Everything Positive

About

Negative Working Capital:

A Conceptual Analysis of Indian FMCG Sector

A PROJECT REPORT

Submitted By

ARITRIKA PAUL

6TH Semester, B.Com

Roll No.:857

In partial fulfillment for the award of the degree

Of

BACHELOR OF COMMERCE

From

ST. XAVIER’S COLLEGE (AUTONOMUS)

Affiliated to

UNIVERSITY OF CALCUTTA

2013

Under the supervision of

Prof. Saptarshi Roy

1

Bonafide Certificate-

Certificate that this project report titled “Everything Positive About Negative Working

Capital: A Conceptual Analysis of Indian FMCG Sector” is the bonafide record of

independent project work of Ms. ARITRIKA PAUL who carried out the project under

my supervision during January,2013 to March,2013 and submitted to the Department of

Commerce, St.Xavier’s College, affiliated to the University of Calcutta, in partial

fulfillment for the award of the Degree in BACHELORS OF COMMERCE.

Certified further, that to the best of my knowledge the work reported herein does not

form part of any other project report or dissertation or thesis on the basis of which a

degree, fellowship or any award was conferred on an earlier occasion on this or any

other candidate.

Signature of Supervisor

2

Acknowledgement

A Project depends on the contribution from a wide range of people for its success. I

would like to take this opportunity to acknowledge the many people who have

contributed a great deal of their time and expertise to the development of this project.

Firstly, I express my sincere thanks to my project guide, Prof. Saptarshi Roy, for getting

me started and for guiding me through the project. Needless to say, without his

knowledge, guidance and experience this project would not have gone so far.

Secondly, I am thankful to my Institution St.Xavier’s College for providing me with the

dire and rare opportunity to undertake this responsibility of doing such a project. I am

thankful to the principal and Vice Principal of my college.

It was a very good learning experience and would benefit me in future.

Above all I want to thank God for giving me confidence and patience to successfully

complete the project.

3

Abstract

Working capital is important for smooth operation of day to day activities of a

corporate. As working capital is defined as current assets over current liabilities, at the

time of determination of working capital, quality of current assets especially size of

debtors and inventory are important factors. Significance of working capital also

increases, as it is directly associated to the liquidity position of the corporate. However,

in some cases, current assets are lower as compared to current liabilities (known as

negative working capital) then how can a firm manage the level of liquidity. Negative

working capital arises in cash base business, efficient utilization of resources and sound

inventory management etc, which leads to minimum stock of inventory etc., and the

overall impact is lower level of current assets. On the other hand, due to better contract

and negotiations to the creditors and suppliers, they are extending more liberal credit,

which enhances the level of current liabilities. Study of negative working capital is

important to understand the efficiency of the corporate, which enhances the earning

capacity. Concurrently, liquidity is also significant from short term solvency point of

view, which does not exist in case of negative working capital. Keeping these views in

mind, this research article explains the conceptual background of the negative working

capital and how it affects profitability of the corporate. Leading FMCG companies are

taken as a case, to analyze the negative working capital and its impact on the

profitability and earning capacity of the firms. Finally, it is found that companies in

which negative working capital exist, profitability is more and shareholders are getting

more dividend and capital appreciation, which maximizes the shareholders value in the

long run.

Table of contents

4

Chapter No. Title Page No.

5

  Acknowledgement 3  Abstract 4  Table of Contents 5  List of Tables 6  List of Figures 61 Introduction 71.1 Working Capital 71.2 Working Capital & Liquidity 81.3 Negative Working Capital 91.4 Negative Working Capital Creation 112 Research Objective & Methodology 122.1 Objective Of Study 122.2 Research methodology 122.3 Limitation 133 Industry Profile 143.1 Definition of FMCG 143.2 FMCG Industry 153.3 Top Players of the industry 164 Negative Working Capital: Indian FMCG Companies 174.1 Share holder Value creation 184.2 Leveraging supply 195 Hindustan Unilever 215.1 Components of Working Capital 225.2 Net Working Capital And Managerial Efficiency 235.3 Financial Ratio Analysis 266 Nestle India 276.1 Components of Working Capital 286.2 Net Working Capital And Managerial Efficiency 296.3 Financial Ratio Analysis 327 Findings & Recommendations 327.1 Specific Observations 337.2 Recommendations 348 Conclusion 359 References 36

List of Tables and Figures

Table No.

Title Page No.

6

1Current assets of Hul

22

2Net Working Capital of Hul

23

3Inventory, Receivable, Payable Days allowed by Hul

24

4Profitability Trends

25

5Financial Ratios

28

6Current assets of Nestle

28

7Net Working Capital of Nestle

29

8Inventory, Receivable, Payable Days allowed by Nestle

30

9Profitability Trends

31

10Financial Ratios

32

Fig No. Title Page No.

1Current assets of Hul

22

2Net Working Capital of Hul

23

3Inventory, Receivable, Payable Days allowed by Hul

24

4Profitability Trends

25

5Current assets of Nestle

26

6Net Working Capital of Nestle

29

7Inventory, Receivable, Payable Days allowed by Nestle

30

8Profitability Trends

31

7

1. INTRODUCTION

1.1 Working Capital

Working Capital is a measure of both a company's efficiency and its short-term financial health. The working capital ratio is calculated as:

"Working capital, also called net current assets, is the excess of current assets over

current liabilities. All organizations have to carry working capital in one form or the

other. Working capital also gives investors an idea of the company's underlying

operational efficiency. The efficient management of working capital is important from

the point of view of both liquidity and profitability. Poor management of working

capital means that funds are unnecessarily tied up in idle assets, thereby reducing

liquidity and also reducing the ability to invest in productive assets such as plant and

machinery, affecting the profitability"1. The working capital management refers to

management of the working capital, or to be more precise the management of current

assets.

Fig 1: Working Capital Cycle

8

Out of the total BSE 200 companies, 23 have negative working capital — their current

liabilities or payables are higher than current assets or receivables. This essentially

means the companies do not have to deploy their own capital or borrow from banks to

carry out their routine business activities. It is actually very good to have negative

working capital because this entitles companies to earn relatively better returns on

capital and equity. This also shows the operational efficiency of a company. But just

this would not be enough. The companies should also have good fundamentals. Such

companies are preferred by investors as they reward shareholders relatively better. The

BSE 200 companies have an average returns on capital and shareholders’ funds at about

20 per cent, which is far less than the 32-35 per cent returns generated by companies

with negative working capital. More important, the top ten companies with negative

working capital have a dividend payout ratio of 62 per cent, which is far greater than the

average 26 per cent of the BSE 200 companies.

1.2 Working Capital &Liquidity

Liquidity plays a significant role in the successful functioning of a business unit.

Liquidity refers to the ability of a concern to meet its current obligation as and when

these become due. The short-term obligation is met by realizing amounts from current,

floating or circulating assets. The current assets should either be liquid or near liquidity.

These should be convertible in to cash for paying obligations for short-term nature.

Comparing them with short-term liabilities would assess the sufficient or insufficient

current assets. If current assets can pay-off current liabilities, then the liquidity position

will be satisfactory. On the other hand, if current liabilities may not be easily met out of

current assets, then liquidity position will not be satisfactory.

9

1.3 Negative Working Capital

Negative working capital is a reverse situation as compared to normal working capital.

It is a situation in which current assets are lower as compared to current liabilities. A

negative working capital is an indication of managerial efficiency in a business with

low inventory and account receivables. This happens because customer pays in advance

and so quickly, the business enjoys cash transactions; products are delivered and sold to

the customer before the company even pays their suppliers and creditors. Negative

Working capital doesn't always mean bad financial condition; it indicates that most of

the day to day activities are funded by customers rather than company’s own working

capital. Some latest examples are movie theaters -customers are paying first and

distributors are normally paid later on; Schools/ educational institutions- fees

paid in advance by the students annually, whereas faculties are getting salary after one

month. When an organization uses supplier’s credit and customers' advance to fulfill

their day to day needs, leading to a situation of lower or negative working capital.

Banks, financial institutions, distributors, retailers with cash business or advance

payment contract have negative working capital. Normally, when we analyze working

capital, it always refers to normal or positive working capital (excess or current assets

over current liabilities). However, there are certain situations in which working capital

is in negative form (excess of current liabilities over current assets). In that situation,

how can a company manage liquidity with the negative working capital?

10

In modern business, the concept of negative working capital is significant for the

following reasons:

• It indicates operational efficiency of a corporate. That means without or lowers current

assets the firm is managing day to day operations in an efficient manner. Eventually, it

reduces cost of working capital and maximum earnings for the shareholders, which is

the ultimate goal of the financial management.

• Concept of negative working capital is important to analyze liquidity position of

corporate. When current assets are lower than current liabilities, what about the liquidity

position of the corporate, how are they discharging current obligations in the short

period. Traditionally, liquidity ratios are the measurement of liquidity of a firm with the

ideal standard of 2:1. Negative working capital indicates lower cost of working capital

(another way is higher profitability), but at the same time, it indicates poor liquidity

(worried situation for the creditors, etc.) or we can say company is overburdened with

current liabilities, which is not good for any situation

(specially in a period of recession, etc).

• Another important impact of negative working capital is cash recovery or realization

situation. Negative working capital indicates quick realization of cash recourses

(conversion of debtors in to cash) or one can say working capital cycle is shorter (for a

days or maybe less than that). At the same time, payable policy of the company is to

take longer time for payment against creditor. It indicates significant variations in the

credit policy towards supplier’s and customers. To analyze, explain and focus on all

these situations, a study of negative working capital and its impact on

liquidity, profit earning capacity and overall impact on shareholders’ value creation is

important in the contemporary scenario.

11

1.4 Creation of Negative Working Capital

There are many ways to create negative working capital. Most important method is to

minimize the size of current assets with favorable contract and agreement to the

suppliers and other parties (to delay payments) and the same time, try to minimize

credit facilities or maximize cash based business (collection of cash before the

disbursement of actual payments to the various parties). When maximum customers are

paying in advance, low or negative working capital is created. Another way to minimize

the size of current assets is to adopt efficient collection method or brand oriented

collection policy. Many companies are trying to minimize their cash resources with

efficient utilization of funds. Some companies are effectively using ERP system

involving trade partners in planning and monitoring working capital items to reduce the

level of working capital. Efficient cash collection and inventory management system

provides an opportunity to run business with the negative working capital, because most

of the suppliers are granting 30 days credit in general. Companies who are able to

operate and maintain with negative working

capital, have advantages to receive funds without cost as a form of credit from their

suppliers which will enhance ROI in a significant manner. However, no availability of

liquid resources is not a good situation at any time (especially in the stage of growth and

boom).

12

2. Research Objective & Methodology

2.1Objective of studyMuch has been written and studied about working capital management and profitability

of the firm in different industries but this research add some financial insight about this

issue related to the specific companies in the FMCG sector namely- HUL, Nestle..

Similarly, it benefits the top manager and policy makers of these selected companies

regarding decision on optimum level of working capital, ways of managing it and

overall policies on working capital management. And also it gives clear understanding

about the relation between working capital components and corporate profitability.

Besides, the study helps as a guideline for those who conduct their study on similar

topic and it gives brief information for the shareholders, prospective customers and

creditors of a firm regarding profitability in relation to efficient working capital

management and policy. Finally, the study benefits the researcher to obtain new

knowledge about the problem under study and gives clear picture about the discipline

called research.

2.2 RESEARCH METHOD ADOPTEDIn order to achieve the main research objectives quantitative methods have been

adopted. The purpose of using such approach is to gather data that help the researcher to

investigate cause-effect relationships. In this particular case, the effect is the company’s

profitability and the research is targeted at identifying significant causes, i.e.

determinants on profitability related to working capital. A brief explanation about the

data collection and analysis method adopted is given below.

To gather data on working capital component and profitability, it is apparent to use

survey of structured documentary review. Accordingly, to achieve its objective

companies audited financial statement especially balance sheet and income statement

was reviewed. Annual reports were thoroughly seen for all the details and schedules

detailing the various important components such as assets, liabilities, sales, profit etc.

13

Once data were found acceptable, data entry and process was made using Microsoft

EXCEL. Analysis of data was undertaken with the help of ratio calculations and

plotting of graphs.

2.3 LIMITATION

The study is carried on Working Capital Management of FMCG sector only .

A detail study has been performed on Hindustan Unilever Ltd and Nestle India Ltd.

This study is carried on the basis of the data available for the selected companies during

the period 2008-2012. The study is confined to understanding the relationship between

working capital and profitability.

Data of FY 2012of Nestle India could not be obtained.(Press Release-Nestlé Gurgaon,

January 30, 2013 “Nestlé India Ltd has informed BSE that a meeting of the Board of

Directors of the Company will be held on February 20, 2013, inter alia, to consider

audited financial results of the Company for the year ended December 31, 2012 and the

recommendation of final dividend for the year 2012, if any. Consequently, the

Company will not be publishing the un-audited financial results for the fourth quarter

ended December 31, 2012”)

14

3. Industry Profile

3.1 FMCG: DEFINITION

Products which have a quick turnover, and relatively low cost are known as Fast

Moving Consumer Goods (FMCG). FMCG products are those that get replaced within a

year. Examples of FMCG generally include a wide range of frequently purchased

consumer products such as toiletries, soap, cosmetics, tooth cleaning products, shaving

products and detergents, as well as other non-durables such as glassware, bulbs,

batteries, paper products, and plastic goods. FMCG may also include pharmaceuticals,

consumer electronics, packaged food products, soft drinks, tissue paper, and chocolate

bars.

Characteristics Of FMCG Products

They are used at least once a month

They are used directly by the end-consumer

They are non-durable

They are sold in packaged form

They are branded

Industry Segments

15

3.2FMCG Industry

The FMCG sector in India is at present, the

fourth largest sector with a total market size in

excess of USD 13 billion as of 2012. This

sector is expected to grow to a USD 33 billion

industry by 2015 and to a whooping USD 100

billion by the year 2025.

The Indian economy experienced an economic

slowdown with high inflation in fiscal year 2012. However, India’s FMCG Industry was

resilient in face of slowdown with growth in both sales and profitability. The ever

increasing middle class backed by rising per capita income is driving the growth of the

FMCG sector in the country. Moreover the wide distribution network built by erstwhile

major players ensures the high penetration of the FMCG products in rural India as well,

which is home to more than 65% of Indian population. Hence, FMCG is one of the

sectors in the country which has successfully mitigated the rural-urban divide. In the

second half of 2012, consumer confidence remained strong in the Indian market. India

was ranked first along with Indonesia in a consumer confidence index published by

Nielsen. However, inflation was hovering around the 10% mark which prevented the

Reserve Bank of India from initiating any cuts in benchmark interest rate. The

performance of leading players in FMCG sector was above par in the second half with

almost all of them experiencing double digit growths. Their stock prices also saw a

significant appreciation during the course of the year. The outlook for Indian FMCG is

positive because of growing sales, strong financials of leading players and ever

increasing urbanization. Reforms announced in second half of the year like opening of

retail sector to foreign companies will add further to the growth of the sector.

16

3.3Top Players of FMCG Sector:

1. Hindustan Unilever Ltd.

2. ITC (Indian Tobacco Company)

3. Nestlé India

4. GCMMF (AMUL)

5. Dabur India

6. Godrej

7. Cadbury India

8. Britannia Industries

9. Procter & Gamble Hygiene and Health Care

10. Marico Industries

Fig 2: Logos of top FMCG companies in India

4.Negetive Working Capital: Indian FMCG Companies In India, negative working capital is equally popular at par with the global companies

17

such as; McDonald’s and Amazon.com. In India, HUL and Nestlé are the Fast Moving

Consumer Goods (FMCG) companies, having negative working capital for more than

the last ten years. Now the question arises as to how they are managing day to day

operations smoothly without sufficient liquidity. HUL is one of the leading FMCG

companies having sound marketing network, distribution channels and strong brands

which will aid financial benefits over competitors. As other FMCG companies such as,

Britannia, ITC, Colgate, and Dabur, etc. belong to similar business segment mostly

have positive working capital (except few years).Conventionally, the FMCG

Companies are famous for negative working capital due to efficient supply chain

management. This industry has lower level of debtors, which are usually financed by

creditors or suppliers; this situation offers them some gains related to negative working

capital. Another situational gains for FMCG industry is their turnover does not depend\

upon their production (like other Mfg. industry), it depends upon the capability to sales

in the competitive market, therefore maximum resources are utilized for marketing and

promotion of product rather than manufacturing activities, etc. (because most of their

products are manufactured by small companies under contract production agreement).

Similarly development of SCM, ERP and JIT, etc. made effective management of

inventory and resources, which will significantly minimize the size of current assets. In

current assets nearly 50% part is in the form of inventory, but in FMCG companies due

to efficient supply chain management and efficient inventory holding, level of inventory

comes down to significant lower level as compared to other industry (such as

manufacturing). Similarly due to the cash base of business, level of debtors are also

lower which significantly decreases the level of current assets another important change

in the nature of investors is, rational thinking about investment. Nowadays strategic

investors are also focusing on working capital management of a company, because it is

directly associated to earning capacity of the firm. A study of top Indian companies

having higher return on capital employed shows many companies is having negative

working capital.

4.1Share Holders Value Creation

18

Shareholders value creation is the

ultimate agenda for every

corporate. There are two ways to

create value for shareholders

(1)Higher dividend as compared

to other corporate.

(2) Higher value of shares in the

open market (capital appreciation

in the way of higher market

capitalization).

Both these can be obtained by the company with higher profitability or reduced cost of

capital, which will enhance overall efficiency in the day to day operations with the

sound working capital management.

HUL, Nestle and Godrej Consumers Products Ltd have ROCE in excess of 40%.The

success of this high return is associated with the way these companies have managed

their working capital management cycles.

Says Jigar Shah of broking firm KR Choksey: Companies operating in industries like

FMCG and automobiles have been able to manage working capital efficiently and, thus,

create value for shareholders by way of high ROCE.

4.2Leveraging on Supply Chain

19

FMCG companies first sell

their goods and later on pay

their raw material

suppliers. This is possible only

when the companies are huge

in size and account for the bulk

of turnover for their suppliers.

Strong brand loyalty of FMCG

Sector helps them maintain a

low inventory as well as

generate speedy sales. In such a

situation, they are always in a

position to arm-twist the

suppliers by taking more credit.

Thus the products are sold to

the customers and the cash

generated even before the

company pays its suppliers.

The additional cash generated

can be utilized for other purposes. Nestle collects its money from customers in just four

days (average collection period), whereas it pays in 52 days to its raw material

suppliers. HUL, which had a net negative working capital has been able to maintain its

creditor days at 64 as compared to receivable days at 16.  Godrej Consumer Products

(GCPL) is another company with negative working capital maintains creditor days at

53,compared to average debtors of six days only.

20

Says Sunil Sapre, vice-president, finance, Godrej Consumer Products (GCPL):Effective

use of ERP systems, involving trade partners in planning and monitoring working

capital items, following win-win policies, efficient operations at all levels enable GCPL

to manage working capital efficiently. It has given us an advantage of higher sales and

better ROCE.

The strong distribution and dominant position in the FMCG industry has made these

companies to bargain with the debtors and creditors to expand the payment cycle in

favor of the company. The FMCG companies have been able to keep their creditors

almost equal to debtors and inventory, which have resulted in a lot of cash generation

for these companies, which is again invested in the business. These companies also

make investment in short-term papers and call money, which allows them to earn good

returns. Traditionally, the FMCG companies are known for maintaining negative working

capital which is leveraged on strong supply chain management. Since this industry

accounts for very negligible amount of debtors, the whole trade is financed by creditors

from the production side and vendors and dealers from the supply side.

21

HUL is India's largest consumer goods company based in Mumbai, Maharashtra. It is

owned by the British-Dutch company Unilever which controls 52% majority stake in

HUL. Its products include foods, beverages, cleaning agents and personal care products.

HUL was formed in 1933 as Lever Brothers India Limited and came into being in 1956

as Hindustan Lever Limited through a merger of Lever Brothers, Hindustan Vanaspati

Mfg. Co. Ltd. and United Traders Ltd. It is headquartered in Mumbai, India and has

employee strength of over 16,500 employees and contributes to indirect employment of

over 65,000 people. The company was renamed in June 2007 as “Hindustan Unilever

Limited”.

With over 35 brands spanning 20 distinct categories such as soaps, detergents,

shampoos, skin care, toothpastes, deodorants, cosmetics, tea, coffee, packaged foods,

ice cream, and water purifiers, the Company is a part of the everyday life of millions of

consumers across India. Its portfolio includes leading household brands such as Lux,

Lifebuoy, Surf Excel, Rin, Wheel, Fair & Lovely, Pond’s, Vaseline, Lakmé, Dove,

Clinic Plus, Sun silk, Pepsodent, Closeup, Axe, Brooke Bond, Bru, Knorr, Kissan,

Kwality Wall’s and Pureit.

22

5.1 COMPONENTS OF WORKING CAPITAL:

The table below shows the component-wise analysis of the working capital of HUL from 2007-

08 to 2011-12. It can be seen that inventory constituted a major component of the gross

working capital for the period of study. Next major constituent is cash and bank balances

which make 27.02% of the GWC. So we can observe that the major components of gross

working capital are inventory, cash and bank balances and sundry debtors. The size of the

working capital increased and decreased over the years as percentage of total assets due to

changes in scale of operations.

Particulars Inventory Sundry

Debtors

Cash &

Bank

Balances

Loans and

Advances

Others Gross

Working

Capital

2007-08 200377.42 46493.06 26242.19 66992.65 1852.47 341957.79

2008-09 258052.60 56056.07 186411.67 76187.32 1970.41 578678.07

2009-10 222641.00 69167.00 201238.00 58953.00 1929.00 553928.00

2010-11 287377.00 95489.00 178726.00 66322.00 3775.00 631689.00

2011-12 266737.00 85674.00 199643.00 44611.00 3721.00 825577.00

AVERAE 247037.004 70575.826 158452.17 62613.194 2649.576 586365.97

% of

GWC

42.13% 12.04% 27.02% 10.68% 0.45% 100.00%

Table 1:Current assets of Hul

Fig 1: Current asset compostion of Hul

23

5.2 Net Working Capital and Managerial Efficiency

The table below shows that there was a shortage of working capital in all the years

from 2007 to 2012. The net working capital has been continuously negative. In any

normal situation, a negative net working capital is a sign a company facing bankruptcy

or serious financial trouble. 11

Year Current Assets Current

Liabilities

Net Working

Capital

2007-08 341957.79 519503.56 -177545.77

2008-09 578678.07 588393.59 -9715.52

2009-10 553928.00 681601.00 -127673.00

2010-11 631689.00 750893.00 -119204.00

2011-12 825577.00 670190.00 155387.00

Table 2: Net Working Capital of Hul

Fig 2: Net Working Capital of Hul

24

Particulars 2007-2008 2008-

2009

2009-

2010

2010-

2011

2011-

2012

Inventory Days 41.94 44.13 47.16 37.79 43.42

Receivable Days 12.77 14.28 12.1 8.26 10.96

Payable Days 78.25 91.19 99.52 68.25 88.2

Table 3: Inventory, Receivable, Payable Days allowed by Hul

,

Fig 3 : Inventory, Receivable, Payable Days allowed by Hul

But this is not the case with HUL. Here Negative Working Capital essentially means

that the company is able to pre-sell its products and gets a decent Credit from its

Suppliers which help it to grow its business without any Customer demand for its

products or a very strong brand

25

We can see the impact of negative working capital on ROCE,EPS,DPS over the period

of time. Lower is the working capital higher is the ROCE and thus there is an increasing

trend in Earning per share

PARTICULARS 2007-2008

2008-2009

2009-2010

2010-2011

2011-2012

Working capital/sales -17.44 -125.19 -90.55 58.28 17.17

ROCE(%) 78 107.5 103.7 87.5 96.8

EPS 8.12 11.47 10.69 10.68 12.45

DPS 9 7.5 6.5 6.5 7.5

Table 4: Profitability Trends

26

Fig 4 : Profitability Trends

Harish Manwani, Chairman commented: “We have delivered another quarter of

strong volume led growth with an improvement in margins. The environment

continues to be challenging in terms of inflation and a general economic slowdown.

In this context, we are implementing our strategy with even greater rigor and

managing our business dynamically to remain competitive and cost efficient. We

continue to drive innovation and execution to strengthen our core business while

leading market development in the emerging categories

Ratio Year Current

Ratio

Quick

Ratio

Inventory

Turnover

Ratio

Cash

Conversion

Cycle

Debtors

turnover

ratio

2007-08 0.8 0.45 7.20 -25.02 31.41

2008-09 0.97 0.54 9.26 -10.88 41.83

2009-10 0.97 0.65 8.99 -60.09 29.94

2010-11 1.05 0.63 7.91 88.72 24.28

2011-12 1.23 0.83 9.93 95.06 27.27

5.3 FINANCIAL RATIO ANALYSIS :

Table 5: Financial Ratios

From the table above, we can see that the Current Ratio (CR) of HUL has moved

between 0.66:1 and 1.23 during the period of study. On an average it stands at 0.80:1

for the entire period against the conventional 2:1.

The Quick Ratio (QR) of the company has moved between 0.45:1 and 0.83:1 during the

study period which is moderately good when compared to the standard norm of 1:1.

The Inventory Turnover Ratio (ITR) of the company has moved between 7.20:1 and

9.93:1.

The Cash Conversion Cycle (CCC) of the company has moved between -60.09 and

95.06.

27

The Debtors Turnover Ratio of the company has moved between 31.41 to 27.27

Nestle India Ltd, one the biggest players in FMCG segment, is a subsidiary of Nestle S.A. The

company has presence across India with 7 manufacturing facilities and four branch offices

spread across the region. The four branch offices in the country help facilitate the sales and

marketing of its products. They are in Delhi, Mumbai, Chennai and Kolkata.

It has a presence in milk & nutrition, beverages, prepared dishes & cooking aids & chocolate &

confectionery segments. The company is engaged in the food business. The food business

incorporates product groups, such as milk products and nutrition, beverages, prepared dishes

and cooking aids, chocolates and confectionery.

The brands and products of the company are focus of continuous innovation so that they

meet and exceed consumers’ expectations. The company seeks a clear-cut advantage

over competitors’ products and to ensure its products are available wherever, whenever

and however the customers want them. Although profitability may be considered the

governing factor of a business, nevertheless the management of working capital can

effectively bring to a halt, or to its ultimate downfall, what might otherwise be a

successful and profitable company.

28

6.1COMPONENTS OF WORKING CAPITAL:

The table below shows the component-wise analysis of the working capital of Nestle

India Ltd. from the year 2003-04 to 2011-12. It can be easily noted that Inventory

constitutes the major component of the working capital which on an average accounts to

around 60%. Similarly, Sundry debtors constitute about 7.75% on an average for all the

years. Besides, Cash &Bank Balances, Advances and loans contribute 13.02% and

21.96% respectively to the Gross Working Capital. Hence the major components of

working capital are Inventory, Sundry Debtors, Deposits and Advances. The size of the

working capital increased and decreased over the years as percentage of total assets due

to changes in scale of operations.

Particulars Inventory Sundry

debtors

Cash &

Bank

balances

Loans,

Advances

Gross

Working

capital

2008 4012153.00 534901.00 3,77,604 1453883.00 6378541.00

2009 4349117.00 455933.00 1936893.00 1237589.00 7979532.00

2010 4987379.00 64863.00 1555863.00 1380487.00 8565592.00

2011 5759516.00 632854.00 2552915.00 1514412.00 10459697.00

AVERAGE 4777041.25 422137.75 2015223.67 1396592.75 8345840.50

% of GWC 57% 6% 17% 20% 100%

Table 6:Current assets of Nestle

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Fig 5 : Current asset compostion of Nestle

6.2 Net Working Capital and Managerial Efficiency

Working capital management as a financial strategy has its effects on liquidity as well as

profitability of the firm. The table below shows that there was a shortage of working capital

in all the years from 2003 to 2011. The net working capital has been continuously negative.

This trend is generally considered to be a sign of bankruptcy facing the company or

sometimes a serious financial trouble.

 Year Current Assets Current Liabilities Net Working Capital

2008 6378541 9577693 -31991522009 7979532 11839651 -38601192010 8565592 14223846 -56582542011 10459697 16696075 -62363782012 x x x

Table7: Net Working Capital of Nestle

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Figure 6 : Net Working Capital of Nestle

But the same is not true for Nestle India Ltd. The company has been able to generate

cash so quickly, and customers paying upfront that the business have no problem raising

the cash. Hence profitability could not be linked to the net working capital. Instead, a

negative working capital proves to be a sign of managerial efficiency in their business

with low inventory and accounts receivable (which means they operate on an almost

strictly cash basis). The company tries to attack the growth in Working Capital sensibly,

not by focusing on absolute value which in some previous years was impacted by

double-digit inflation, but by targeting days covers for inventories, accounts receivable

and accounts payable.

Particulars 2008 2009 2010 2011

Receivable Days 4.04 3.84 3.65 4.25

Inventory Days 34.13 32.63 30.76 31.16

Payable Days 54.19 52.18 52.1 57.99

Table 8: Inventory, Receivable, Payable Days allowed by Nestle

Fig 7 : Inventory, Receivable, Payable Days allowed by Nestle

Nestle India Ltd is a good example which proves that negative Working capital doesn't

always mean bad financial condition; it indicates that most of the day to day activities

are funded by customers rather than company’s own working capital.

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The data and figure below also shows the performance and profitability of Nestle in

terms of its return on capital employed, earnings per share and dividend per share.

There has been a continuous growth in the share prices over the past 9-10 years and

hence the performance has been expectedly good. Thus, working capital cannot be

considered as the sole and correct indicator of the company’s performance

PARTICULARS 2008 2009 2010 2011 2012

Working

Capital/Sales

-11.36 -9.23 -10.22 -9.13 x

ROCE(%) 151.7 149.7 128.1 60.47 x

EPS 55.39 67.94 84.91 99.73 x

DPS 42.5 48.5 48.5 48.5 x

Table 9: Profitability Trends

Fig 8 : Profitability Trends

6.3 Financial Ratios Analysis

Year Current

ratio

Liquidity

ratio

Inventory

Turnover

Cash

conversion

Cycle

Debtors

turnover ratio

2008 0.67 0.29 0.59 -4.58 87.37

2009 0.670 0.24 0.59 -6.24 93.68

2010 0.62 0.27 0.59 -5.99 98.22

2011 0.42 0.24 0.60 -14.07 83.83

2012 x x x x x

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Table 10: Financial Ratios

It appears from Table that the Current Ratio (CR) of Nestle India Limited has moved

between 0.67:1 and 0.42:1 during the period of study. It reveals that the liquidity of

Nestle as measured by the current ratio is relatively very low.

The Quick Ratio (LR) of the company has moved between 0.29:1 and 0.24:1 during the

study period, which is moderately bad, when compared to the standard norm of 1:1

Cash conversion cycle (CCC) is again not strongly correlated (0.11) with the

profitability and thus fails to explain the performance of the business to a great extent.

Also, the CCC is seen to be mostly negative for the company basically because the no.

of day’s accounts payable exceeds the no. of day’s accounts receivable.

Inventory turnover ratio (ITR) moves on an average of 0.58 during the complete period

of 4 years. Also ITR shows a medium correlation with the profitability of the company.

Debtor’s turnover ratio moves from 87.37 to 83.83 during the period of study.

7.1Specific Observations

After the analysis of trend of negative working capital and various components of

profitability it is clear that:

• FMCG companies are having trend to use negative working capital to minimize the

cost of borrowing for working capital.

• Whenever they are having trends of negative working capital, profitability is always

higher(because of lower cost of interest and borrowings).

• HUL and Nestle are the two leading FMCG companies in India, regularly using

negative working capital for their day to day operations.

• An important observation is, rather than negative impact of poor working capital

(negative working capital) FMCG companies are having greater advantages because of

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brand image and lower operating cost for their product (because of strong influence of

brands).

• In FMCG companies early cash realization and minimum chances for bad debts (due

to lower level of debtors) are the key areas responsible for higher profitability.

• Brand image of the products (intangible assets) enhances marketing efficiency and

profitability (higher demand for the product).

• Another important area of advantages is; in FMCG Company’s contribution of

intangible assets are more than 90% of the market capitalization that will provide them

unique opportunity to enhance market share of the product.

• Intangible assets such as brand, internal operation methodologies, strong supply chain

network and strong customer base etc. are the key areas responsible for lower

requirement of working capital

7.2Recommendations

Negative working capital creates many financial gains but at the same time it has some

adverse impacts

Lower or poor working capital (or negative working capital) creates artificial

pressure on a company to increase borrowings for day to day operations. Due to

delayed payments to the creditors, in some cases ranking of such companies are

treated as poor, which will affect cost of borrowings or capital (in the way of

higher rate of interest).

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In case of expansion and modification of business, negative working capital

creates financial barriers (lower liquidity). It will create artificial hurdle for the

growth of the organization.

Due to poor liquidity, investors behave with caution; it will create financial

unrest among the general investors. They are worried about their investment as

well as future returns.

At the time of business valuation, negative working capital creates hurdle for

better valuation because of chances of bankruptcy risk in a short time.

Negative working capital position only works when the company is growing

revenues (such as General Motors that used it for several years until revenues

began declining). When the company’s revenues are declining the positive effect

of a negative working capital position reverses and it immediately starts needing

annual working capital investment during a time when the company can least

afford .

The companies working on negative working capital should keep an eye on the above

impacts of negative working capital. If the companies can overcome the over

shortcomings they can employ the advantages of negative working capital.

8. Conclusion

Negative working capital indicates non-liquidity or less liquidity within the firm which

is not favorable at each and every stages of business. Companies operating in industry

like FMCG are able to manage negative working capital efficiently, creating

shareholder value by way of higher EPS and higher market capitalization. At the same

time, companies with higher working capital are having sufficient liquidity, are more

successful because of liquidity and they can expand business and grow up to maximum

possible extent. However, a company with higher working capital needs higher revenue

to maintain their healthy operating ratio. A better credit management system will help

these companies to generate higher ROCE in the long run (HUL is the live example). 35

However, in each and every situation lower level of liquidity is not preferable; a proper

tradeoff between liquidity and working capital requirement is needed in the long run.

9. References

Web Pages

1. www.hul.co.in

2. http://www.blurtit.com/q575408.html

3. http://www.investopedia.com/

4. http://www.proquest.co.uk/en-UK/

5. www.google.com

6. http://www.nestle.in/investors/stockandfinancials/annualreports

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Research Papers

1. Dr. T.Satyanarayana Chary, Ramanadh Kasturi and Dr. K. Sampath Kumar-

Relationship between working capital and profitability - A Statistical Approach,

2011

2. Mulualem Mekonnen- The impact of working capital managemnt on firms’

profitability, 2011

3. Wajahat Ali and Syed Hammad Ul Hassan- Relationship between the

Profitability and working Capital policy of Swedish Companies, 2010

4. Lingesiya Y. and Nalini.S- Working capital management and Firm’s

performance: an analysis od Sri Lankan Manufacturing companies

5. OWOLABI, Sunday Ajao and ALU, Chituru Nkechinyere- EFFECTIVE

WORKING CAPITAL MANAGEMENT AND PROFITABILITY: A Study of

Selected Quoted Manufacturing Companies in Nigeria- 2012

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