Working Capital Management

1

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

BY

AMIT KUMAR SINGH

PG/14/012

Under the guidance of Submitted to Industrial Guide Academic Guide

Mr. VIMAL RAHEJA Mr. Shyam Lal Dev Panday

DY.MANAGER (Accounts Dept.) Sr.Lecturer

HINDALCO INDUSTRIES LTD. SCHOOL OF MANAGEMNT SCIENCES

SCHOOL OF MANAGEMENT SCIENCES, VARANASI

2

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:

3

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.

4

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

6

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.

7

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

8

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

9

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.

10

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 value-

added 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):

14

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

15

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

16

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

20

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

21

� 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.

22

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.

23

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 high-

grade 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

25

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

26

� 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

27

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

28

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.

29

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.

30

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 day-

to-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)

31

• 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.

32

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

33

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

34

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

Composition & Level of

CA

Composition &Level of

CL

Profitability, Risk&

Liquidity

Working Capital

Management

36

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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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.

W I P

Sales

Finished

Foods

Accounts Receivabl

e

Cash

Raw-

Material

38

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

amount from suppliers)

We increase our cash resources

Shift inventory(stocks)faster We free up cash

Move inventory(stocks) slower We consume more cash

40

TYPES OF WORKING CAPITAL

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

WORKING CAPITAL

BASIS OF CONCEPT

BASIS OF TIME

Gross

Working Capital

Permanent / Fixed WC

Temporary / Variable WC

Net

Working Capital

41

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.

42

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.

43

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

W C

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:

44

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.

45

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 following-

1. 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.

46

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.

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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

48

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.

49

• 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.

50

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.

51

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.

52

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

53

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.

54

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.

55

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

56

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.

57

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.

58

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.

59

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 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.

Cash collection

Deficit

Surplus

Borrow

Invest

Cash payments

Business operation

Information & control

60

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.

61

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

62

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.

63

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.

64

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.

65

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.

\

66

Ratios associated with Working Capital Management

Activity or Turnover ratio

Ratio

S.N. 2007-08 2006-07 2005-06 2004-05

1 Inventory turnover

ratio

7.02 Times 5.75 Times 5.03 Times 7.41 Times

2 Debtor turnover ratio 12.26

Times

12.17

Times

9.13 Times 12.09

Times

3 Creditor turnover ratio 5.85

Times

5.00 Times 3.50 Times 3.44 Times

4 Average collection

period

30Days 30Days 39Days 30Days

5 Average payment

period

61Days 72Days 103Days 104Days

6 Working capital

turnover ratio

4.83 Times 4.88 Times 2.75 Times 4.86 Times

8 Current asset turnover

ratio

2.45 Times 2.35 Times 1.56 Times 2.13 Times

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

Gross profit Or

EBIT

33602.26 42998.15 28475.42 25373.96

Cost of goods

sold

158947.91 140131.73 85489.34 69857.21

Sundry debtors 15650.22 15045.02 12484.01 7873.67

67

Sundry

creditors

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

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.

68

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.

69

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

70

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 2007-

08 current assets is being utilised in much better way compared to the FY 2006-07.

71

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 2005-

06 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.

72

Average payment period

6172

103 104

0

20

40

60

80

100

120

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

years

Da

ys

Average payment period

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

78516.69 77783.4 73027.74

44764.25

0

10000

20000

30000

40000

50000

60000

70000

80000

Value(Rs.in

millions)

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

Current Asset

Current Asset

73

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.

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.

Gross Working Capital

(Rs. In millions) 2007-08 2006-07 2005-06 2004-05

Current asset 78516.69 77783.40 73027.74 44764.25

77783.4

40275.231527.28

25181.93

0

10000

20000

30000

40000

50000

60000

70000

80000

Value(Rs. in

millions)

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

Years

Current liabilities

Current liabilities

78516.69 77783.4 73027.74

44764.25

0

10000

20000

30000

40000

50000

60000

70000

80000

Value

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

Years

Current asset(Rs.in millions)

Current asset(Rs.in

millions)

74

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

Net Working

Capital

(CA –CL)

733.29 37508.2 41500.46 19582.32

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.

733.29

37508.2 41500.46

19582.32

0

5000

10000

15000

20000

25000

30000

35000

40000

45000

Values

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

Years

Net Working Capital

75

Debtors Management

Rs in million 2007-08 2006-07 2005-06 2004-05

Sundry

debtors

15650.22 15045.02 12484.01 7873.67

15650.2215045.02

12484.01

7873.67

0

2000

4000

6000

8000

10000

12000

14000

16000

Values

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

Years

Sundry debtors

Sundry debtors

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

5,097.914,315.31

4,095.09

2,374.52

0.00

1,000.00

2,000.00

3,000.00

4,000.00

5,000.00

6,000.00

Values

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

Years

Inventories

Inventories

76

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

balances(in

millions)

1469.77 6654.96 9172.85 4009.69

1469.77

6654.96

9172.85

4009.69

0

1000

2000

3000

4000

5000

6000

7000

8000

9000

10000

Value

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

Years

Cash and Bank balances

Cash and Bank balances

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

creditors

20386.63 22866.93 19745.3 14274.60

77

20386.6322866.93

19745.3

14274.6

0

5000

10000

15000

20000

25000

Value

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

Years

Sundry creditors

Sundry creditors

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.

78

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 liability, 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.

79

• 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 2007-

08 has lowest Net Working Capital as compared to earlier years. The Net

Working Capital measures the liquidity of the firm.

80

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 2nd 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.

81

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

82

Annexure

Profit & Loss Account

Rs. In million FY 08 FY 07 FY 06 FY 05

Income

Gross sales 210219 199201 124764 104803

Less: excise duty 18209 16071 10799 9572

Net sales and operating revenue

192010 183130 113965 95231

Other income 4929 3700 2439 2701

196940 186830 116404 97932

Expenditure

(increase)/decrease in stock

-1370 -4425 -10338 -2556

Raw material consumed & goods purchased

159370 110783 66033 46394

Payments to and provision for employees

6212 5196 4628 4116

Other operating expenses

143788 31426 27591 24512

Interest and finance charge

2806 2424 2252 1700

Depreciation & impairment

5878 6380 5211 4633

166684 151784 95377 78799

Profit before

extraordinary

item & tax

30256 35046 21027 19133

extraordinary item - - -30 91

Profit before tax 30256 35046 21027 19133

Provision for current tax

6064 9841 3241 5705

Provision for deferred tax

876 -551 1159 759

FBT 114 113 101 -

Provision for deferred tax for earlier years written back

- - - -716

Net profit 28609.39 25643 16556 13294

83

Balance Sheet

Rs. In million FY 08 FY 07 FY 06 FY 05

Sources of fund Shareholders fund Share capital 1226 1043 986 928

Reserve and surplus 171737 123137 95077 75738

Loan funds

Secured loan 62054 64102 28480 29523

Unsecured loan 21232 9584 20554 8477

Deferred tax liability(net)

13237 11258 12333 11297

Total 270881 209124 157430 125963

Application of funds

Fixed funds

Gross block 126085 112526 104183 87728

Less: depreciation & impairments

46368 42459 36355 31693

Net block 78093 70067 67828 56035

Capital work in progress 11198 14764 8329 13230

89292 84831 76157 69265

Investments 141080 86753 39713 37021

Current asset, Loan &

advances

Inventories 50979 43153 40951 23745

Sundry debtors 15650 15045 12484 7874

Cash and bank balance 1470 6655 9173 4010

Other Current asset, Loan & advances

10418 12930 10420 9136

78517 77783 73028 44765

Less: current liabilities

and provision

Current liabilities 28948 27434 21996 16484

provisions 9060 12841 9532 8698

38008 40275 31528 25182

Net current asset 40509 37508 41500 19583

Misc expenditure - 32 60 94

Total 270881 209124 157430 125963

84