A STUDY ON THE

WORKING CAPITAL MANAGEMENT

OF

NATIONAL FERTILIZERS LIMITED

A Summer Project Proposal for

Masters in international business

By

Satya prakash

Under the guidance of

Shri. M.A. Khan Manager (F&A)Corporate OfficeNational Fertilizers Ltd.

Acknowledgement

1

The present report is an amalgamation of hard work and contribution of experience of eminent personalities. The project could not have been completed without the guidance of Mr. M. A. Khan who not only served as my supervisor and mentor but also encouraged me throughout my training program. He patiently guided me throughout and never accepting less than my best effort.

Here, I would like to express my greatest appreciation to all employees of National Fertilizers Limited for providing me their continued support and guidance in the completion of this project.

A STUDY ON THE WORKING CAPITAL MANAGEMENT OF NATIONAL FERTILIZERS

LIMITED

By

2

Satya prakash

We all know that working capital is the life-blood of all types of enterprises, manufacturing

and trading both. It is constantly required to buy raw materials for payment of wages and

other day-to-day expenses. Without adequate working capital, manufacturing operations will

be crippled. It is a base on which all the activities of business enterprise depend. The working

capital management refers to the management of working capital, or precisely to the

management of current assets. A firm’s working capital consists of its investments in current

assets, which includes short-term assets— cash and bank balance, inventories, receivable and

marketable securities. So the project was aimed at understanding the working capital

management of NFL.

The major objective of the study was to understand the working capital management of

National Fertilizers Limited and its impact on the operating performance of the company. We

also try to understand the liquidity position of the company and how stringent the company is

to face the short term liabilities in this competitive business environment. Different factors

were also identified which showed impact on the working capital of the company. The

impact of working capital on profitability was also analyzed during the study. In addition to

the above the effects of the ratios (Working Capital Ratio, Acid Test Ratio, Current Assets to

Total Assets Ratio, Current assets to Sales Ratio, Working Capital Turnover Ratio, Inventory

Turnover Ratio, Debtors Turnover Ratio and Cash Turnover Ratio) relating to working

capital management and profitability were also analyzed. In the end we also tried to the

working capital leverage for examining the sensitivity of ROE to changes in the level of

gross working capital of the company.

The major findings are:

1. The mission of the company is to be the market leader of the company, but on the other

hand it is trying to keep the debt equity ratio to a minimum. As a result the company is

losing out on opportunity to leverage the opportunity of high demand in the Indian

3

market and its current position of low debt to equity ratio to get loans for further

expansion in the market and sectors in India (mostly towards the southern states).

2. The second major finding was that the profitability of the company has a positive relation

with the accounts receivable of the company. This shows that in the Indian fertilizer

industry in which most of the customers are farmers, who are poor, will be happy to see

themselves get credit sales. This brings in more customers and higher sales.

3. Liquidity of the company is seen to be stable and good. It was also found that liquidity

also has a positive impact on the profitability of the company. The analysis shows us that

with increase in the liquidity of the company the profitability also gets a good lift. It has

to be noted that, high liquidity can also have a bad effect on the company. So the balance

has to be maintained.

4. It was also found that the ratios Working Capital Ratio, Acid Test Ratio, Current Assets

to Total Assets Ratio, Inventory Turnover Ratio, Debtors Turnover Ratio and Cash

Turnover Ratio contributed 70 percent of the variations in the profitability of the

company.

5. Net sales of the company have only 31.6 percent impact on the change of working

capital.

Methodology including collecting primary data from personnel from National Fertilizer

limited. This was done through one to one interview and observation. Secondary data was

also collected from the company library and annual reports for the last 20 years. Once the

data was collected tests like correlation and regression test using excel were conducted and

the data analyzed.

4

Table of Content

Page

ACKNOWLEDGEMENT 2

ABSTRACT 3

5

TABLE OF CONTENTS 5

LIST OF FIGURES 7

LIST OF TABLES 8

LIST OF ABBREVIATIONS 9

I. PROFILE OF NATIONAL FETRILIZERS LIMITED 11

I.1. INTRODUCTION TO NATIONAL FERTILIZERS LIMITED 11

I.2. CORPORATE MISSION 13

I.3. MARKETING AND SERVICES 13

I.4. HUMAN RESOURCE 14

I.5. INFORMATION TECHNOLOGY 14

I.6. FINANCE 15

I.7. SWOT ANALYSIS 15

I.8. AWARDS AND RECOGNITIONS 16

I.9. CORPORATE SOCIAL RESPONSIBILITIES 16

I.10. MAJOR PRODUCTS AND SERVICES OFFERED BY NFL 17

II. INTRODUCTION TO THE STUDY 18

II.1. BACKGROUND OF THE STUDY

18

II.2. PROBLEM STATEMENT

19

II.3. NEED AND IMPORTANCE OF THE STUDY

19

II.4. HYPOTHESIS

19

6

III. RESEARCH DESIGN 19

III.1. METHEDOLOGY

19

III.1.1. COLLECTION OF DATA 20

III.1.2. TOOLS EMPLOYED 20

IV. A THEORETICAL PERSPECTIVE OF WORKING CAPITAL

MANAGEMENT 20

IV.1. INTRODUCTION TO WORKING CAPITAL MANAGEMENT

20

IV.2. NEED OF WORKING CAPITAL

24

IV.3. CONCEPT OF WORKING CAPITAL

24

IV.4. CLASSIFICATION OF WORKING CAPITAL

26

IV.5. DETERMINANTS OF WORKING CAPITAL

28

V. PERFORMANCE ANALYSIS 31

V.1. FINANCIAL PERFORMANCE REVIEW

31

V.1.1. TURNOVER 31

V.1.2. CURRENT RATIO 31

V.1.3. QUICK/ACID TEST RATIO 32

V.1.4. DEBT EQITY RATIO 33

V.1.5. RETURN ON EQUITY 34

7

V.2. ASSETS AND LIABILITIES

35

V.3. CAPITAL EXPENDITURE

36

V.4. WORKING CAPITAL LEVEL ANALYSIS

36

V.4.1. WORKING CAPITAL LEVEL 36

V.4.2. WORKING CAPITAL TREND ANALYSIS 37

V.4.3. CURRENT ASSET 39

V.4.4. CURRENT LIABILITIES 40

V.4.5. CHANGES IN WORKING CAPITAL 41

V.4.6. OPERATING CYCLE 42

V.4.7. WORKING CAPITAL AND PROFITABILITY 45

V.4.8. WORKING CAPITAL AS A FUNCTION OF SALES 48

V.5. RECEIVABLES MANAGEMENT

49

V.6. INVENTORY MANAGEMENT

51

V.7. CASH MANAGEMENT

54

V.8. WORKING CAPITAL FINANCE AND ESTIMATION

59

VI. SUMMARY 62

VI.1. FINDINGS

62

VI.2. RECOMMENDATIONS

63

VI.3. REFERENCES

64

8

List of Figures

Figure No. Description Page

5.1 Performance Review – Turnover 31

5.2 Liquidity Ratio – Current Ratio 32

5.3 Liquidity Ratio – Quick/Acid Test Ratio 33

5.4 Leverage Ratio – Debt Equity Ratio 34

5.5 Performance Review – Return on Equity 34

5.6 Working Capital Index 38

5.7 Current Asset Index 39

5.8 Current Liabilities Index 40

9

5.9 Receivable Index 50

5.10 Inventory Index 53

5.11 Cash Index 57

10

List of Tables

Table

No. Description Page

5.1 Capital Expenditure of NFL 36

5.2 Size of Working Capital 37

5.3 Working Capital Variance Analysis 38

5.4 Variance Analysis of Current Assets 39

5.5 Variance Analysis of Current Liabilities 40

5.6 Changes in Working Capital 42

5.7 Operating Cycle 45

5.8 Correlation Analysis between Ratios relating to WC management and ROE 46

5.9 Correlation Matrix of Ratios relating to WC management and ROE 47

5.10 Multiple Regression Analysis of Ratios relating to WC management and ROE 48

5.11 Multiple Regression Analysis of Working Capital as a function of Net Sales 48

5.12 Size of Receivables 49

5.13 Size of Subsidy 50

5.14 Average Collection Period 51

5.15 Size of Inventory 52

5.16 Inventory Holding Period 53

5.17 Size of Cash 57

5.18 Cash Cycle 59

5.19 Cash Credit 61

11

Abbreviations

ADSL Asymmetric Digital Subscriber Line

APO Accounts Payable Outstanding

ARO Accounts Receivable Outstanding

ATR Acid Test Ratio

B2B Business to Business

CCC Cash Conversion Cycle

CII Confederation of Indian Industry

CMO Chief Marketing Officer

CPP Creditors Payment Period

CTR Cash Turnover Ratio

CTSR Current Assets to Sales Ratio

CTTR Current Assets to Total Assets Ratio

D/E Debt to Equity

DIH Days of Inventory Holding

DoF Department of Fertilizers

DSLAM Digital Subscriber Line Access Multiplexer

DTR Debtors Turnover Ratio

12

ERP Enterprise Resource Planning

FGCP Finished Goods Conversion Period

FMS Fertilizers Monitoring System

FO Fuel Oil

HRD Human Resource Development

IOD Inventory in Days

ISO International Organization for Standardization

IT Information Technology

ITR Inventory Turnover Ratio

JVC Joint Venture Company

KRIBHCO Krishak Bharati Cooperative Limited

LAN Local Area Network

LSHS Low Sulphur Heavy Stock

MoU Memorandum of Understanding

MPLS Multiprotocol Label Switching

NFL National Fertilizers Limited

NG Natural Gas

OSHAS Occupational Health and Safety Advisory Services

PBT Profit Before Tax

PSU Public Sector Undertaking

RCF Rashtriya Chemicals and Fertilizers Ltd.

RCP Receivables Conversion Period

R-LNG Re-liquefied natural Gas

RMCP Raw Material Conversion Period

ROE Return on Equity

UVL Uravarak Videsh Limited

WC Working Capital

WCC Working Capital Cycle

WCDL Working Capital Demand Loan

WCM Working Capital Management

WCR Working Capital Ratio

13

WIPCP Work–In-Process Conversion Period

WTR Working Capital Turnover Ratio

14

I. PROFILE OF NATIONAL FETRILIZERS LIMITED

I.1. INTRODUCTION TO NATIONAL FERTILIZERS LIMITED

National Fertilizers Limited is the second largest producer of Nitrogenous Fertilizers in the

Country with 15.8% share in domestic production of Urea achieved in the country during

2009-10. NFL has been upgraded as a schedule A company because of its constant good

performance.

It was incorporated on 23rd August 1974 with an authorized capital of Rs. 500 Crores and a

capacity of 10.36 lakhs MT Nitrogen at its two manufacturing units at Bathinda and Panipat.

Subsequently, on the reorganization of Fertilizer group of Companies in 1978, the Nangal

Unit of Fertilizer Corporation of India came under the NFL fold. The Company expanded its

installed capacity in 1988 by installing and commissioning of its Vijaipur gas based Plant in

Madhya Pradesh.

The Vijaipur Plant was a landmark achievement in project management in India. The plant

was completed well within time and approved project cost. In recognition of this

achievement, the project was awarded the First Prize on Excellence in Project Management

15

by Govt. of India. Subsequently the Vijaipur plant doubled its capacity to 14.52 lakh MTs

by commissioning Vijaipur Expansion Unit i.e. Vijaipur-II in 1997. The annual capacity was

subsequently re-rated w.e.f. 1.4.2000 from 7.26 lakh MT of urea to 8.64 lakh MT for

Vijaipur-I & Vijaipur-II Plants each.

Three of the Units are strategically located in the high consumption areas of Punjab and

Haryana. The Company has an installed capacity of 32.31 lakh MT of Urea. The company

produced 33.30 lakh tonnes of Urea and recorded an annual sales turnover of Rs.5091 crores

during 2009-10.

NFL, a profitable public sector undertaking operates under the administrative control of

Department of Fertilizers in the Ministry of Chemicals & Fertilizers. The Company is

consistently making profits and registered a profit (PBT) of Rs.260 crores for the year 2009-

10.The Company’s strength lies in its sizeable presence, skilled manpower, Marketing and

strong distribution network nationwide.

Aiming towards further growth, NFL is already in the process of revamping its three fuel oil

based plants for change over its feedstock from FO/LSHS to NG/R-LNG and Capacity

Augmentation of Urea at Vijaipur Unit. Towards reduction of Green House Gases,

Company has already initiated action for various CDM (Clean development Mechanism)

Projects so as to earn revenue in terms of carbon credits.

NFL in collaboration with M/s KRIBHCO and RCF has formed a joint venture company

(JVC) named as Uravarak Videsh Limited (UVL) to explore investment opportunities

abroad and within the country in Nitrogenous, Phosphatic and Potassic sectors and to render

consultancy services for setting up Projects in India and abroad. A brown field gas based

Urea plant at Barauni in Bihar has been entrusted to the above Joint venture Company.

Kisan Urea NFL’s popular brand is sold over a large marketing territory spanning the length

and breadth of the country. The Company also manufactures and markets Bio-fertilizers and

a wide range of industrial products which include Methanol, Sodium Nitrate, Sodium

16

Nitrite, Nitric Acid, Sulphur, Liquid Oxygen, Liquid CO2, Liquid Nitrogen etc. The

Company has also developed Neem coated Urea which on demonstration has shown

improved results in terms of increase in yield by 4-5% and environment friendly.

Accordingly Company has been manufacturing and selling Neem Coated Urea from its

manufacturing plants since 2002-03. The Company is further focusing its thrust to widen the

marketing operations of Neem coated Urea. The company has also taken initiative to make

available other agro inputs under single window like quality seeds, Insecticides and Bio-

pesticides by collaboration with other reputed organizations. R&D trials are under way for

testing the efficacy of Bio-pesticides, elemental Sulphur, in collaboration with Agriculture

Institutes.

NFL is known in the industry for its work culture, value added human resources, Quality

Management, Safety, Environment, Concern for Ecology and its

commitment to social upliftment and to ensure their compliance, All NFL plants are

certified and being maintained under ISO-9001 (2000), ISO-14001 and OSHAS-18001 by

conforming to International Quality, Environmental and Occupational Safety and Hazards

standards. With the certification of Corporate Office/Marketing operations under ISO-9001:

2000, NFL has become the first Fertilizer Company in the country to have its total business

covered under ISO-9001 Certification.

Urea is an essential commodity under the Essential Commodities Act, 1955. The

Department of Fertilizers (DoF) plans and monitors production, import and distribution of

fertilizers and manage the subsidy for indigenous and imported fertilizers in the country. In

this regard, DoF has set up an on line web based Fertilizers Monitoring System (FMS).

Presently Fertilizer companies are allowed to market 50% of their total Urea produce outside

EC allocation.

The Department of Public Enterprises, Government of India in order to improve

accountability and giving higher autonomy to Public Sector Undertakings (PSUs),

introduced the concept of MoU from early nineties NFL enters into a Memorandum of

Understanding (MoU) with the Government for each year under which the Government

17

undertakes to assist NFL with regard to availability of inputs, obtaining ECA allocations

commensurate with the availability of fertilizers from NFL plants etc. NFL on its part

undertakes to adhere to its production and movement plans, achieve its ECA allocation and

provide regular feedback to the Administrative department. NFL signed first MoU with

Department of Fertilizers (DoF) for the year 1991-92. The company has been awarded

Excellent rating for the fiscal year 2008-09, which is 9th excellent rating in a row.

I.2. CORPORATE MISSION

NFL’s mission is to be the market leader in fertilizers and a significant player in all its other

business, reputed for customer satisfaction, reasonable reward to shareholders, ethics,

professionalism and concern for ecology and the community.

I.3. MARKETING AND SERVICES

The complete farmer satisfaction through best services is the drawing force of NFL’s

marketing, strategy. The Company has expanded its program from improving the crop

productivity at farm level to the overall development of the farming community. To provide

the farmers high quality products in the right time, NFL has an extensive and integrated

marketing network.

Marketing department is also responsible in the distribution of the fertilizer across India.

The fertilizers produced at the plants are first sent to the three zonal marketing offices –

Bhopal, Chandigarh and Lucknow. From the zonal offices, the required amounts are

transferred to the area offices across India. At these area offices it is stored at warehouses

and then distributed to the wholesale dealers, who sell it ahead to the retailers and then the

farmers. The marketing department gives a credit sale up to 30 days, after which interest is

lewd on the amount. The credit is given to wholesalers based on dealer deposit, bank

guarantee or advances. Discount is given to customers who pay back within 30 days.

18

The Company provides a comprehensive capsule of various fertilizer promotion activities,

which includes agronomical programs, use of extension media, publicity and farmer

development programs. Soil testing services are provided free of cost to the farmers to

advocate the balanced use of fertilizers at economic levels. One mobile soil-testing unit

caters to the need of the remotest of remote farmers in far areas and provides technical

guidance to the farmer at field level. Other farm services include fertilizer demonstration on

cultivators’ fields, field days, fertilizer/farmers mela, pilot project, adoption of villages etc.

NFL also conducts various training programs to educate the farmers on the balanced use of

fertilizer and its timely application besides providing guidance on pesticides and fungicides.

I.4. HUMAN RESOURCE

The Corner stone of NFL's meritorious track record is its human resource. At NFL, they

firmly believe that employees are the most valued resources. NFL has always been a

forerunner in the fertilizer sector and this has been made possible through the company's trust

on human resources development.

The Company's concern for its employees is reflected through its efforts in the area of health,

safety and welfare of its employees. NFL not only meets the statutory obligations, but has

undertaken numerous voluntary measures beyond the statutory requirements. The Company

has well equipped hospitals, canteens recreation clubs, housing facilities, schools and safe

working environment. The onus of NFL's high production levels, lay on harmonious and

cordial industrial relations at all its manufacturing Units. The Company has not lost even a

single man day on this account.

To cater to the needs of training and development, NFL has a well defined and well designed

training plan. Major activities undertaken by HRD are the recruitment and training of

Trainees at various levels viz. officers, supervisors and workers, organizing of developmental

and functional programs based on training needs, as judged in the area of updating of

technical, supervisory and managerial skills along with specialized requirements from time to

time. Imparting of training to people from other organizations within India and abroad also

forms as a part of training. HRD also works to formulate policies regarding manpower

19

deployment on hire to other organizations within India and abroad. The services which have

been developed in the area of Training and Development within the organization are readily

available to other organizations within the laid policies and procedures of the Company.

I.5. INFORMATION TECHNOLOGY

The company is using information technology in all of its business functions and now

looking at integration of these functions through the implementation of Enterprise Resource

Planning (ERP). On the IT Infrastructure front, the company has replaced its Leased Line

based wide area network by setting up MPLS-Virtual Private Network, which is providing a

secured and scalable connectivity amongst corporate office, units and marketing offices. The

marketing mobile staff has been provided with high-speed data cards. DSLAMs/ADSL

Routers have been provided at the units for LAN connectivity to remote locations through

internal exchanges.

I.6. FINANCE

Finance department in NFL has different sections. One of the three main sections is the cash.

This is where daily cash flow is managed. All payment are received and disbursed. All

decisions regarding managing cash in the company is done in this section. The major part of

their work is to distribute funds to the four units daily. They also take care of the payments to

IOC, GAIL, Railways etc. They also manage the flow of cash. They have to make sure that

20

company has enough cash to manage their daily and upcoming financial requirements. The

next section is the budget section. As the name suggests they make the budgeting plans for

the finance department. They also take care of the subsidy. They have to make sure that the

subsidy bill is properly prepared and sent to FICC. The third most important section is the

central finance; this is the accounting section of the company which takes care of the

documentation and keeps tracks of the transactions that happen in the company. They are

also in charge of creating balance sheet and profit and loss statements and the release of

annual report yearly.

I.7. SWOT ANALYSIS

STRENGTH

The company’s strength lies in its brand loyal customers, its harmonious commitments on

human resources, its efficient operations, internal relations, goodwill it has generated over

the years through good work culture and fulfilling its social commitments. The strengths that

drive its achievements are:

Excellent track record and high profits

An early starter in Fertilizer industry with 36 years of experience

Highly motivated and dedicated workers

Plants are located amidst high fertilizer consumption areas in the state of Punjab, Haryana

and Madhya Pradesh.

A well developed and efficient marketing/distribution network

WEAKNESS

Control of major decision making is held by government officials

Company doesn’t take necessary measures to advertise its products

Lot of policies, which restricts the decision making facility of managers

No planned structure to achieve the mission of market leader in the company

OPPORTUNITIES

Setting up of joint ventures/mergers in India and abroad

21

Good demand for neem-coated Urea

Scope for the growth of Bio-fertilizers

Leveraging the location advantage of its production plants

Changeover of feedstock from FO/LSHS to NG/RLNG will reduce the cost of production

and help in being more competitive in the market.

Increase in the demand for Industrial products.

THREATS

Price rise of feed stocks FO/LSHS, NG/RLNG and Coal.

Slow growth in UREA consumption

Government policies

Reduction in average under food production because of depletion in water levels.

Scantly rains because of monsoon failure affects urea demand.

I.8. AWARDS AND RECOGNITIONS

Company excelled in performance in various areas, which got recognition from various

quarters during the year.NFL plants have won several prestigious awards in the field of

safety, productivity, energy, innovation, conservation and environment. NFL received the

“Excellent” MoU rating for the ninth time for the year 2008-09. Vijaipur unit received

“Green Tech Safety Award 2009” in fertilizer sector from Green Tech Foundation, New

Delhi, for best safety practices. It also received second award for bio-fertilizers in

manufacturing sector for the year 2006-07 from National Productivity Council, New Delhi.

Vijaipur and Panipat unit also received National Safety Awards.

The Vijaipur unit of NFL also received the “National Productivity Award for Bio-Fertilizers”

for the year 2002-03. It also bagged the “Silver Award for outstanding achievement in

Environment Management” by M/s Green tech Foundation, Hyderabad in the year 2004-05.

In addition Vijaipur unit was also able to get “National Energy Conservation Award” from

Ministry of Power, “Prashansha Patra” from National Safety Council of India and “National

Energy Management Award” from CII in the year 2005. The Panipat unit was awarded with

22

the “Golden Peacock Innovation Award” from IOD, N. Delhi in the year 2005. The Bathinda

unit was also awarded the “Suraksha Puruskar for adopting Occupational Safety and Health

Management Systems” from NSC in the year 2004.

I.9. CORPORATE SOCIAL RESPONSIBILITIES

NFL is committed towards improving the crop productivity and living standard of socio-

economically weaker sections of the society. Keeping with this strong commitment to rural

development, NFL continue to facilitate the farming community in improving the crop

productivity by educating farmers about the efficient use of fertilizers. In furtherance to this

cause, during the year 2009-10, 424 field demonstrations and 161 R&D trials were

undertaken on different crops in different areas. Around 60,000 soil samples were collected

and tested for nutrient deficiency and analysis report provided to the farmers. Mass

awareness campaign was undertaken through intensive farmers’ training to apply inputs

including micronutrients as per soil test recommendations.

Krishi melas, exhibitions, crop seminars, farmers’ and dealers training programmes and study

tours were organized to disseminate information regarding improving farm technology and

establish direct comunnication with the farmers and also to educate farmers of the balance

useof fertilizers and its timely application besides providing guidance on pesticides and

fungicides. A large number of crop literature in the form of folders, leaflets, pamphlets in

local languages were distributed during these programmes. Krishi diary, an annual

publication for farmers and kisan Sandesh, a season-wise crop advisory newsletter was

adressed to the farmers. A number of health camps for women and children, animal health

camps, vocational training programmes were organized.Water tank, water coolers, solar

lights, tricycles, school furniture, books etc. were also distributed.

Vijaipur, Panipat, Bathinda and Nangal Units carried out various activities for the benefit of

socially and economically weaker sections of the society in their peripheral areas. Health

awareness programmes, medical camps were also organized. Finaincial aid, blankets, sewing

machines etc. were provided to the poor and needy persons of the nearby villages.

23

Scholarship to meritorious students belonging to SC/ST categories, stationery items,

sweaters, furnitur items etc. were also distributed to school children. Community workin the

surrounding villages such as construction of boundary walls, flooring work and other civil

works at nearby schools were also carried out to provide better environment for the students.

1.10.MAJOR PRODUCTS AND SERVICES OFFERED BY NFL

Urea

o Kisan Urea

o Neem Coated Urea

Bio-Fertilizer

o Nitrogen Bio-Fertilizer

o Azetobactor

o Rhizobium

o Phosphorous Bio-Fertilizer

Industrial Products

o Methanol

o Nitric Acid Dilute

o Ammonium Nitrate

o Sulphur

o Industrial Grade Urea

o Liquid Oxygen

o Liquid Nitrogen

o Carbon Slurry

o Carbon dioxide Gas

o Anhydrous Ammonia

o Sodium Nitrate

o Liquid Argon

o Liquid CO2

o Off Grade Methanol

24

Specialized Service

o Commissioning Activities of Plant/Equipments

o Heavy Equipment Erection supervision

o Complete operation of Chemical plants on a continuous basis

o Overall maintenance of plants

o Special maintenance & repair services for rotatory equipment, like

pumps, compressors, turbines etc.

o Energy Audits leading to energy savings

o Safety Audit Services

o Design and monitoring of Environment Protection Systems

o NDT, Corrosion and RLA services

o Laboratory Services

o Training of technical manpower in Operation Maintenance and Safety

Management

o Consultancy in Project Management

II. INTRODUCTION TO THE STUDY

II.1. BACKGROUND OF THE STUDY

The Major Objective of this study is to understand the working capital management of

National Fertilizers Limited and to suggest necessary measures to overcome the shortfalls if

any in the industry

The project “Working Capital Management of National Fertilizers Limited” describes about

how the company manages its working capital and the various steps that are required in the

management of working capital. Cash is the lifeline of a company. If this lifeline deteriorates,

so does the company's ability to fund operations, reinvest and meet capital requirements and

payments. Understanding a company's cash flow health is essential in making investment

25

decisions. A good way to judge a company's cash flow prospects is to look at its Working

Capital Management (WCM).

Working capital refers to the cash of a business requires for day-to-day operations or, more

specifically, for financing the conversion of raw materials into finished goods, which the

company sells for payments. Other important items of working capital are levels of

inventory, accounts receivables and accounts payables. Analysts look at these items for signs

of a company's efficiency and financial strength. Since working capital is an important

yardstick to measure the company’s operational and financial efficiency the company should

have a right amount of cash and lines of credit for its business needs at all times.

There are numerous instances in the history of business world where inadequacy of working

capital i.e. when a firm finds it difficult to meet day to day affairs, has led to business

failures. Operating expenses may have to be postponed, operating plans will go out of gear

and enterprise objectives on investment slumps the suppliers and creditors of the firm may

have to wait longer to raise their dues and will hesitate to extend further credit to the firm.

Thus efficient management of working capital is an important prerequisite for successful

working of the business. It reduces the chances of business failures, and generates a feeling

of security and confidence in the minds of stakeholders. This assures steadiness in the

organization.

II.2. PROBLEM STATEMENT

To understand the working capital management in National Fertilizers Ltd.

To analyze the liquidity position of NFL.

To study the different factors that affects the working capital of the company.

To assess the impact of working capital on profitability

To examine the combine effect of the ratios relating to working capital management and

profitability with the assistance of multiple correlation coefficient and multiple

26

correlation coefficient and multiple regression equation and to test the significance of the

regression coefficients.

To determine the working capital leverage for examining the sensitivity of ROE to

changes in the level of gross working capital of the company

II.3. NEED AND IMPORTANCE OF THE STUDY

This project is helpful in knowing the company’s position of funds maintenance and

setting the standards for working capital inventory levels, current ratio level, quick ratio,

current asset turnover level and size of current liability etc.

This project is also useful as it combines the present year data with the previous year data

and thereby it shows the trend analysis, i.e. increasing or decreasing funds.

The project is done as a whole and will give an overall view of the organization and it is

usefulness in further expansion decision to be taken by management.

II.4. HYPOTHESIS

H1: There is a significant impact of working capital on the profitability of the company

H2: There is a significant impact that is created by the ratios (Working Capital Ratio, Acid

Test Ratio, Current Assets to Total Assets Ratio, Current assets to Sales Ratio, Working

Capital Turnover Ratio, Inventory Turnover Ratio, Debtors Turnover Ratio and Cash

Turnover Ratio) relating to working capital management and profitability on the company.

H3: There is a significant sensitivity of ROE to changes in the level of gross working capital

of the company.

III. RESEARCH DESIGN

III.1. METHEDOLOGY

Methodology may be a description of process, or may be expanded to include a

philosophically coherent collection of theories, concepts or ideas as they relate to a particular

27

discipline or field of inquiry. This project requires a detailed understanding of the concept –

Working Capital Management. Therefore, firstly we need to have a clear idea of, what is

working capital, how it is managed in National Fertilizers Limited, what are the different

ways in which the financing of working capital is done in the organization etc. In order to

understand further data was collected from departments – Finance and Accounting and

Marketing department at corporate office.

III.1.1. COLLECTION OF DATA

There are two ways of collecting data – Primary data and secondary data.

Primary Data

The first handed information collected through various methods is known as primary data.

The primary data was gathered through personal interaction with various functional and

technical personnel of NFL. Some information was also collected by observation.

Secondary Data

Secondary data is data collected by someone other than the user. Common sources of

secondary data for social science include censuses, surveys, organizational records and data

collected through qualitative methodologies or qualitative research. Secondary data was

collected from various reports, annual reports, documents charts, internet etc.

The analysis of the information gathered has been made on the basis of the clarifications

sought during the personal discussions with the concerned people and perception during the

personal visits to the important areas of services. In marking observations identifying

problems and suggesting certain remedies such emphasis was given on the basis of opinions

gathered during the personal discussions and with the personal experience gained during the

academic study of M.B.A course.

III.1.2. TOOLS EMPLOYED

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Tools employed in the study are Microsoft Excel and Microsoft Word.

IV. A THEORETICAL PERSPECTIVE OF WORKING CAPITAL MANAGEMENT

IV.1. INTRODUCTION TO WORKING CAPITAL MANAGEMENT

“Working capital occupies a peculiar position in the capital structure of a company. The

decision as to the adequacy of working capital is a complicated and yet a very important

decision”.

Working capital is the life-line of all types of enterprises, manufacturing and trading both. It

is constantly required to buy raw materials, for payment of wages and other day-to-day

expenses. Without adequate working capital, manufacturing operations will be crippled. For

trading enterprises, the capacity to stock a variety of goods for sale depends upon its working

capital. It is a base on which all the activities of business enterprise depend.

Many companies still under estimate the importance of working capital management. They

consider it as a lever for freeing up cash from inventory, accounts receivable and accounts

payable. By effectively managing these components, companies can sharply reduce their

dependence on outside funding and can use the released cash for further investments or

acquisitions. This will not only lead to more financial flexibility, but also create value and

have a strong impact on a company’s enterprise value by reducing capital employed and thus

increasing asset productivity.

High working capital ratios often mean that too much money is tied up in receivables and

inventories. Typically, the knee-jerk reaction to this problem is to apply the “big squeeze” by

aggressively collecting receivables, ruthlessly delaying payments to suppliers and cutting

inventories across the board. But that only attacks the symptoms of working capital issues,

not the root causes. A more effective approach is to fundamentally rethink and streamline

key processes across the value chain. This will not only free up cash but lead to significant

cost reductions at the same time.

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Only those enterprises which have adequate working capital can survive in times of

depression. The investment in raw materials becomes long- term investments during

depression and cash flow declines due to fall in sale. In such circumstances only enterprises

with adequate working capital can survive.

Excessive working capital is equally unprofitable. The extra working capital is not utilized in

business operations and earns no profit for the firm. It results in unnecessary accumulation of

inventories, leading to inventory mishandling, waste, theft etc. The abundance of working

capital would lead to waste and inefficiency.

Shortage of working capital funds renders the firm unable to avail attractive credit

opportunities etc. The firm loses its reputation when it is not in a position to honor its short

term obligations. As a result, the firm faces tight credit terms. It stagnates growth.

Definitions

According to Guttmann & Dougall

“Working capital is defined as current assets minus current liabilities”. A positive position

means that a company is able to support its day-to-day operations. i.e. to serve both maturing

short-term debt and upcoming operational expenses.

According to Park & Gladson

“The excess of current assets of a business (i.e. cash, accounts receivables, inventories) over

current items owned to employees and others (such as salaries & wages payable, accounts

payable, taxes owned to government)”

Working capital like many other accounting terms and financial terms has been used by

different people in different senses.

One school of thought believes that, as all capital resources are available to a business

organization - from shareholders, bondholders, and creditors (secured and unsecured) works

30

up in the business activities to generate revenues and facilitate future expansion and growth;

they are to be considered as ‘working capital’.

Another school of thought links working capital with current assets and current liabilities.

According to them, the excess of current assets over current liabilities is to be rightly

considered as the working capital of a business organization.

“Working capital is descriptive of that capital which is not fixed. But, the more common use

of working capital is to consider it as the difference between the current assets and the

current liabilities”. Current assets and current liabilities are assets and liabilities which arise

in the course of business. The WC demonstrates the amount of liquid assets that are available

to sustain and build the business by measuring company’s efficiency and short-term financial

health. As such, it carries great value to those who might be interested in investing in

business or even purchasing it.

Working capital, also known as net working capital, is a measurement of a business’s current

assets, after subtracting its short-term liabilities. Sometimes referred to as operating capital, it

is a valuation of the assets that a business or organization has available to manage and build

the business. Generally speaking, companies with higher amounts of working capital are

better positioned for success because they have the liquid assets that are essential to expand

their business operations when required.

Characteristics of Working Capital

Working capital is the life blood and nerve centre of a business. Just as circulation of blood is

essential in the human body for maintaining life, working capital is very essential to maintain

the smooth running of a business. No business can run successfully without an adequate

amount of working capital.

The features of working capital distinguishing it from the fixed capital are as follows:

Short term Needs:

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Working capital is used to acquire current assets which get converted into cash in a short

period. In this respect it differs from fixed capital which represents funds locked in long

term assets. The duration of the working capital depends on the length of production

process, the time that elapses in the sale and the waiting period of the cash receipt.

Circular Movement:

Working capital is constantly converted into cash which again turns into working capital.

This process of conversion goes on continuously. The cash is used to purchase current

assets and when the goods are produced and sold out; those current assets are transformed

into cash. Thus it moves in a circular away. That is why working capital is also described

as circulating capital.

An Element of Permanency:

Though working capital is a short term capital, it is required always and forever. As

stated before, working capital is necessary to continue the productive activity of the

enterprise. Hence so long as production continues, the enterprise will constantly remain

in need of working capital. The working capital that is required permanently is called

permanent or regular working capital.

An Element of Fluctuation:

Though the requirement of working capital is felt permanently, its requirement fluctuates

more widely than that of fixed capital. The requirement of working capital varies directly

with the level of production. It varies with the variation of the purchase and sale policy;

price level and the level of demand also. The portion of working capital that changes with

production, sale, price etc. is called variable working capital.

Liquidity:

Working capital is more liquid than fixed capital. If need arises, working capital can be

converted into cash within a short period and without much loss. A company in need of

cash can get it through the conversion of its working capital by insisting on quick

recovery of its bills receivable and by expediting sales of its product. It is due to this trait

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of working capital that the companies with a larger amount of working capital feel more

secure.

Less Risky:

Funds invested in fixed assets get locked up for a long period of time and cannot be

recovered easily. There is also a danger of fixed assets like machinery getting obsolete

due to technological innovations. Hence investment in fixed capital is comparatively

more risky. As against this, investment in current assets is less risky as it is a short term

investment. Working capital involves more of physical risk only, and that too is limited.

Moreover, working capital gets converted into cash again and again; therefore, it is free

from the risk arising out of technological changes.

Special Accounting System not needed:

Since fixed capital is invested in long term assets, it becomes necessary to adopt various

systems of estimating depreciation. On the other hand working capital is invested in short

term assets which last for maximum one year only. Hence it is not necessary to adopt

special accounting system for them.

Among the most important items of working capital are levels of inventory, accounts

receivable, and accounts payable. Working capital can be expressed as a positive or a

negative number. When a company has more debts than current assets, it has negative

working capital; when current assets outweigh debts, a company has positive working

capital.

A company will try to manage cash by:

Identifying the cash balance that allows it to meet day-to-day expenses but minimizes the

cost of holding cash

Finding the level of inventory that allows for continuous production but lessens the

investment in raw materials and reduces reordering costs

Identifying the appropriate source of financing, given the cash-conversion cycle.

33

It may be necessary to use a bank loan or overdraft. However, inventory is preferably

financed by credit arranged with the supplier. If a company is not operating efficiently, this

will show up as an increase in the working capital. This can be judged by comparing the

amounts of working capital from one period to another. Slow collection and inventory

turnover may signal an underlying problem in the company’s operations.

Advantages

Proper management of working capital gives a firm the assurance that it is able to continue

its operations and that it has sufficient cash flow to satisfy both maturing short term debt and

upcoming operational expenses.

Disadvantages

If a company’s current assets do not exceed its current liabilities, then it may run into trouble

paying back creditors in the short term. A declining working-capital ratio over a longer time

period could also be a red flag that merits further analysis. For example, it could be that the

company’s sales volumes are decreasing and, as a result, its accounts receivable are

diminishing.

IV.2. NEED OF WORKING CAPITAL

Working capital is among the many important things that contribute to the success of a

business. Without it, a business may cease to function properly or at all. Not only does a lack

of working capital render a company unable to build and grow, but it may also leave a

company with too little cash to pay its short-term obligations. Simply put, a company with a

very low amount of working capital may be at risk of running out of money. When a

company has too little working capital, it can face financial difficulties and may even be

forced toward bankruptcy. This is true of both very small companies and billion-dollar

organizations. A company with this problem may pay creditors late or even skip payments. It

may borrow money in an attempt to remain afloat. If late payments have affected the

company’s credit rating, it may have difficulty obtaining a loan at an affordable interest rate.

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The need for working capital gross or current assets cannot be over emphasized. As already

observed, the objective of financial decision making is to maximize the shareholders wealth.

To achieve this, it is necessary to generate sufficient profits which will depend upon the

magnitude of the sales among other things but sales cannot convert into cash. There is a need

for working capital in the form of current assets to deal with the problem arising out of lack

of immediate realization of cash against goods sold. Therefore sufficient working capital is

necessary to sustain sales activity. Technically this is refers to operating or cash cycle.

IV.3. CONCEPT OF WORKING CAPITAL

There are two concepts of working capital:

Gross working capital

Net working capital

Gross Working Capital

The gross working capital is the capital invested in the total current assets of the enterprises.

Current assets are those assets which can convert in to cash within a short period normally

one accounting year.

Constituents of Current Assets:

Current assets are assets which are expected to be sold or otherwise used within one fiscal

year. Typically, current assets include cash, cash equivalents, account receivable, inventory,

prepaid accounts which will be used within a year, and short-term investments.

Cash in hand and cash at bank

Bills receivables/Sundry debtors

Short term loans and advances

Inventories of stock as:

o Raw material

o Work in process

o Stores and spares

o Finished goods

Temporary investment of surplus funds

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Prepaid expenses

Accrued incomes

Marketable securities

Net Working Capital

In a narrow sense, the term working capital refers to the net working capital. Net working

capital is the excess of current assets over current liability.

NET WORKING CAPITAL = CURRENT ASSETS – CURRENT LIABILITIES

Net working capital refers to the difference between current assets and current liabilities.

Current liabilities are those claims of outsiders which are expected to mature for payment

within an accounting year and include creditors, bills payable and outstanding expenses. Net

working capital can be positive or negative.

Constituents of Current liabilities:

Current liabilities are considered as liabilities of the business that are to be settled in cash

within the fiscal year. Current liabilities include accounts payable for goods, services or

supplies, short-term loans, long-term loans with maturity within one year, dividends and

interest payable, or accrued liabilities such as accrued taxes.

Accrued or outstanding expenses

Short term loans, advances and deposits

Dividends payable

Bank overdraft

Provision for taxation, if it does not amount to appropriation of profit

Bills payable

Sundry creditors

The gross working capital concept is financial or going concern concept whereas net working

capital is an accounting concept of working capital. Both the concepts have their own merits.

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The gross concept is sometimes preferred to the concept of working capital for the following

reasons:

It enables the enterprise to provide correct amount of working capital at correct time.

Every management is more interested in total current assets with which it has to operate

then the source from where it is made available.

It take into consideration of the fact every increase in the funds of the enterprise would

increase its working capital.

This concept is also useful in determining the rate of return on investments in working

capital.

The net working capital concept, however, is also important for following reasons:

It is qualitative concept, which indicates the firm’s ability to meet to its operating

expenses and short-term liabilities.

It indicates the margin of protection available to the short term creditors.

It is an indicator of the financial soundness of enterprises.

It suggests the need of financing a part of working capital requirement out of the

permanent sources of funds.

Working capital, on the one hand, can be seen as a metric for evaluating a company’s

operating liquidity. A positive working capital position indicates that a company can meet its

short-term obligations. On the other hand, a company’s working capital position signals its

operating efficiency. Comparably high working capital levels may indicate that too much

money is tied up in the business.

The most important positions for effective working capital management are inventory,

accounts receivable, and accounts payable. Depending on the industry and business,

prepayments received from customers and prepayments paid to suppliers may also play an

important role in the company’s cash flow. Excess cash and no operational items may be

excluded from the calculation for better comparison.

IV.4. CLASSIFICATION OF WORKING CAPITAL

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Working capital may be classified in two ways:

On the basis of concept

On the basis of time

On the basis of concept working capital can be classified as gross working capital and net

working capital. On the basis of time, working capital may be classified as:

Permanent or fixed working capital.

Temporary or variable working capital

Permanent or Fixed Working Capital

The operating cycle is a continuous feature in almost all the going concerns and therefore

creates the need for working capital and their efficient management. However the magnitude

of working capital required will not be constant, but will fluctuate. At any time, there is

always a minimum level of current assets which is constantly and continuously required by a

business unit to carry on its operations. This minimum amount of current assets, which is

required on a continuous and uninterrupted basis, is after referred to as fixed or permanent

working capital. This type of working capital should be financed (along with other fixed

assets) out of long term funds of the unit. However in practice, a portion of these

requirements also is met through short term borrowings from banks and suppliers credit.

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Chart 5-1 Permanent Working Capital

The amount of current assets required to meet a firm’s long-term minimum needs are called

permanent current assets. For e.g., In a manufacturing unit, basic raw materials required for

production has to be available at all times and this has to be financed without any

disturbance.

Temporary or Variable Working Capital

Any amount over and above the permanent level of working capital is variable, temporary or

fluctuating working capital. This type of working capital is generally financed from short

term sources of finance such as bank credit because this amount is not permanently required

and is usually paid back during off season or after the contingency. As the name implies, the

level of fluctuating working capital keeps on fluctuating depending on the needs of the unit

unlike the permanent working capital which remains constant over a period of time.

The Temporary or Variable working capital is the amount of working capital which is

required to meet the seasonal demands and some special exigencies. Variable working capital

can further be classified as Seasonal Working Capital and Special Working Capital. The

capital required to meet the seasonal need of the enterprise is called seasonal working capital.

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Special working capital is that part of working capital which is required to meet special

exigencies such as launching of extensive marketing for conducting research, etc.

Temporary working capital differs from Permanent working capital in the sense that is

required for short periods and cannot be permanently employed gainfully in the business.

IV.5. DETERMINANTS OF WORKING CAPITAL

Working capital management is an indispensable functional area of management. However

the total working capital requirements of the firm are influenced by the large number of

factors. It may however be added that these factors affect differently to the different units and

these keep varying from time to time. In general, the determinants of working capital which

are common to all organizations can be summarized as under:

Nature of Business

This is one of the main factors. Usually in trading businesses the working capital needs are

higher as most of their investment is concentrated in stock or inventory. Manufacturing

businesses also need a good amount of working capital to meet their production

requirements. Whereas, those companies that sell services and not goods, on a cash basis

require least working capital because there is no requirement on their part to maintain heavy

inventories.

Size of Business

In very small company the working capital requirement is quit high due to high overhead,

higher buying and selling cost etc. as such medium size business positively has edge over the

small companies. But if the business start growing after certain limit, the working capital

requirements may adversely affect by the increasing size.

Credit Terms/Credit Policy

Some time due to competition or custom, it may be necessary for the company to extend

more and more credit to customers, as result which more and more amount is locked up in

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debtors or bills receivables which increase the working capital requirement. On the other

hand, in the case of purchase, if the credit is offered by suppliers of goods and services, a part

of working capital requirement may be financed by them, but it is necessary to purchase on

cash basis, the working capital requirement will be higher. Credit terms greatly influence

working capital needs. If terms are:

buy on credit and sell by cash, working capital is lower

buy on credit and sell on credit, working capital is medium

buy on cash and sell on cash, working capital is medium

buy on cash and sell on credit, working capital is higher.

Prevailing trade practices and changing economic condition do generally exert greater

influence on the credit policy of concern. A liberal credit policy if adopted more trade

debtors would result and when the same is tightened, size of debtors gets slim. Credit periods

also influence the size and composition of working capital. When longer credit period is

allowed to debtors as against the one extended to the firm by its creditors, more working

capital is needed and vice versa. Collection policy is another influencing factor. A stringent

collection policy might not only deter away some credit customers, but also force the existing

customers to be prompt in settling dues resulting in lower level of working capital. The

opposite holds well with a liberal collection policy. Collection procedure also influences the

working capital needs. A decentralized collection of dues from customers and centralized

payments to suppliers shall reduce the size of working capital. Centralized collections and

centralized payments would lead to moderate level of working capital. But with centralized

collections and decentralized payments, the working capital need would be the highest.

Seasonality

Seasonality of Production:

Agriculture and food processing and preservation industries have a seasonal production.

During seasons, when production activities are in their peak, working capital need is high.

Seasonality in supply of raw materials:

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This also affects the size of working capital. Industries that use raw materials which are

available during seasons only, have to buy and stock those raw materials. They cannot afford

to buy these items in a phased way, since either supplies would get reduced or prices would

be higher. Also, from the point of view of quality of raw materials, it pays to buy in bulk

during the seasons. Hence the high level of working capital needed when season exists for

raw materials.

Seasonality of demand for finished goods:

In case of products like umbrella, rain-coats and other seasonal items, the demand is high

during peak seasons. But the production of these items has to be continuous throughout the

year to meet the high demand during peak seasons. Thus, working capital requirement would

be higher.

Business Trade Cycle

Trade cycle refers to the periodic turns in business opportunities from extremely peak levels,

via a slackening to extremely tough levels and from there, via a recovery phase to peak

levels, thus completing a business cycle. There are 4 phases of trade cycle.

Boom Period – more business, more production, more working capital.

Depression period – less business, less production, less working capital.

Recession period – slackening business, stock pile-up, more working capital.

Recovery period – recouping business, stock speedily converts to sales, less working

capital.

Inflation

Under inflationary conditions generally working capital increases, since with rising prices

demand reduces resulting in stock pile-up and consequent increase in working capital.

Length of Production cycle

The time lapse between feeding of raw material into the machine and obtaining the finished

goods out from the machine is what is described as the length of manufacturing process. It is

42

otherwise known as conversion time. Longer this time period, higher is the volume and value

of work-in-progress and hence higher the requirement of working capital and vice versa.

System of Production process

If capital intensive, high-technology automated system is adopted for production, more

investment in fixed assets and less investment in current assets are involved. Also, the

conversion time is likely to be lower, resulting in further drop in the level of working capital.

On the other hand, if labor intensive technology is adopted, less investment in fixed assets

and more investment in current assets, this would lead to higher requirement of working

capital.

Growth and expansion plans

Growth and expansion industries need more working capital than those that are static.

Profitability

The profitability of the business may be vary in each and every individual case, which is in

turn its depend on numerous factors, but high profitability will positively reduce the strain on

working capital requirement of the company, because the profits to the extent that they

earned in cash may be used to meet the working capital requirement of the company.

Operating efficiency

If the business is carried on more efficiently, it can operate in profits which may reduce the

strain on working capital; it may ensure proper utilization of existing resources by

eliminating the waste and improved coordination etc.

Apart from the above factors, dividend policy, depreciation policy, price level changes,

operating efficiency and government regulations also influence the level and the size of

working capital.

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V. PERFORMANCE ANALYSIS

V.1. FINANCIAL PERFORMANCE REVIEW

V.1.1. TURNOVER

Turnover for the company has been increasing steadily for the past ten years, with a growth

of 81.23 percent since 2000-01. The marginal decrease/increase in sales turnover in the

following years is on the account of decrease/increase in prices of petroleum products i.e.

LSHS/FO at FO based units and substitution of Naphtha with RIL gas at Vijaipur resulting in

decrease/increase in subsidy rate. This in turn results in decrease/increase in the amount of

subsidy provided by the government, which in the end results in lower/higher turnover.

Figure 5.1 – Performance Review – Turnover

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LIQUIDITY RATIOS

V.1.2. CURRENT RATIO

Current ratio may be defined as a liquidity ratio that measures a company's ability to pay

short term obligations. This ratio is also known as liquidity ratio, cash asset ratio and cash

ratio. It is a measure of general liquidity and is most widely used to make the analysis for

short term financial position or liquidity of a firm. It is calculated by dividing the total of the

current assets by total of the current liabilities. A ratio under 1 suggests that the

company would be unable to pay off its obligations if they came due at that point. While

this shows the company is not in good financial health, it does not necessarily mean that it

will go bankrupt as there are many ways to access financing, but it is definitely not a good

sign.

But as we see from the chart that the current ratio of NFL is well beyond 1, which shows that

the company is stable and can easily counter any short term liabilities with ease. This was

easily visible when the company decided to go for up-gradation of its plants and was able to

handle its investments easily because of its high current ratio in the years 2009-10.

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Figure 5.2 – Liquidity Ratio – Current Ratio

V.1.3. QUICK/ACID TEST RATIO

An indicator of a company's short-term liquidity. The quick ratio measures a

company's ability to meet its short-term obligations with its most liquid assets. The higher the

quick ratio/ ATR, the better the position of the company. The quick ratio/ATR is more

conservative than the current ratio, a more well-known liquidity measure, because it  excludes

inventory from current assets. Inventory is excluded because some companies have difficulty

turning their inventory into cash. In the event that short-term obligations need to be paid off

immediately, there are situations in which the current ratio would overestimate a company's

short-term financial strength. Companies with ratios of less than 1 cannot pay their current

liabilities and should be looked at with extreme caution.

But when looking at the chart we can see that for NFL, the quick ratio/ATR is more than 1

with some exception in the early 2000s. This shows that the company is in a good position to

handle its current liabilities and has passed the acid test. Also as said earlier, NFL with its up-

gradation plans, this excess liquidity will help it in the days to come.

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Figure 5.3 – Liquidity Ratio – Quick/Acid Test Ratio

LEVERAGE RATIO

V.1.4. DEBT EQITY RATIO

It is a measure of the company's financial leverage calculated by dividing its total

liabilities by stockholders' equity. It indicates what proportion of equity and debt the

company is using to finance its assets. A high debt/equity ratio generally means that a

company has been aggressive in financing its growth with debt. If a lot of debt is used to

finance increased operations (high debt to equity), the company could potentially generate

more earnings than it would have without this outside financing. If this were to increase

earnings by a greater amount than the debt cost (interest), then the shareholders benefit

as more earnings are being spread among the same amount of shareholders. However, the

cost of this debt financing may outweigh the return that the company generates on the debt

through investment and business activities and become too much for the company to handle.

This can lead to bankruptcy, which would leave shareholders with nothing

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The debt equity ratio of NFL has been reducing continuously over the years. This is for the

reason that NFL is trying to become a debt free company and has been striving for the same.

But in the year 2010-11, this ratio is expected to go higher as many expansion and

modernization projects have been carried out. Also since the D/E ratio is low, company is in

a better position to get loans from the banks.

Figure 5.4 – Leverage Ratio – Debt Equity Ratio

OTHER RATIOS

V.1.5. RETURN ON EQUITY

ROE indicates what return a company is generating on the owners' investment. Sometimes

ROE is referred to as Stockholder's return on investment, it tells the rate that shareholders are

earning on their shares. Companies that generate high returns relative to their shareholder's

equity are companies that pay their shareholders off handsomely, creating substantial assets

for each dollar invested.

From the chart we can see that the ROE of NFL has grown from a mere 5.57 percent in 2001

to 34.96 percent in 2010. This shows that the stockholders’ like government of India and

some financial institutions are receiving a good value for their investments.

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Figure 5.5 – Performance Review – Return on Equity

V.2. ASSETS AND LIABILITIES

Current Assets

Current assets are important to businesses because they are the assets that are used to fund

day-to-day operations and pay ongoing expenses. A balance sheet account that represents the

value of all assets that are reasonably expected to be converted into cash within one year in

the normal course of business. Current assets include cash, accounts receivable, inventory,

marketable securities, prepaid expenses and other liquid assets that can be readily converted

to cash.

Current assets of the company as per the balance sheet as at 31 st March 2010 was recorded as

Rs. 1959.67crores. As a result the current assets jumped up by 40.6 percent in comparison to

the previous year. It was also seen that, this has been the trend for the last few years. Cash

and Bank balance as we know plays an important part in the company’s performance, has

seen a tremendous jump from Rs. 107.6 crores in 2009 to Rs. 690.81 crores in 2010. This

shows that company has a good amount of cash which the company was able to use in 2010-

11, which reduced the amount of debt the company borrowed.

Fixed Assets

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A long-term tangible piece of property that a firm owns and uses in the production of its

income and is not expected to be consumed or converted into cash any sooner than at least

one year's time. Buildings, real estate, equipment and furniture are good examples of fixed

assets. 

Fixed assets for the years 2009-10 and 2008-09 have remained nearly the same. Only

variation was found with respect to capital work in progress. There was an increase in capital

work in progress from Rs. 17.49 crores (2008-09) to Rs.29.20 crores (2010-09). The increase

in capital work in progress was due to the expenditure incurred on projects of energy saving

and urea capacity enhancement in Vijaipur and changeover of feedstock at Nangal, Bhatinda

and Panipat units.

Current Liabilities

These are bills that are due to creditors and suppliers within a short period of time. Normally,

companies withdraw or cash current assets in order to pay their current liabilities. In other

words they are company's debts or obligations that are due within one year. Current liabilities

appear on the company's balance sheet and include short term debt, accounts payable,

accrued liabilities and other debts.

Current liabilities of NFL in the year 2008-09 were accounted to be Rs. 665.51 crores. In the

year 2009-10, it was accounted as Rs. 578.53. This decrease in current liabilities is mainly on

account of decrease in outstanding liability towards sundry creditors for raw materials and

reduction in actual valuation of employee benefit scheme.

V.3. CAPITAL EXPENDITURE

Table below shows the major expenditures of NFL. NFL had a reduction in expenditure from

Rs. 5052.3 crores to Rs. 4888.12. This was mainly because of the reduction in raw materials

50

consumed, which are petroleum products. Since the price of petroleum products fell, resulted

in a decrease in the total expenditure. But on the other hand the prices of store and spares

increased. Also salary escalation and additional provision to pension scheme also increased.

Similar to the raw materials, because of reduction in price of petroleum product, the cost of

Power and Fuel reduced. Also freight and handling which forms a major part of the expense

reduced.

Table 5.1 – Capital Expenditure of NFL (Rs. Crores)

 

2009-

10

2008-

09

Raw Materials Consumed

2611.7

2 2832.32

Packaging Materials 80.11 85.9

Stores and Spares 31.39 19.06

Employees Remuneration and

Benefits 349.52 330.34

Power and Fuel

1066.8

5 1240.39

Freight and Handling 228.68 232.66

Repairs and Maintenance 76.57 65.57

Production Urea (Lakh MT) 33.3 33.44

V.4. WORKING CAPITAL LEVEL ANALYSIS

V.4.1. WORKING CAPITAL LEVEL

The guiding principle for working capital is called the hedging principle or principle of self-

liquidating debt or matching principle (different from the matching principle used in

measuring accounting profit).

51

It is an accepted belief in business that the term of a funding arrangement must match the

term of the investment itself. This means that any funds used for short-term assets or

purposes should be financed from short term sources. Likewise investments in long term

assets should be funded from long term sources. Therefore a key criterion for acquiring

additional finance is matching up the life of the assets acquired with the term of the loan or

other method of funding. For example, the buying of an unusually large quantity of inventory

should be financed by a loan, or credit, with a repayment period of less than one year. The

level of any long-term assets funded by short term debt shows the firm's level of 'aggression

in its financing policy. Although this type of action may increase profits (due to the lower

cost of short term debt) it greatly increases the risk of cash shortages if short term financing

can't be renewed.

Table 5.2 – Size of Working Capital (Rs. Crores)

CURRENT ASSETS 2005 2006 2007 2008 2009 2010

Cash and Bank Balance 133.48 11.83 13.39 161.37 107.6 690.81

Sundry Debtors 435.06 824.47 1205.72 776.72 930.48 920.55

Inventory 350.84 324.49 348.2 381.03 348.68 347.12

Interest on Investments 0 0 0 8.13 6.99 1.19

Loans and Advances 87.94 110.93 125.72 115.72 130.22 126.08

Total Current Assets 1007.32 1271.72 1693.03 1442.97 1523.97 2085.75

CURRENT

LIABILITIES 2005 2006 2007 2008 2009 2010

Sundry Creditors 437.68 407.73 487.31 579.9 603.9 499.72

Security Deposits 40.12 39.03 40.37 42.5 44.91 51.3

Advances from

Customers 11.49 9.66 11.69 10.36 10.21 19.14

Other Liabilities 14.31 5.12 11.28 14.86 6.49 8.37

Provisions 98.05 91.2 110.73 168.3 219.6 219.12

Total Current Liabilities 601.65 552.74 661.38 815.92 885.11 797.65

Net Working Capital 405.67 718.98 1031.65 627.05 638.86 1288.1

52

V.4.2. WORKING CAPITAL TREND ANALYSIS

Trend analysis is an improvement over the year to year analysis. When a comparison of

Financial Statements covering more than 3 years is undertaken, the year to year analysis

becomes cumbersome. In trend analysis, the changes are calculated for several successive

years instead of two or three years. Therefore the trend analysis is a company's financial

position over a long period of time. Trend analysis is important as it may point to basic

changes in the nature of business and also helps in drawing meaningful conclusions

regarding the operating performance over several years and the financial position of the

enterprise. It is based on the idea that what has happened in the past gives an idea of what

will happen in the future.

In working capital analysis the direction at changes over a period of time is of crucial

importance. Working capital is one of the important fields of management. It is therefore

very essential for an analyst to make a study about the trend and direction of working capital

over a period of time. Such analysis enables as to study the upward and downward trend in

current assets and current liabilities and its effect on the working capital position.

One of the main goals of trend analysis is to forecast future values of the series. It allows a

researcher to look at a pattern of change over a long period of time rather than at a single

discrete point in time or over a short time so that better conclusions can be drawn.

Table 5.3 – Working Capital Variance Analysis

Year 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10

Total Current Assets

(Rs. Crores) 1007.32 1271.72 1693.03 1442.97 1523.97 2085.75

Total Current Liabilities

(Rs. Crores) 601.65 552.74 661.38 815.92 885.11 797.65

53

Net Working Capital

(Rs. Crores) 405.67 718.98 1031.65 627.05 638.86 1288.1

WC Variation (Base 2005) 100 177.233 254.308 154.571 157.483 317.524

WC Yearly Growth - 77.23% 43.49% -39.22% 1.88% 101.62%

Index = 100 * (Index Year Amount / Base Year Amount)

Chart 5.6 – Working Capital Index

For the analysis year 2004-05 has been taken as the base with an index of 100 and the

remaining index values are computed based on this base. It was observed that the in the year

2009-10 working capital increased by 101.62 percent compared to that in 2008-09. This is

because of the reason that current assets increased by 36.86 percent but on the other hand

current liabilities reduced by 9.88 percent. As we can see above that the normal trend of WC

is of an upward one, except in the year 2007-08, when current assets fell and liabilities

increased. This is because of the reason that the sundry debtors for that year reduced and the

provision was increased.

Looking at the 2009-10 data, we can easily see that the company is well positioned in terms

of working capital, as the bank balance has increased to Rs. 690.81 crores. This shows that

54

the company has enough liquid cash to take care of any expenses that it occurs. This is also

helpful taking in consideration that NFL is going for up-gradation of its plants.

V.4.3. CURRENT ASSET

A balance sheet item which equals the sum of cash and cash equivalents, accounts receivable,

inventory, marketable securities, prepaid expenses and other assets that could be converted to

cash in less than one year. A company's creditors will often be interested in how much that

company has in current assets, since these assets can be easily liquidated in case the company

goes bankrupt. In addition, current assets are important to most companies as a source of

funds for day-to-day operations.

Table 5.4 – Variance Analysis of Current Assets

Year 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10

Total Current Assets

(Rs. Crores) 1007.32 1271.72 1693.03 1442.97 1523.97 2085.75

Variation (Base 2005) 100 126.248 168.073 143.248 151.29 207.059

Yearly Growth - 26.25% 33.13% -14.77% 5.61% 36.86%

Index = 100 * (Index Year Amount / Base Year Amount)

55

Chart 5.7 – Current Asset Index

For the analysis year 2004-05 has been taken as the base with an index of 100 and the

remaining index values are computed based on this base. It can be observed that we see an

upward trend in the current assets. In the last six years, from 2005 to 2010, the current assets

have increased by 107.06 percent. In the year 2010, the rise was by 36.86 percent when

compared to that in 2009. This was mainly because of the increase in cash and bank balance

which also raised by an impressive 542.02 percent. The rest of the factors remained nearly

the same. We also notice that sundry debtors contribute the most towards the current assets,

which shows that NFL has a good credit policy and is also good at its collection

management.

V.4.4. CURRENT LIABILITIES

Current liabilities are debts, accounts payable, interest due, trade credit, loans and other

obligations that are due and payable within one year. Current liabilities are calculated and

identified on a business balance sheet. Current liabilities as a total are information that is

used as one measure of the financial condition of a company, especially in association with

current assets to calculate the level of working capital.

56

Table 5.5 – Variance Analysis of Current Liabilities

Year 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10

Total Current Liabilities

(Rs. Crores) 601.65 552.74 661.38 815.92 885.11 797.65

Variation (Base 2005) 100 91.8707 109.928 135.614 147.114 132.577

Yearly Growth - -8.13% 19.65% 23.37% 8.48% -9.88%

Index = 100 * (Index Year Amount / Base Year Amount)

Chart 5.8 – Current Liabilities Index

For the analysis year 2004-05 has been taken as the base with an index of 100 and the

remaining index values are computed based on this base. It can be observed that the current

liabilities also show an upward trend, but compared to the year 2009, current liabilities has

fallen by 9.88 percent in 2010. This is because of the reason that sundry creditors has reduced

by 17.25 percent. This shows good sign for the company, as it is able to reduce the amount of

credits it takes from its suppliers, which results in better goodwill for the company. It can

also be seen that in the year 2010, NFL has collected more advances when compared to 2009.

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V.4.5. CHANGES IN WORKING CAPITAL

The excess of current assets over current liabilities is referred to as the company’s working

capital. The difference between the working capital for two given reporting periods is called

the change in working capital.

Changes in working capital is included in cash flow from operations because companies

typically increase and decrease their current assets and current liabilities to fund their

ongoing operations. When a company increases its current assets, it’s a cash outflow: The

company had to shell out money to buy the extra assets. Likewise, when a company increases

its current liabilities, it’s a cash inflow: The added liabilities, such as short term debt, provide

money. A change in working capital simply shows the net effect on cash flows of this adding

and subtracting from current assets and current liabilities. When a change in working capital

is negative, the company is investing heavily in its current assets, or else drastically reducing

its current liabilities. When a change in working capital is positive, the company is either

selling off current assets or else raising its current liabilities.

For many growing companies, changes in working capital is a little like capital spending. It is

the money company is investing in things like inventory in order to grow. To get a true

picture of the cash a company is generating before investment, one can add back changes in

working capital to cash flow from operations. A negative value for changes in working

capital could mean the company is investing heavily in growth, or that something’s going

wrong. If a company is having trouble selling its goods, inventories will balloon, and changes

in working capital will turn sharply negative.

There are so many reasons for the changes in working capital:

1. Changes in sales and operating expenses

There may be long run trend of change e.g. The price of raw material say coal, FO or NG

may constantly raise resulting in the holding of large inventory

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Cyclical changes in economy dealing to ups and downs in business activity will influence

the level of working capital both permanent and temporary

Changes in seasonality in sales activities

2. Policy Changes

The second major case of changes in the level of working capital is because of policy

changes initiated by management and government. The term current assets policy may be

refined as the relationship between current assets and sales volume

3. Technology Changes

Change in working capital could be because of changes in technology. So to install these

technologies in our business, more working capital is required.

Table 5.6 – Changes in Working Capital (Rs. Crores)

CURRENT ASSETS 2009 2010 Percent Change Increase Decrease

Cash and Bank Balance 107.6 690.81 542.02% 583.21  

Sundry Debtors 930.48 920.55 -1.07%   9.93

Inventory 348.68 347.12 -0.45%   1.56

Interest on Investments 6.99 1.19 -82.98%   5.8

Loans and Advances 130.22 126.08 -3.18%   4.14

Total Current Assets 1523.97 2085.75 36.86% 561.78  

CURRENT LIABILITIES 2009 2010      

Sundry Creditors 603.9 499.72 -17.25%   104.18

Security Deposits 44.91 51.3 14.23% 6.39  

Advances from Customers 10.21 19.14 87.46% 8.93  

Other Liabilities 6.49 8.37 28.97% 1.88  

Provisions 219.6 219.12 -0.22%   0.48

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Total Current Liabilities 885.11 797.65 -9.88%   87.46

Net Working Capital 638.86 1288.1 101.62% 649.24  

From the above table we can observe the major changes that have happened between 2009

and 2010. We can easily see that major increase in the amount of cash and bank balance in

the company. As a result the current assets increased by an amount of Rs. 561.78 crores. On

the current liabilities side the percentage increase in the advances collected from customers is

high, but when looked at the amount it’s very small. But an important this is to be noticed is

that the sundry creditors has reduced by 17.25 percent and shows that the company has

enough money to pay back its liabilities. It also brings goodwill to the company. To conclude

we can see that the increase in current assets and decrease in sundry creditors, has resulted in

working capital to increase by an impressive amount of Rs. 649.24 crores.

V.4.6. OPERATING CYCLE

Working capital is also known as revolving capital or a circular path of conversion. This

revolution of cycle is called as the Operating Cycle. Available cash tends to be tied up in

what is known as the Working Capital Cycle (WCC). Every business, regardless of what they

do operates this cycle. To start any business cash is required; this cash is then used to

purchase stock in order to generate a sale. When the stock is sold it is either by way of a cash

sale or credit, creating a debtor.

When the debt is collected the WCC continues on. In a service industry the stock is client

base or the service provided. The need of working capital arrived because of time gap

between production of goods and their actual realization after sale. This time gap is called

Operating Cycle or Working Capital Cycle. The operating cycle of a company consist of time

period between procurement of inventory and the collection of cash from receivables. The

operating cycle is the length of time between the company’s outlay on raw materials, wages

and other expanses and inflow of cash from sales of goods.

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Thus a revolution or cycle from cash to raw materials to work-in-progress, to finished goods,

to debtors, and back to cash takes place. This revolution is called as operating cycle.

While waiting for cash to return, more stock has to be purchased to keep the business

operating and to do so, many businesses use their overdraft facility which is costing them

money. If there is no overdraft they use credit funds that could be better utilized elsewhere.

The faster you can turn the WCC the faster the dollar returns and the less overdraft or credit

funds you have to use. This is where efficiency in debt collection and stock turnover is the

key.

Managing cash in any business is important. Many profitable businesses end up closing down

simply because they could not get the cash to carry them in the short term. Beyond survival

workshops emphasize the difference between cash flow and profits, constructs a cash flow

budget for a business and analyses where does all the cash go. It will demonstrate the

importance on the efficient operation of the working capital cycle, how to improve debtor

collection and stock turnover to help increase cash holdings and reduce the overdraft limit.

Thus, the term operating cycle, refers to the length of time necessary to complete the

following cycle of events:

Conversion of cash into inventory

Conversion of inventory into debtors

Conversion of debtors into cash

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Stage 1: Cash to Inventory – In this stage, cash first gets converted into raw materials, then

work-in progress and then finished goods in a typical manufacturing concern. As regards

non-manufacturing concerns, when the goods are purchased, cash gets converted into

inventory.

Stage 2: Inventory to Debtors – The inventory thus produced or purchased, gets converted

into debtors or receivables upon credit sales.

Stage 3: Debtors to Cash – The debtors or accounts receivables get converted back into cash

when they make payment.

Length of Operating Cycle

When raw materials remain in store pending issue for production for a less duration, when

raw materials gets converted into WIP in a short duration, when finished goods remain in

warehouse pending for sales for a short duration only, and when cash realizations out of sales

are made quickly and finally when payment to creditors is made slowly, the operating cycle

would be smaller and consequently the working capital will also be reasonable. Thus shorter

duration of operating cycle indicates an efficient working capital management.

Operating cycle is an important concept in management of cash and management of cash

working capital. The operating cycle reveals the time that elapses between outflow of cash

and inflow of cash. Quicker the operating cycle less amount of investment in working capital

is needed and it improves profitability. The duration of the operating cycle depends on nature

of industries and efficiency in working capital management.

Calculation of Operating Cycle

To calculate the operating cycle of NFL, last five year data is used.

Gross Operating Cycle Period = RMCP+WIPCP+FGCP+RCP-CPP

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RMCP - Raw Material Conversion Period

WIPCP - Work–In-Process Conversion Period

FGCP - Finished Goods Conversion Period

RCP - Receivables Conversion Period

CPP - Creditors Payment Period

However, a firm may acquire some resources on credit and thus defer payments for certain

period. In that case, Net Operating Cycle Period can be calculated as below:

Net Operating Cycle Period = Gross Operating Cycle Period – Payable Deferral period

Raw Material Conversion Period = Average Stock of Raw Material / Raw Material

Consumption per day

Work in process Conversion Period = Average Stock of Work-in-Progress / Total Cost of

Production per day

Finished Goods Conversion Period = Average Stock of Finished Goods / Total Cost of

Goods sold per day

Receivables Conversion Period = Average Accounts Receivables / Net Credit Sales per day

Payable Deferral Period = Average trade Creditors / Average Credit Purchase per day

After computing the period of one operating cycle, the total number of operating cycles that

can be computed during a year can be computed by dividing 365 days with number of

operating days in a cycle. The total expenditure in the year when year when divided by the

number of operating cycles in a year will give the average amount of the working capital

requirement.

Table 5.7 – Operating Cycle (days)

63

Year 2005-06 2006-07 2007-08 2008-09 2009-10

Inventory Period 34.33 31.76 32.14 25.97 24.94

Account Receivables Period 64.02 96.45 88.49 61.65 67.23

Account Payables Period 42.97 42.25 47.03 42.14 39.56

Operating Cycle 98.35 128.20 120.63 87.63 92.17

Cash Cycle 55.37 85.95 73.60 45.49 52.61

The Table above shows that in the year 2010, NFL on an average took 52.61 days for

converting its raw materials into cash. It also means that the company has to finance its

inventory for 52.61 days. Similarly we can see that historical cash cycle has been around 2

months. The main reason for this because of the subsidy received. On an average NFL

receives its subsidy after a period of three months, and payments of regular sales within one

month.

V.4.7. WORKING CAPITAL AND PROFITABILITY

In this part of the analysis we try to understand the impact of working capital on profitability.

In addition we also try to examine the combine effect of the ratios relating to working capital

management and profitability with the assistance of multiple correlation coefficients and

multiple correlation coefficients and multiple regression equation and to test the significance

of the regression coefficients. In the end we try to determine the working capital leverage for

examining the sensitivity of ROE to changes in the level of gross working capital of the

company.

The ratios relating to working capital management which have been selected and computed

for the study are Working Capital Ratio (WCR), Acid Test Ratio (ATR), Current Assets to

Total Assets Ratio (CTTR), Current assets to Sales Ratio (CTSR), Working Capital Turnover

Ratio (WTR), Inventory Turnover Ratio (ITR), Debtors Turnover Ratio (DTR) and Cash

Turnover Ratio (CTR). For determining the sensitivity of ROE to change in the level of

working capital, the working capital leverage has been computed. All statistical computations

have been done through excel.

64

Working Capital and Profitability - Correlation Analysis

The co-efficient of correlation between selected ratios relating to working capital

management and ROE are presented in Table 5.8. It is evident from the table the correlation

coefficient between ROE and WCR is (-) 0.14. It indicated that there is a lower degree of

negative association between the profitability and the working capital ratio of the company.

The value of the correlation coefficient is found to be significant at 5 percent level. It is

evident from these ratios that the increase in working capital is causing a negative effect on

the profitability of the company so, lesser the working capital better it is.

Similarly, the correlation coefficient between ROE and ATR is (+) 0.27 which is found to be

significant at 0.05 level. It reveals that there is also a lower degree of positive correlation

between the two variables. In the end we can say that with the liquid assets increasing, it will

result in more risk as well as higher profitability.

Thirdly, the coefficient of correlation between ROE and CTTR is (+) 0.17. It implies that

there is a positive correlation between the two variables, at 5 percent level, the value of the

correlation coefficient is found to be significant. Fourthly, the coefficient of correlation

between CTSR and ROE is (+) 0.02 which is found to be significant at 5 percent level. It

reflected a very lower degree of positive association between the two variables. Here we can

say that the current assets to sales ratio don’t have any effect on the efficiency of the working

capital and the scope of profitability. Fifthly, the correlation coefficient between ROE and

WTR is (+) 0.10, which indicates a lower degree of, positive correlation between these two

variables. This value is found to be significant at 0.05 level. The steady movement of

working capital turnover, the lower the working capital and greater is the profitability

conforms to principle.

Sixthly, the co-efficient of correlation between ROE and ITR is found to be (+) 0.28 it

viewing a moderately lower degree of positive correlation between the variables. Hence we

can say that the company should try to keep a lower inventory to achieve more profitability

in the future. Also this value is found to be significant at 0.05 level. Seventhly, the co-

65

efficient of correlation between ROE and DTR shows negative association of (–) 0.23. It is

found to be significant at 0.05. This shows us that if the company has higher receivables, it

will bring in more profitability to the stockholders. Lastly, the co-efficient of correlation (+)

0.35 between ROE and CTR shows moderate degree of positive association. This correlation

is insignificant.

Table 5.8 – Correlation Analysis between Ratios relating to WC management and ROE

Year WCR ATR CTTR CTSR WTR ITR DTR CTR

ROE

(%)

2000-01 2.14 0.98 0.53 1.11 1.70 1.69 3.12 37.21 5.57

2001-02 2.33 0.9 0.57 0.93 1.87 1.96 3.09 46.33 8.28

2002-03 1.98 1.22 0.52 0.93 2.18 2.45 2.50 71.95 58.35

2003-04 3.09 1.97 0.49 0.66 2.23 3.72 2.69 16.13 17.33

2004-05 1.67 1.06 0.48 0.58 4.25 4.65 3.84 10.47 32.8

2005-06 2.3 1.69 0.56 0.78 2.27 4.84 2.59 22.49 23.73

2006-07 2.45 1.9 0.65 1.03 1.65 4.90 1.61 130.77 35.90

2007-08 1.76 1.27 0.5 0.89 2.59 4.45 1.62 18.57 22.15

2008-09 1.72 1.3 0.56 0.91 2.63 4.61 1.94 12.51 19.87

2009-10 2.61 2.15 0.72 1.23 1.32 4.87 1.81 4.25 34.96

Correlation wrt

ROE -0.14 0.27 0.17 0.02 0.10 0.28 -0.23 0.35 -

p-value wrt

ROE 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.41 -

Impact of Working Capital Ratios on Profitability - Multiple Regression Analysis.

In order to understand influence on profitability, a linear multiple regression models were

used. In table 5.10 multiple correlation and multiple regression techniques have been applied

and impact of working capital on profitability of the company, the regression coefficients

have been tested with the assistance of the most popular 't' test. In this study WCR, ATR,

CTTR, ITR, DTR and CTR have been taken as the explanatory variable and ROE has been

66

used as the dependent variable. For the purpose of selection of variable in this analysis, the

correlation matrix representing the correlation coefficients between the explanatory variables

has been constructed in Table 5.9. This table reveals that there is a very high degree of

correlation between CTSR and WTR (–) (0.81). Due to this cause CTSR and WTR have not

been used for analysis. The regression model used is this analysis is hereunder. ROI=b0 + b1

WCR + b2 ATR + b3 CTTR + b4 ITR + b5 DTR+b6 CTR, where b0, b1, b2, b3, b4, b5 and

b6 are the parameters of the ROE to be estimated.

Table 5.9 – Correlation Matrix of Ratios relating to WC management and ROE

  WCR ATR CTTR CTSR WTR ITR DTR CTR ROE(%)

WCR 1.00                

ATR 0.69 1.00              

CTTR 0.35 0.58 1.00            

CTSR 0.13 0.18 0.76 1.00          

WTR -0.59 -0.41 -0.67 -0.81 1.00        

ITR -0.04 0.62 0.31 -0.19 0.27 1.00      

DTR -0.11 -0.56 -0.54 -0.51 0.52 -0.46 1.00    

CTR 0.11 0.06 0.25 0.26 -0.36 -0.14 -0.26 1.00  

ROE(%) -0.14 0.27 0.17 0.02 0.10 0.28 -0.23 0.35 1.00

The pooled regression results of the models exhibiting the impact of working capital on

profitability of the company are presented in Table 5.10. Table exhibiting the relationship

between the dependent variable ROE, and all the independent variables taken together and

the impact of these independent variables on the profitability of the company. From the

regression analysis we can see that when WCR increases by one unit the ROE decreases by

68.69 units. This again shows that for higher profitability working capital has to kept lower

and well managed. Similarly when ATR increases by one unit the ROE increases by 93.64

units. This shows that higher liquidity brings a positive impact on the profitability of the

company. When CTTR increased by one unit ROE decreases by 34.62 units. When ITR

increased by one unit, profitability of the company decreases by 13.22 units which clearly

signifies us that the company should keep a check on the inventory levels. When DTR

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increased by one unit, the ROE of the company stepped up by 11.81 units, which tells us that

as the amount of receivables increase ROE also increases. Lastly if there is a unit increase in

CTR, the company's profitability increased by 0.18 units. The multiple correlation co-

efficient of ROE on WCR, ATR, CTTR, ITR, DTR and CTR is 0.837. It reveals that the

profitability of the company was highly influenced by WCR, ATR, CTTR, ITR, DTR and

CTR. It is also evident from the value of R Square that the independent variables WCR,

ATR, CTTR, ITR, DTR and CTR contributed 70 percent of the variations in the profitability

of the company.

Table 5.10 – Multiple Regression Analysis of Ratios relating to WC management and ROE

Variable Regression Coefficient Standard Error

WCR -68.69 31.87

ATR 93.64 44.64

CTTR -34.62 86.20

ITR -13.22 9.33

DTR 11.81 10.27

CTR 0.18 0.14

Constant 76.09 68.12

Multiple R = 0.837 R Square = 0.7 Adj. R Square = 0.099

Regression equation is given by:

ROI = 76.09 – 68.89 WCR + 93.64 ATR – 34.62 CTTR – 13.22 ITR + 11.81 DTR + 0.18

CTR

V.4.8. WORKING CAPITAL AS A FUNCTION OF NET SALES

Working Capital of a firm can be estimated with the help of regression analysis. It’s a useful

statistical technique which can be applied for the forecasting of the working capital required

by a firm. It helps in making working capital requirement projections after establishing the

average relationship between sales and working capital and its various components in the

past years. This method of least square is used in this regard. This relationship between sales

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and working capital is given by the equation Y = a + bX. For this analysis the working

capital and net sales for the last 19 years are considered.

Table 5.11 – Multiple Regression Analysis of Working Capital as a function of Net Sales

Variable Regression Coefficient Standard Error

Constant 282.052 151.873908

Net sales 0.312 0.111243154

Multiple R = 0.562 R Square = 0.316 Adj. R Square = 0.276

Regression equation is given by:

Working Capital = 282.052 + 0.312 Net sales

From the table we can see that multiple correlation co-efficient of working capital on net

sales is 0.562. It reveals that the working capital of the company was moderately influenced

by net sales. It is also evident from the value of R Square that the independent variable net

sales contributed 31.6 percent of the variations in the working capital of the company. In the

end we can say that if there is a unit change in the net sales of the company that would have

caused because of the increase in 0.312 units of working capital.

V.5. RECEIVABLES MANAGEMENT

Receivables or debtors are the one of the most important parts of the current assets which is

created if the company sells the finished goods to the customer on credit. Trade credit arises

when firm sells its products and services on credit and does not receive cash immediately. It

is essential marketing tool, acting as bridge for the movement of goods through production

and distribution stages to customers. Trade credit creates receivables or book debts which the

firm is expected to collect in the near future. The receivables include three characteristics:

It involve element of risk which should be carefully analyzed

69

It is based on economic value. To the buyer, the economic value in goods or services

passes immediately at the time of sale, while seller expects an equivalent value to be

received later on

It implies futurity. The cash payment for goods or serves received by the buyer will be

made by him in a future period.

The sales of goods on credit basis are an essential part of the modern competitive economic

system. The credit sales are generally made up on account in the sense that there are formal

acknowledgements of debt obligation through a financial instrument. As a marketing tool,

they are intended to promote sales and there by profit. However extension of credit involves

risk and cost, management should weigh the benefit as well as cost to determine the goal of

receivable management. Thus the objective of receivable management is to promote sales

and profit until that point is reached where the return on investment in further funding of

receivables is less than the cost of funds raised to finance that additional credit.

Table 5.12 – Size of Receivables

Year 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10

Account Receivables

(Rs. Crores) 435.06 824.47 1218.42 789.29 942.76 932.71

Variation (Base 2005) 100 189.507 280.058 181.421 216.697 214.387

Yearly Growth - 89.51% 47.78% -35.22% 19.44% -1.07%

Index = 100 * (Index Year Amount / Base Year Amount)

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Chart 5.9 – Receivable Index

We can observe from the table that the accounts receivable has increased by around twice

from 2005 to 2010. For the last two years the accounts receivables have been pretty stable.

This shows that NFL has a good credit policy and collection process. This also shows the

reliability of their customers of paying in time.

NFL receives its receivable through its customers and the government in the form of subsidy.

Subsidy in PSUs forms a major part of their turnover. A subsidy (also known as a

subvention) is a form of financial assistance paid to a business or economic sector. Most

subsidies are made by the government to producers or distributors in an industry to prevent

the decline of that industry (e.g., as a result of continuous unprofitable operations) or an

increase in the prices of its products or simply to encourage it to hire more labor (as in the

case of a wage subsidy). For the fertilizer industry the government allocates a subsidy

amount in their budget. And this subsidy is then distributed among the fertilizer companies

based on their production.

Table 5.13 – Size of Subsidy

Year 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10

Subsidy 1748 1957 2217 2518 3444 3396

Turnover 3474 3591 3866 4114 5127 5091

Percent share of Subsidy 50.32% 54.50% 57.35% 61.21% 67.17% 66.71%

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in Turnover

As we can see above that the size of subsidy has been more than 50 percent and in the year

2010, it was as high as 66.71 percent. This clearly shows how much of subsidy is provided

by the government to control the price of fertilizers in India.

Average Collection Period

The average collection period measures the quality of debtors since it indicate the speed of

their collection. The shorter the average collection period, the better the quality of the debtors

since a short collection period implies the prompt payment by debtors. The average

collection period should be compared against the firm’s credit terms and policy judges its

credit and collection efficiency. The collection period ratio thus helps an analyst in two

respects. In determining the payment ability of debtors and thus the efficiency of collection

efforts. Secondly in ascertaining the firm’s comparative strength and advantages related to its

credit policy and performance. The debtor’s turnover ratio can be transformed in to the

number of days of holding of debtors.

Table 5.14 – Average Collection Period

Year 2005-06 2006-07 2007-08 2008-09 2009-10

Account Receivables Turnover 5.70 3.78 4.12 5.92 5.43

Account Receivables Period (days) 64.02 96.45 88.49 61.65 67.23

From the observation we can see that on an average the account receivable is around 2

months. This is mainly for the reason that subsidy from government is received with a delay

of 3 months and the daily sales payment is received within a period of 30 days. This 2

months of receivable period is considered to be good, which in turn tells us the effectiveness

of the collection and credit policy of the company.

NFL provides credit based on its credit policies set by the top management. The time limit

for the payment without any penalty is 30 days and a penalty interest is lewd on the amount,

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which is around 2 percent above bank rate. Also company provides discounts to customers

who pay early. The discount is given on the rate of Rs. 1.2 per day of early payment.

V.6. INVENTORY MANAGEMENT

Inventory management is primarily about specifying the size and placement of stocked

goods. Inventory management is required at different locations within a facility or within

multiple locations of a supply network to protect the regular and planned course of

production against the random disturbance of running out of materials or goods. The scope of

inventory management also concerns the fine lines between replenishment lead time,

carrying costs of inventory, asset management, inventory forecasting, inventory valuation,

inventory visibility, future inventory price forecasting, physical inventory, available physical

space for inventory, quality management, replenishment, returns and defective goods and

demand forecasting. Balancing these competing requirements leads to optimal inventory

levels, which is an on-going process as the business needs shift and react to the wider

environment.

Inventory management involves a retailer seeking to acquire and maintain a proper

merchandise assortment while ordering, shipping, handling, and related costs are kept in

check.

Systems and processes that identify inventory requirements, set targets, provide

replenishment techniques and report actual and projected inventory status.

Handles all functions related to the tracking and management of material. This would

include the monitoring of material moved into and out of stockroom locations and the

reconciling of the inventory balances. Also may include ABC analysis, lot tracking, cycle

counting support etc.

Management of the inventories with the primary objective of determining/controlling

stock levels within the physical distribution function to balance the need for product

availability against the need for minimizing stock holding and handling costs.

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The term inventory is used to designate the aggregate of those items of tangible assets which

are Finished goods (saleable), Work-in-progress (convertible) and Material and supplies

(consumable).

In financial view, inventory defined as the sum of the value of raw material and supplies,

including spares, semi-processed material or work in progress and finished goods. The nature

of inventory is largely depending upon the type of operation carried on. For instance, in the

case of a manufacturing concern, the inventory will generally comprise all three groups

mentioned above while in the case of a trading concern, it will simply be by stock- in- trade

or finished goods.

In company there should be an optimum level of investment for any asset, whether it is plant,

cash or inventories. Again inadequate disrupts production and causes losses in sales. Efficient

management of inventory should ultimately result in wealth maximization of owner’s wealth.

It implies that while the management should try to pursue financial objective of turning

inventory as quickly as possible, it should at the same time ensure sufficient inventories to

satisfy production and sales demand. The objectives of inventory management consist of two

counterbalancing parts. Firstly to minimize the firm’s investment in inventory and secondly

to meet a demand for the product by efficiently organizing the firms production and sales

operation.

This two conflicting objective of inventory management can also be expressed in term of cost

and benefits associated with inventory. That the firm should minimize the investment in

inventory implies that maintaining an inventory cost, such that smaller the inventory, the

better the view point obviously, the financial manager should aim at a level of inventory

which will reconcile these conflicting elements. Some objectives are as follows:

To have stock available as and when they are required.

To utilize available storage space but prevents stock levels from exceeding space

available.

To maintain adequate accountability of inventories assets.

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To provide, on item – by- item basis, for re-order point and order such quantity as would

ensure that the aggregate result confirm with the constraint and objective of inventory

control.

Table 5.15 – Size of Inventory

Year 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10

Inventory (Rs. Crores) 350.84 324.49 348.2 381.03 348.68 347.12

Variation (Base 2005) 100 92.4895 99.2475 108.605 99.3843 98.9397

Yearly Growth - -7.51% 7.31% 9.43% -8.49% -0.45%

Index = 100 * (Index Year Amount / Base Year Amount)

Chart 5.10 – Inventory Index

We can see that the inventory has remained newly the same for the last six years. This is

mainly because there has been no change in the production capacity of the plants. The minor

variations that are visible are mainly because of the varying prices of petroleum products.

Inventory Holding Period

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The reciprocal of inventory turnover gives average inventory holding in percentage term.

When the numbers of days in year are divided by inventory turnover, we obtain Days of

Inventory Holding (DIH).

Inventory management involves a retailer seeking to acquire and maintain a proper

merchandise assortment while ordering, shipping, handling, and related costs are kept in

check. Systems and processes that identify inventory requirements, set targets, provide

replenishment techniques and report actual and projected inventory status.

Number of Days Inventory = 365 days / Inventory Turnover Ratio

The number of day’s inventory is also known as average inventory period and inventory

holding period. A high number of days inventory indicates that, there is a lack of demand for

the product being sold. A low days inventory ratio (inventory holding period) may indicate

that the company is not keeping enough stock on hand to meet demands. The number of days

inventory and inventory turnover ratios are included in the financial statement ratio analysis

spreadsheets highlighted in the left column, which provide formulas, definitions, calculation,

charts and explanations of each ratio.

Table 5.16 – Inventory Holding Period

Year 2005-06 2006-07 2007-08 2008-09 2009-10

Inventory Turnover 10.63 11.49 11.36 14.05 14.63

Inventory Period (days) 34.33 31.76 32.14 25.97 24.94

The table shows that on an average, NFL holds 25 days of inventory at a time. It can be seen

that over the years, inventory period has been reducing, which is a good sign. It shows that

NFL is improving its inventory management. This period is on the higher side because of the

usage of coal at its units (except Vijaipur). This value will reduce drastically once all the

other units will be up-graded to gas units.

NFL has an excellent monitoring system of inventory monitoring. The different units send

monthly inventory reports of corporate office for records and maintenance. Where they are

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analyzed for any discrepancies and immediately corrected. The document used are material

receipt notes, daily transfer register, issue slips, stock ledgers etc.

Rarely in case of raw materials there is delay in supply and if then any contingency plan is

prepared and the problem is eliminated quickly. There is hardly any damage to the finished

goods but still there may be some damage as the goods are hygroscopic in nature and the

damage is 1 to 1.5 percent of the total product which is negligible. All the stocks of NFL are

hypothecated to bank so that bank can finance the requirements. Sometimes problem of stock

out arises in case of coal, which get moist and wet during transit but these problems are not

that acute to hamper the production process.

V.7. CASH MANAGEMENT

Cash is money that is easily accessible either in the bank or in the business. It is not

inventory, it is not accounts receivable, and it is not property. These might be converted to

cash at some point in time, but it takes cash on hand or in the bank to pay suppliers, to pay

the rent, and to meet the payroll. Profit growth does not always mean more cash.

Profit is the amount of money you expect to make if all customers paid on time and if your

expenses were spread out evenly over the time period being measured. However, it is not

your day-to-day reality. Cash is what you must have to keep the doors of your business open.

Over time, a company's profits are of little value if they are not accompanied by positive net

cash flow. You can't spend profit; you can only spend cash.

Cash Flow refers to the flow of cash into and out of a business over a period of time. The

outflow of cash is measured by the money you pay every month to salaries, suppliers, and

creditors. The inflows are the cash you receive from customers, lenders, and investors.

Positive Cash Flow

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If the cash coming into the business is more than the cash going out of the business, the

company has a positive cash flow. A positive cash flow is very good and the only concern

here is managing the excess cash prudently.

Negative Cash Flow

If the cash going out of the business is more than the cash coming into the business, the

company has a negative cash flow. A negative cash flow can be caused by a number of

problems that result in a shortage of cash, such as too much or obsolete inventory, or poor

collections on accounts receivable. If the company doesn't have money in the bank or can't

borrow additional cash at this point, it may be in serious trouble.

A Cash Flow Statement is typically divided into three components so that you can see and

understand both the internal and external sources and uses of cash.

Operating Cash Flow (Internal)

Operating cash flow, often referred to as working capital, is the cash flow generated from

internal operations. It is the cash generated from sales of the product or service of your

business. Because it is generated internally, it is under your control.

Investing Cash Flow (Internal)

Investing cash flow is generated internally from non-operating activities. This component

would include investments in plant and equipment or other fixed assets, nonrecurring gains

or losses, or other sources and uses of cash outside of normal operations.

Financing Cash Flow (External)

Financing cash flow is the cash to and from external sources, such as lenders, investors and

shareholders. A new loan, the repayment of a loan, the issuance of stock and the payment of

dividend are some of the activities that would be included in this section of the cash flow

statement.

Knowing when, where, and how your cash needs will occur, Knowing what the best sources

are for meeting additional cash needs; and, Being prepared to meet these needs when they

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occur, by keeping good relationships with bankers and other creditors. Daily cash, and Long-

term (annual, 3-5 years) cash flow projections to help firms to develop the necessary capital

strategy to meet their business needs. They also prepare and use historical cash flow

statements to gain an understanding about where all the money went.

Cash flows are somewhat unpredictable, with the degree of predictability varying among

firms and industries. Unexpected cash needs at a short notice may also be the result of

following:

Uncontrollable circumstances such as strike and natural calamities.

Unexpected delay in collection of trade dues.

Cancellation of some order for goods due unsatisfactory quality.

Increase in cost of raw material, rise in wages, etc.

The higher the predictability of firm’s cash flows; the lower will be the necessity of holding

this balance and vice versa. The need for holding the precautionary cash balance is also

influenced by the firm’s capacity to have short term borrowed funds and also to convert short

term marketable securities into cash.

Cash does not enter in to the profit and loss account of an enterprise, hence cash is neither

profit nor losses but without cash, profit remains meaningless for an enterprise owner.

A sufficient amount of cash can keep an unsuccessful firm going despite losses.

An efficient cash management through a relevant and timely cash budget may enable a

firm to obtain optimum working capital and ease the strains of cash shortage, fascinating

temporary investment of cash and providing funds normal growth.

Cash management involves balance sheet changes and other cash flow that do not appear

in the profit and loss account such as capital expenditure.

Cash Management in PSUs

PSUs have come of age and have function like other business systems. They must ensure that

they have an effective bottom line. Globalization of Indian economy necessitates these

enterprises to be sound in terms of profitability and EPS. The management of working capital

is a vital element in PSUs. The board of directors in the case of each PSU is expected to

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determine the reasonable level of working capital, and reviewing the position from time to

time to ensure that the total investment in working capital is kept as low as possible. PSUs

can approach SBI or any other nationalized bank to finance their working capital

requirement. The requirement can be met by one bank or through consortium of banks. To

hedge risk, generally a single bank alone doesn’t provide the whole required working capital.

Whenever the total requirement of working capital cannot be met by banks alone, the PSUs

may approach the government for short term loans.

Cash Management in NFL

In NFL sales are made through zonal offices and cheques collected from regional offices are

deposited in their accounts. From these accounts at the end of the day, a sweep is done and

the funds from all the zonal offices are moved to the sweep account at the corporate office

bank account. From the sweep account the funds are transpired to the principal account or the

cash credit account on a daily basis. This cash credit account is used to make payments.

Similarly every plant has its own cash credit account with a limit of 2 crores. Daily funds for

their daily expenses are sent everyday from the corporate cash credit account. Another thing

to be noted is that, the corporate office tries to keep a minimum balance of only 2 lacs. This

is mainly for the corporate office expenses. If excess cash is available with the company, the

finance department tries to determine if the excess cash will be needed in the near future. If

not, it’s used to create a fixed deposit for a minimum of 7 days. This is done after a tradeoff

calculation is done. This means that if the excess cash that the company has should be kept

idle or a FD should be created is decided by looking at the rates. Say for example that the

company has Rs. 100 crore surpluse. The company has an option to create a FD with it. But

before that decision can be made, futuristic need of money is analyzed, which is any expense

that will occur within 7 days period. If a FD is created and then an expense payment date

comes up then the only option for the company is to take money from the cash credit

account, which has high interest rate (11-14 percent), but on the other hand FDs have low

interest rate (6 – 7 percent). So the cash department has to make sure that opening an FD will

not cause the company any losses. So cash department do calculations to check what decision

to make.

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Another important part of the cash management to find funds for its daily operation. The

most common method is to take it from the cash credit account at the time of need. But the

main issue with cash credit account is its high interest rate. So in order to counter it, company

has an option to take WCDL. This WCDL comes at lesser interest rate and is given by the

consortium banks based on the limit they had fixed for the cash credit account.

When NFL has to procure working capital, a board resolution has to be passes to resolve the

cash credit limit of the company to meet the working capital required. The board also decides

upon the following issues of, how much fund to be procured, who will be signed authority

and how power has to be delegated. After resolution is passed, the finance dept will decide

upon the consortium of banks and meet the bank officials. All banks in the consortium have

to sign the agreement shown bellow.

Working Capital Consortium Agreement (CF1)

It’s an agreement between NFL and banks in which working capital facilities given to

meet the working capital needs of borrower is mentioned.

Joint Deed of Hypothecation (CF2)

It is a deed between NFL and banks in which borrower agrees with the terms and

conditions given in the consortium agreement. The borrower agrees to repay each of

banks their principal amount as well as the interest and commission per annum as

mentioned in their consortium agreement.

Inter se Agreement among Consortium Banks

It’s an agreement between consortium banks. In this they choose their lead and second

lead bank. The members agree to abide by the directions given by the lead bank with the

second lead in the matters if cash credit accounts opened by borrower.

Letter regarding the grant of individual limits within the overall limit (CF5)

It is the letter in which the amount given to the borrower is written along with its overall

loan limit, rate of int. and nature of the facility given.

Table 5.17 – Size of Cash

Year 2004-05 2005-06 2006-07 2007-08 2008-09 2009-10

Cash and Bank Balance 133.48 11.83 13.39 161.37 107.6 690.81

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(Rs. Crores)

Cash Index (Base 2005) 100 8.86 10.03 120.89 80.61 517.54

Index = 100 * (Index Year Amount / Base Year Amount)

Chart 5.11 – Cash Index

As seen we can easily deduce that the cash and bank balance of NFL has increased

drastically in the year 2010. This is good signs for NFL as it plans for up-gradation and the

company will be in a better position in the times to come. It also shows the company’s

effectiveness in able to collect the money from its customers.

Cash Conversion Cycle

The cash conversion cycle is simply the duration of time it takes a firm to convert its

activities requiring cash back into cash returns. The cycle is composed of the three main

working capital components: Accounts Receivable Outstanding in days (ARO), Accounts

Payable Outstanding in days (APO) and Inventory in Days (IOD). The Cash Conversion

Cycle (CCC) is equal to the time is takes to sell inventory and collect receivables less the

time it takes to pay your payables.

Cash Conversion Cycle = IOD + ARO – APO

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Cash Cycle is very important, because it represents the number of days a firm's cash remains

tied up within the operations of the business. It is also a powerful tool for assessing how well

a company is managing its working capital. The lower the cash conversion cycle, the more

healthy a company generally is. If you compare the results of the cycle over time and see a

rising trend it is often a warning sign that the business may be facing a cash flow crunch.

When evaluating cash flow, factors directly affecting profit, revenue and expenses, are easy

to understand and their effect on cash is straight forward; decreases in costs or increases in

profit margin results in less cash going out or more cash coming in, and increased profits.

However, the working capital components of the CCC are a little more complex. In simple

terms, an increase in the amount of time accounts receivables are outstanding uses up cash, a

decrease provides cash; an increase in the amount of inventory uses cash, a decrease provides

cash; an increase in the amount of time it takes you to pay your payables provides cash, a

decrease uses cash.

The Operating Cycle consists of 3 phases:

In phase 1, Cash gets converted into inventory. This includes purchase of raw material,

conversion of raw material into work-in-progress, finished goods and finally the transfer of

goods to stock at the end of the manufacturing process. In the case of trading companies, this

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phase is shorter as there would be no manufacturing activity and cash is directly converted

into inventory. This phase is of course totally absent in the case of service organizations.

In phase 2 of the cycle, the inventory is converted into receivables as credit sales are made to

customers. Firms which do not sell on credit obviously don't have the phase 2 of the

operating cycle.

The last phase i.e. phase 3 of the operating cycle, represents the stage when receivables are

collected. This phase completes the operating cycle. Thus, the firm has moved from cash to

inventory, to receivables and to cash again.

Table 5.18 – Cash Cycle (days)

Year 2005-06 2006-07 2007-08 2008-09 2009-10

Inventory Period 34.33 31.76 32.14 25.97 24.94

Account Receivables Period 64.02 96.45 88.49 61.65 67.23

Account Payables Period 42.97 42.25 47.03 42.14 39.56

Cash Cycle 55.37 85.95 73.60 45.49 52.61

V.8. WORKING CAPITAL FINANCE AND ESTIMATION

Corporate finance is an area of finance dealing with financial decisions business enterprises

make and the tools and analysis used to make these decisions. The primary goal of corporate

finance is to maximize corporate value while managing the firm's financial risks. Although it

is in principle, different from managerial finance which studies the financial decisions of all

firms, rather than corporations alone, the main concepts in the study of corporate finance are

applicable to the financial problems of all kinds of firms.

The discipline can be divided into long term and short term decisions and techniques. Capital

investment decisions are long-term choices about which projects receive investment, whether

to finance that investment with equity or debt, and when or whether to pay dividends to

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shareholders. On the other hand, the short term decisions can be grouped under the heading

working capital management. This subject deals with the short term balance of current assets

and current liabilities. The focus here is on managing cash, inventories, and short-term

borrowing and lending (such as the terms on credit extended to customers).

After determine the level of working capital, a firm has to consider how it will finance.

Following are sources of working capital finance:

Trade Credit

Trade credit is an arrangement between businesses to buy goods or services on account, that

is, without making immediate cash payment. The supplier typically provides the customer

with an agreement to bill them later, stipulating a fixed number of days or other date by

which the customer should pay. It can be viewed as an essential element of capitalization in

an operating business because it can reduce the required capital investment required to

operate the business if it is managed properly. Trade credit is the largest use of capital for a

majority of business to business (B2B) sellers in most of the countries, and is a critical source

of capital for a majority of all businesses.

Bank Financing

Banks are main institutional source of working capital finance in India. After trade credit,

bank credit is the most important source of financing working capital in India. A bank

considers a firms sales and production plane and desirable levels of current assets in

determining its working capital requirements. The amount approved by bank for the firm’s

working capital is called credit limit. Credit limit is the maximum funds which a firm can

obtain from the banking system. In practice banks do not lend 100% credit limit, they deduct

margin money.

Forms of Bank Financing:

Overdraft

An overdraft occurs when withdrawals from a bank account exceed the available balance.

In this situation a person is said to be overdrawn. If there is a prior agreement with the

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account provider for an overdraft protection plan, and the amount overdrawn is within

this authorized overdraft limit, then interest is normally charged at the agreed rate. If the

balance exceeds the agreed terms, then fees may be charged and higher interest rate

might apply.

Term Loan

While the four prior debt instruments address cyclical working capital needs, term loans

can finance medium/long term no cyclical working capital. A term loan is a form of

medium/long term debt in which principal is repaid over several years, typically in 3 to 7

years. Since lenders prefer not to bear interest rate risk, term loans usually have a floating

interest rate set between the prime rate and prime plus 300 basis points, depending on the

borrower’s credit risk. Sometimes, a bank will agree to an interest rate cap or fixed rate

loan, but it usually charges a fee or higher interest rate for these features. Term loans

have a fixed repayment schedule that can take several forms. Level principal payments

over the loan term are most common. In this case, the company pays the same principal

amount each month plus interest on the outstanding loan balance.

Cash Credit

In practice, the operations in cash credit facility are similar to those of those of overdraft

facility except the fact that the company need not have a formal current account. Here

also a fixed limit is stipulated beyond which the company is not able to withdraw the

amount.

Under this arrangement a business is authorized to draw cash subject to the limit prefixed

by the bank. Under term loan where full amount is available to the borrower but in case

of a cash credit a credit limit is put at the companies disposal. This gives the borrower a

lot more flexibility. The business can avail funds to the extent it desires. The interest is

charged only for the amount against the limit. This borrowed money can be returned back

at the borrower convenience. At times cash credit and overdraft are taken to be identical,

but a bank extends cash credit facility to its valued customers on a regular basis for a long

tenure. On the contrary overdraft facility is provided occasionally and for shorter

duration.

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Cash credit approved by board of NFL is Rs. 450 crores, which can be procured from the

consortium of banks. NFL also avails working capital demand loan (WCDL) which is

part of the cash credit limit, but it is provided at a lower interest rate by the banks. NFL

has fund based cash credit limit of Rs. 450 crores for working capital requirement, which

is availed by the company through consortium of several banks. Further with a view to

meet temporary additional shortfalls in the working capital, company is given a padding

of Rs. 100 crores which can be raised through short term loans from banks.

Table 5.19 – Cash Credit

Banks Percent Share

State Bank of India 30%

Oriental Bank of Commerce 14%

Bank of India 23.33%

State Bank of Hyderabad 11.33%

Punjab National Bank 1.11%

State Bank of Patiala 1.11%

Union Bank of India 18.89%

Bank of India, Noida Branch 0.22%

Letter of Credit

A standard, commercial letter of credit is a document issued mostly by a financial institution,

used primarily in trade finance, which usually provides an irrevocable payment undertaking.

The letter of credit can also be source of payment for a transaction, meaning that redeeming

the letter of credit will pay an exporter. Letters of credit are used primarily in international

trade transactions of significant value, for deals between a supplier in one country and a

customer in another. They are also used in the land development process to ensure that

approved public facilities (streets, sidewalks, storm water ponds, etc.) will be built. The

parties to a letter of credit are usually a beneficiary who is to receive the money, the issuing

bank of whom the applicant is a client, and the advising bank of whom the beneficiary is a

client.

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Almost all letters of credit are irrevocable, i.e., cannot be amended or canceled without prior

agreement of the beneficiary, the issuing bank and the confirming bank, if any. In executing

transaction, letters of credit incorporate functions common to General Interbank Recurring

Order and Traveler's cheques. Typically, the documents a beneficiary has to present in order

to receive payment include a commercial invoice, bill of lading, and documents proving the

shipment were insured against loss or damage in transit. However, the list and form of

documents is open to imagination and negotiation and might contain requirements to present

documents issued by a neutral third party evidencing the quality of the goods shipped, or

their place of origin.

VI. SUMMARY

VI.1. FINDINGS

Working capital of the company was increasing and showing positive working capital

each year. It shows good liquidity position.

Positive working capital indicates that company has the ability of payments of short

terms liabilities

Working capital increased because of increment in the cash and bank balance and

reduction is sundry creditors.

Current assets components shows sundry debtors were the major part in current assets it

shows that the efficient receivables collection management.

Inventory period has been continuously going down, which shows better inventory

management by the company.

Study of the cash management of the company shows that company have a good control

on cash management in the year 2010, where cash came from higher profits, and return of

investments.

Cash credit interest is quiet high; as a result money from it is taken as the last resort.

Company has repaid most of its debt and is trying to become a zero debt company. But in

the future because of investments in up-gradation of plants, this will not be a reality.

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NFL is trying to convert non gas plants at Bhatinda, Panipat and Nangal to gas based

plant for which they require loan term loan.

Daily cash report are prepared with the help of which balance funds are analyzed. It gives

the details of funds collected from different sources i.e. marketing FICC, Cash credit and

other short term loans from different consortium banks. It also contains details of funds

transferred to the units and other payment details to IOC, GAIL, Railways, freight,

dividends etc.

Subsidy forms the major part of NFLs turnover. The subsidy bill is submitted to the FICC

which issues NFL with their authorized amount. Since it’s a government agency, special

attention is paid while dealing with it, which needs documents with meticulous precision.

The profitability of the company has a positive relation with the accounts receivable of

the company. This shows that in the Indian fertilizer industry in which most of the

customers are farmers, who are poor, will be happy to see themselves get credit sales.

This brings in more customers and higher sales.

Liquidity of the company is seen to be stable and good. It was also found that liquidity

also has a positive impact on the profitability of the company. The analysis shows us that

with increase in the liquidity of the company the profitability also gets a good lift. It has

to be noted that, high liquidity can also have a bad effect on the company. So the balance

has to be maintained.

Subsidy from government is received from government on an average of 3 months delay,

which can be considered to be very good when compared to the industry standard.

It was also found that the ratios Working Capital Ratio, Acid Test Ratio, Current Assets

to Total Assets Ratio, Inventory Turnover Ratio, Debtors Turnover Ratio and Cash

Turnover Ratio contributed 70 percent of the variations in the profitability of the

company.

Net sales of the company have only 31.6 percent impact on the change of working

capital.

The company tries to save interest on its borrowing by substituting its cash credit loan by

working capital demand loan.

VI.2. RECOMMENDATIONS

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Better credit policies and collection policies can help the company is reducing the

average collection period and also expand on the number of people who can go for credit

purchase and in turn increase the receivables and the customer reach. Company can use

legal ways or through collection agencies to keep a strict check on the defaulters.

NFL has a high inventory holding period, considering that the production is done with

gas and coal. With the conversion of all plants to gas based plant, the company should

strive for a minimum inventory concept, as pipelines are used to provide these plants with

gas continuously.

The D/E ratio of the company is low and it wants to be a zero debt company. But with the

low supply of fertilizer in the Indian market, NFL can use this opportunity to expand its

production and market share in the Indian market, which is the mission of the company.

With a low D/E ratio, company is in a good position to get loans at low interest rate,

which can be a good opportunity of NFL.

Liquidity of the company is good, but can be considered on a little higher side. So

company should try to make use of every opportunity to make use of the available liquid

money for some investments.

Since petroleum products form part of the raw materials, company can use hedging

methods to counter the variation in its prices.

The amount of sundry debtors forms 44 percent of the current assets. Company should

find ways to reduce it and make use of this money for expansion plans which will bring

NFL more sales.

There are various global challenges that are faced by every company n the present

competitive environment and NFL is not any exemption. To face the present global

challenges the human resources department should be develop to improve various skills

among the employees specially the motivational skills and having the regular training for

the employees about various developments in the market.

NFL right now has only three zonal offices – Chandigarh, Lucknow and Bhopal.

Company should try to expand its zones to the south too, as they are also one of the most

farming intensive states.

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Limitations of the Study

Whenever there is a task to be completed, it cannot be perfect because of a lot of constraints

behind its completion. There are lot of areas which are not covered in the project. However I

have tried my best to collect relevant information, yet there are some limitations which are

enumerated below:

It takes a lot of time to understand the working capital of a company but the time frame

of the training was just eight weeks. Still I have tried my best to know much more about

the company.

It was not possible to see the data of the company because of its sensitivity.

Estimates are based upon predictions only.

VI.3. REFERENCES

1. Annual report of National Fertilizers Limited. (From 2000-01 to 2009-10)

2. National Fertilizers Limited, “About Us”, Retrieved April 16, 2011 from

www.nationalfertilizers.com/about.htm

3. National Fertilizers Limited, “Industrial Products”, Retrieved April 16, 2011 from

www.nationalfertilizers.com/indlprod.htm

4. National Fertilizers Limited, “Financial Performance”, Retrieved April 16, 2011 from

www.nationalfertilizers.com/production.htm

5. National Fertilizers Limited, “Major Awards and Recognitions”, Retrieved April 16,

2011 from www.nationalfertilizers.com/awards.htm

6. A. Vijay Kumar & Dr. A. Venkata Chalam (1995), "Working Capital & Profitability -an

empirical analysis", The Management Accountant, October 95, Vol. 30 No.10, pp 748-

50

7. A.Vijay Kumar (2001), Working Capital Management, Northern Book Centre, New

Delhi

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