High inventory levels worsen working capital situation, reveals study of top 500 companies

India Inc has the potential to release ?1.8 lakh crore of cash trapped in its balance sheets, according to a study by EY.

In its annual EY report, a study — ’Working capital management - are you leaving cash on the table?’ — of the top 500 companies (by sales) in India reveals that the working capital situation has worsened mainly on account of increase in inventory levels, which has resulted in an increase in cash-conversion cycle to 44 days in FY17.

Cash-conversion cycle

As the cash-conversion cycle has increased and the operating cash flow deteriorated (by 0.7 percentage points in FY17), there was a need to increase working capital funding, which has led to a significant increase in short-term borrowings, the report said.

Further, the ability of companies to service debt (interest coverage) has been steadily declining over the years. This indicates a significant need to improve working capital management, according to the report.

The cash-conversion cycle for larger companies (top one-third by revenue) is significantly lower than for smaller companies (bottom one-third by revenue), the report noted.

Larger companies have better negotiating leverage and operating efficiencies, thus driving improved collections and relatively lower inventory levels.

Sectors such as oil and gas, and metals and mining displayed a significant increase in the cash-conversion cycle days with a corresponding increase in short-term debt, signifying increased funding needs.

Sectors like EPC (engineering, procurement, and construction), pharmaceuticals and chemicals recorded the longest cash-conversion cycles in terms of days, the report said.

Receivables for Indian EPC companies were more than twice those of companies in the US, Europe and China.

High collection period (days of sales outstanding) for technology companies and higher inventory levels for Indian auto-parts companies predominantly drove a longer cycle compared to other developed regions across these sectors.

Tax structure

The report said that the transition from the old tax structure to GST initially impacted the working capital cycle of companies. Firms with strong working capital management are expected to see over the short-term disruption better than firms with lesser focus on cash management. GST can prove to be both a challenge and an opportunity to effectively manage working capital.

The report said that there has been a significant increase in stressed assets, which has led to a decline in fresh lending.

Lending from banks to Indian corporations declined by 5.2 per cent in FY17 as compared to a growth of 2.8 per cent in FY16, which has had an impact on both short- and long-term financing.

Alternative funding solutions such as corporate bonds and commercial paper have emerged as short-term funding instruments.

Other sources, such as channel financing are undergoing significant change as fintech firms are developing technology platforms that are intended to help MSMEs sell their receivables at a discount, thus freeing up cash for operational needs.

 12 Mar 2018, 04:44 AM