Understanding Working Capital Management |
|
|
|
On
the other hand going through some of the assignments submitted by students
specialising in HR at the MBA level convinces me of their abject ignorance
of Finance. How can these students ever go in for successful Strategic HR
interventions in the corporate world remains a major worry for teachers
like us? That is what got us thinking and hence this paper is addressed to
these managers in waiting as well. To begin with let the HR Manager (in
practice or in waiting) appreciate that the dark and dismal science of
economics is certainly not dark neither is it dismal. It is fairly exact
and very exciting provided the tools are in the hands of the right
craftsman and the teacher knows his subject. We have always opined that
people who are ill schooled in this fine subject should have sufficient
self-respect and refrain from teaching it. The younger generation deserves
this. We shall therefore begin with understanding some Economics (which we
consider the jewel in the crown of social sciences) and move through
common sense into one aspect of Financial Management (which is a
specialisation we consider to be bedrock of all managerial sciences). In
both instances mathematics is a language that the craftsman must
understand and learn to use judiciously. From a teacher's viewpoint the
author's advice to HR Managers (in practice and in waiting) is to get
their theory right since once theory is perfected reality would be unable
to hold out. Case studies are an excellent tool for teaching a subject provided
the theory has been understood. If not, they degenerate into story telling
sessions where the mouth starts to function long before the brain is
engaged into gear. This paper merely attempts to simplify the theory
behind working capital management for HR Managers in particular and
non-Finance Managers in general. Some basic premises of the Economic science also need to
be cited So you cannot say "I am investing two years of my time and Rs 2
Lakhs as fees in getting an MBA Degree." What you are doing is making
a financial outlay in the hope that the piece of paper (Diploma /Degree)
that you get at the end of the two-year period can be traded for a job in
the labour market. What you get by way of knowledge is abstract commodity
and it can well be argued that both the teacher and the taught are
partners in the expansion of knowledge. Machinery, goods in process,
inventory and buildings on the other hand are capital. Money is not
capital. In fact Crowther's famous poem is very helpful to recall at this
stage. So
the question rises as to what is working capital? Imagine a
four-legged table with a glass top. This is the euphemistic structure of
working capital. The first leg symbolizes cash and bank balances,
the second leg symbolizes Inventories, the third leg symbolizes
Receivables and the fourth leg symbolizes Investments. The
glass top symbolizes the allocation and utilization of scarce
available resources so that corporate objectives are met. The tabletop
made of brittle glass has to support some very heavy iron weights and to
top it all there is a glass of whisky on it. The glass of whisky is stable
so long as the four legs are equal and the top is even in surface. If any
leg were to be longer than the rest or shorter than them the whisky would
spill. If the table were weak and cannot support the weights then also the
whole structure would collapse. Now replace the wife with the shareholders and the iron
weights with your short-term liabilities. The dish of chicken with
additional business you never expected but now has to be financed and
which the four legs which stand for your assets would have to support. The
glass of whisky is replaced with profits. Now very simply, putting the
right weight, having a balanced table and enjoying your whisky and chicken
in peace is what working capital management amounts to. Keeping the
wife pleased is a bonus.
In short, it boils down to the management of funds in the short term as
opposed to managing long-term capital such as shares and debentures.
The HR Manager must appreciate that short-term capital has
to be repaid within a short period such as a year so its management is
volatile. Working capital is after all the sum total of current assets,
which are used to pay back current liabilities and generate profits. The
goal of proper working management is to see that the current assets and
current liabilities are maintained in such a way that a satisfactory level
of working capital is maintained. It relates to funds in the short term or
a period normally one year and it is always transformed from cash into
other assets and back into cash within a business cycle.
Now let us see what the cash we need has to do with the
normal operating time often called the process cycle time. Some types of
businesses may have a longer operating cycle and this could be well more
than a year or even a decade as in the case of distilleries. Other
businesses may have a short operating cycle as a fast food store.
Working
capital could be either in terms of gross or net value. Whereas Gross
working capital is the total of current assets, Net working capital is the
total of current assets minus current liabilities. As a rule of thumb the
best possible practice is to see that there is sufficient liquidity to pay
back current liabilities without blocking too much funds. The trade off
between profitability and risk is the key to working capital management.
Anyone working with a fixed training budget would find this easy to
understand. Too little working capital increases profit but reduces
liquidity, as current assets are more expensive than fixed assets. For
instance if a management feels that worker training is a cost they will
apportion less funds for it. If on the other hand a management sees it as
an investment in manpower, the funds allocated would increase
substantially.
If
at a point of time the organisation does not have sufficient funds to meet
its short-term debts such as creditors and salaries as well as day-to-day
expenses it may become technically insolvent. On the other hand, if
it is very conservative it will have a surplus of working capital, which
will adversely affect profits. So it is easy to appreciate that the ratio
of fixed assets to current assets is a good measure of the balance to be
maintained.
There is no specific thumb rule. It varies from
industry to industry and the nature of business. Some industry norms are
given below. INDUSTRY
PROPORTION The ideal mix thus depends on the nature of the industry. Now we shall
very briefly take each component of working capital and see what are the
best practises adopted by industry in managing them.
Inventory is one of the most important components
of working capital and its proper management cannot be under stressed.
Fundamentally, inventory consists of raw material, work in progress and
finished goods. The proportion of inventories to fixed assets is quite
high ranging from 25% to 45% in the manufacturing sector (in cement it is
around 25%). Hence inventory management is crucial for all managers
irrespective of functional specialization. Since a number of industrial
relations disputes in manufacturing industries are linked to production
bonus and incentives relating to inventory irrespective of the market need
for inventory, the HR Manager must understand this point well. Every
member of the organization feels its impact and yet scant respect is paid
to it. This is most unfortunate. A serious study of sick companies will
support this contention. Hence those managers who are involved with
Strategic HR should take note of some of these important criteria for
insuring proper management. Further research by industrial economists sheds light on some practises
adopted by various industries, which are shown through extracts from their
balance sheets. Let us quickly glance at some of these important
indicators.
Accounts receivable : This also forms an
important part of working capital and depends on the credit policy adopted
by the firm namely Cash management: This as mentioned is the most
liquid of all assets and is required to Too much cash is not good nor is having too little a healthy practice.
Good companies usually have a practise to plant surplus cash in risk free
securities or inter company deposits. On the other hand, companies with a
deficit tend to borrow at a high rate of interest indicating a lack of
planning. A sudden surge in business may spur the need of working capital
and this may also require additional interest to be paid and again
planning is important.
The key to all management and especially working capital management is
to plan your work and then work to your plan. This also is an important
aspect of working capital management and good companies have the practise
of planning their needs well in advance.
Here is piece of advice to all those colleagues within
the HR fraternity. The next time your wife makes chicken and you invite
your colleagues over to your house for dinner and drinks, please remember
that this is all about working capital management. If they have a fun time
you are a damned good manager. If someone drops the glass or breaks your
table or slips and breaks his head then you know what to think of
your self. |