Topic 2 working capital & its management

Working capital & its management 2013
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Learning Objectives:
1. The next important topic for the students at this level would be to understand ‘working
capital as well its management’. Working capital would include:
 The cyclical behaviour of working capital assets unlike fixed assets that get depreciated
 The components of working capital – what constitute the current liabilities and current
assets?
 Next we should understand the ‘Operating cycle’, its components and managers. The
students should also know how to determine the values of operating cycle in number of
days and amount.
2. There are costsassociatedwithdifferentcomponentsof workingcapital like inventory&
receivables.Theyare knownas‘inventorycarryingcosts’and‘receivable carryingcosts’respectively.
The studentsshouldknowhowtodetermine these coststhatare not reflectedfullyinthe
conventional ‘Profit&Loss’statement. Thenthere are factorsonwhichthe investmentinworking
capital by the enterprise depends;atone endof the spectrumwill be the servicesindustrywhile at
the otherendwill be the manufacturingsectorwithtradingsectorlyinginbetween,intermsof
investmentinworkingcapital. Amongthe differentsectorsinmanufacturingagain,there are
variations.Atone endof the spectrumwouldbe the FMCG sectorwhile atthe otherendof the
spectrumwouldbe the heavyengineeringsector.The studentsshouldbe fullyaware of this.
3. As the lastcritical area of learningwe have kept‘simpleratioanalysis’.Asmentionedearlier,the
twomost importantchaptersin‘Fundamentalsof finance’are ‘ratioanalysis’and‘time value of
money’.While we have discussedthe timevalue of moneyinthe previouschapter,inthischapter,
we discuss‘ratioanalysis’.Thisisone of the toolsemployedin‘financial analysis.Thisfacilitatesthe
studentunderstandkeybusinessnumbersandassessthe financial performance of agiven
enterprise.
Contents Index
2.1 Introduction to working capital & its components
2.2 Working capital management
2.3 Simple ratio analysis – assessment of business performance
2.4 Solved questions
2.5 Unsolved questions
2.6 Summary
2.7 Handout

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2.1 Introductiontoworking capital & its components:
2.1.1 Working capital vs. long-termcapital
What is working capital?
Capital in any business is split into long-term capital and short-term capital. Long-term capital
refers to investment in fixed assets while short-term capital refers to investment in working
capital. Working capital is used for day-to-day operations of the business enterprise and hence
the name. Further as we already know from the basic course, the long-term assets reduce in
value over a period of time with the exception of ‘land’ due to use. This concept is
‘depreciation’. As distinct from this, the working capital assets go in a cycle, known as
‘operating cycle’.
This cycle commences from cash and ends in cash upon realization of cash from sales. This cycle
is known as ‘operating cycle’ or ‘working capital cycle’. Working capital has got two
connotations – gross working capital and net working capital.
Gross working capital = Sum total of current assets
Net working capital = Difference between gross working capital and current liabilities.
Current assets turn over from one from into another and this characteristic trait of current
assets is known as “turn over”. This term is mistaken to mean the value of sales or operating
income in a given period. There should be no doubt in the readers’ minds about the linkage
between the current assets turning over and the value of sales revenue in a given period. The
sales are due to the “turnover” of current assets. This is unlike the fixed assets that provide the
platform for the activity but do not turnover by changing form. The time taken for cash to be
converted back to cash is known as “Operating Cycle” or “Working Capital Cycle”. Let us
examine the following diagrammatic representation to understand this.
Cash Materials
Sales Work in progress or semi-finished goods
Finished goods
The above cycle is known as “operating cycle” or “working capital cycle”. This can be expressed
in value as well as in number of days.

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Components of working capital – Current assets and current liabilities
Gross working capital is also known as short-term assets or current assets
Current liabilities that finance working capital are also known as short-term liabilities or
working capital liabilities
Current assets are:
 Cash
 Bank balances
 Inventory of materials, work-in-progress, finished goods, components and consumables
 Inland short-term receivables
 Loans and advances given including advance tax paid
 Pre paid expenses
 Accrued income
 Investments that can be converted into cash
Current liabilities are:
 Short-term bank borrowing like overdraft, cash credit, bills discounted and export finance
 Creditors outstanding for materials, components, consumables etc.
 Other short-term loans and advances for working capital like Commercial paper, fixed
deposits accepted from public for less than 12 months, inter-corporate deposits etc.
 Outstanding expenses or provision for expenses, tax and dividend payable etc.
Why should current assets be greater in value than current liabilities?
Current assets include receivables that include profit. Further inventory excepting materials,
components that are bought out and consumables would be valued after value addition. For
example, work in progress and finished goods would be higher in value than the materials that
have gone into them; whereas the current liabilities would be at cost and hence less in value
than the value of current assets. Please recall what we have seen in Chapter 3 of the Basics
course under application of accounting principles. One of the accounting principles is ‘value =
costs’. This is applicable to the value of inventory and not receivables.
Receivables include profit element whereas inventory does not include profit.
In view of the above, the value of current assets is always expected to be higher than the value
of current liabilities as the difference represents the net liquidity available in the business
enterprise.

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In other words, let us say that current liabilities for a firm are Rs. 100 lacs and the current assets
are Rs. 80 lacs. This means that the net working capital is negative and that the enterprise does
not have any liquidity. This is a very dangerous situation. An examination of the current assets
as above would reveal that all the current assets are not the same in the context of
convertibility into cash. While some of them like inventory of materials, components, work-in-
progress cannot be converted into cash immediately; the debtors outstanding (unless it
happens to be bad debts) could be converted into cash with a little more ease.
Thus can we differentiate between some current assets and others in the context of liquidity?
Yes. Those assets that can be converted into cash without difficulty are known as “liquid
assets”. They are:
 Cash on hand
 Receivables (conventional thinking whereas in reality, there could be some percentage of
debtors that cannot be converted into cash easily)
 Investments that can be converted into cash immediately like investment in limited
companies whose shares are listed on stock exchanges
 Bank balances like current account etc.
Current assets to current liabilities relationship is known as “current ratio”. Current ratio should
always be greater than 1:1. Why? Let us examine this in practical terms. Let us recall another
accounting principle, ‘going concern’. As opposed to this, is ‘gone concern’? The practical
application of this principle is the reduction in value of the assets of the company in case it is
not doing well; of course, ‘gone concern’ refers to an enterprise that is going down the drain
and is not capable of revival. Even before this stage, is the continuous ‘business loss’ stage.
Readers would appreciate that if a business firm incurs loss for say three years continuously, its
value comes down in the market. This will affect the current assets as well as fixed assets.
Herein, we are discussing ‘current assets’. Let us illustrate this with an example.
Example no. 1
The current ratio of an enterprise is 1:1. Let the value of current assets and current liabilities be
Rs. 100 lacs. The firm has been incurring loss for the past 2 years and is desperate for survival. It
is not yet a ‘gone concern’. Still the market would value the assets at less than Rs. 100 lacs; let
us assume the realizable value of current assets is Rs. 80 lacs. This means that the firm will not
be able to meet its current liabilities of Rs. 100 lacs with the current assets of Rs. 80 lacs.
Learning: This is precisely the reason that conventional wisdom demands a current ratio of
more than 1:1.

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2.1.3 Estimationof working capital and operating cycles:
Example no. 2
Recall what we have seen under ‘operating cycle’ or ‘working capital cycle’
Segment 1: Cash to materials = 10 days = “procurement time” or “lead time”
Segment 2: Material to finished goods = 21 days = process time or production time through
work-in-progress stage
Segment 3: Finished goods to sales = 10 days = stocking time
Segment 4: Sales to cash = 30 days = Average collection period (ACP) or this can be nil (in most
of the companies, this would be existent and very rarely this would be “zero”). This would
depend upon whether there is credit sales or not.
The operating cycle in number of days would simply be the sum total of all the components of
the cycle = 71 days.
Suppose there is credit on purchases, what would be its impact on the above?
To the extent credit is available on purchases, the cycle would shorten as due to availability of
material on credit, there would be no lead-time or procurement time or usual procurement
time would reduce to that extent. If we take 10 days as credit period given by suppliers on the
purchases, the operating cycle would be 71 days (-) 10 days = 61 days.
What is the use of this operating cycle?
The operating cycle indicates the efficiency of operations of working capital assets in the
enterprise or otherwise. In the above case, the more the number of times the cycle repeats,
the higher the efficiency and vice-versa. Let us understand this through another example.
Example no. 3
Let us compare two business enterprises with differing operating cycles in number of days.
Unit 1 = 60 days Turnover = 6 times; 360/60 (for sake of convenience the year is taken to
consist of 360 days instead of 365 days)
Unit 2 = 90 days Turnover = 4 times; 360/90
It is obvious that the turnover of unit 1 is more efficient. This is also referred to as “operating
efficiency index” Formula for operating efficiency index = number of days in a year/no. of days
per working capital cycle.
It should be borne in mind in the above example that the two units under comparison should
be from the same industry and have comparable scale of operations.

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Operating cycle in practice
Although we have seen in Example no. 1 how one determines the number of days in a cycle,
in practice the cash portion is neglected and instead credit on purchases is considered. Let us
see the following example to understand this.
Example no. 4
Item in the current assets Number of days Value of item (Rupees in
lacs)
Materials 45 230
Work in progress 21 200
Finished goods
Receivables or debtors 30 500
Creditors outstanding or credit on 15 76
Purchases
Then the operating cycle in number of days = 45 + 21 + 15 + 30 – 15 = 96 days
Operating cycle in value = 230 + 200 + 180 + 500 – 76 = Rs. 1034 lacs
Is there any difference between operating cycle in value and operating cycle in terms of funds
invested?
Yes. In the above case, the value of operating cycle is Rs. 1034 lacs. However this is not the
same as the amount of funds invested in operating cycle. The difference is the profit on
outstanding debtors. Let us assume that the profit margin is 10%. Hence in the above example,
the profit on Rs. 500 lacs works out to be Rs. 50 lacs. This is return on investment and not a
part of investment. Hence to determine how much of funds have been invested in current
assets, we will have to deduct this amount. After deducting Rs. 50 lacs, the resultant figure is
Rs.984 lacs.
Thus in the given example, the investment in operating cycle is Rs. 984 lacs and the value of one
operating cycle is Rs.1034 lacs.
Are there factors that influence working capital requirement of a business enterprise?
1. The type of activity that the business enterprise is carrying on:
 Manufacturing = maximum investment in current assets
 Trading = no investment in material but investment only in finished goods and no
requirement of cash for conversion of materials into finished goods
 Service industry = no investment in material or finished goods and hence least
investment in current assets
2. The kind of product that the manufacturing enterprise produces:
 Capital goods = requirement of funds especially work-in-process will be high

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 FMCG = requirement of funds especially in finished goods will be high but overall
inventory held will be less than in the case of capital goods manufacturer
 Manufacturer of components or intermediaries = requirement will be in between the
capital goods manufacturer and FMCG
3. Dependence upon imports for materials or components or spares or consumables:
 If it is high the lead time1 will be high and accordingly the amount invested in materials
or components or spares or consumables as the case may be will be high
4. Whether the operations are seasonal or not?
 For example a sugarcane crushing industry is a seasonal industry – the material of
sugar cane is not available throughout the year. Hence whenever available stocking in
large quantities is necessary. The same thing is true of a manufacturer producing
edibles that are dependent upon availability of the required agricultural products in
the market.
5. What is the policy of the management towards current assets?
 Is it conservative? If it is the management is risk-averse and tends to carry higher
inventory of materials and cash on hand at least. The current ratio tends to be high
with higher dependence on medium and long-term sources for financing current
assets rather than short-term liabilities
 If it is aggressive, it is risk taking and tends to carry less inventory of materials and cash
on hand. The current ratio tends to be low with higher dependence on short-term
liabilities for financing current assets
 If it moderate, it is between conservative and aggressive and hence investment in
materials and cash on hand is moderate. The current ratio would also be moderate
with balanced dependence on medium and long-term liabilities on one hand and
short-term liabilities on the other hand to finance current assets.
6. The degree of process automation in the industry
 If it is more = less investment in work in progress or semi finished goods
 If it is less = more investment in work in progress or semi finished goods
7. Government policy in the country
 If it allows freely imports just as it is at present in India, imported materials will be
higher in the inventory with consequent higher holding and higher requirement of
working capital funds
8. Who the customers are for the industry?
1 Lead time is the time gap between placing the order for materials and its receipt at the factory

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 If the unit supplies more to Government agencies = more outstanding debtors and
hence higher requirement of working capital
9. Whether the unit is in a buyer’s position or seller’s position as a supplier and as a customer?
 If the unit is in the buyer’s position as a supplier = more outstanding debtors due to
higher ACP
 If the unit is in the buyer’s position as a customer = longer credit on purchases and less
requirement of working capital
 Contrary would be true for the opposite position, i.e., unit is in seller’s position as a
supplier and seller’s position as a customer.
10. The market acceptance for the unit – the credit rating given by suppliers, banks etc. The
better the rating the better the terms of supply or lower the cost of borrowed funds and
hence the requirement of working capital funds would alter
11. Availability of bank finance – freely and on easy terms:
 If it is so the enterprise tends to stock more and draw more finance from banks; if it
converse, it will be less bank finance. The same goes for rates of interest on working
capital finance charged by the banks. If it is less – dependence on bank finance would
increase; if it is converse, it would reduce
12. Easy availability of materials, components and consumables in the local markets:
 If they are freely available then there is no need to stock it and the unit can adopt
what is known as “Just in Time (JIT). Their investment in inventory of materials,
components and consumables would be less
Estimation of working capital requirement for a business enterprise
Factors considered are:
1. What is the desired level of stocks for materials, consumables, components and spares that
the unit should have to ensure that it does not run the risk of suspension of operations?
2. What is the credit policy on sales? Or Average Collection Period (ACP)
3. What is the period of credit available on purchases?
4. What is the expected increase in production/sales and accordingly what is the expected
increase in stocks etc.?
5. What is the policy of stocking of finished goods?
6. Is the product more customized or standard?
7. What is the lead-time for materials and dispatch of finished goods – location of the factory –
is it in a backward area or a developed area nearer to the market?
Based on the above factors, the unit estimates the gross working capital and then the level of
net working capital that it is required to bring in as a % of gross working capital. It also
estimates the level of current liabilities other than bank finance that could be available to it

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without any difficulty. The balance is the bank finance. Please refer to previous examples for
understanding this.
Case let:
Information Technology companies do not require working capital unlike the manufacturing
companies. Hence these companies hardly have any working capital facilities with banks. What
could be the reasons for the same?
Hint: They are in the services sector. Draw the operating cycle for a service company in general
and an I.T. company in particular. Further the working capital in an I.T. company is driven more
by contracts with its clients. The contracts get some advance and no investment is required in
material or inventory. The average collection period on their debtors is also around 30 days
only.
Class activity:
Study the levels of current assets and current liabilities for the following sectors, at least 2
companies in each sector with the help of details available in their annual financial statements:
1. Heavy engineering – BHEL & HAL
2. Medium engineering – Cummins India Limited & Tata Motors Limited
3. Light engineering – Thermax India Limited & SKF Ball Bearings India Limited
4. FMCG – HUL & Godrej India Limited
5. Consumer Durables – TTK India Limited & Bajaj Auto Limited
2.2 Working capital management
2.2.1 Components of working capital management
The components of working capital management are:
 Cash management;
 Inventory management &
 Receivables management
Cash management
Objective – to minimize holding of cash that is at once liquid and unproductive. Conventional
authors have written about various cash management models like Miller-Orr model etc.
However in practice these models are seldom used. The control over cash is more through cash
flow statement or in some cases cash budgeting. This is similar to funds flow statement. All
cash inflow items and cash outflow items are listed out with due bifurcation as shown in the
Annexure to the chapter. Cash budgeting could also be for estimates of income and expenses
whereas cash flow statement is essentially for monitoring available cash at the end of the

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period vis-à-vis the actual requirement. On review, this enables to take a suitable decision to
reduce the average requirement of cash or increase it as the case may be.
There could be three alternative positions in respect of cash in an enterprise as under:
Example no. 5 (Rupees in lacs)
Parameter Alternative 1 Alternative 2 Alternative 3
Opening balance 5 5 5
Cash receipts during the period 105 105 105
Cash outgo during the period 100 107 115
Cash surplus during the period 5 (2) (10)
Overall cash position at the end
Of the period 10 3 (5)
In the first, the cash position is surplus during the month getting added to the opening balance
of cash
In the second, the cash position is deficit during the month reducing the opening balance of
cash. The unit is required to draw cash to the extent of average desired holding from bank
overdraft or cash credit.
It is the third one that is alarming or should be sounding warning signal to the business
enterprise. If the trend continues the unit would face liquidity crunch sooner or later – more
chances for “sooner” rather than “later”.
The student should understand that any short-term excess can be invested in short-term
securities provided cost benefit analysis has been done and return on investment in short-term
security is more than the overdraft interest. This is unlikely to be nowadays. If the short-term
surplus represents the profit of the organisation that partially can be committed to investment
in the medium to long-term, this can be done without fear of liquidity problems in future.
Inventory management
What do you mean by "inventory management"?
In simple terms, it means effective management of all the components of inventory in a
business enterprise with the objective of and resulting in:
Optimum utilization of resources - this will be possible only if the unit carries neither too much
nor too little inventory. There should be just sufficient investment in the inventory so as to
maximize the number of times the inventory turns over in one accounting period and
simultaneously the unit's production or selling is not hampered for want of inventory. This
means striking a balance between carrying larger inventory than necessary (conservative

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inventory or working capital policy - too much of "elbow" room) and high risk of stoppage of
activity for want of inventory (aggressive inventory or working capital policy or the practice of
over trading - too little "elbow" room).
Please refer to example above on “operating efficiency”.
Who takes more risk? – An enterprise holding higher inventory or less inventory?
Let us assume that the enterprise holding too much inventory has the right mix of inventory
that is needed for his business, carries less risk of stoppage of production or selling but ends up
paying higher cost in carrying higher inventory. On the other hand, the person carrying less
inventory incurs less cost in carrying inventory but runs the risk of stoppage of production of
selling for want of resources. He is perhaps rewarded with higher sales revenue and profits for
the higher risk that he takes, provided that his operations are not hampered for want of
resources. Thus inventory management as a subject offers a classic proof for one of the two
popular maxims in Finance, namely "Risk" and "Return" go together.
What are the specific objectives of inventory management then?
 To minimize investment in inventory and to ensure maximum turnover of the inventory in
an accounting period
 To ensure stocking of relevant materials in adequate quantities and to ensure that
unwanted or slow-moving/non-moving items do not pile up
 To minimize the inventory carrying costs in business - both ordering and carrying costs
 To eliminate waste/delay in the process of manufacturing at all stages so as to reduce
inventory pile-up
 To ensure adequate/timely supply of finished goods to the market through proper
distribution
Other components of inventory namely work-in-progress and finished goods are not discussed
here, as they require different kind of handling.
Steps in ‘Inventory management’
As mentioned earlier, one of the objectives of inventory management is to minimize the total
costs associated with it, namely ordering costs and carrying costs. The underlying principle that
should be kept in mind while discussing this is that ordering cost and carrying cost are inversely
related to each other. Suppose the ordering cost increases because of more number of times
the order is repeated, a direct consequence would be reduction in inventory held (average
value of inventory held) and hence carrying cost would be less. Conversely if the number of
orders is less, this means that the average value of inventory held is higher with the
consequence of higher inventory carrying costs.

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Average inventory could be the average of opening and closing stocks or wherever this
information is not available, this could be half of the size of inventory per order.
Are there tools for effective inventory management?
Yes. The tool depends upon the type of inventory, namely materials, work-in-progress or
finished goods. Let us examine the tools for managing materials.
Tool No. 1: Economic order quantity (EOQ)
This refers to that quantity per order, which ensures that the total of ordering and carrying
costs is the minimum. Above this quantity per order, the ordering costs reduce while carrying
costs increase and below this quantity per order, the converse effect is felt.
The formula is 2 x A x O
C
Wherein, A = Annual requirement of a particular
material in units or numbers or kgs.
O = ordering cost per order
And C = carrying cost per unit or as a % of per unit cost
Assumptions:
The demand is estimable and it is uniform throughout the period without any seasonal
variation.
The ordering costs do not depend upon the size of the order; they are the same for all orders.
The carrying cost can be determined per unit either in terms of % of the unit's value or in actual
numbers, wherein the total carrying costs in a year is divided by the actual inventory carried
(expressed in number of units)
Tool No. 2 - ABC analysis
Each management has its own way of classifying the items into A, B or C. One of the ways
usually adopted in this behalf is based on the experience that 10% - 15% of the items in
inventory account for 60% to 65% of consumption in value - "A" class items
"B" class - 20% to 25% of the items in inventory accounting for 20% to 25% of the consumption
in value
"C" class - 60% to 65% of the items in inventory accounting for 10% to 15% of the consumption
in value.

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Based on this, items of regular consumption ("A" class items) would be ordered regularly and
other items would be progressively less stocked or ordered when you go "B" and then to "C"
items.
Tool No. 3 - Movement analysis
Inventory items are bifurcated into fast moving, moderate moving, slow moving or non-moving
as the case may be. The parameter for this bifurcation depends exclusively on the experience of
the management or materials department in this behalf. This bifurcation leads to better
inventory management by not ordering items in the category of slow moving or non-moving
and reducing the stocks of moderately moving items. Further efforts will also be on to eliminate
non-moving items even at reduced prices so that future inventory carrying costs would be less.
There are other tools in material management like JIT (Just in Time technique), XYZ analysis etc.
Receivables management:
Receivables form the bulk of the current assets in most of the business today, as business firms
generally sell goods or services on credit and it takes a little time for the receivables to realise.
Hence “receivables management” forms an important part of working capital management, as
it involves the following:
1. Company’s cash flow very much depends on the timely realisation of receivables, so much
so that the cash inflow assumed in the cash flow statement turns out to be reliable;
2. With any delay in realisation of bills, the likelihood of bad debts increases automatically and
3. There is a cost associated with the bills or book-debts in the form of following costs:
 Receivable carrying cost in the form of interest on bank borrowing against the
receivables as well as on the margin brought in by the promoters;
 Administrative costs associated with the maintenance of receivables;
 Costs relating to recovery of receivables and
 Defaulting cost due to bad debts.
Hence “receivables management” assumes significance in the context of overall efficient
working capital management.
Steps involved in “receivables management” or “monitoring receivables”:
1. Selective extension of credit to customers instead of uniform credit “across the board” to all
the customers. In fact, there should be a well designed “credit policy” in a company, which
lays down the parameters for “credit decision” on sales. In fact, the company should have
its own credit rating system of all its customers and details of these have been discussed
under “credit evaluation” elsewhere in the note.

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2. Try to raise bill of exchange on the customers especially for bills with credit period and
route the documents through the banks, so that there is a control over the customers due
to their acceptance on the bill of exchange. Acceptance means commitment to payment on
due dates. Even in the case of bills not involving any credit period, i.e., “sight bills” or
“demand bills”, it should be customary to despatch documents through banks so that better
control can be exercised on the “receivables”.
3. Try and obtain “Advance money” against bank guarantees so that the outstanding comes
down automatically, besides improving the liquidity available with the company.
4. Try for early release of payment by offering “cash discount”. Any decision of this kind
should take into consideration both the cost saved due to interest on bank borrowing and
margin money on one hand and the increase in cost due to the discount. For example, let
us say that the interest on bank borrowing and margin money is 15% p.a. The present
credit period is 30 days and you desire to have immediate payment by offering 1.5% cash
discount. The decision should be taken after comparing the saving of interest due to
immediate payment with the amount of cash discount. At 15% p.a., the interest burden per
month is 1.25%, as against the additional cost of 1.5% cash discount. Hence, cash discount
is costlier.
Note: Here, the matter has been considered only from “finance point of view” and not from
the “liquidity” point of view. All credit decisions are influenced to a great extent by
consideration of “liquidity” also.
5. Proper bifurcation of receivables of the company into different credit periods for which they
have been outstanding from the respective dates of invoices like the following. This is more
from the point of view of control and easy review rather than anything else:
Receivables up to 30 days;
Receivables between 31 days and 60 days;
Receivables above 180 days up to 1 year;
Receivables between 1 year and 2 years and so on.
6. Proper and timely follow up with the customers whose bills are outstanding, both by distant
communication as well as personal visits to find out whether the delay is due to any
dissatisfaction of the customer with the quality of the goods and/or services or the after
sales service rendered by the company. This should be done regularly by ensuring that the
marketing and sales personnel are provided with the statement of outstanding receivables
every month so that the matter can be followed up with the customers during their periodic
visit to them.
7. Once any customer’s profile is available as regards his outstanding bills, any further order
from the same customer should not be processed by the marketing department for sending
it on to the production department for manufacturing, especially in case the outstanding

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position of receivables is not satisfactory. Thus at the very first stage, i.e., even production
of goods for customers who are defaulting would be avoided.
2.2.2 Costs relatedtoinventory andreceivables
Inventory carrying cost is the cost related to inventory and not ordering cost that is included in
‘EOQ’ seen above. Let us understand this through a suitable example.
Cost of carrying inventory would consist of:
1. Cost of finance as above
2. Maintenance cost - materials department’s cost &
3. Obsolescence cost – when material has become old
Example no. 6
Let us assume a figure of Rs. 60 lacs inventory on an average. Hope the student recalls that
inventory would include materials, semi-finished goods and finished goods.
Let us say that the company has taken bank finance to the extent of 75% of this value and the
balance of 25% is provided by the owners. The bank finance and owners’ contribution work out
as under:
Bank finance – Rs. 45 lacs &
Owners’ contribution – Rs.15 lacs
Let us also assume that the bank finance is at 15% p.a. and owners’ contribution should get a
return of 20% p.a.
Let us say that the maintenance cost is 10% of the value of the average inventory. Let us say
that there is no obsolescence cost.
Then the total cost of inventory would work out as under:
1. Cost of finance = Rs. 45 lacs @ 15% p.a. (+) Rs. 15 lacs @ 20% p.a. = Rs. 6.75 lacs (+) Rs. 3
lacs = Rs. 9.75 lacs
2. Carrying cost @ 10% of Rs. 60 lacs = Rs. 6 lacs
3. Obsolescence cost = None
Total cost = Rs. 15.75 lacs
Note: This cost will go up with the value of inventory held on an average
Cost of carrying receivables would consist of:
1. Cost of funds excluding profits
2. Cost of administration = maintaining debtors ledgers and follow-up; this does not exceed
1.5% of the sales per annum
3. Bad debts cost; this is always expressed as a percentage of total sales

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Example no. 7:
Let us assume average debtors outstanding of Rs. 100 lacs. Let us also assume the following
other factors:
Profit margin 12%
Cost of bank finance @ 60% of outstanding debtors @ 16% p.a.
Cost of own funds on the balance @ 25% p.a.
Bad debts on the entire sales of Rs.600 lacs per annum @ 1%
Credit administration costs @ 1% of total sales
Then the cost of carrying receivables would work out to:
Step 1: Determining the amount of investment in receivables
Rs. 100 lacs (-) profit margin of Rs. 12 lacs = Rs. 88 lacs
Step 2: Bank finance @ 60% of Rs. 100 lacs = Rs. 60 lacs
Own finance, the balance = Rs. 28 lacs
Step 3 – Determining all the costs
Cost of funds = Rs. 60 lacs @ 16% (+) Rs. 28 lacs @ 25% = Rs. 9.6 lacs (+) Rs. 7 lacs = Rs. 16.6 lacs
Cost of administration @ 1% of Rs. 600 lacs = Rs. 6 lacs
Cost of bad debts @ 1% of Rs. 600 lacs = Rs. 6 lacs
Total cost of receivables on an annual basis = Rs. 28.6 lacs
Case lets:
1. Cash management:
Apoorva Chemicals Limited has its registered office in Surat. It has in all 9 branch offices all over
the country. It has a very well established dealer net work throughout the country. Its suppliers
are from major cities – Mumbai, Baroda, Chennai, Delhi and 5 other cities. All the decisions on
cash and investment are centralized in Surat. The present practices are:
1. In the beginning of the year, the branch offices get their budgets approved, both for sales
and expenses.
2. Every month at the end, the branch offices prepare MIS reports on the actual budget for
sales and expenses for the month and the estimates agreed upon at the beginning.
3. The branch offices have got their current account with State Bank of India and on a daily
basis, the credit balances beyond Rs.25,000/- are expected to get transferred to the central
office account with State Bank of India, Surat. For these there are nominal charges.
4. Again from central office funds get transferred to those branch offices located in such cities
having suppliers for making payments to them, as per due dates of bills. For this, there are
usual bank charges for remittance.

17
The above system has been put in practice for a long time. However due to increasing
competition, the management wants to cut down costs. They want to take advantage of the
technology innovation in the banking industry.
Discuss the following:
1. What could be done to save cost on remittance here?
2. In what way the bank balances can be better managed considering that first funds get
transferred to the central office and there is reverse transfer of funds for payment to
creditors?
3. What is the advantage that banking system offers now in comparison with the past?
4. Is there any fee based service that the banking system offers now for management of cash
for a limited company?
5. What is the role of cash flow statement in management of cash?
6. Draw the comprehensive cash management systemmap for Apoorva Chemicals Limited.
2. Inventory management:
Atlas Copco India Limited, Pune has recently revamped the purchase system and introduced
ERP system. This systemis operating at a global level. They have also introduced the ‘global
vendor system’ for smooth operations on global purchases.
They had conducted the cost analysis for inventory for the past three years and come to the
shocking conclusion that inventory carrying costs had increased about 7% in the past three
years. This is real cost excluding inflation rate.
The company for its production depends upon vendors for bought out components to the
extent of 50%. This means that for every Rs.100/- spent on materials, Rs.50/- are from bought
out components. The suppliers are both from India and foreign countries like China, USA &
Germany. The management hopes that with the introduction of ERP systemthey will be able to
have effective inventory management. They also have the policy of having only 3 vendors for
any component or material globally.
Discuss the following:
1. What do you understand by the term ‘inventory management’?
2. From the details given here, what is the component of inventory that we are referring to?
3. What could be the possible steps involved in managing inventory given the scenario of the
company?
4. What is the name for the systemthat can be an effective tool in inventory management in
this case?

18
3. Receivables management:
At present your enterprise is giving 30 days credit and the monthly sales are Rs.100 lacs. The
competition is intense and you are asking the marketing department to assess different ways of
increasing the sales. They suggest the following:
1. Increase the credit period by 15 days to be more attractive
The increase in sales would be 5% per month.
The profit margin is 10% and bad debts are nil at present. They are likely to be 0.5% on the
entire revised sales if the proposal is accepted.
Total cost of funds may be assumed to be 18% p.a.
Examine the proposal and advise whether this should be accepted or not.
2.3 Simple ratioanalysis
2.3.1 Introductiontoratioanalysis:
Ratio analysis is a part of ‘financial analysis’. The objective of ‘financial analysis’ is to assess the
financial performance of a given business in terms of liquidity, profitability and growth.
 Liquidity is measured in terms of cash on hand and it results in ability of the enterprise to
meet its commitments to creditors etc.;
 Profitability should be good in terms of turnover and should not be coming down over a
period of time &
 Growth should be positive in terms of real growth and not nominal growth.
Ratio analysis is done on the basis of the following financial statements of the enterprise:
1. Balance sheet &
2. Profit and loss
Liquidity is represented by current assets (please refer to the earlier part of this chapter for
liquid assets)
Profitability: This is actually in % terms of the turn over or total income {turn over (+) other
income}. Please note the difference between profitability and profits. The former is a %
relationship between the amount of profit and sales volume while the latter refers to the
amount of profits.
Let us illustrate this with an example:
Example no. 8
The profit for year 1 was Rs.10 lacs on a sales figure of Rs. 100 lacs. The respective figures for
the second year are: Rs.12 lacs and Rs.150 lacs.
In terms of profits, year 2 performance appears to be better than that of the first year

19
In terms of profitability, the first year figure was 10% while the second year figure is around 8%.
This is a reduction of 2%. This means that operating costs of the enterprise have gone up in the
second year. This needs examination and correction. This is the very essence of ratio analysis.
Real growth rate = nominal growth rate (in terms of increase in value over the previous year) (-)
rate of inflation; this actually represents growth in volume terms and is the real growth on a
year-to-year basis. Let us illustrate this with an example:
Example no. 9
Last year the sales figures were Rs. 100 lacs and this year the sales figures are Rs.108 lacs. In the
same period, the rate of inflation was 10%.
In terms of nominal growth, the rate was 8%.
In terms of real growth, the rate was (-) 2% = 8% (-) 10%
This means in reality there was no growth.
Ratio analysis could be attempted by comparison with another business in the same sector. This
is called ‘industry analysis’. It is very difficult to carry out this exercise in India as details are not
available for analysis; besides the scales of operations of these two enterprises may not be
comparable. Hence what is the alternative?
The alternative is what is called ‘trend analysis’. This is intra-firm analysis. This is done on a
year-to-year basis in terms of growth and other critical parameters. A brief on the parameters is
given in the subsequent paragraph. This is usually done for a minimum period of 5 years to
have any significant conclusion on the trend.
Some of the critical parameters relate to profit and loss, some others relate to balance sheet
& the rest of them could be relating to profit and loss and balance sheet.
Critical parameters for a general finance student to understand in ratio analysis:
Profitability ratios – Profit & Loss
1. Operating profit ratio – Operating income (-) operating expenses/Sales or services turnover;
no bench mark by the market; only trend on a year-to-year basis
2. Total profit ratio – Total profit or Profit before tax/Sales or services turnover (+) other
income; again no bench mark by the market; only trend on a year-to-year basis
Liquidity ratio – Balance sheet
1. Current ratio – Current assets/current liabilities; bench mark by a lender – a minimum of
1.5:1
Risk ratios – Balance sheet
1. Debt to equity ratio – Term liabilities/Net worth; bench mark by a lender – a maximum of

20
2:1
2. Total debt to equity ratio – Total liabilities/Net worth; bench mark by a lender – a maximum
of 3:1
Note: The students would appreciate that with increase in debt, the risk to the enterprise
also increases; the risk of repayment of the loan along with interest.
Just a word on ‘limitations to ratio analysis’
The ratio analysis is useful in assessing the financial performance of the enterprise. However it
also has limitations especially in the case of balance sheet ratios. Balance sheet states the
financial position as on a particular date and does not give the annual averages for all the assets
and liabilities. Hence the year-end position could be vastly different from the averages for the
year. This is the major limitation of the tool of ratio analysis.
How to overcome this:
Take the position as at the end of every month and take the average for the year. The picture
would definitely be more reliable. In case the enterprise is in a position to ascertain the average
on a daily basis, the picture would be truly reliable.
Return on investment ratios – Balance sheet and profit and loss combined
1. Return on investment or capital employed ratio; no bench mark and only a trend analysis on
a year-to-year basis
Formula = [Earnings before interest and tax (EBIT)/Total capital employed in business] x 100
This is expressed as a %.
2. Return on equity or owners’ funds; no bench mark again and only a trend analysis on a year-
to-year basis
Formula = [PAT (-) dividend on preference share capital (-) dividend tax both on equity &
preference capital]/[Net worth (Equity share holders’ funds = Paid up capital (+) Reserves &
surplus)] x 100. This is expressed as a %.
3. Earnings per share or EPS; again no bench mark and only trend; on a year-to-year basis. This
is always expressed in Rs.
Formula = [PAT (-) dividend on preference share capital (-) dividend tax both on equity &
preference capital]/number of equity shares

21
Example to understand the criticality of the above ratios:
Example no. 10
Year no. Parameters (Figures are in Indian Rupees in Millions)
Sales Operating
profitability
Total
profitability
Current
ratio
Return on
investment
Return
on equity
EPS
(In Indian
Rs.) (Face
value
Rs.10/-)
1 10 10% 11% 1.8:1 23% 34% 7.80
2 12 9.16% 10% 1.6:1 28% 28% 6.35
Further relating to debt to equity, the following details are given:
Year no. 1 – Debt to equity 1.3:1 & year 2 – 1.8:1
Year no. 1 – Total debt to equity ratio 2.2: 1 & year 2 – 3.2:1
Observations:
1. Sales has increased by 20%
2. Operating profitability has come down; operating costs have gone up
3. Total profitability has come down; overall profitability has come down
4. Current ratio has come down; less liquidity in the enterprise and less ability to meet its
current liabilities including creditors
5. Return on investment has gone up; company has reduced its term liabilities
6. Return on equity has come down; higher net worth earning less returns
7. EPS has come down – Earnings for the equity share holders have come down due to more
shares issued (could be one of the reasons)
8. In the second year, both the ratios relating to debt to equity have gone up thereby
increasing the risk, although in the case of term debt to equity ratio, even in the second
year, the ratio is less than the bench mark. It has however exceeded the bench mark in the
case of total debt to equity ratio.
Note: Only some of the critical ratios have been detailed here considering that this is not a
finance specialization course. The following have not been included in the discussion:
1. Turn over ratios or efficiency ratios or activity ratios relating to turnover of inventory,
current assets, debtors etc.
2. Coverage ratios – these indicate the ability of the enterprise to service its loans taken
Case lets
1. Examine the followinganddiscussthe reasons:(all figuresare inthousands)
a. Operatingincome 100
Otherincome 18
Profitbefore tax 15

22
What isthe operatingprofit?Whatdoesitindicate?
b. Increase inincome 25%
Increase inoperatingprofit18%
What doesitindicate?
c. Year 1 PBT – 28 & Year 2 PBT – 24
Year 1 Provisionfortax – 7 & year2 provision –4.8
What do these figuresindicate?
d. Year 1 – paidup capital 2000 & EPS – Rs. 10.56
Year 2 – paidup capital 2500 & EPS – Rs. 8.25
Why has EPScome downinthe secondyear?
2. An enterprisehasreasonable PATlike28on revenuesof 180. Its liquidityisnotsogood at 8 instead
of 12. What could be the possible reasonforlessliquiditydespite reasonableprofits?
Class activity:
Attempt the following numerical exercises on ratio analysis:
1. From the following find out the financial ratios as required:
 EBIT = 800 lacs
 Interest = 220 lacs
 Income Tax = 30%
 Preference share capital = 100 lacs @ 11%
 Dividend tax 11.10 lacs
You are required to determine the following:
 Term debt to equity
 Total debt to equity
 Profit before tax
 Amount of provision for tax required to be made in the books
 Return on equity
 Return on total capital employed (medium and long term liabilities – 1000 lacs, current
liabilities – 600 lacs and net worth – 800 lacs)
2. From the following find out the required financial parameters:
 Profit after tax: Rs.300 lacs;
 Dividend on share capital of Rs. 500 lacs at 15%. Dividend tax to be considered @ 16%
 Interest for all liabilities – Rs. 150 lacs
 Reserves excl. current year’s retained profits: Rs.100 lacs
 Face value of share: Rs.100/
 Depreciation for the year – Rs.75 lacs & amortization amount – Rs.30 lacs

23
Ratios to be found out:
 Gross cash accruals
 Net cash accruals &
 EPS
3. From the following find out the financial parameters indicated (Rs. in lacs)
 Operating income – 8000
 Other income - 500
 Operating expenses other than interest - 7200
 Interest 320
 Depreciation 200
 Income tax 30%
 Dividend on preference share capital Rs. 30 lacs (rate 10%)
 Dividend on equity share capital – Rs. 200 lacs (rate 18%) – FV Rs. 25/-
 No dividend tax
 Reserves 800 including the profit retained in business for the period
 Outstanding medium and long-term liabilities 1600 and outstanding current liabilities
1000
 Current assets – 1500
Find out the following ratios:
 Profitability ratios:
Operating profit
Total profit
 Earnings per share
 Return on equity
 Return on total capital employed
 Current ratio
 Term debt to equity ratio &
 Total debt to equity ratio
2.4 Solvedquestions:
Question no. 1:
What is the type of ratio analysis that is possible in India and what is the limitation on carrying
out ‘industry analysis’?
Answer:
The ratio analysis carried out in India is known as ‘trend analysis’. This is ‘intra-firm analysis’ and
not ‘inter-firm analysis’. Here through the financial statements of balance sheet and profit and
loss, critical ratios are studied; some of them from balance sheet only, some others from profit

24
and loss statement only while the rest come both from balance sheet and profit and loss. The
trend is studied at least for a period of 5 years. The overall objective of ratio analysis is to assess
the financial performance of the enterprise in terms of:
Liquidity, profitability & growth
Some of the ratios do have bench marks while some others do not have. For example,
profitability and return ratios do not have any bench marks while liquidity ratios do have a
bench mark.
In India for want of adequate details, a full-fledged industry analysis or inter-firm analysis is not
possible. Even listed companies do not disclose fully finer details that are required for an
effective financial analysis through ratios. Further what adds to the problem is that the scales of
operations of any two listed companies in the same sector are not comparable at all. This is the
limitation in carrying out ‘inter-firm’ or ‘industry’ analysis in India.
Question no. 2:
What is the use of operating cycle to an enterprise? Does it help in determining the required
bank finance for working capital? Explain through an example.
Answer:
Working capital assets behave in a different manner from that of long-term or fixed assets of
the enterprise. While the fixed assets get depreciated over a period of time due to constant
use, the current assets or working capital assets get consumed through turnover. The concept
of turnover is to change form constantly, ultimately resulting in sales income. The term
‘turnover’ now is synonymous with total revenues from operations during a financial year.
The operating cycle starts from cash and ends in cash as under:
Cash Materials
Materials Finished goods through semi-finished goods
Finished goods Sales
Sales Cash (if no credit is given to buyers)
Sales Debtors (if credit is given to buyers) &
Debtors Cash
Then the cycle repeats itself. The number of times the cycle repeats itself is the basis on which
the operating efficiency of the enterprise is determined. The more the number of times the
operating cycle repeats, the higher the efficiency and the higher the turnover from operations
during the financial year. Thus, operating cycle helps us in determining turnover as well as
investment in various stages of the cycle.
An example:

25
In practice, the cash to materials is ignored as there is no investment in cash. Cash is ready with
the enterprise. Let us explain the concept of operating cycle through the following example:
Materials – 30 days –Rs. 50 lacs
Semi-finished goods – 15 days – Rs. 35 lacs
Finished goods – 15 days – Rs.45 lacs
Debtors – 30 days – Rs.120 lacs
Creditors – 15 days – Rs. 25 lacs
The operating cycle in number of days (gross – without considering credit) = 90 days and the
number of times the cycle repeats itself in a year = 4 (360/90)
The operating cycle in value (gross without credit) = Rs. 250 lacs; this is not the turnover. The
turnover is represented by the debtors. The debtors are Rs. 120 lacs for 30 days and hence
annual turnover is Rs. 1,440 lacs (12 x 120)
The net values of the operating cycle are:
No. of days = 75 days [90(-) 15]
Value = Rs. 225 lacs [250 (-) 25]
The bank finance is based on the net value and not gross value. In the above case, the amount
of Rs. 225 lacs is financed by two sources – owners’ contribution in terms of net worth and
bank finance.
Question no. 3:
What have you understood by working capital management?
Answer:
Working capital management means managing the three components of the working capital
properly so as to optimize the efficiency. The overall objective is to utilize the working capital
assets in an optimal manner. This means close monitoring and not acquiring unnecessary
working capital assets, falling to the temptation of discounts etc. This requires meticulous
planning and execution besides monitoring.
For example the enterprise carries more cash than necessary – this will affect the profits
The enterprise carries more inventory than necessary – inventory carrying costs go up and
profits are affected besides the risk of a portion of inventory going obsolete &
The enterprise has large debtors – debtors carrying costs go up and both liquidity and profits
are affected.
This is the criticality of working capital management. There are separate tools for effective
management of all the three components of working capital.
Question no. 4:

26
Why should the enterprise ensure that the value of current assets is always more than the
amount of current liabilities? Explain through an example.
Answer:
The current assets include work in progress, finished goods and receivables besides materials.
While materials are valued at cost, work in progress and finished goods are materials + value
add in terms of conversion charges. Similarly debtors would include all the costs and profit.
Hence automatically the value of current assets would be higher than the value of current
liabilities.
Secondly in order to meet all its current liabilities, any enterprise should ensure that the value
of current assets would be higher than that of current liabilities. The value of current assets is
always subject to variation in the market depending upon the following:
1. How realistic the valuation is by the enterprise?
2. How well the company is doing?
Suppose the valuation is not realistic, it is likely to come down in the market. Further in case the
enterprise is not doing well, again the value of the current assets in the market is likely to be
less than what is given in the books. So in order to ensure that by and large and at all times, the
enterprise is ready to meet all its current obligations from its current assets, the value of
current assets will be higher than that of current liabilities.
2.5 Unsolvedquestions:
1. Does the working capital requirement of an enterprise depend upon the sector? Explain
with examples.
2. Are all current assets the same in their ease of conversion into cash? If not, explain the
concept of some of them being more liquid than the others.
3. What are the names for the different components of the operating cycle? Name the
departments responsible for such different components.
4. What is the concept of real growth rate when we refer to growth in any enterprise? Explain
with an example. What is the importance of profitability in the financial analysis? Explain
with an example.
2.6 Summary:
In the ‘Advance’ module of ‘Practical finance’, in the first chapter we had learnt about the
critical concept of ‘time value of money’ and its applications. In this chapter, we have learnt
about the second critical concept of ‘ratio analysis’ to be able to understand key business
numbers and assess financial performance of a business enterprise. The chapter has been
designed keeping in mind that the participants are not from finance stream. Hence only very

27
critical financial ratios have been detailed. As is the practice, the reinforcement of learning is
being done through examples, case lets & class roomactivity.
Any aspirant for a corporate job should possess a minimum knowledge of finance. This among
other things would include basics of working capital management. The characteristics of
working capital assets as distinct from fixed assets, the components of working capital cycle,
the link between working capital cycle and operating efficiency, the estimate of working capital
requirement and bank finance, the costs associated with inventory and receivables and the
management of different components of working capital are to be understood by any
management student.
Most of the times the management takes decisions that are not well informed and later on
regret the same. For example taking additional material due to the lure of discount, extending
credit period without assessing cost benefit analysis etc. could lead to long-term consequences
that are irreversible. Hence the students should know the ‘hidden costs’ associated with
inventory and receivables.
2.7 Handouts:
Extra reading material on ‘Working capital management’
Bala – Notes on Working capital management – Feb. 2013
What is the objective of working capital management?
 To maximise operating efficiency thereby increasing the turnover of current assets
 To manage the components of working capital, namely inventory, cash and receivables
What are the different terms associated with working capital?
 Gross working capital
 Net working capital
Are these known by different terms?
 Gross working capital = total current assets
 Net working capital = current assets (-) current liabilities = permanent investment in current
assets = long-term investment in current assets
Are investments not a part of working capital?
 Generally no. Investments are out of current assets. However it could so happen that at
times that there is a short-term liquid surplus that is invested outside one’s business. One
must ensure that such investment is liquid and earns return that is comparable with the
interest payable on short-term liabilities.
 Usually investments are made out of the profits of the business enterprise

28
What are the components of current assets?
 Cash and bank
 Inventory
 Receivables or trade debtors
 Loans and advances
 Others like prepaid expenses, accrued income etc.
What are the components of current liabilities?
 Bank borrowing for working capital
 Creditors outstanding
 Accrued expenses or provision for expenses or outstanding expenses or expenses due but
not paid
 Provision for tax
 Dividend payable
 Other short-term liabilities for working capital like commercial paper, inter-corporate
deposits etc.
What are the sources for working capital assets?
 Bank finance
 Market finance like commercial paper etc.
 Market credit like credit on purchases
 Net working capital coming from medium and long-term sources
Is there any order in which these sources are available to a business enterprise?
Initially:
 Share capital
 Medium and long-term liability like debenture, bond, unsecured loans from friends and
relatives
What is the typical characteristic feature of current assets?
 Unlike fixed assets in business, current assets keep on changing form. They are in a state of
flux. Cash changes into material, material changes into finished goods and finished goods
change into credit sale and credit sale into cash. This is called “turn over”. The time taken
for completing one cycle is called “operating cycle”. The shorter the cycle, the higher the
operating efficiency and the longer the cycle, the less the operating efficiency. Credit on
sales prolongs the cycle and credit on purchases shortens the cycle.
How do you measure the operating cycle?
 In number of days as well as in value. Let us give names for different components of the
operating cycle as under:

29
Conversion time of cash into material = lead time
Conversion time of material into finished goods = process time
Conversion time of finished goods into sales = stocking time
Conversion time of sales into cash = Average collection period
 Let inventory holding period be “A” in number of days
Let semi-finished goods holding period be “B” in number of days
Let finished goods holding period be “C” in number of days
Let receivables holding period be “D” in number of days
Let creditors outstanding be “E” in number of days
Then, operating cycle = A + B + C + D – E
 If we substitute the number of days with values, we get operating cycle in value.
What is the difference between value of one operating cycle and investment in one operating
cycle?
 The operating cycle as above includes the outstanding debtors. Outstanding debtors include
profits. Profits are return on investment and not investment. Hence we deduct profit on
outstanding debtors and arrive at the investment in operating cycle. The same difference
will be relevant in the case of value of current assets and investment in current assets.
What happens in case you have more than one kind of material, how do you determine the
holding of materials in number of days?
 Through weighted average method for all the components of materials.
HUL weaves sustainability into its business plans
R. Srinivasan
New Delhi, April 24, 2012
From sustainably grown tomatoes in its ketchups to developing the technology for converting
used shampoo sachets into fuel, consumer products giant Hindustan Unilever Ltd (HUL) said on
Tuesday that its ambitious ‘Sustainable Living' programme was ahead of target in most areas.
Releasing a status report on the plan, which aims at incorporating the concept of sustainability
into its core business plans, the HUL Managing Director and CEO, Mr. Nitin Paranjpe, said there
was now clear evidence that the plan was not only improving the company's environmental and
social footprints, but was also boosting top lines and bottom lines.

30
Tuesday's release in the capital was part of a global release of similar reports by HUL's parent
Unilever worldwide. Announced in November 2010 as a global initiative by Unilever, the plan
set 60 specific targets
To be achieved over a 10-year time frame, aimed at halving its environmental footprint and
sourcing 100 per cent of its agricultural raw material from sustainable sources.
In India, HUL said that as much as 60 per cent of the tomatoes it sources for its Kissan ketchup
is from sustainable farms. And 16 per cent of the tea it sells in India under the Brooke Bond and
Lipton labels are now sourced from certified sustainable plantations.
Safe water campaign
Two other key initiatives, launched in India by then HUL CEO and current Unilever COO Mr.
Harish Manwani, have been rolled out into other markets worldwide. One is to provide safe
drinking water through a low-cost, non-electric storage water filter. The other was the hand-
washing (with soap) campaign aimed at children, which the company said had helped reduce
diarrhoeal diseases by 20 per cent and improved school attendance by 40 per cent among a
sample group studied in Mumbai in 2008.
Both are now being rolled out in other emerging markets. HUL's Pure it filters are now being
sold in many developing markets worldwide, and the company said that as many as 35 million
people have gained access to safe drinking water through Pure it, since its launch in 2005.
Palm oil sourcing
But the company said the biggest strides were made in the sustainable sourcing of palm oil, a
key ingredient in as much as 60 per cent of Unilever's worldwide output by volume. Rampant
destruction of rainforest to clear land for palm oil cultivation has been cited as the major
reason for environmental degradation in the rainforest ecology of South East Asia.
Unilever said that its palm oil target has been reached three years ahead of schedule, with
800,000 tonnes of the 1.3 million tonnes the company consumes annually being certified as
sustainable.
The balance, which is in the form of palm oil derivatives, is less easily certifiable. Unilever has
announced a $100-million investment in Indonesia to set up a palm oil processing plant in
Sumatra.
Consumer habits
But Mr. Paranjpe admitted that progress on sustainability was slower in some areas, especially
those relating to changing consumer habits — like using less water while bathing or washing

31
clothes — was slower. He sought the cooperation of other stakeholders, including
governments, NGOs and consumer forums, to work towards a common sustainability goal.
Earlier, formally releasing the report in India, the Union Corporate Affairs Minister, Mr. M.
Veerappa Moily, said that corporate social responsibility and corporate governance were being
embedded in the new Companies Bill under preparation.
Raghavan.s@ thehindu.co.in
Casestudy covering all the objectivesof the chapter- Pleaserefer to Chapter3

Topic 2 working capital & its management

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