137729783 Working Capital Management in Steel Industry

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WORKING CAPITAL MANAGEMENT IN STEEL INDUSTRY

INTRODUCTION

Indian steel industry plays a significant role in the countrys economic growth. The major

contribution directs the attention that steel is having a stronghold in the traditional sectors, such

as infrastructure & constructions, automobile, transportation, industrial applications etc. The

liberalization of industrial policy and other initiatives taken by the Government have given a

definite impetus for entry, participation and growth of the private sector in the steel industry.

While the existing units are being modernized/ expanded, a large number of new steel plants

have also come up in different parts of the country based on modern, cost effective, state of-the-

art technologies. In the last few years, the rapid and stable growth of the demand side has also

prompted domestic entrepreneurs to set. At present, crude steel making capacity is 84 mt and

India, the 4th largest producer1 of crude steel in the world, has to its credit, the capability to

produce a variety of grades and that too, of international quality standards up fresh green field

projects in different states of the country. Management of working capital is an important

component of corporate financial management because it directly affects the profitability of the

firms. Net working capital trend is one of the devices for measuring liquidity. Net working

capital trend analysis is highly relevant as it presents the composite reflection of the trend

analysis of current assets and current liabilities. The direction of change in working capital


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position over the period of time is an indication of the effectiveness or ineffectiveness of the

working capital management. The study has been done on the basis of published annual reports

of operating five steel companies in India for a period of six years starting from 2006 and ending

on 2011. Company may have an optimal level of working capital that maximizes their value.

Large inventory and generous trade credit policy may lead to high sales. The larger inventory

also reduces the risk of a stock-out. Trade credit may stimulate sales because it allows a firm to

access product quality before paying. Another component of working capital is accounts

payables delaying payment of accounts payable to suppliers allows firms to access the liquidity.

A popular measure of working capital management is the net operating cycle, that is, the time

span between the expenditure for the purchases of raw materials and the collection of sales of

finished goods. Longer the time lag, the larger the investment in working capital. A long net

operating cycle might increase profitability because it leads to higher sales. However, corporate

profitability might decrease with the net operating cycle, if the costs of higher investment in

working capital rise faster than the benefits of holding more inventories and/or granting more

trade credit to customers. The present work aims to examine the working capital management of

steel companies in India

Current assets minuscurrent liabilities. Workingcapital measures how much inliquid

assets acompany hasavailable to build itsbusiness. Thenumber can bepositive ornegative,depending on how muchdebt the company is carrying. In general,companies that have alot of

working capital will be more successful since they canexpand and improve theiroperations.

Companies withnegative working capital maylack thefunds necessary forgrowth. also

callednet current assets orcurrent capital.

Corporate finance is the area of finance dealing with monetary decisions that business

enterprises make and the tools and analysis used to make these decisions. The primary goal of

corporate finance is to maximize shareholder value.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.
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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

shareholders.On the other hand, short term decisions deal with the short-term balance ofcurrent

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).

The terms corporate finance and corporate financier are also associated with investment

banking.The typical role of aninvestment bank is to evaluate the company's financial needs and

raise the appropriate type of capital that best fits those needs. Thus, the terms corporate finance

and corporate financier may be associated with transactions in which capital is raised in order

to create, develop, grow or acquire businesses

Capital investment decisions are long-term corporate finance decisions relating to fixed assets

and capital structure. Decisions are based on several inter-related criteria. (1) Corporate

management seeks to maximize the value of the firm by investing in projects which yield a

positive net present value when valued using an appropriate discount rate in consideration of

risk.(2) These projects must also be financed appropriately. (3) If no such opportunities exist,

maximizing shareholder value dictates that management must return excess cash to shareholders

(i.e., distribution via dividends). Capital investment decisions thus comprise an investment

decision, a financing decision, and a dividend decision

Management must allocate limited resources between competing opportunities (projects) in a

process known as capital budgeting. Making this investment, or capital allocation, decision

requires estimating the value of each opportunity or project, which is a function of the size,

timing and predictability of future cash flows.

n general,[4]each project's value will be estimated using adiscounted cash flow (DCF) valuation,

and the opportunity with the highest value, as measured by the resultant net present value (NPV)

will be selected (applied to Corporate Finance byJoel Dean in 1951; see alsoFisher separation

theorem,John Burr Williams#Theory). This requires estimating the size and timing of all of the
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incrementalcash flows resulting from the project. Such future cash flows are thendiscounted to

determine theirpresent value(seeTime value of money). These present values are then summed,

and this sum net of the initial investment outlay is theNPV.SeeFinancial modeling.

The NPV is greatly affected by the discount rate.Thus, identifying the proper discount rate

often termed, the project "hurdle rate" is critical to making an appropriate decision. The hurdle

rate is the minimum acceptable return on an investmenti.e. theproject appropriate discount

rate. The hurdle rate should reflect the riskiness of the investment, typically measured by

volatility of cash flows, and must take into account the project-relevant financing mix. [6]

Managers use models such as theCAPM or theAPT to estimate a discount rate appropriate for a

particular project, and use theweighted average cost of capital (WACC) to reflect the financing

mix selected. (A common error in choosing a discount rate for a project is to apply a WACC thatapplies to the entire firm. Such an approach may not be appropriate where the risk of a particular

project differs markedly from that of the firm's existing portfolio of assets.)

In conjunction with NPV, there are several other measures used as (secondary)selection criteria

in corporate finance. These are visible from the DCF and include discounted payback period,

IRR,Modified IRR,equivalent annuity,capital efficiency, andROI.Alternatives (complements)

to NPV includeResidual Income Valuation,MVA /EVA (Joel Stern,Stern Stewart & Co)and

APV (Stewart Myers). Seelist of valuation topics.

n many cases, for exampleR&Dprojects, a project may open (or close) various paths of action

to the company, but this reality will not (typically) be captured in a strict NPV approach .[7]Some

analysts account for this uncertainty by adjusting the discount rate (e.g. by increasing thecost of

capital)or the cash flows (usingcertainty equivalents,or applying (subjective) "haircuts" to the

forecast numbers). Even when employed, however, these latter methods do not normally

properly account for changes in risk over the project's lifecycle and hence fail to appropriately

adapt the risk adjustment. Management will therefore (sometimes) employ tools which place an

explicit value on these options. So, whereas in a DCF valuation the most likely or average or

scenario specific cash flows are discounted, here the flexible and staged nature of the

investment ismodelled,and hence "all" potentialpayoffs are considered. Seefurther underReal
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options valuation.The difference between the two valuations is the "value of flexibility" inherent

in the project.

The two most common tools are Decision Tree Analysis (DTA) and Real options valuation

(ROV); they may often be used interchangeably:

DTA values flexibility by incorporating possible events (or states) and consequentmanagement decisions. (For example, a company would build a factory given that

demand for its product exceeded a certain level during the pilot-phase, and outsource

production otherwise. In turn, given further demand, it would similarly expand the

factory, and maintain it otherwise. In a DCF model, by contrast, there is no "branching"

each scenario must be modelled separately.) In the decision tree, each management

decision in response to an "event" generates a "branch" or "path" which the company

could follow; the probabilities of each event are determined or specified by management.

Once the tree is constructed: (1) "all" possible events and their resultant paths are visible

to management; (2) given this knowledge of the events that could follow, and assuming

rational decision making,management chooses the branches (i.e. actions) corresponding

to the highest value pathprobability weighted;(3) this path is then taken as representative

of project value. SeeDecision theory#Choice under uncertainty.

ROV is usually used when the value of a project iscontingenton thevalueof some otherasset orunderlying variable.(For example, theviability of aminingproject is contingent

on the price ofgold;if the price is too low, management will abandon themining rights,

if sufficiently high, management will develop the ore body. Again, a DCF valuation

would capture only one of these outcomes.) Here: (1) usingfinancial option theory as a

framework, the decision to be taken is identified as corresponding to either acall option

or a put option; (2) an appropriate valuation technique is then employed usually a

variant on the Binomial options model or a bespoke simulation model, while Black

Scholes type formulae are used less often; seeContingent claim valuation.(3) The "true"

value of the project is then the NPV of the "most likely" scenario plus the option value.

(Real options in corporate finance were first discussed by Stewart Myers in 1977;
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viewing corporate strategy as a series of options was originally per Timothy Luehrman,

in the late 1990s.) See alsoOption pricing approaches underBusiness valuation.

Given the uncertainty inherent in project forecasting and valuation,[12][14] analysts willwish to assess thesensitivityof project NPV to the various inputs (i.e. assumptions) to the

DCF model. In a typical sensitivity analysis the analyst will vary one key factor while

holding all other inputs constant,ceteris paribus.The sensitivity of NPV to a change in

that factor is then observed, and is calculated as a "slope": NPV / factor. For example,

the analyst will determine NPV at various growth rates in annual revenue as specified

(usually at set increments, e.g. -10%, -5%, 0%, 5%....), and then determine the sensitivity

using this formula. Often, several variables may be of interest, and their various

combinations produce a "value-surface",[15](or even a "value-space",) where NPV is then

afunction of several variables.See alsoStress testing.

Using a related technique, analysts also run scenario based forecasts of NPV. Here, ascenario comprises a particular outcome for economy-wide, "global" factors (demand for

the product, exchange rates, commodity prices, etc...) as well as for company-specific

factors (unit costs,etc...). As an example, the analyst may specify various revenue growth

scenarios (e.g. 0% for "Worst Case", 10% for "Likely Case" and 20% for "Best Case"),

where all key inputs are adjusted so as to be consistent with the growth assumptions, and

calculate the NPV for each. Note that for scenario based analysis, the variouscombinations of inputs must be internally consistent (see discussion at Financial

modeling), whereas for the sensitivity approach these need not be so. An application of

this methodology is to determine an "unbiased"NPV, where management determines a

(subjective) probability for each scenario the NPV for the project is then the

probability-weighted average of the various scenarios. SeeFirst Chicago Method.

A further advancement which "overcomes the limitations of sensitivity and scenarioanalyses by examining the effects of all possible combinations of variables and their

realizations." [16] is to construct stochastic[17] or probabilistic financial models as

opposed to the traditional static and deterministic models as above.[14]For this purpose,

the most common method is to useMonte Carlo simulation to analyze the projects NPV.

This method was introduced to finance by David B. Hertz in 1964, although has only

recently become widespread. (Risk-analysis add-ins, such as @Risk or Crystal Ball,
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allow analysts to run simulations in spreadsheet based DCF models, whereas before

these, some knowledge ofprogramming was required.). Here, the cash flow components

that are (heavily) impacted by uncertainty are simulated, mathematically reflecting their

"random characteristics". In contrast to the scenario approach above, the simulation

produces several thousand random but possible outcomes, or trials, "covering all

conceivable real world contingencies in proportion to their likelihood;" [18] see Monte

Carlo Simulation versus What If Scenarios.The output is then a histogram of project

NPV, and the average NPV of the potential investmentas well as itsvolatility and other

sensitivitiesis then observed. This histogram provides information not visible from the

static DCF: for example, it allows for an estimate of the probability that a project has a

net present value greater than zero (or any other value).

Continuing the above example; instead of assigning three discrete values to revenuegrowth, and to the other relevant variables, the analyst would assign an appropriate

probability distribution to each variable (commonly triangular or beta), and, where

possible, specify the observed or supposed correlation between the variables. These

distributions would then be "sampled" repeatedly incorporating this correlationso as

to generate several thousand random but possible scenarios, with corresponding

valuations, which are then used to generate the NPV histogram. The resultant statistics

(average NPV and standard deviation of NPV) will be a more accurate mirror of theproject's "randomness" than the variance observed under the scenario based approach.

These are often used as estimates of theunderlying "spot price"and volatility for the real

option valuation as above; seeReal options valuation: Valuation inputs.A more robust

Monte Carlo model would include the possible occurrence of risk events (e.g., a credit

crunch)that drive variations in one or more of the DCF model inputs.

Working capital(abbreviated WC) is a financial metric which representsoperating

liquidityavailable to a business, organization or other entity, including governmental entity.

Along with fixed assets such as plant and equipment, working capital is considered a part of

operating capital. Net working capital is calculated ascurrent assets minuscurrent liabilities.It is
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a derivation of working capital, that is commonly used in valuation techniques such as DCFs

(Discounted cash flows). If current assets are less than current liabilities, an entity has a working

capital deficiency, also called a working capital deficit.

A company can be endowed withassets andprofitabilitybut short ofliquidity if its assets cannotreadily be converted into cash. Positive working capital is required to ensure that a firm is able to

continue its operations and that it has sufficient funds to satisfy both maturingshort-term debtand

upcoming operational expenses. The management of working capital involves managing

inventories, accounts receivable and payable, and cash.

OBJECTIVE

To study the structure of the working capital of selected steel companies.

2. To study the management of working capital components by steel companies

3. To know the comparative position of steel companies in working capital management.

Every business needs some amount of working capital. It is needed for following purposes-

For the purchase of raw materials, components and spares.

To pay wages and salaries.

To incur day to day expenses and overhead costs such as fuel, power, and o ffice expenses etc.

To provide credit facilities to customers etc.

Factors that determine working capital:

The working capital requirement of a concern depend upon a large number of factors such as

? Size of business

? Nature of character of business.
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? Seasonal variations working capital cycle

? Operating efficiency

? Profit level.

? Other factors.

Achieving the goals of corporate finance requires that any corporate investment be financed

appropriately. The sources of financing are, generically, capital self-generated by the firm and

capital from external funders, obtained by issuing new debt and equity (and hybrid- or

convertible securities). As above, since both hurdle rate and cash flows (and hence the riskiness

of the firm) will be affected, the financing mix will impact the valuation of the firm (as well as

the other long-term financial management decisions). There are two interrelated considerations

here:

Management must identify the "optimal mix" of financingthe capital structure thatresults in maximum firm value. (SeeBalance sheet,WACC,Fisher separation theorem;

but, see also theModigliani-Miller theorem.) Financing a project through debt results in a

liability or obligation that must be serviced, thus entailing cash flow implications

independent of the project's degree of success. Equity financing is less risky with respect

to cash flow commitments, but results in a dilution of share ownership, control and

earnings. Thecost of equity(seeCAPM andAPT)is also typically higher than thecost of

debt- which is, additionally, adeductible expense - and so equity financing may result in

an increased hurdle rate which may offset any reduction in cash flow risk.
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Management must attempt to match the long-term financing mix to the assets beingfinanced as closely as possible, in terms of both timing and cash flows. Managing any

potential asset liability mismatch or duration gap entails matching the assets and

liabilities respectively according to maturity pattern ("Cashflow matching") or duration

("immunization"); managing this relationship in the short-term is a major function of

working capital management, as discussed below. Other techniques, such as

securitization,orhedging usinginterest rate- orcredit derivatives,are also common. See

Asset liability management;Treasury management;Credit risk;Interest rate risk.

Much of the theory here, falls under the umbrella of the Trade-Off Theory in which firms are

assumed to trade-off thetax benefits of debt with thebankruptcy costs of debt when making their

decisions. However economists have developed a set of alternative theories about financing

decisions. One of the main alternative theories of how firms make their financing decisions is the

Pecking Order Theory (Stewart Myers), which suggests that firms avoidexternal financing while

they haveinternal financing available and avoid new equity financing while they can engage in

new debt financing at reasonably low interest rates.Also, Capital structure substitution theory

hypothesizes that management manipulates the capital structure such that earnings per share

(EPS) are maximized. An emerging area in finance theory isright-financing whereby investment

banks and corporations can enhance investment return and company value over time by

determining the right investment objectives, policy framework, institutional structure, source of

financing (debt or equity) and expenditure framework within a given economy and under given

market conditions. One of the more recent innovations in this are from a theoretical point of view

is the Market timing hypothesis.This hypothesis, inspired in the behavioral finance literature,
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states that firms look for the cheaper type of financing regardless of their current levels of

internal resources, debt and equity.

Whether to issue dividends, and what amount, is calculated mainly on the basis of the company's

unappropriatedprofit and its earning prospects for the coming year. The amount is also often

calculated based on expectedfree cash flowsi.e. cash remaining after all business expenses, and

capital investment needs have been met.

If there are no NPV positive opportunities, i.e. projects wherereturns exceed the hurdle rate, then

finance theory suggests management must return excess cash to shareholders as dividends.

This is the general case, however there are exceptions. For example, shareholders of a "growth

stock", expect that the company will, almost by definition, retain earnings so as to fund growth

internally. In other cases, even though an opportunity is currently NPV negative, management

may consider investment flexibility / potential payoffs and decide to retain cash flows; see

above andReal options.

Management must also decide on the form of the dividend distribution, generally as cash

dividends or via a share buyback. Various factors may be taken into consideration: where

shareholders must paytax on dividends,firms may elect to retain earnings or to perform a stock

buyback, in both cases increasing the value of shares outstanding. Alternatively, some companies

will pay "dividends" fromstock rather than in cash; seeCorporate action.Today, it is generally

accepted that dividend policy is value neutral i.e. the value of the firm would be the same,

whether it issued cash dividends or repurchased its stock (seeModigliani-Miller theorem).
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Decisions relating toworking capital and short term financing are referred to as working capital

management. These involve managing the relationship between a firm'sshort-term assets and its

short-term liabilities.In general this is as follows: As above, the goal of Corporate Finance is the

maximization of firm value. In the context of long term, capital investment decisions, firm value

is enhanced through appropriately selecting and funding NPV positive investments. These

investments, in turn, have implications in terms of cash flow and cost of capital. The goal of

Working Capital (i.e. short term) management is therefore to ensure that the firm is able to

operate, and that it has sufficient cash flow to service long term debt, and to satisfy both

maturing short-term debt and upcoming operational expenses. In so doing, firm value is

enhanced when, and if, the return on capital exceeds the cost of capital; See Economic value

added (EVA). Managing short term finance and long term finance is one task of a modern CFO.

Decision criteria

Working capital is the amount of capital which is readily available to an organization. That is,

working capital is the difference between resources in cash or readily convertible into cash

(Current Assets), and cash requirements (Current Liabilities). As a result, the decisions relating

to working capital are always current, i.e. short term, decisions. In addition to time horizon,

working capital decisions differ from capital investment decisions in terms of discounting and

profitability considerations; they are also "reversible" to some extent. (Considerations as toRisk

appetite and return targets remain identical, although some constraints such as those imposed

byloan covenantsmay be more relevant here).

Working capital management decisions are therefore not taken on the same basis as long term

decisions, and working capital management applies different criteria in decision making: the
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main considerations are (1) cash flow / liquidity and (2) profitability / return on capital (of which

cash flow is probably the most important).

The most widely used measure of cash flow is the net operating cycle, orcash conversion

cycle.This represents the time difference between cash payment for raw materials and

cash collection for sales. The cash conversion cycle indicates the firm's ability to convert

its resources into cash. Because this number effectively corresponds to the time that the

firm's cash is tied up in operations and unavailable for other activities, management

generally aims at a low net count. (Another measure is gross operating cycle which is the

same as net operating cycle except that it does not take into account the creditors deferral

period.)

In this context, the most useful measure of profitability isReturn on capital (ROC). Theresult is shown as a percentage, determined by dividing relevant income for the 12

months by capital employed; Return on equity (ROE) shows this result for the firm's

shareholders. As above, firm value is enhanced when, and if, the return on capital,

exceeds thecost of capital.ROC measures are therefore useful as a management tool, in

that they link short-term policy with long-term decision making.

Management of working capital

Guided by the above criteria, management will use a combination of policies and techniques for

the management of working capital.[24] These policies aim at managing the current assets

(generallycash andcash equivalents,inventories anddebtors)and the short term financing, such

that cash flows and returns are acceptable.
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Cash management.Identify the cash balance which allows for the business to meet dayto day expenses, but reduces cash holding costs.

Inventory management.Identify the level of inventory which allows for uninterruptedproduction but reduces the investment in raw materials and minimizes reordering costs

and hence increases cash flow. Note that "inventory" is usually the realm ofoperations

management: given the potential impact on cash flow, and on the balance sheet in

general, finance typically "gets involved in an oversight or policing way".[25]:714 See

Supply chain management; Just In Time (JIT); Economic order quantity (EOQ);

Dynamic lot size model;Economic production quantity (EPQ);Economic Lot Scheduling

Problem;Inventory control problem;Safety stock.

Debtors management. There are two inter-related roles here: Identify the appropriatecredit policy,i.e. credit terms which will attract customers, such that any impact on cash

flows and the cash conversion cycle will be offset by increased revenue and hence Return

on Capital (or vice versa); seeDiscounts and allowances.Implement appropriateCredit

scoring policies and techniques such that the risk of default on any new business is

acceptable given these criteria.

Short term financing. Identify the appropriate source of financing, given the cashconversion cycle: the inventory is ideally financed by credit granted by the supplier;

however, it may be necessary to utilize a bankloan (or overdraft), or to "convert debtors

to cash" through "factoring".

Relationship with other areas in finance
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Investment banking

Use of the term corporate finance varies considerably across the world. In theUnited States it

is used, as above, to describe activities, decisions and techniques that deal with many aspects of a

companys finances and capital. In theUnited Kingdom andCommonwealth countries, the terms

corporate finance and corporate financier tend to be associated with investment banking

i.e. with transactions in which capital is raised for the corporation.[26]These may include

Raising seed, start-up, development or expansion capital

Mergers, demergers, acquisitions or the sale of private companies

Mergers, demergers and takeovers of public companies, including public-to-private deals Management buy-out, buy-in or similar of companies, divisions or subsidiaries

typically backed by private equity

Equity issues by companies, including the flotation of companies on a recognised stockexchange in order to raise capital for development and/or to restructure ownership

Raising capital via the issue of other forms of equity, debt and related securities for therefinancing and restructuring of businesses

Financing joint ventures, project finance, infrastructure finance, public-privatepartnerships and privatisations

Secondary equity issues, whether by means of private placing or further issues on a stock

market, especially where linked to one of the transactions listed above.

Raising debt and restructuring debt, especially when linked to the types of transactionslisted above
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Financial risk management

Main article:Financial risk management

See also:Credit risk;Default (finance);Financial risk;Interest rate risk;Liquidity risk;

Operational risk;Settlement risk;Value at Risk;Volatility risk.

Risk management is the process of measuring risk and then developing and implementing

strategies to manage ("hedge") that risk.Financial risk management,typically, is focused on the

impact on corporate value due to adverse changes in commodity prices, interest rates, foreign

exchange rates andstock prices (market risk). It will also play an important role in short term

cash- and treasury management; see above. It is common for large corporations to have risk

management teams; often these overlap with theinternal audit function. While it is impractical

for small firms to have a formal risk management function, many still apply risk management

informally. See alsoEnterprise risk management.

The discipline typically focuses on risks that can be hedged using tradedfinancial instruments,

typically derivatives; see Cash flow hedge, Foreign exchange hedge, Financial engineering.

Because company specific, "over the counter" (OTC)contracts tend to be costly to create and

monitor, derivatives that trade on well-established financial markets or exchanges are often

preferred. These standard derivative instruments include options, futures contracts, forward

contracts, and swaps; the "second generation" exotic derivatives usually trade OTC. Note that

hedging-related transactions will attract their ownaccounting treatment: seeHedge accounting,

Mark-to-market accounting,FASB 133,IAS 39.
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This area is related to corporate finance in two ways. Firstly, firm exposure to business and

market risk is a direct result of previous Investment and Financing decisions. Secondly, both

disciplines share the goal of enhancing, or preserving, firmvalue.There is a fundamental debate

[28] relating to "Risk Management" and shareholder value. Per the Modigliani and Miller

framework, hedging is irrelevant since diversified shareholders are assumed to not care about

firm-specific risks, whereas, on the other hand hedging is seen to create value in that it reduces

the probability of financial distress. A further question, is the shareholder's desire to optimize

risk versus taking exposure to pure risk (a risk event that only has a negative side, such as loss of

life or limb). The debate links the value of risk management in a market to the cost of bankruptcy

in that market. SeeFisher separation theorem.

Personal and public finance

Corporate finance utilizes tools from almost all areas of finance. Some of the tools developed by

and for corporations have broad application to entities other than corporations, for example, to

partnerships, sole proprietorships, not-for-profit organizations, governments, mutual funds, and

personal wealth management. But in other cases their application is very limited outside of the

corporate finance arena. Because corporations deal in quantities of money much greater than

individuals, the analysis has developed into a discipline of its own. It can be differentiated from

personal finance andpublic finance.

Alternate Approaches

A standard assumption in Corporate finance is that shareholders are the residual claimants and

that the primary goal of executives should be tomaximizeshareholder value.Recently, however,
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legal scholars (e.g. Lynn Stout[29])have questioned this assumption, implying that the assumed

goal of maximizing shareholder value is inappropriate for a public corporation. This criticism in

turn brings into question the advice of corporate finance, particularly related to stock buybacks

made purportedly to "return value to shareholders," which is predicated on a legally erroneous

assumption.

Calculation

Current assets and current liabilitiesinclude three accountswhich are of special importance.

These accounts represent the areas of the business where managers have the most direct impact:

accounts receivable (current asset) inventory (current assets), and accounts payable (current liability)The current portion ofdebt (payable within 12 months) is critical, because it represents a short-

term claim to current assets and is often secured by long term assets. Common types of short-

term debt are bank loans and lines of credit.

An increase in working capital indicates that the business has either increased current assets(that

is has increased its receivables, or other current assets) or has decreased current liabilities,for

examplehas paid off some short-term creditors.

Implications onM&A:The common commercial definition of working capital for the purpose

of a working capital adjustment in an M&A transaction (i.e. for a working capital adjustment

mechanism in a sale and purchase agreement) is equal to:
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Current Assets Current Liabilities excludingdeferred tax assets/liabilities, excess cash, surplus

assets and/or deposit balances.

Cash balance items often attract a one-for-one purchase price adjustment.

Working capital management

Decisions relating to working capital and short term financing are referred to as working capital

management. These involve managing the relationship between a firm'sshort-term assets and

itsshort-term liabilities.The goal of working capital management is to ensure that the firm is

able to continue itsoperations and that it has sufficient cash flow to satisfy both maturing short-

term debt and upcoming operational expenses.

Decision criteria

By definition, working capital management entails short term decisions - generally, relating to

the next one year period - which are "reversible". These decisions are therefore not taken on the

same basis as Capital Investment Decisions (NPV or related, as above) rather they will be based

on cash flows and / or profitability.

One measure of cash flow is provided by thecash conversion cycle - the net number of daysfrom the outlay of cash forraw material to receiving payment from the customer. As a

management tool, this metric makes explicit the inter-relatedness of decisions relating to

inventories, accounts receivable and payable, and cash. Because this number effectively

corresponds to the time that the firm's cash is tied up in operations and unavailable for other

activities, management generally aims at a low net count.
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In this context, the most useful measure of profitability isReturn on capital (ROC). Theresult is shown as a percentage, determined by dividing relevant income for the 12 months

bycapital employed;Return on equity (ROE) shows this result for the firm's shareholders.

Firm value is enhanced when, and if, the return on capital, which results from working

capital management, exceeds thecost of capital, which results from capital investment

decisions as above. ROC measures are therefore useful as a management tool, in that they

link short-term policy with long-term decision making. SeeEconomic value added (EVA).

Credit policy of the firm: Another factor affecting working capital management is credit

policy of the firm. It includes buying of raw material and selling of finished goods either in

cash or on credit. This affects thecash conversion cycle.

Management of working capital

Guided by the above criteria, management will use a combination of policies and techniques for

the management of working capital. These policies aim at managing the current

assets(generallycash andcash equivalents,inventories anddebtors)and the short term financing,

such that cash flows and returns are acceptable.

Cash management.Identify the cash balance which allows for the business to meet day today expenses, but reduces cash holding costs.

Inventory management. Identify the level of inventory which allows for uninterrupted

production but reduces the investment in raw materials - and minimizes reordering costs -

and hence increases cash flow. Besides this, the lead times in production should be lowered

to reduceWork in Progress (WIP) and similarly, theFinished Goodsshould be kept on as low
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level as possible to avoid over production - seeSupply chain management;Just In

Time (JIT);Economic order quantity (EOQ);Economic quantity

Debtors management. Identify the appropriatecredit policy, i.e. credit terms which willattract customers, such that any impact on cash flows and the cash conversion cycle will be

offset by increased revenue and hence Return on Capital (or vice versa); seeDiscounts and

allowances.

Short term financing. Identify the appropriate source of financing, given the cashconversion cycle: the inventory is ideally financed by credit granted by the supplier;

however, it may be necessary to utilize a bankloan (or overdraft), or to "convert debtors to

cash" through "factoring".

Accounts receivable

Accounts receivablealso known as Debtors, is money owed to a business by its clients

(customers) and shown on its Balance Sheet as an asset It is one of a series ofaccounting

transactions dealing with the billing of acustomer forgoods andservices that the customer has

ordered.

Overview

Accounts receivable represents money owed by entities to the firm on the sale of products or

services on credit. In most business entities, accounts receivable is typically executed by

generating aninvoice and either mailing orelectronically delivering it to the customer, who, in
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turn, must pay it within an established timeframe, called credit termsorpayment terms.

The accounts receivable departments use thesales ledger, this is because a sales ledger normally

records[2]:

- The sales a business has made.

- The amount of money received for goods or services.

- The amount of money owed at the end of each month varies (debtors).

The accounts receivable team is in charge of receiving funds on behalf of a company and

applying it towards their current pending balances.

Collections and cashiering teams are part of the accounts receivable department. While the

collection's department seeks the debtor, the cashiering team applies the monies received.

Payment terms

An example of a common payment term isNet 30,which means that payment is due at the end

of 30 days from the date of invoice. Thedebtor is free to pay before the due date; businesses

entities can offer a discount for early payment. Other common payment terms includeNet 45,Net

60and 30 days end of month.

Booking a receivable is accomplished by a simple accounting transaction; however, the process

of maintaining and collecting payments on the accounts receivable subsidiary account balances

can be a full-time proposition. Depending on the industry in practice, accounts receivable

payments can be received up to 1015 days after the due date has been reached. These types of
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payment practices are sometimes developed by industry standards, corporate policy, or because

of the financial condition of the client.

Since not all customer debts will be collected, businesses typically estimate the amount of and

then record anallowance for doubtful accounts[3]which appears on the balance sheet as acontra

account that offsets total accounts receivable. When accounts receivable are not paid, some

companies turn them over to third partycollection agencies or collection attorneys who will

attempt to recover the debt via negotiating payment plans, settlement offers or pursuing other

legal action.

Outstanding advances are part of accounts receivable if a company gets an order from its

customers with payment terms agreed upon in advance. Since billing is done to claim the

advances several times, this area of collectible is not reflected in accounts receivables. Ideally,

since advance payment occurs within a mutually agreed-upon term, it is the responsibility of the

accounts department to periodically take out the statement showing advance collectible and

should be provided to sales & marketing for collection of advances. The payment of accounts

receivable can be protected either by aletter of credit or byTrade Credit Insurance

Accounts Receivable Age Analysis

The Accounts Receivable Age Analysis Printout, also known as the Debtors Book is divided in

categories for current, 30 days, 60 days, 90 days, 120 days, 150 days and 180 days and over due

that are produced in Modern Accounting Systems. The printout is done in the order of the Chart

of Accounts for the Accounts Receivable and/or Debtors Book. The option to include Zero

Balances outstanding or to specifically leave it out is also possible in the printout features.
http://en.wikipedia.org/wiki/Allowance_for_bad_debtshttp://en.wikipedia.org/wiki/Allowance_for_bad_debtshttp://en.wikipedia.org/wiki/Allowance_for_bad_debtshttp://en.wikipedia.org/wiki/Contra_accounthttp://en.wikipedia.org/wiki/Contra_accounthttp://en.wikipedia.org/wiki/Collection_agencyhttp://en.wikipedia.org/wiki/Creditor%27s_rightshttp://en.wikipedia.org/wiki/Letter_of_credithttp://en.wikipedia.org/wiki/Trade_Credit_Insurancehttp://en.wikipedia.org/wiki/Trade_Credit_Insurancehttp://en.wikipedia.org/wiki/Letter_of_credithttp://en.wikipedia.org/wiki/Creditor%27s_rightshttp://en.wiki

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137729783 Working Capital Management in Steel Industry

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