOUs with the Orissa and Jharkhand governments for setting up a greenfield alumina facility and aluminium facility respectively, in the states

Hindalco Business Hindalco in India enjoys a leadership position in aluminium and copper. The company's aluminium units across the country encompass the entire gamut of operations from bauxite mining, alumina refining, aluminium smelting to downstream rolling,

extrusions,

foils

and

alloy

wheels,

along

with

captive

power plants and coal mines. The Birla Copper unit produces copper cathodes, continuous cast copper rods along with other by-products, including gold, silver and DAP fertilizers.

Hindalco is the world's largest aluminium rolling company and one of the biggest producers of primary aluminium in Asia. In India, Hindalco enjoys a leadership position in speciality alumina, primary aluminium and downstream products. Hindalco's major products include standard and speciality grade aluminas and hydrates, aluminium ingots, billets, wire rods, flat rolled products, extrusions, foil and alloy wheels

indalco's Birla Copper unit at Dahej in Gujarat is the world's largest single location custom copper smelter with 500,000 tpa capacity. The plant is backed by captive power plants, oxygen plants, as also by product facilities for fertilisers and precious metals. A captive jetty with cargo handling capacity of over four million tpa, facilitates easy input of copper concentrate and other imported raw materials.

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The two copper mines in Australia were acquired in 2003. Birla Nifty mine consists of an open-pit mine, heap leach pads and a solvent extraction and electro winning (SXEW) processing plant, which produces copper cathode. Birla Nifty's copper cathode capacity is 25,000 tpa. A copper sulphide deposit is located at the lower levels of the Nifty open pit mine and an underground mine and concentrator have been developed to mine and process ore from this deposit. The Nifty sulphide operation commenced ore production from stoping in December 2005 and concentrate production in March 2006. With the start-up of the Nifty sulphide operation and its progressive ramp up during FY2007, Aditya Birla Minerals (ABML) is entering a period of rapid growth.

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Hindalco Vision: “To strengthen our position as a premium aluminium company, sustaining domestic leadership and global competitiveness through innovation, quality and value added growth.” Hindalco Mission: “To pursue the creation of value for our customers, shareholders, employees and society at large.” Hindalco Values: Integrity Honesty in every action Commitment On the foundation of integrity, doing whatever it takes to deliver, as promised. Passion Missionary zeal arising out of an emotional engagement with work Seamlessness Thinking and working together across functional silos, hierarchy levels, businesses and geographies. Speed Responding to stakeholders with a sense of urgency

Hindalco Strategy: Efficiency focus To be one of the lowest cost producers globally Effectiveness focus To continue to remain the market leader domestically

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Growth focus To pursue value adding growth opportunities in aluminium

THE MARKET LEADER Hindalco is a leading domestic player in two metals business segments — aluminium and copper. The aluminium division's product range includes alumna chemicals, primary aluminium ingots, billets, and wire rods, product extrusions, foils and alloy Wheels.The Company has a significant market share in all the segments in which it operates. It enjoys a domestic market share of 42 per cent in primary aluminum, 63 per cent in rolled products, 20 per cent in extrusions, 44 per cent in foils and 31 per cent in wheels. As a step towards expanding the market for value-added products and services, Hindalco has launched several brands in recent years, which include Aura for alloy wheels, Fresh Rapp for kitchen foil and Ever last for roofing sheets. Our exclusive showroom, The Aluminium Gallery, seeks to promote Hindalco products to its customers. It is a platform for the company to showcase quality products to a quality audience in an appropriate ambience. The exhibits include products like windows, doors, furniture, ladder, roofing sheets and ceiling and cladding panels. Hindalco products are well received not only in the domestic market, but also in the international market. The company's metal is accepted for delivery under the highgrade aluminium contract on the London Metal Exchange (LME). The company exports about 17 per cent of its total sales volume of Aluminum.The Company’s alumna chemical business is a leader in manufacturing and marketing of specialty alumna and alumna hydrate products in the country. It has a market share of 90 per cent in the country. These specialty products find wide usage in diversified industries including water treatment chemicals, refractory, ceramics, cryolite, glass, fillers and plastics, conveyor belts and cables, among others. The company also exports these alumna chemicals to over 30 countries covering North America, Western Europe and the Asian region

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Birla Copper, Hindalco's copper division at Dahej in Gujarat enjoys a leadership position in India, having built over 40 per cent of the domestic market share within three years of its commissioning. It has also made successful forays into the export markets of the Middle East, Southeast Asia, China, Korea and Taiwan. The

copper plant produces world-class copper

cathodes, continuous cast copper rods and precious metals.

Sulphuric

acid,

phosphoric

acid,

DI-

ammonium phosphate, other phosphate fertilizers and phosphor-gypsum are also produced at this plant.

SWOT ANALYSIS OF HINDALCO INDUSTRIES LIMITED STRENGTHS: 

Strong brand recognition



Internet sales



Growing international presence



Superior research and development department



Strong financial returns



Strong sense of culture in the working environment



Successful experience being competitive



Effective Leadership



Cost leadership

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Prestigious Client Base



Customer Loyalty



Diversified Business



Product innovation capabilities



Technological excel.



Good corporate image

WEAKNESSES: •

Complexity of operation

•

Lengthy processing chain

OPPORTUNITIES: •

Growth of core sector industries

•

Rapid integration with global economy

•

Booming construction business in Asia

•

Growing e-commerce’s business.

•

Increasing urbanization

THREATS: •

Entry of global players

•

Take over possibilities

•

Political threats

•

The impact of foreign currency fluctuation and interest rates.

•

Loss of sales to substitutes

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COMPETITORS 1. Domestic: Textiles

Copper Auminum Cement

Telecommunication

Reliance

Vedant group

Ambuja

Bharti airtel

Raymond

Essar

Unitech

Reliance

Mayur

Sail

Vodafone

Tata Nalco

BSNL

2. International: •

ALCOA Inc.

•

ALCAN Inc.

•

Russian Aluminium

•

NORSK HYDRO

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OBJECTIVES 1. To know about the current assets and current liabilities position of Hindalco Industries Ltd.

2. To determine the ratios relating to the working capital.

3. To find out the Gross Working Capital position of Hindalco Industries Ltd.

4. To know about the net working capital position of Hindalco Industries Ltd.

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METHODOLOGY OF THE PROJECT The methodology followed in this project involved the following Phases:

•

Collection of Data

•

Type of the project

•

Analysis of Data

•

Conclusion & Recommendation

Collection of Data: Data required for the project e.g. Balance Sheet, statement of Profit & Loss Account etc. were collected from the annual reports of Hindalco period of 2005-06, 2006-07, 2007-08. Besides for Explanation of several issues, different articles, Internet data’s, books etc were consulted. The data collected are Secondary Data. Type of the project: The project is descriptive and analytical in nature. Analysis: For the comparative analysis ratios were used along with graphs, charts, and necessary diagrams. The current year i.e., 2008-09 has not been taken into calculation because, at that time of preparation of this report annual closing accounting of the Company was going on. Interpretation & Recommendation: After completion of the entire analysis, interpretation & recommendation were made on the basis of figures and diagrams. Statistical tools like Tables, Charts, Bar graphs used for representation of data.

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Working Capital Management “More business fails for lack of cash than for want of profit”. Efficient management of working capital is one of the pre-conditions for the success of an enterprise. Efficient management of working capital means management of various components of working capital in such a way that an adequate amount of working capital is maintained for smooth running of a firm and for fulfilment of twin objectives of liquidity and profitability. While inadequate amount of working capital impairs the firm’s liquidity. Holding of excess working capital results in the reduction of the profitability. But the proper estimation of working capital actually required, is a difficult task for the management because the amount of working capital varies across firms over the periods depending upon the nature of business, production cycle, credit policy, availability of raw material, etc. Thus efficient management of working capital is an important indicator of sound health of an organisation which requires reduction of unnecessary blocking of capital in order to bring down the cost of financing. Meaning of Working Capital: Working capital is the amount of capital that a business has available to meet the dayto-day cash requirements of its operations, or more specially, for financing the conversion of raw material into finished goods, which the company sells for payment. Funds are also needed for short-term purposes for the purpose of raw materials, payment of wages and other day-to-day expenses, etc. These funds are known as working capital.In simple words, working capital refers to that part of the firm’s capital, which is required for financing short-term or current assets such as cash, marketable securities, debtors and inventories. Working capital is a valuation metric that is calculated as current assets minus current liabilities. Working capital is also known as operating capital.

Current Assets This is any cash or assets that can be quickly turned into cash. Current assets are assets, which can be converted into cash within an accounting year. Constituents of Current Assets: •

cash in hand and bank balance

•

bills receivables

•

Sundry debtors (provision for bad debts)

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•

Short tern loans and advances

•

Inventories of stocks.

•

Raw material.

•

Work in progress.

•

Stores and spares.

•

Finished goods.

•

Prepaid expenses.

•

Accrual incomes.etc

Current Liabilities Current liabilities are those claims of outsiders, which are expected to mature for payment within an accounting year. Constituents of current Liabilities: •

Bills payable

•

Sundry creditors or account payable

•

Short term borrowings

•

Dividend payable

•

Bank overdraft

•

Provisions

•

Outstanding expenses

•

Unaccrued income

Determinants of working capital: Working capital requirements of a concern depends on a number of factors, each of which should be considered carefully for determining the proper amount of working capital. It may be however be added that these factors affect differently to the different units and these keeps varying from time to time. In general, the determinants of working capital which re common to all organization’s can be summarized as under: Nature of business: Need for working capital is highly depends on what type of business, the firm in. there are trading firms, which needs to invest a lot in stocks, ills receivables, liquid cash etc. public utilities like railways, electricity, ete., need much less inventories and cash. Manufacturing concerns stands in between these two extends. Working capital requirement for manufacturing concerns depends on various factors like the products, technologies, marketing policies.

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Production policies: Production policies of the organization effects working capital requirements very highly. Seasonal industries, which produces only in specific season requires more working capital. Some industries which produces round the year but sale mainly done in some special seasons are also need to keep more working capital. Size of business: Size of business is another factor to determines the need for working capital Length of operating cycle: Operating cycle of the firm also influence the working capital. Longer the orating cycle, the higher will be the working capital requirement of the organization. Credit policy: Companies; follows liberal credit policy needs to keep more working capital with them. Efficiency of debt collecting machinery is also relevant in this matter. Credit availability form suppliers also effects the company’s working capital requirements. A company doesn’t enjoy a liberal credit from its suppliers will have to keep more working capital Business fluctuation: Cyclical changes in the economy also influencing the working capital. During boom period, the tendency of management is to pile up inventories of raw materials and finished goods to avail the advantage of rising prove. This creates demand for more capital. Similarly during depression when the prices and demand for manufactured goods. Constantly reduce the industrial and trading activities show a downward termed. Hence the demand for working capital is low. Current asset policies: The quantum of working capital of a company is significantly determined by its current assets policies. A company with conservative assets policy may operate with relatively high level of working capital than its sales volume. A company pursuing an aggressive amount assets policy operates with a relatively lower level of working capital. Fluctuations of supply and seasonal variations: Some companies need to keep large amount of working capital due to their irregular sales and intermittent supply. Similarly companies using bulky materials also maintain large reserves’ of raw material inventories. This increase the need of working capital. Some companies manufacture and sell goods only during certain 32

seasons. Working capital requirements of such industries will be higher during certain season of such industries period. Other factors: Effective co ordination between production and distribution can reduce the need for working capital. Transportation and communication means. If developed helps to reduce the working capital requirement.

EXCESS

OR

ADEQUATE

WORKING

CAPITAL

Every business concern should have adequate working capital to run its business operations.

It should not have either redundant / excess working capital or

inadequate/ shortage of working capital. Both excess as well as shortage of working capital situations are bad for any business. However, out of the two, inadequacy or shortage of working capital is more dangerous from the point of view of the firm. Disadvantages of Redundant or Excess Working Capital: 1.Idle funds, non-profitable for business, poor ROI. 2. Unnecessary purchasing & accumulation of inventories over

required level.

3. Excessive debtors and defective credit policy, higher incidence of

B/D.

4.Overall inefficiency in the organization. 5. When there is excessive working capital, Credit worthiness suffers. 6. Due to low rate of return on investments, the market value of shares may fall. Disadvantages or Dangers of Inadequate or Short Working Capital: 1Can not pay off its short-term liabilities in time. 2. Economies of scale are not possible. 3. Difficult for the firm to exploit favorable market situations. 4. Day-to-day liquidity worsens. 5. Improper utilization the fixed assets and ROA/ROI falls sharply.

Need for working capital The basic objective of financial management is to maximize shareholder’s wealth. For this it is necessary to generate sufficient profits. The extent to it, which the profit can be earned, largely depends on the magnitude of sales. However sales do not convert into cash instantly. There is invariable the time gap between the sales of goods and receipts of cash. There is, therefore, a need for working capital in the form of Current Assets to deal with the problem arising. Out of the lack of immediate realization of

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cash again goods sold. Therefore, sufficient working capital is necessary to sustain sales activity. Working capital is needed for the following purpose: 1. For the purchase of raw material, components and spares. 2. To incur day to day expenses and overhead costs such as fuel, power and office expenses, etc. 3. To meet selling costs as packing, advertisement etc. 4. To provide credit facilities to the customers. 5. To maintain the inventories of raw material, work in progress, stores and spare and finished goods. 6. To pay wages and salaries.

Meaning of working capital management Working Capital Management is concerned with the problems that arise in attempting to manage the Current Assets, Current Liabilities and the inter-relationship that exists between them. Working Capital Management means the deployment of current assets and current liabilities efficiently so as to maximize short-term liquidity. Working capital management entails short term decisions - generally, relating to the next one year periods - which are "reversible"

Steps involved in working capital management I. Forecasting the Amount of Working Capital II. Determining the Sources of Working

Objectives of Working Capital Management I. Deciding Optimum Level of Investment in various WC Assets II. Decide Optimal Mix of Short Term and Long Term Capital III. Decide Appropriate means of Short Term Financing

Forecasting /Estimation of Working Capital Management Requirement Factors to be considered: •

Total costs incurred on materials, wages and overheads.The length of time for which raw materials remain in stores before they are issued to production.

•

The length of the production cycle or WIP, i.e., the time taken for conversion of raw material into finished goods.

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•

The length of the sales cycle during which finished goods are to be kept waiting for sales.

•

The average period of credit allowed to customers.

•

The amount of cash required to pay day to day expenses of the business.

•

The amount of cash required for advance payments if any.

•

The average period of credit to be allowed by suppliers.

•

Time – lag in the payment of wages and other overheads

Nature of Working Capital Management

Profitability, Risk& Liquidity

Working Capital Management

Composition & Level of CA

Composition &Level of CL

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Working Capital Cycle The working capital requirement of a firm depends, to a great extent upon the operating cycle of the firm. The operating cycle may be defined as the time duration starting from the procurement of goods or raw material and ending with the sales of realization. The length and nature of the operating cycle may differ from one firm to another depending upon the size and nature of the firm. In a trading concern, there is a series of activities starting from procurement of goods (saleable goods) and ending with the realization of sales revenue (at the time of sale itself in the case of cash sales and at the time of debtors realization in case of credit sales).similarly in case of manufacturing concern, this series starts from the procurement of raw materials and ending with the sales realization of finished goods. In both the cases, however, there is a time gap between the happening of the first event and the happening of the last event. This time gap is called the operating cycle. Thus, the operating cycle of a firm consists of the time required for the completion of the chronological sequences of some or all of the following:

1. Procurement of raw material and services. 2. Conversion of raw material into work-in-progress. 3. Conversion of work-in-progress into finished goods. 4. sale of finished good(cash or credit) 5. Conversion of receivable into cash.

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RawMaterial

WIP

Cash

Finished Foods

Accounts Receivabl e

Sales

The working capital cycle (Operating cycle)

Operating cycle period The length or time duration of the operating cycle of any firm can be defined as the sum of its inventory conversion period and the receivable conversion period. 1. Inventory conversion period: It is the time required for the conversion of raw material into finished goods sales. In a manufacturing firm the inventory conversion period is consisting of raw material conversion period (RMCP), work-in-progress conversion period (WPCP) and finished goods conversion period (FGCP). Raw material conversion period refers to the period for which the raw material is generally kept in stores before it is issued to the production department. The work-in-progress conversion period (WPCP) refers to the period for which the raw material remains in the production process before it is taken out as finished units.

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The finished goods conversion period refers to the period for which finished units remains in stores before being sold a customer. 2. Receivable conversion period (RCP): It is the time required to convert the credit sales into cash realization. It refers to the period between the occurrence of credit sales and collection from debtors. The total of Inventory conversion period (ICP) and Receivable conversion period (RCP) is also known as total operating cycle period (TOCP).the firm might be getting some credit facilities from supplier of raw material, wages earners etc.This period for which the payment to these parties are deferred or delayed is known as deferred period (DP).the net operating cycle (NOC) of the firm is arrived at by deducting the DP from TOCP. NOC=TOCP-DP =ICP+RCP-DP For calculating total operating cycle period (TOCP) and net operating cycle (NOC), the following formula is being used: RMCP = Average Raw material stock ×365 Total Raw material consumption WPCP=Average Work-in-progress ×365 Total cost of production FGCP= Average Finished Goods ×365 Total Cost of goods sold RCP=Average Receivable ×365 Total Credit sales

DP=Average Creditors ×365 Total Credit purchase

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*The average value in the numerator is the average of opening balance and closing balance of the respective item. However, if only the closing balance is available, then even the closing balance may be taken as the ‘average’. *The figure ‘365’represents number of days in a year. However, there is no hard and fast rule and sometimes even 360 days are considered. *The ‘Total’ figure in the denominator refers to the value of the item in a particular year.

Time and Money concept in Working Capital Cycle Each component of working capital (namely inventory, receivables and payables) has two dimensions .TIME and MONEY, when it comes to managing working capital. Time is Money: If we can get money to move faster around the cycle (e.g. collect money due from debtors more quickly) or reduce the amount of money tied up (e.g. reduce inventory levels relative to sales), the business will generate more cash or it will need to borrow less money to fund working capital. As a consequence, we can reduce the cost of bank interest or will have additional free money available to support additional sales growth or investment. Similarly, if we can negotiate improved terms with suppliers e.g. get longer credit or an increased credit limit; we effectively create free finance to help future sales.

If we

Then

Collect receivables (debtors) faster

We release cash from cycle

Collect receivables(debtors) faster

Our receivables soak up cash

Get better credit(in terms of duration or We increase our cash resources amount from suppliers) Shift inventory(stocks)faster

We free up cash

Move inventory(stocks) slower

We consume more cash

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TYPES OF WORKING CAPITAL

WORKING CAPITAL

BASIS OF TIME

BASIS OF CONCEPT

Gross Working Capital

Permanent / Fixed WC

Net Working Capital

Temporary / Variable WC

On the basis of concept 1. Gross working capital: the gross working capital refers to the firm’s investment in all the assets taken together. The total of investment in all the individual current assets is the gross working capital. For example: if a firm has a cash balance of Rs. 50,000 ,debtors of Rs.70,000 and inventory of raw material and finished goods has been assessed at Rs.1,00,000,then the

gross

working

capital

of

the

firm

is

Rs.2,20,000(i.e.,Rs

50,000+Rs.70,000+Rs.1,00,000). 2. Net working capital: the term net working capital may be defined as the excess of total current assets over total current liabilities. Current liabilities refer to those liabilities which are payable within a period of 1 year. The net working capital may either be positive or negative. If the total current assets are more than total current liabilities, then the difference is known as positive net working capital, otherwise the difference is known as negative net working capital. The net working capital measures the firm’s liquidity. The greater the margin, the better will be the liquidity of the firm.

Net working capital= total current assets – total current liabilities

40

A financial manager must consider both (gross and net working capital) because they provide different interpretation. The gross working capital denotes the total working capital or the total investment in current assets. This will help avoiding 1.the unnecessarily stoppage of work or chance of liquidation due to insufficient working capital, and 2.effects on profitability (over flowing working capital implies cost).The gross working capital also gives an

idea of total funds required for maintaining

current assets. On the other hand, net working capital refers to the amount of funds that must be invested by firm, more or less, regularly in current assets. The net working capital also denotes the net liquidity being maintained by the firm.

On the basis of time 1. Permanent /fixed working capital: Permanent working capital may be defined as the minimum level of current assets, which is required by a firm to carry on its business operations. Every firm has to maintain a minimum level of raw materials, work-in-progress, finished goods and cash balances. For example-extra inventory of finished goods will have to be maintained to support the peak periods of sale. Permanent working capital is permanently needed for the business and therefore, it should be financed out of long term funds. 2. Fluctuating /variable working capital: It is the extra working capital needed to support the changing production and sales activities of the firm. The amount of temporary working capital keeps on fluctuating on time to time on the basis of business activity. Both kind of working capital – permanent and fluctuating (temporary) are necessary to facilitate production and sales through the operating cycle. The amount over and above permanent working capital is temporarily variable or fluctuating.

41

Permanent and temporary working capital of a stable firm

Amt.

Of

W C

Temporary

Permanent W C

Time

In the above figure, it is shown that permanent working capital is stable over time, while temporary working capital is fluctuating –some times increasing and sometimes decreasing.

42

Permanent and temporary working capital of a Raising Firm: In the case of an expanding firm the permanent W C line may not be horizontal. This is because the demand for permanent Current Assets might be increasing or decreasing to support a rising level of activities. In that case line should be raising one as follows:

Amt.

Of

Temporary W C

WC

Permanent W C

Sources of working capital The company can choose to finance its current assets by 1. Long term sources 2. Short term sources 3. A combination of them. Long term sources of permanent working capital include equity and preference shares, retained earning, debentures and other long term debts from public deposits and financial institution. The long term working capital needs should meet through long term means of financing. Financing through long term means provides stability, reduces risk or payment. And increases liquidity of the business concern. Various types of long term sources of working capital are summarized as follow:

43

1. Issue of shares: It is the primary and most important sources of regular or permanent working capital. Issuing equity shares as it does not create and burden on the income of the concern. Nor the concern is obliged to refund capital should preferably raise permanent working capital. 2. Retained earnings: Retain earning accumulated profits are a permanent sources of regular working capital. It is regular and cheapest. It creates not charge on future profits of the enterprises. 3. Issue of debentures: It crates a fixed charge on future earnings of the company. Company is obliged to pay interest. Management should make wise choice in procuring funds by issue of debentures. 4. Long term debt: Company can raise fund from accepting public deposits, debts from financial institutution like banks, corporations etc. the cost is higher than the other financial tools. 5. Other sources: sale of idle fixed assets, securities received from employees and customers are examples of other sources of finance.

Short term sources of temporary working capital Temporary working capital is required to meet the day to day business expenditures. The variable working capital would finance from short term sources of funds. And only the period needed. It has the benefits of, low cost and establishes closer relationships with banker. Some sources of temporary working capital are given below: 1. Commercial bank: A commercial bank constitutes significant sources for short term or temporary working capital. This will be in the form of short term loans, cash credit, and overdraft and though discounting the bills of exchanges. 2. Public deposits: Most of the companies in recent years depend on this source to meet their short term working capital requirements ranging fro six month to three years.

44

3. Various credits: Trade credit, business credit papers and customer credit are other sources of short term working capital. Credit from suppliers, advances from customers, bills of exchanges, etc helps to raise temporary working capital 4. Reserves and other funds: Various funds of the company like depreciation fund. Provision for tax and other provisions kept with the company can be used as temporary working capital.The company should meet its working capital needs through both long term and short term funds. It will be appropriate to meet at least 2/3 of the permanent working capital equipments form long term sources, whereas the variables working capital should be financed from short term sources. The working capital financing mix should be designed in such a way that the overall cost of working capital is the lowest, and the funds are available on time and for the period they are really required.

SOURCES OF ADDITIONAL WORKING CAPITAL Sources of additional working capital include the following1. Existing cash reserves 2. Profits (when you secure it as cash) 3. Payables (credit from suppliers) 4. New equity or loans from shareholder 5. Bank overdrafts line of credit 6. Long term loans If we have insufficient working capital and try to increase sales, we can easily over stretch the financial resources of the business. This is called overtrading. Early warning signs include 1. Pressure on existing cash 2. Exceptional cash generating activities. offering high discounts for clear cash payment 3. Bank overdraft exceeds authorized limit 4. Seeking greater overdrafts or lines of credit 5. Part paying suppliers or there creditor. 6. Management pre occupation with surviving rather than managing.

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Trade - Off between Profitability and Risk In evaluating the firm’s working capital position an important consideration is the trade-off between profitability and risk. In other words, the level of NWC has a bearing on profitability and risk. The term profitability used in this context is measured by profit after expenses. The term risk is defined as the profitability that a firm will become technically insolvent so that it will not be able to meet its obligation when they become due for payment.It is assured that greater amount of NWC, the less risk prone the firm is, or greater the NWC, the more liquid is the firm, and therefore the less likely it is to become technically insolvent. Conversely lower level of NWC and liquidity are associated with increasing level of risk.A firm must have adequate WC. It should neither be excessive nor inadequate. Excessive WC means the firms has idle funds, which are in no profit for the firm. This situation decreases both risk and profitability of the firm. Inadequate WC means the firm doesn’t have sufficient funds for running its operation which ultimately results in production interruption, and lowering down the profitability. Lower level of WC increases the risk but has the potentiality of increasing the profitability also. The above principle is based on the following assumption: 1. There is direct relationship between profitability and risk. 2. Current assets are less profitable than fixed assets 3. Short term funds are less expensive than long term funds.

Effect of level of CA on Profitability-Risk Trade Off The effect of level of CA’s on profitability risk trade-off can be shown using the ratio of CA to TA. This ratio indicates the percentages of TA’s that are in form of CAs.An increase in the ratio will lead to decline in profitability because CAs is less profitable than FAs. It would also increase risk of technical insolvency because increase in CA assuming no change in CL will increase NWC. Conversely a decrease in ratio will result in increase in profitability as well as risk.

46

Effect of level of CL on risk profitability trade-off: The effect of CL can be demonstrated by using the ratio of CL to TAs. This portion of short term financing which is less expensive as compared to long term financing. These will therefore, be a decline in cost and corresponding rise in profitability. The increased ratio will also increase risk because assuming no change in CA, this would decrease in NWC. The consequence of decrease in the ratio is exactly opposite to the result of an increase. Thus it will lead to decrease in profitability and risk

Different Aspects of Working Capital Management •

Management of Inventory

•

Management of Receivables/Debtors

•

Management of Cash

•

Management of Payables/Creditors

MANAGEMENT OF INVENTORY Inventories constitute the most significant part of current assets of a large majority of companies. On an average, inventories are approximately 60% of current assets. Because of large size, it requires a considerable amount of fund. The inventory means and includes the goods and services being sold by the firm and the raw material or other components being used in the manufacturing of such goods and services. Nature of Inventory: The common type of inventories for most of the business firms may be classified as raw-material, work-in-progress, finished goods. •

Raw material: it is basic inputs that are converted into finished products through the manufacturing process. Raw materials inventories are those units which have been purchased and stored for future productions.

•

Work–in–process: Work-in-process is semi-manufactured products. They represent products that need more work before they become finished products for sale.

•

Finished goods: These are completely manufactured products which are ready for sale. Stocks

of

raw

materials

and

work-in-process

facilitate

production, while stock of finished goods is required for smooth marketing

47

operations. Thus inventories serve as a link between the production and consumption of goods.The levels of three kinds of inventories for a firm depend on the nature of business. A manufacturing firm will have substantially high levels of all the three kinds of inventories. While retail or wholesale firm will have a very high level of finished goods inventories and no raw material and work-in-process inventories.

Need to hold inventories Maintaining inventories involves trying up of the company’s funds and incurrence of storage and holding costs. There are three general motives for holding inventories: Transactions Motive: IT emphasizes the need to maintain inventories to facilitate smooth production and sales operation. Precautionary Motive: It necessitates holding of inventories to guard against the risk of unpredictable changes in demand and supply forces and other factors. Speculative Motive: It influences the decision to increase or reduce inventory levels to take advantage of price fluctuations.

Objectives of inventory management The aim of inventory management should be to avoid excessive and inadequate levels of inventories and to maintain sufficient inventory for smooth production and sales operations. An effective inventory management should: •

To ensue a continuous supply of raw material to facilitate uninterrupted production.

•

To maintain sufficient stocks of raw materials in the periods of short supply and anticipate price changes.

•

To maintain sufficient finished goods inventory for smooth sales operation, and efficient customers service.

•

To Minimize the carrying cost and time ,and

•

To Control investment in inventories and keep it at an optimum level.

Effect of Excess or Inadequate inventory If too much inventory is held, the organization wastes money through a variety of factors.

48

•

Money is held up in stock when it could be put to better use.

•

There are superfluous warehousing and storage costs.

•

Inventory may deteriorate.

•

There is potentially greater risk of theft.

On the other hand, too little inventory can lead to stock-out which can: •

Halt activity.

•

Lose income.

•

Cause discomfort or distress to Clint.

Inventory Management Technique IN managing inventories, the firm’s objective should be in consonance with the shareholder wealth maximisation principle. For this, the firm should determine the optimum level of inventory. Efficiently controlled inventories make the firm flexible. Inefficient inventory control results in unbalanced inventory and inflexibility-the firm may sometimes run out of stock and sometimes may pile up unnecessary stocks. This increases the level of investment and makes the firm unprofitable. To manage inventories efficiently, the following two questions should be kept in mind: 1. How much should be ordered? 2. When should be ordered? To answer the above two questions, we must calculate Economic Order Quantity and Re-Order Point.

Economic Order Quantity (EOQ) The Economic Order Quantity model attempts to determine the order size that will minimize the total inventory cost. It assumes that total inventory cost =total carry cost +total ordering cost. The EOQ model as a technique of inventory management defines three parameters for any inventory: 1. Minimum level of inventory of that item depending upon the usage rate of that item, time leg in procuring that item and unforeseen circumstances, if any. 2. The re-order level of that item ,at which next order for that item must be placed to avoid any chance of a stock –out ,and 3. The re-order quantity for which each order must be placed.

49

Assumptions: The EOQ model is based on the following assumptions:

1. The total usage of a particular item for a given period (usually 1 year) is known with certainty and that the usage rate is even through out the period. 2. That there is no time gap between placing an order and getting its supply. 3. The cost per order of an item is constant and the cost of carrying inventory is also fixed and is given as % of average value of inventory. 4. That there are only two costs associated with the inventory, and these are the cost of ordering and the cost of carrying the inventory.

EOQ may be presented as follows

EOQ=

2AO C

Where, EOQ=Economic quantity per order.

A=Total annual requirement for the item

O=Ordering cost per order of that item

C=Carrying cost per unit per annum. Ordering cost: The term ordering costs is used in case of raw materials (or supplies) and includes the entire costs of acquiring raw material. It includes requisitioning, purchase ordering, transporting , receiving, inspecting and storing. Ordering cost increase in proportion to the number of order placed. Thus, the more frequently inventory is acquired, the higher the firm’s ordering cost. On the other hand, if the firm maintains large inventory level, there will be few orders placed and ordering costs will be relatively small.

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Total ordering cost = (Annual requirement ×per order cost)

Order size

TOC= AO Q Carrying cost: Costs incurred for maintaining a given level of inventory are called carrying cost. It includes storage, insurance, Taxes, deterioration and obsolescence. Carrying costs very with inventory size. Carrying cost decline with increase in inventory size. Total cost Costs (Rs.)

Carrying cost

Order cost

O EOQ

It is shown that the total ordering cost for any particular item is decreasing as the size per order is increasing. It is just because of the increase in the size of the order; the total no. of orders for a particular item will decrease resulting in decrease in the total order cost. The total annual carrying cost is increasing with the increase in order size. This will happen because the firm would be keeping more and more items in stores. The total cost of inventory initially reduces with the increase in the size of order but then increases with the increase in the size of order. The trade-off of these two costs is attained at the level at which the total annual cost is the least.

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The order point: The re-order level is the level of inventory at which the fresh order for the item must be placed to procure fresh supply. The re-order point depends on Lead time, Average usage, Economic Order Quantity. Lead time is the time normally taken between the placement of an order and receiving the supply. Average usage is the rate at which the inventory is being used up. Reorder point=Lead time× Average usage Safety stock: safety stock is the minimum level of inventory desired for an item given the expected usage rate and the expected time to receive an order. If an order is placed when the inventory reaches 150 units instead of 100 units, the additional 50 units constitute the safety stock. The firm expects to have 50 units in stock when the new order arrives. The safety stock protects the firm from stock –outs due to unanticipated demand for the item or to slow deliveries. The level of inventory investment is increased by the amount of the safety stock. The safety level is ascertained and introduced as a part of inventory management because there is always an uncertainty involved with respect to the time lag, usage rate or any other factor. The unexpected variations in both the time lag and the demand for the product affect the level of safety. The more certain are the patterns of movement of stock, the less is the safety stock required. For better stock/inventory control: •

Review the effectiveness of existing purchasing and inventory systems.

•

Know the stock turn for all major items of inventory.

•

Apply tight controls to the significant few items and simplify controls for the trivial many.

•

Sell off outdated or slow moving merchandise - it gets more

•

Difficult to sell the longer you keep it.

•

Consider having part of your product outsourced to another manufacturer rather than make it yourself.

•

Review your security procedures to ensure that no stock is going out the back door.

Management of Receivables/Debtors The Receivables (including the debtors and the bills) constitute a significant portion of the working capital. The receivables emerge whenever goods are sold on credit and

52

payments are deferred by customers. A promise is made by the customer to pay cash within a specified period. The customers from whom receivable or book debts have to be collected in the future are called trade debtors and represents the firm’s claim or assets. Thus, receivable is s type of loan extended by the seller to the buyer to facilitate the purchase process. Receivable Management may be defined as collection of steps and procedure required to properly weight the costs and benefits attached with the credit policy. The Receivable Management consist of matching the cost of increasing sales (particularly credit sales) with the benefits arising out of increased sales with the objective of maximizing the return on investment of the firm.

Nature The term credit policy is used to refer to the combination of three decision variables: 1. Credit standards: It is the criteria to decide the type of customers to whom goods could be sold on credit. If a firm has more slow –paying customers, its investment in accounts receivable will increase. The firm will also be exposed to higher risk of default. 2. Credit terms: It specifies duration of credit and terms of payment by customers. Investment in accounts receivable will be high if customers are allowed extended time period for making payments. 3. Collection efforts: It determine the actual collection period. The lower the collection period, the lower the investment in accounts receivable and vice versa. Goals: A firm may follow a lenient or a straight credit policy. The firm following a lenient credit policy tends to sell on credit to customers on very liberal terms and standards. Credits are granted for long longer period even to those customers whose creditworthiness is not fully known or whose financial position is doubtful. A firm following a straight credit policy sells on credit on a highly selective basis only to those customers who have proven creditworthiness and who are financially strong. In practice, firms follow credit policies ranging between stringent to lenient.

Costs and Benefits of Credit Policy: There are various costs and benefits attached with a credit policy.

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Costs: Cost of financing: the credit sales delays the time of sales realization and therefore the item gap between incurring the cost and the sales realization is extended. This results blocking of funds and the company has to arrange funds to meets its obligation. These funds are to be procured at some explicit or implicit cost. This is known as the cost of financing the receivables. Administration cost: A firm will have to incur various costs in order to maintain the record of credit customers both before and after the credit sales. 1. Delinquency costs: The firm may have to incur additional cost as delinquency costs, if there is delay in payment by a customer. it includes reminders, phone calls,postage,legal notice etc.More over ,there is always an opportunity cost of the fund tied up in the receivable due to delay in payment. 2. Cost of default by customers: If any default is made by the customers in payment, partly or wholly, it will termed as bad debts. It becomes cost to the firm. Benefits: 1. Increase in sales: The sales can be increased by credit sales. This will attract more customers to the firm resulting in higher sales and growth of the firm. 2. Increase in profit: Increase in sales will help the firm to easily recover the fixed expenses and attaining break –even level and increase the operating profit of the firm. In a normal situation, there is a positive relation between the sales volume and the profit. 3. Extra profit: Sometimes, the firm make the credit sales at a price which is higher than the usual cash selling price. It brings an opportunity for the firms to make extra profits.

Trade- off on Receivables: The trade –off on receivables can be applied to find out whether to liberalize the credit terms or not. More liberal credit terms may be expected to generate higher sales revenue and higher profit. But they increase the potential cost also in the form of bad debts and a decrease in liquidity of the firm. If the net benefit expected from liberalizing the credit terms is positive, the firm may offer such terms, otherwise not. On the other hand, a stringent credit policy reduces the profitability but may increase the liquidity of the firm.

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Profitability Costs and Benefits

Liquidity Optimum

Stringent

Credit policy

Liberal policy

Policy

Credit Policy, Profitability and Liquidity of a Firm It is clear from the above figure that as the firm takes its credit policy towards more and more liberal; its liquidity decreases whereas the profitability increases. On the other hand, if the firm makes its credit policy more and more stringent, the liquidity may increase but profitability will go down. Thus, a firm should try to frame its credit policy in such a way as to attain the best possible combination of profitability and liquidity. Credit Evaluation: Credit evaluation involves determination of the type of customers who are going to qualify for the trade credit. Evaluation of credit worthiness of a customer is a two fold steps procedure: 1. Collection of information 2. Analysis of information

55

Collection of information: In order to make better decisions, the firm may collect information from various on the prospective credit customers. The following are sources of information which can provide sufficient data or information about the credit worthiness of a customer: 1. Bank Reference: The bank may be asked to comment on the financial position of a particular customer. The customer may also be required to ask his bank to provide necessary information in this respect. 2. Credit Agency Report: There are certain credit rating agencies which provide independent information on the credit worthiness of different parties. These credit agencies gather information on the credit history and see it to the firm which want to extend credit. 3. Published information: The published financial statements of the customers for few preceding years may also be taken as a source of information. Various ratios calculated on the basis of these financial statements may throw light on the profitability, liquidity and debt service capacity of a customer. 4. Credit scoring: If the credit request is large enough, then the firm can send its own representatives/employees to collect information about the customer. In this case, the customer may be evaluated through the use of credit scoring which involves the numerical evaluation of each new customer who receives a score based on his answer to a simple set of questions. This score is then evaluated according to a pre-determined standard; it’s relative to the standard determining whether credit should be extended. Analysis of Information: Once all the available credit information about a potential customer has been gathered, it must be analyzed to reach at some conclusion regarding the credit worthiness of a customer. A firm should go for further information and analysis only if required. If it is evident at any stage that the customer has satisfactory credit worthiness, then there is no need to go for costly exercise of further ananlysis.In case of those customers who are marginally creditworthy. In such situation, the financial manager must attempt to balance the potential profitability against the potential loss from the default.

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Control of receivables Once the credit has been extended to a customer as per the credit policy, the next important step in the management of receivables is the control of these receivables. In this reference, the efforts may be required in the two directions as follow: I. The collection procedure: once a firm decides to extend credit and defines the terms of credit sales, it must develop a policy for dealing with delinquent or slow paying customers. The overall collection procedure of the firm should neither be too lenient nor too strict. A strict collection policy can affect the goodwill and damage the growth prospect of sales. If a firm has a lenient credit policy, the customer may become slower in payments. Thus, the objective of collection procedure and policies should be to speed up the slow paying customers and reduce the incidence of bad debts. II. Monitoring of Receivables: in order to control the level of receivables, the firm should apply regular checks and there should be a continuous monitoring system. The finance manager should keep a watch on the credit worthiness of all the individual customers and the total credit policy of the firm. For this ,number of measures are available as follows: 1. Average collection period: A common method to monitor the receivables is the collection period or number of day’s outstanding receivables. The average collection period may be as follows: Debtors ×360 Credit sales The collection period so calculated is compared with the firm’s stated credit period to judge the collection efficiency. There are 2 limitations to this method. • It provides an average picture of collection experience and it is based on aggregate data. • It is susceptible to sales variations and the period over which sales and receivables have been aggregated. 2. Aging schedule: the aging schedule removes one of the limitations of the average collection period. It breaks down receivables according to the length of time for which they have been outstanding.

57

For example: the receivables of a firm, having a normal credit period of 30 days, may be classified as follows:

Age Group

% of total outstanding Receivables

(No. of Days)

Less than 30 days

60%

31-45 days

20%

46-60 days

10%

61 and above

10%

It may be noted that ,the firm has a credit period of 30 days and 60% of the total receivables are less than 30 days old.20 % of the receivables are over due by 15 days,10 % are over due by 30 days and 10 % are over due by more than 30 days. This aging schedule provides early warning suggesting: 1. Deterioration of receivables quality 2. Where to emphasize the appropriate corrective actions. When compared with the past aging schedule done by the same firm or done by other comparable firms, this may provide an indication of whether the firm should start worrying about its collection procedures. By comparing the aging schedules for different periods, the financial manager can get an idea of any required changes in the collection procedure and can also point out those customers which require special attentions. However, a basic shortcoming of the aging schedule is that it is influenced by the change in sales volume. 3. Lines of credit: another control measures for receivables management is the line of credit which refers to the maximum amount a particular customer may have as due to the firm at any time. Different lines of credit may be allowed to different customers. The lines of credit must be reviewed periodically for all the customers. 4. Accounting Ratios: accounting information may be useful in order to control the receivables.2 accounting ratios may be calculated to find out the changing pattern of receivables. 

Receivables Turnover Ratio



Average Collection Period.

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Management of Cash Cash management refers to management of cash balance and the bank balance and also includes the short terms deposits. Cash is the important current asset for the operations of the business. Cash is the basic input needed to keep the business running on a continuous basis. It is also the ultimate output expected to be realised by selling the service or product manufactured by the firm. The term cash includes coins, currency, and cheque held by the firm and balance in the bank accounts. Factors of Cash Management: cash management is concerned with the managing of 1.cash flows into and out of the firm 2.cash flows within the firm and 3.cash balance held by the firm at a point of time by financing deficit or investing surplus cash.

Cash collection

Business operation Deficit Surplus

Borrow Invest

Information & control Cash payments

Cash Management Cycle

Sales generate cash which has to be disbursed out. The surplus cash has to be invested while deficit has to borrow. Cash management seeks to accomplish this cycle at a minimum cost and it also seeks to achieve liquidity and control.

59

Facets of Cash Management: In order to resolve the uncertainty about cash flow prediction and lack of synchronisation between cash receipts and payments .the firm should develop appropriate strategies regarding the following four facets of cash management: Cash Planning: Cash inflows and outflows should be planned to project cash surplus or deficit for each period of the planning period. Cash budget should be prepared for this purpose. Managing the cash flows: The flow of cash should be properly managed. The cash flow should be accelerated while the cash outflows should be decelerated. Optimum cash level: The firm should decide about the appropriate level of cash balances. The cost of excess cash and danger of cash deficiency should be matched to determine the optimum level of cash balances. Investing surplus cash: The surplus cash balances should be properly invested to earn profits. The firm should decide about the division of such cash balance between alternative short –term investment opportunities such as bank deposits, marketable securities, or inter-corporate lending. The idea cash management system will depend on the firm’s product, organisation structure, competition, culture and options available. The task is complex and decisions taken can affect important areas of the firm. For example-to improve collections if the credit period is reduced, it may affect sales.

Motives of holding cash A distinguishing feature of cash as an asset is that it does not earn any substantial return for the business. Even though firm hold cash for following motives: Transaction motive: This refers to the holding of cash to meet routine cash requirement to finance. The transactions, which a firm carries on in the ordinary course of business. 1. Precautionary motive: This implies the needs to hold cash to meet unpredictable contingencies such as strike, sharp increase in raw materials prices. If a firm can borrow at short notice to pay them unforeseen contingency, it will need to maintain relatively small balances and vice-versa. 2. Speculative motives: It refers to the desire of the firm to take advantage of

opportunities which present themselves at unexpected movements and

which are typically outside the normal course of business.

60

3. Compensatory motive: Bank provides certain services to their client free of cost. They therefore, usually require client to keep minimum cash balance with them to earn interest and thus compensate them for the free service so provided.

Objectives of cash management There are two basic objectives of Cash Management: Meeting cash disbursement: This is the first basic objective of cash management, according to which the firm should have sufficient cash to meet the various requirement of the firm at different time period. Cash has been described as “Oil to lubricate the ever turning wheels if business, without it the process grinds to a stop.” Minimising funds locked up as cash balances: In this process the finance manager is confronted with two conflicting aspects. A higher cash balance ensures power savings with all its advantages. But this will result in a large balance of cash remaining idle. Low level of cash balance may result in failure of the firm to meet the payment schedule. The finance manager should, therefore try to have an optimum cash balance. Managing your cash balances is one of the most important parts of working capital management. If an organization runs out of cash resources it will have to stop operating immediately .There may not even be the money to pay the salaries at the end of the month, and the banks might have started dishonouring cheques. Furthermore, the trustees or directors could stand charged with wrongful or fraudulent trading, which could entail personal liability or even imprisonment. If the organization has too much liquidity in the long term, it may well be invested in fairly low return areas, such as bank deposit accounts. Long term surplus should be invested in making the organization grow. Cash planning: Cash planning is a technique to plan and control the use of cash. It helps to anticipate the future cash flows and needs of the firm and reduces the possibility of idle cash balances and cash deficits. Cash planning protects the financial conditions of the firm by developing a projected cash statement from a forecast of expected cash inflows and outflows for a given project. Cash plans are very crucial in developing the overall operating plans of the firm. Cash planning may be done on

61

daily, weekly or monthly basis. The period and frequency of cash planning generally depends upon the size of the firm and philosophy of management. Cash forecasting and Budgeting: cash budget is the most significant device to plan for and control cash receipts and payments. A cash budget is a summery statement of the firm’s expected cash inflows and outflows over a projected time period. It gives information on the timing and magnitude of expected cash flows and cash balances over the projected period. This information helps the financial manager to determine the future cash needs of the firm, plan for the financing of these needs and exercise control over the cash and liquidity of the firm. The time horizon of a cash budget may differ from firm to firm. A firm whose business is affected by seasonal variations may prepare monthly cash budgets. Daily or weekly cash budgets should be prepared for determining cash requirement if cash flows show extreme fluctuations. Cash flows for a longer intervals may be prepared if cash flows are relatively stable.

Importance and Significance of Cash Budget Cash budget is an effective tool of cash management and it may help the management in the following ways: 1. Identification of the period of cash shortage so that the financial manager may plan well in advance about arranging the funds at an appropriate time. 2. Identification of cash surplus position and duration for which surplus would be available so that alternative investment of this excess liquidity may be considered in advance. 3. Better coordination of the timing of cash inflows and outflows in order to avoid chances of shortages or surplus of cash. Cash forecasts are needed to prepare cash budgets. Cash forecasting may be done on short or long –term basis. Generally, forecasts covering periods of one year or less are considered short term. Those extending beyond one year are considered long –term. Short – term Cash Forecast: It is comparatively easy to make short- term cash forecasts. The important functions of carefully developed short – term cash forecasts are: •

To determine operating cash requirements.

•

To anticipate short – term financing.

•

To manage investment of surplus cash.

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The short – term forecast helps in determining the cash requirements for predetermined period to run a business. One of the significant roles of the short – term forecasts is to pinpoint when the money will be needed and when it can be repaid. Other uses: •

Planning reductions of short and long –term debt.

•

Scheduling payments in connection with capital expenditure programmes.

•

Planning forward purchase of inventories.

•

Checking forward purchase of inventories.

•

Taking advantage of cash discounts offered by supplies.

•

Guiding credit policies.

Long – term Cash Forecasting: Long –term cash forecasts are prepared to give an idea of the company’s financial requirements in the distant future. They are not as detailed as the short –term forecasts are. A Company can the impact of new product development or plant acquisitions on the firm’s financial conditions. The major uses of the long – term cash forecast are: •

It indicates as company’s future financial needs, especially for its working capital requirement.

•

It helps to evaluate proposed capital projects. It pinpoints the cash required to finance these projects as well as the cash to be generated by the company to support them

•

It helps to improve corporate planning. Long – term cash forecasts compel each division to plan for future and to formulate projects carefully.

Long – term cash forecast may be made for two, three or five years. Long –term cash forecasting reflects the impact of growth, expansion or acquisitions. It also indicates problems arising from these developments. Control Aspects: After preparation of cash budget, the Financial Manager should also ensure that there are no significant difference between the expected cash flows and the actual cash flows. This requires controlling and reviewing of the whole exercise on a regular basis.

63

Management of Payables/Creditors Creditors are a vital part of effective cash management and should be managed carefully to enhance the cash position. Purchasing initiates cash outflows and an over-zealous purchasing function can create liquidity problems. Consider the following: •

Who authorizes purchasing in our company-is it tightly managed or spread among a number of people?

•

Are purchase quantities geared to demand forecasts?

•

Do we use order quantities which take account of stock-holding and purchasing costs?

•

Do we know the cost to the company of carrying stock?

•

Do we have alternative source of supply?

•

How many of ours suppliers have a returns policy?

•

Are we in a position to pass on cost increases quickly through price increase?

•

If a supplier of good or service lets you down can you charge back the cost of delay?

•

Can we arrange delivery of supplies staggered or on a just-in-time basis?

Trade credit: Trade credit refers to that credit that a customer gets from suppliers of goods in the normal course of business. This deferral of payments is a short –term financing called trade credit. It is a major source of financing for firms. It is mostly an informal arrangement and is granted on an open account basis. open account trade credit appears as sundry creditors on the buyer’s balance sheet. Credit terms: Credit terms refer to the conditions under which the supplier sells on credit to the buyer and the buyer is required to repay the credit. These conditions include the due date and the cash discount given for prompt payments. Due date is the date by which the supplier expects payments. Cash discount is the concession offered to the buyer by the supplier to encourage him to make prompt payments. Benefits and costs of Trade Credit: Trade credit is normally available to a firm. As the volume of the firm’s purchase increases, trade credit also expands. The major advantages of trade credits are as follows: Easy availability: unlike other sources of finance, trade credit is relatively easy to obtain. Except in the case of financially very unsound firms, it is almost automatic and does not require any negotiations.

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Flexibility: Trade credit grows with the growth in firm’s sales. The expansions in the firm’s sales cause its purchase of goods and services to increase which is automatically financed by trade credit. Informality: it does not require any negotiations and formal aggrement.it does not have the restrictions which are usually parts of negotiated sources of finance.Trade credit involves implicit cost. The cost of credit may be transferred to the buyer via the increased price of goods supplied to him. The user of trade credit should be aware of the costs of trade credit to make use of it intelligently. Most of the time the supplier passes on all or part of costs to the buyer implicitly in the form of higher purchase price of goods and services supplied. Credit terms sometimes include cash discount if the payment is made within a specified period. The buyer should take a decision whether or not to avail it. If the buyer takes discount, he benefits in terms of less cash outflow, but then he foregoes the credit granted by the supplier beyond the discount period. In case of stretching accounts payable the firm has to forgo the cash discount and may also be required to pay penalty interest charges.

Monitoring credit control The ratio to watch here is the average number of day’s credit you take from your suppliers. Take too little and you may be paying extra costs like bank overdraft interest and charges unnecessarily. Take too much and you risk your suppliers demanding cash on delivery or worse cash with order. Try to keep the figure same each year or cautiously increase it.

\

65

Ratios associated with Working Capital Management Activity or Turnover ratio Ratio S.N. 1

2007-08 Inventory

2006-07

2005-06

2004-05

turnover 7.02 Times 5.75 Times 5.03 Times

7.41 Times

ratio 2

3

Debtor turnover ratio

12.26

12.17

Times

Times

Times

5.00 Times 3.50 Times

3.44 Times

collection 30Days

30Days

39Days

30Days

payment 61Days

72Days

103Days

104Days

Creditor turnover ratio 5.85

9.13 Times

12.09

Times 4

Average period

5

Average period

6

Working

capital 4.83 Times 4.88 Times 2.75 Times

4.86 Times

Current asset turnover 2.45 Times 2.35 Times 1.56 Times

2.13 Times

turnover ratio 8

ratio

Data used:

Rs in million

2007-08

2006-07

2005-06

2004-05

Opening stock

24649.04

22167.99

11805.03

8151.21

Closing stock

28066.89

26606.87

22167.99

10707.69

Average stock

27357.9

24387.43

16986.51

9429.45

Net sales

192010.27

183129.88

113964.76

95231.17

42998.15

28475.42

25373.96

140131.73

85489.34

69857.21

15045.02

12484.01

7873.67

Gross profit Or 33602.26 EBIT Cost of goods 158947.91 sold Sundry debtors

15650.22

66

Sundry

20386.63

22866.93

19745.3

14274.60

Net purchase

119384.06

114383..06

69134.06

49175.90

Working capital

40508.81

37508.2

41500.46

19582.32

Current asset

78516.69

77783.4

73027.74

44764.25

creditors

Formula used: Inventory turnover ratio

Net sales/ Avg. Inventory

Debtor turnover ratio

Net sales/ Sundry debtors

Creditor turnover ratio

Net purchase/Sundry creditors

Average collection period

360/ debtor turnover ratio

Average payment period

360/creditors turnover ratio

Working capital turnover ratio

Net sales / working capital

Current asset turnover ratio

Net sales/current asset

Current Ratio: The current ratio of the company is increasing in all the years, with the highest increase in the year 2005-2006. This is due to increase in the current assets of the company namely sundry debtors, cash & bank balance and the loans and the advances made by the company. Again in the current year it is increasing which is 2.06.

67

Liquid / Quick Ratio: Sundry debtors and loan and advances also affect the quick ratio of the company. The increase in these sundry debtors and the loans and advances may decrease the profitability of the company. Usually, a high acid test ratio quick ratio is an indication that the firm is liquid and has the ability to meet its current liabilities in time. As a rule of thumb is 1:1 is considered satisfactory. In FY 2004-05 the quick ratio is 0.83, so we can say that this is not completely satisfactory. It may not be able to meet its current liabilities on time. Whereas in the FY 2005-06 it is 1.02, which can be considered satisfactory and in the FY 2006-07 it is 0.86 as well as in 2007-08 it is 0.72 which again can be considered non satisfactory. It may not be able to meet its current liabilities on time, which is not good sign for the enterprises.

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Inventory turnover ratio: The inventory turnover ratio shows how rapidly the inventory is turning into receivables through sales. This ratio has been continuously increasing since FY 2005-06 compared to the 2004-05. A high inventory turnover indicates the efficient management of inventory because more frequently the stocks are sold. So we can say that enterprises have a very good turnover ratio. Thus Hindalco has a very good inventory management.

Debtors Turnover Ratio: The Debtors turnover ratio, which shows that the number of times the debtors are turned over during a year. But the debtor of the

69

company is reducing which shows that the company is not properly managing its debtors. There is no rule of thumb, which may be used as a norm to interpret the ratio, as it may be different from firm to firm depending upon the nature of the business.

Current Turnover Ratio: It is establish the relationship between net sales and current asset indicating how efficiently they have been used in achieving the sales. It measures the efficiency with which current asset employed. A high ratio indicates a high degree of efficiency in current asset utilisation and vice-versa. In the FY 2004-05, 2005-06, 2006-07, 2007-08 it is 2.13, 1.56, 2.35 & 2.45 respectively. So it seems that although in the FY 2005-06 it is not good, but it is good in the previous year and next year, i.e. In the 2004-05 and 2006-07 the ratio is very good and in the FY 2007-08 it is also increased. So it means that although in the firm has staggered a bit but still it again managed to regain and recovered. In the FY 200708 current assets is being utilised in much better way compared to the FY 2006-07.

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Working Capital Turnover Ratio: In the FY 2004-05, 2005-06, 2006-07, 2007-08 it is 4.86, 2.75, 4.88 and 4.83 respectively. So, it seems that although in the FY 2005-06 it was not good but in the year previous of 2005-06 and also after 200506 it is good, i.e. in the FY 2004-05, FY 2006-07, FY 2007-08 the ratio is very good. So it means that although in the mid the firm staggered a bit but still it again managed to regain and recovered.

Average Collection Period: it is the relationship between no. Of days in a year (360) and debtor turnover ratio Here in the FY 2004-05, FY 2005-06, FY 2006-07 and FY 2007-08 it is 30days, 39days, 30days and 30days. In the FY2005-06 it is increased but in the other FY it is same. This is again good sign for the enterprise.

71

Average payment period 120 100 Days

80 60 40 61

103

104

2005-06

2004-05

Average payment period

72

20 0 2007-08

2006-07

years

Average payment period: It is clear that that the average payment period is less in year 2007-08 as compared to earlier years. It is continuously decreasing .It shows that the company has sufficient liquidity for the payment.

Current Assets and Current Liabilities (Rs. In millions)

2007-08

2006-07

2005-06

2004-05

Current asset

78516.69

77783.40

73027.74

44764.25

Current liabilities

77783.40

40275.20

31527.28

25181.93

Current Asset 78516.69

77783.4

80000 70000 60000 50000 Value(Rs.in 40000 millions) 30000 20000 10000 0

73027.74

44764.25

Current Asset

2007-08 2006-07

2005-06 2004-05

72

It is clear that in the year 2007-08, the total investment in current assets is 7816.69 million and it is higher than years 2006-07, 05-06 and 04-05.

Current liabilities 77783.4 80000 70000 60000 50000 Value(Rs. in 40000 millions) 30000 20000 10000 0

40275.2

31527.28

25181.93 Current liabilities

2007-08 2006-07 2005-06 2004-05 Years

It is clear that Current Liabilities are increasing year by year. It means that the company is expending business year by year. In the year 2007-8 the total Current Liabilities is Rs.77783.4 million, which is much higher than any previous years. (Rs. In millions)

2007-08

2006-07

2005-06

2004-05

Current asset

78516.69

77783.40

73027.74

44764.25

Gross Working Capital

Current asset(Rs.in millions) 78516.69

77783.4 73027.74

80000 70000 60000 50000 Value 40000 30000 20000 10000 0

44764.25

Current asset(Rs.in millions)

2007-08

2006-07

2005-06 2004-05

Years

73

It is clear that Gross Working Capital has increased heavily as compared to year 2004-05.if we compare the Gross Working Capital of the years 2006-07 and 2007-08, there is slightly difference. It denotes the total working capital or total investment in current assets. Sufficient working capital helps the company to avoid stoppage of work and effects on profitability. The company can also get an idea about the required funds for maintaining current assets.

Net Working Capital (Rs. In millions)

2007-08

2006-07

2005-06

2004-05

Current asset

78516.69

77783.40

73027.74

44764.25

Current liabilities

77783.40

40275.20

31527.28

25181.93

37508.2

41500.46

19582.32

Net

Working 733.29

Capital (CA –CL)

Net Working Capital 45000 40000 35000 30000 25000 Values 20000 15000 10000 5000 0

41500.46

37508.2

19582.32

733.29

2007-08

2006-07

2005-06

2004-05

Years

It is clear from above that the situation of Net Working Capital is fluctuating from very high to very low. The year 2007-08 has lowest Net Working Capital as compared to earlier years. The Net Working Capital measures the liquidity of the firm. The greater the margin, the better will be the liquidity of the firm.

74

Debtors Management Rs in million

2007-08

2006-07

2005-06

2004-05

Sundry

15650.22

15045.02

12484.01

7873.67

debtors

15650.22

Sundry debtors 15045.02 12484.01

16000 14000 12000

7873.67

10000 Values 8000 Sundry debtors

6000 4000 2000 0 2007-08

2006-07

2005-06

2004-05

Years

It is clear that sundry debtors are increasing year by year. It means that the company is selling its product on credit. It will affect the liquidity of the company.

Inventory management Rs in million

2007-08

2006-07

2005-06

2004-05

Inventories

5,097.91

4,315.31

4,095.09

2,374.52

Inventories

6,000.00

5,097.91 4,315.31

4,095.09

5,000.00 4,000.00

2,374.52

Values 3,000.00 Inventories

2,000.00 1,000.00 0.00 2007-08

2006-07

2005-06

2004-05

Years

75

It is clear that the company is increasing investment in inventories year by year. It shows that the company is preparing itself for any kind of situation and maintain sufficient inventory for smooth production and sales operations.

Cash management Years

2007-08

2006-07

2005-06

2004-05

Cash and Bank 1469.77

6654.96

9172.85

4009.69

balances(in millions)

Cash and Bank balances 9172.85 10000 9000 8000 7000 6000 Value 5000 4000 3000 2000 1000 0

6654.96 Cash and Bank balances 4009.69 1469.77

2007-08

2006-07

2005-06

2004-05

Years

It is very clear that the cash and bank balance of the company is very low in year 2007-08 as compared to previous years. The highest cash and bank balance held by the company is in the year 2005-06.

Creditor’s management Years

2007-08

2006-07

2005-06

2004-05

Sundry

20386.63

22866.93

19745.3

14274.60

creditors

76

Sundry creditors

25000

20386.63

22866.93

19745.3

20000

14274.6

15000 Value Sundry creditors

10000 5000 0 2007-08

2006-07

2005-06

2004-05

Years

It is clear from the above that the company has low sundry creditors balance, Rs.0386.63 in year 2007-8 as compared to previous year 2006-7. The company has highest creditors balance in year 2007-08.

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Conclusion •

It can be observed that Current Ratio of Hindalco varied between 1.7776 to 2.0658 during the period from 2005-2002008-2007. It is evident that, on an average, per one rupee of current liabilit y, the company has been maintaining 2.0216 rupee of current assets as a cushion to meet the short- term liabilities. Usually, a Current Ratio of 2:1 is considered to be the standard to indicate sound liquidity position, and Hindalco has been successfully maintaining as a rule of thumb is 1:1 is considered satisfactory. In 2007-08 it is 0.72 which again can be considered non satisfactory. It may not be able to meet its current liabilities on time, which is not good sign for the enterprises.

•

The inventory turnover ratio shows how rapidly the inventory is turning into receivables through sales. This ratio has been continuously increasing since FY 2005-06 compared to the 2004-05. A high inventory turnover indicates the efficient management of inventory because more frequently the stocks are sold. So we can say that enterprises have a very good turnover ratio. Thus Hindalco has a very good inventory management.

•

Working Capital Turnover Ratio indicates the efficiency of the firm in utilizing the working capital in the business. It varies between 2.74 times and 4.89 times. This ratio signifies that on an average, a rupee of working capital generate Rs. 4.3107 worth of business/sales of the firm, which is excellent for the management of the firm.

•

The Debtors Turnover Ratio was highest (12.2688 times) in 2007-2008 and lowest (9.1288 times) in 2006-2005 and average is 11.416 times. Debtors and Receivables management appears to be excellent. More the number of times debtors' turnover, better the liquidity position of the firm. The combined effect of better management of inventory and debtors & receivables has enabled the firm to generate reported business of the firm.

•

Average Collection Period is the relationship between no. Of days in a year and debtor turnover ratio. Here in the FY 2004-05, FY 2005-06, FY 2006-07 and FY 2007-08 it is 30days, 39days, 30days and 30days. In the FY2005-06 it is increased but in the other FY it is same. This is again good sign for the enterprise.

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•

The current assets and liabilities are increasing year by year. It means the company is investing in current assets and expending its business.

•

Gross Working Capital has increased heavily as compared to year 2004-05.if we compare the Gross Working Capital of the years 2006-07 and 2007-08, there is slightly difference. It denotes the total working capital or total investment in current assets.

•

Net Working Capital is fluctuating from very high to very low. The year 200708 has lowest Net Working Capital as compared to earlier years. The Net Working Capital measures the liquidity of the firm.

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Suggestions •

The year 2007-08 has lowest Net Working Capital as compared to earlier years. The company must increase its NWC. The greater the margin, the better will be the liquidity of the firm.

•

The company should maintain the low level of creditors because the company can pay them easily whenever required.

•

The company has 2 nd highest market capitalization after NALCO. The company should try to increase productivity and produce products at lower rate.

•

The company should maintain a proper inventory management system, so the unnecessary blockage of money can be avoided.

•

The company must have adequate cash and bank balance to face any situations. The company has low cash and bank balance in the year 2007 -08.

Limitations 

Time is definitely the main Constraint. Time was not sufficient enough to assess all processes and policies of an organization of the stature of HINDALCO INDUSTRIES LTD.



Inadequacy of data is another problem.

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Bibliography Books:

•

Payday I.M.,”Financial Management,”7th edition; New Delhi: Vikas Publishing House Pvt. Ltd; 1995.

•

Rustagi R.P.,”Fundamentals of Financial Management,”3rd edition; New Delhi: Galgotia Publishing Company; 2002.

Annual Reports: Annual Report of F Y 2005 -06, 2006 -07 and 2007 -08 of Hindalco Industries Ltd. Internet Source: •

www.hindalco.com

•

www.workingcapital.com

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Annexure Profit & Loss Account Rs. In million Income Gross sales Less: excise duty Net sales and operating revenue Other income Expenditure (increase)/decrease in stock Raw material consumed & goods purchased Payments to and provision for employees Other operating expenses Interest and finance charge Depreciation & impairment

FY 08

FY 07

FY 06

FY 05

210219 18209 192010

199201 16071 183130

124764 10799 113965

104803 9572 95231

4929 196940

3700 186830

2439 116404

2701 97932

-1370

-4425

-10338

-2556

159370

110783

66033

46394

6212

5196

4628

4116

143788

31426

27591

24512

2806

2424

2252

1700

5878

6380

5211

4633

151784 35046

95377 21027

78799 19133

35046 9841

-30 21027 3241

91 19133 5705

-551

1159

759

113 -

101 -

-716

25643

16556

13294

166684 Profit before 30256 extraordinary item & tax extraordinary item Profit before tax 30256 Provision for 6064 current tax Provision for 876 deferred tax FBT 114 Provision for deferred tax for earlier years written back Net profit 28609.39

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Balance Sheet Rs. In million Sources of fund

FY 08

FY 07

FY 06

FY 05

Share capital Reserve and surplus

1226 171737

1043 123137

986 95077

928 75738

Loan funds Secured loan Unsecured loan

62054 21232

64102 9584

28480 20554

29523 8477

13237

11258

12333

11297

270881

209124

157430

125963

126085 46368

112526 42459

104183 36355

87728 31693

78093 11198

70067 14764

67828 8329

56035 13230

89292 141080

84831 86753

76157 39713

69265 37021

50979 15650 1470 10418

43153 15045 6655 12930

40951 12484 9173 10420

23745 7874 4010 9136

78517

77783

73028

44765

27434 12841 40275 37508 32 209124

21996 9532 31528 41500 60 157430

16484 8698 25182 19583 94 125963

Shareholders fund

Deferred tax liability(net) Total Application of funds Fixed funds Gross block Less: depreciation & impairments Net block Capital work in progress

Investments Current asset, Loan & advances Inventories Sundry debtors Cash and bank balance Other Current asset, Loan & advances

Less: current liabilities and provision Current liabilities 28948 provisions 9060 38008 40509 Net current asset Misc expenditure Total 270881

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