INVENTORY AND WORKING CAPITAL MANAGEMENT: AN EMPIRICAL ANALYSIS. Dr.MOHAN.M, Professor, Department of MBA, AGNI COLLEGE OF TECHNOLOGY,

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1 ISSN: , EISSN INVENTORY AND WORKING CAPITAL MANAGEMENT: AN EMPIRICAL ANALYSIS. Introduction: Dr.MOHAN.M, Professor, Department of MBA, AGNI COLLEGE OF TECHNOLOGY, Thalambur, Chennai The developing economies generally face the problem of inefficient utilization of resources available to them. Capital is the scarcest productive resource in such economies and hence a proper utilization of these resources promotes the rate of growth cuts down the cost of production and above all, improves the efficiency of the productivity system. Fixed capital and working capital are the dominant contributors to the capital of a developing country. Fixed capital investment generates productive capacity, whereas working capital makes the utilization of that capacity possible. Thus, the study of the working capital behavior occupies an important place in financial management. The earlier emphasis of the financial management was more on a longterm financial decision. Working capital management, which is concerned with shortterm financial decision, appears to have been relatively neglected in the literature of finance. A deeper understanding of the importance of working capital and it s satisfactory provisions can lead to not only a material saving in the economical use of capital, but also assist in furthering the ultimate aim of a business, namely, that of maximizing financial returns on the minimum amount of capital which need to be employed. On the other hand, investing, which is one of the important elements of current assets, reflects the investment of a firm s fund. Hence, it is necessary to manage inventories efficiently in order to avoid unnecessary investments. A firm which neglects the management of inventories, will have to face serious problem relating to longterm profitability and may fail to survive. With the help of better inventory management, a firm can reduce the levels of inventories to a considerable degrees e.g.,10 to 20% without any adverse effect on production and sales. Thus, inventory is a factor in business operations. For the survival of business, the firm should have requisite levels of inventories. it should neither be excessive nor inadequate. Excessive inventory means accumulation of ideal funds, increase in carrying cost, which may lead to lower profitability. Whereas, in adequate inventories result s in interruption of sales operations. A proper balance between two extreme situation should be maintained for efficient and effective operations of the business with the help of skillful inventory management. The need for efficient inventory management in the corporate sector has increased in the era of global competition. Setting the optimum level of working capital requires in exercise of determining the level of current assets, where the total cost is minimum. An inventory constitutes a major portion of the working capital. Thus, managing working capital is synonymous with controlling inventories. Page 111

2 ISSN: , EISSN Justification of the study The importance of working capital management stems from two reasons: i. A substantial portion of the investment is invested in current assets, and ii. Level of current assets will change quickly, with the variation in sales. Hence, in this study, an attempt has been made to analyze the size and composition of working capital and whether such an investment has increased or declined over a period. After determining the requirements of the current assets, one of the important tasks of the financial manager to select a group of appropriate sources of finance for the current assets. Normally, the excess of current assets over current liabilities should be financed by the long term sources. It is not possible to find out precisely which long term sources has been used to finance current assets, but it can be examined as to what proportion of current assets has been financed by term funds. Therefore, an attempt has been made in this regard. Inventory is one of the major components of current assets, which requires huge investments. The main purpose carrying inventory is uncouple the operation, to make each function of the firm independent of the other function, so that delay in one area doesn t affect the production and sales activities. As the shutting down of the production results in increased and delay in the delivery can result in loosing the customers, inventory management assumes significance in any firm and it is of great concern to any financial manager. Any firm would like to hold higher inventory. This will enable the firm to be more flexible in supply and fixed ease in its production schedule. Most of the customers may require immediate delivery and higher inventories may help in meeting their demands. However, there is always cost involved in the inventories. This cost includes the capital cost of the stock and the cost of storing and carrying. Inventories are the assets of the firm and as such, they present an investment.as such investments require a commitment of funds,managers must ensure that the firm maintains inventories at the correct level. If they become too large, the firm loses the opportunities to employ those funds more effectively. Similarly, if they are too small, the firm may lose sales. Therefore, it is better to maintain an optimum level of inventories that is needed in an organization. While analyzing, the working, it is important to analyze the various components of working capital especially inventory, became inventory is one of the major component and is nearly 50% of the current assets. Hence it is necessary to analyze the size of inventory and the impact on working capital management. Profile of the companies: Chittoor Cooperative Sugars Ltd., (CCS Ltd.,): The Chittoor Cooperative sugars Ltd., Chittoor, AP. was established in the year 1955.It s capacity was 1500 TCD.The share capital of company was Rs 15 lakhs. The objective of CCS Ltd., is avoid middlemen in the transactions of sugar cane producers and the factory and to protect the interest of members through cooperative principles. The sugar cane Zone of the factory is consists of 24 mandals and spread over 617 villages of Chittoor districts. There are about 9274 members and about 5000 formers supplying sugar cane. Page 112

3 ISSN: , EISSN Sri Venkateswara Cooperative Sugar Factory Ltd., (SV Coop.Sugars): Sri Venkateswara Coop.sugar factory Ltd.,Gajula mandyam(vill), Renigunta, Chittoor(Dist),A.P was registered on nunder cooperative societies Act,1964and it started crane crushing during the financial year The increased and installed capacity of the factory was 1250 TCD.The share capital of the company was rs 27 lakhs.the factory management has taken up modernization with additional equipment in the year and the present plant capacity was 1500 TCD. The objective of S.V.CoOp sugar factory Ltd.,is to protect economic interests of members by encouraging proper development of agricultural industries on Cooperative lines and through cooperative principles of 22 mandals and spread over in 507 villages of chittoor district. There are about 11,126 members and about 4000 farmers supplying sugar cane. Objective of the study: To assess the significance of inventory and inventory management by few important parameters like inventory turnover ratio, Inventory to current assets,inventory to working capital ratio, inventory holding ratio etc., To study the impact of inventory on working capital in selected companies by using coefficient of correlation and also test the significance of such a correlation To study the impact of inventory on liquid position in selected companies To offer some suggestions for the better utilization of resources related to working capital and inventory. Limitations of the study: The study is limited to 12 years[ to ] performance of the selected companies, The data used in this study has been taken from annual reports only. As per requirement and necessity, data has been grouped and subgrouped, For giving a clearcut opinion, various inventory ratios, Working capital ratios and trend projection methods of financial management has been used. Research Methodology and Design: In the research paper, two cooperative sugar factories in Chittoor district of Andhra Pradesh have been taken for sample study. Chittoor cooperative Ltd.,Chittoor is one of the largest sugar factory in the district,where as Sri Venkateswara Coop.Sugar factory Ltd., Gajulamandyam is also under cooperative sector in the district. The data of selected companies for the year from to used in this study, has been taken from secondary sources i.e., published annual reports of the companies. Editing classification and tabulation of the financial data, which was collected from the above mentioned sources, has been done as per the requirements of the study. For assessing the performance and position of inventory in working capital, this study uses the technique of ratio analysis, trend projection, and liquidity ranking, has been used. The collected data has been analyzed in the following ways. I. Analysis of inventory and working capital ratios II. Analysis of working capital and inventory trends III. Analysis of components of working capital, and IV. Analysis of liquidity and ranking. Page 113

4 ISSN: , EISSN For assessing the behavior of data, statistical techniques like mean, growth rate, coefficient of variation, rank correlation, regression analysistest and chisquare test have been used in the study. Findings with detailed discussion Analysis of inventory ratios: Inventory term over ratio (ITR) establishes the relationship between the cost of goods sold with the average stock. This ration measures the velocity of conversion of stock into sales. Usually, a high inventory term over indicates efficient management of inventory because the stocks are sold more frequently and lesser amount of money is required to finance the inventory. A low inventory term over ratio indicates an inefficient management of inventory, over investment in inventories, dull business poor quality of goods and lower profit when compared to the total investment. A high inventory term over may be the result of a very low level of inventory, which results in shortage of goods in relation to demand and a position of stock. The turnover may also be high due to a conservative method of valuing inventories at lower level or the policy of the being to butyl frequently in small lots. As per table 1,inventory turnover ratio of both companies are in the same direction, in case if CCS Ltd., Ratio has increased from 5.68 times to 6.17 times between to , but consistently decreased to 3.64 between to and also increased to 5.03 times in the year On the other hand, ITR of SV cooperative sugars as also increased from 3.23 times to 4.60times between to but rapidly decreased to 4.16 times in the year The overall average of ITR for the study period is only 6.63 of CCS ltd., And 4.16 for S V coop., which shows a positive inventory controlled CCS Ltd., as for as ITR is concerned, both the companies have a similar position. Inventory Holding Ratio (IHR): Age of inventory indicates the duration of inventory in an organization. It shows the moving position of inventory during the year. If the age of inventory is lower, it means that the company s activity position is satisfactory and they are able to sell their product with in short period, which indicates the sound liquidity position of an organization. On the other hand, if the age of inventory is too high, it indicates the slow moving of stock due to lower demand of product or excessive production by company. This is due to the stocking policy, which directly affects the liquidity position of a company. Inventory is one of the major items in current assets, which shows investment of working capital in stock. As per Table 1,inventory holding ratio of CCS Ltd., has increased from 64 days to 73 days between to On of the other land, the same ratio of S.V. Coop S.F. Ltd has decreased from 113 days to 85 days with an average of 93 days for the study period i.e., from to Therefore.it is clear from the above, that CCS Ltd., has improved its position in a commendable way with an average of 68 days, but SV Coop sugar factory Ltd., is still behind of CSS Ltd., from the inventory management point of various. Inventory with working capital ratio (IWCR): Inventory to working capital is one of the important ratio, which directory shows operational efficiency, working capital position in any organization. As inventory increased, working capital also increases. Normally, inventory is 50% of the current assets and working capital is current assets minus current liabilities, which means that inventory covers nearly total current liabilities and the rest of the current assets are denoted as working capital. As per table1, inventory 134% between to Average of the study period is 128%, which shows that approximately 138% of the working capital is in Page 114

5 ISSN: , EISSN the form of inventory. In case of S V coop S.F Ltd. Percentage of inventory with working capital, follow the same pattern as in CCS Ltd. It has increased from 132per cent to 240 per cent between to However, the percentage of inventory is working capital S V coop. sugar factory Ltd is higher compared to CCS Ltd. That has negatively affected the working capital and liquidity position of the company. Inventory to current Assets (ICAR): It is one the important ratios, which signifies the level of inventory in current assets. Normally, inventory is one of the major components in current assets, so it is better to analyze the position of inventory compared to current assets. As per table1, inventory compared to current assets in CCS Ltd. is near to 50% with in overall average of 55% for the study period. On other hand, percentage of inventory to current assets of S V coop sugar Ltd has 56% as an average for the study period. Which shows that inventory has increased over the moving (i. e.,50%) and also it is better to get this percentage of inventory to current assets to less than 50%. Table1: Inventory Ratios of Chittoor coop.sugars Ltd& Sri Venkateswara coop Sugar factory Ltd., Year Chittoor Co Op Sugars Ltd., S V Co Op Sugars Ltd., ITR IHP IWC ICA ITR IHP IWC ICA Times days % % Times Days % % Average Growth Rate Source: Compiled from the annual reports of CCS and S V Coop S F Ltd., from to ITR:Inventory turnover ratio 1HR:Inventory holding period 1WC Inventory to working capital 1CA:Inventory to current assests Page 115

6 ISSN: , EISSN Analysis of working capital ratios Current ratio (CR): The current ratio is calculated by dividing current assets by current liabilities. Current assets after to all those assets, which are convertible into cash within a year. Current liabilities includes obligation motoring within a year. The current ratio is thus, a measure of the firm s short term solvency and it indicates the availability of current assets in rupees for every one rupee of current liability. A ratio of greater than one means that the firm has more current assets than current liabilities. The ideal current ratio is 2:1 in normal condition. As per table2, current ratio of CCS is 1.93 as average for the study period and very nearer to the ideal standard. Current ratio of S V coop sugar factory Ltd. The overall average is 1.83.Which shows that the current assets of S V coop sugar factory Ltd have less compared to CCS Ltd during the study period. Liquid ratio (or) Quick ratio (LR): Quick ratio, also known as acid test (or) liquid ratio is a more rigorous test for liquidity than current ratio. The term liquidity refers to the ability of a firm to pay its short term organization as and when they become due. The two differ determinants of current ratio as a measure of liquidity is current assets and current liabilities. Current assets include inventories and prepaid expenses, which are not easily convertible into cash within a short period without losing the values. Quick ratio may be defined as the relationship between quick/ current assets and current or liquidity liabilities. An asset is said to be liquid if it can be converted into cash within a short period without loss of value. In that sense, cash in hand and cash in bank are liquid, the real ratio being 1:1. As per table2, in case of CCS Ltd, acid test ratio is in not satisfactory position. Ratio is always ahead of the ideal position 1:1.Overall average of ratio during the study period In case of S V coop sugar Ltd. The ratio is also in the same direction, overall average during the study period is Both the companies have gone in the same direction. Liquid Assets to Total Assets Although receivables, Debtors and Bills Receivables are generally more liquid than inventory, there may doubts regarding their relaisation into cash immediately or in time. Hence some authorities are of the opinion that the obsolete liquid assets including cash in hand and cash at bank and also marketable securities. As per the table 2, Liquid assets to total assets, in case of CCS has decreased from 0.20 to 0.19 during the period to with an average of In case of SVCo op sugar, the ratio has increased from 0.23 to 0.25 for the same period, which indicates that the both the companies have in different directions in case of utilization of liquid Assets. Working capital Turnover Ratio The working of a business is directly related to sales. The current assets like debtors, Bills receivables, cash and stock are changed with the increase or decrease of sales. The working capital is taken as the excess of current Assets over current Liabilities. This ratio measures the efficiency with which the working capital is being used by a firm. A higher ratio indicates an efficient utilization of working capital and a low ratio indicates otherwise. However, a very high working capital turnover ratio is not a good situation for any firm and hence, care must be taken while interpreting the ratio. As per the Table 2, working capital turnover ratio of CCS has increased from 0.17 to 0.22 for the period from to On the other hand, SVCo op sugar has gone in the same direction as it increased from 0.51 to 0.58 between to and decreased in the next year to The working capital of SVCo Page 116

7 ISSN: , EISSN op sugar is higher that the CCS during the study period. So the position of SVCo op sugar is better compared to CCS. Current Assets Turnover Ratio Current Assets Turnover Ratio establishes the relationship between the costs of goods sold with the current assets. This ration measures the velocity of conversion of sales into current assets. Usually we are using this ratio to know the efficiency of liquidity management. The ratio of CCS has increased from 2.6 to 3.63 for the periods from to Incase of SVCo op sugars the ratio has also increased from 1.46 to 1.62 during the study period, which indicates the current assets turnover of the both concerns follow the same and accurate direction. Table2: Working capital Ratio of CCS & S V Coop Sugar Factory Ltd., Year Chittoor Co Op Sugars Ltd., S V Co Op Sugars Ltd., CR LR LATA WCTO CATO CR LR LATA WCTO CATO Average Growth Rate *Compiled and analyzed from the annual reports of CCS and S V Coop S F Ltd., from to CR:Current Ratio LR:Liquid Ratio LATA:Liquid Assets to total Assets WCTO:Working Capital Turn over Ration CATO:Current Assets Turn over Ratio Page 117

8 ISSN: , EISSN Analysis of working capital and Inventory Trends: In working capital analysis, the direction of changes over a period is very important. Emphasizing the importance of the analysis of working capital trends. So many authors have pointed out that it provides a base to whether the practice and prevailing policy of the management about working capital is good enough or an improvement is to be made in managing the working capital funds. Inventory is one the major components of current assets, which directly affects the working capital and efficiency of the organization. Analysis of the trend of Inventory and working capital is very significant for an analysis of the size of actual inventory and actual working capital. In case of CCS, on the basis of actual working capital, expected working capital is to be calculated, highest negative fluctuations between actual working capital and trend working capital. Similarly, highest positive fluctuations is in the case of SVCo op Suguars, The actual inventory and expected inventory will also be calculated. between actual and expected inventory is in the case of CCS. Highest negative fluctuations lakhs) Table3: Analysis of inventory working capital trends of CCD Ltd.,&S V CoOp S F Ltd.,(Rs. In Year Chittoor Co Op Sugars Ltd., S V Co Op Sugars Ltd., Working Capital Inventory Working Capital Inventory AWC TV FL AI TV FL AWC TV FL AI TV FL Source: Compiled from the annual reports of CCS and S V Coop S F Ltd., from to AWC:Actual working capital. Page 118

9 ISSN: , EISSN TV:Trend Value FL:Fluctuation AI:Actual Inventory Analysis of components of working capital An element wise analysis of Gross working capital enables one to examine in which element the gross working capital funds are lockedup and to find the factors that are responsible for the significant changes in the working capital of different years. In Table 4, the share of each element has been calculated in percentage separately for each of the years under study and the average share percentage for all years has been calculated. Inventory: It is one the important elements of current assets in case of CCS, inventory regularly increased from Rs. 803Lakhs to Rs.2122lakhs between to , but decreased to Rs.515 lakhs in the year and again increased while in case of SVCo op Sugars, a portion of inventory in current asset is increased during the study period ie.,from to from Rs.902 lakhs to Rs.2208 lakshs. In both companies, the effect of inventory on working capital is largely affected. Debtors: Debtors is another important element, which positively affects Gross working capital and liquidity of a firm. In case of CCS, the value of Debtors has regularly increased from Rs.296 lakhs to Rs.1109 lakhs. Similarly portion of Debtors in Gross working capital also increased from 24 per cent to 25 per cent during the study period. On the other hand, in case of SVCo op Sugars, the amount of Debtors is almost equals to CCS during the study period except last three years and also the percentage of Debtors in Gross working capital of SVCo op Sugars increased from 15 per cent to 20 per cent during the periods from to The contribution of Debtors to working capital is lower in both concerns compared to inventory. Short term Loans and Advances: Short term loans and advances to Sugarcane producers, employees and prepaid expenses. In case of CCS, Loans and advances has regularly increased from Rs. 127 lakhs to Rs.487 Lakhs. Share of Loan and Advances in working capital has increased from 10 per cent to 11 per cent. On the other hand, in case of SVCo op Sugars, It has increased from Rs.183 Lakhs to Rs.463 lakhs between to One of the important trends observed is that in case of both concerns, Loans and advances has increased both in terms of amount and percentage. Page 119

10 ltd., Asia Pacific Journal of Research Vol: I Issue XIV, February 2014 ISSN: , EISSN Table4: Analysis of components of working capital of CSS Ltd.,&S V Coop Sugar factory Year Chittoor Co Op Sugars Ltd., S V Co Op Sugars Ltd., Gross Gross Working S T Working capital Inventory Debtors,L& A capital Inventory Debtors S T,L& A (100) 803(64) 296(24) 127(10) 1424(100) 902(63) 212(15) 183(130) (100) 1948(74) 391(15) 183(7) 1879(100) 1047(56) 394( (12) (100) 515(46) 368(33) 176(16) 1583(100) 958(61) 289(18) 197(13) (100) 772(55) 402(28) 209(15) 1840(100) 910(49) 396(22) 251(14) (100) 909(56) 509(31) 194(12) 2127(100) 1369(64) 363(17) 218(10) (100) 921(50) 594(32) 231(12) 2064(100) 1137(55) 415(20) 287(14) (100) 1247(52) 685(29) 285(11) 1680(100) 715(43) 432(26) 294(18) (100) 1333(57) 611(26) 252(10) 1740(100) 829(48) 416(24) 219(13) (100) 1593(55) 723(25) 368(12) 2271(100) 1323(58) 541(24) 232(10) (100) 1792(49) 846(24) 346(09) 2836(100) 1586(56) 699(25) 346(12) (100) 2083(47) 1012(23) 493(11) 1173(100) 1952(58) 748(22) 455(13) (100) 2122(47) 1109(25) 487(11) 3544(100) 2208(62) 697(20) 463(13) Note: Figure in brackets shows percentage with Gross Working Capital Liquidity Ranking Positions: The Liquidity position of a firm is largely affected by the composition of working capital in as much as many considerable shifts from the relatively more current assets to the relatively less currents assets or vice versa, will materially affect a firm s ability to pay its current debts promptly. Therefore, to determine the liquidity position of the company more precisely, a comprehensive test has been done in Table 5. A process of ranking has been used to arrive at a more comprehensive measure of liquidity in which four factors inventory to current assets ratio,debtors to current assets ratio, cash and bank balances to current assets and other current assets including loans and advances to current assets ratio have been combined in a points score. In case of Debtors to Current Assets Ratio, cash and bank balance to current ration, and other current assets ratio, a high value indicates relatively favourable position and ranking has been done in that order. On the other hand a low inventory to current assets ratio shows a more favourable position and hence ranking has been done in that order. Ultimate ranking has been done on the principle that lower the point scored, the more favourable is the liquidity position. In case of CCS, Table 5 shows that the and registered the most sound liquidity position and then it was followed by , , and respectively. On the other hand in case of SVCo op Sugars, the years , and registered the most sound liquidity position. As far as liquidity point is concerned, both the concerns have sound liquidity position for more than four years. Page 120

11 ISSN: , EISSN Table5: Statement of liquidity in order of Ranking in CCS Ltd., and SV Coop Sugar Factory Ltd., Year %Inves ntory with GWC CS S A S V C o o p %Debto rs with GWC SV Co op %ST,L& A with GWC SV Co op Ranking CCS Ltd., Tot al ran kin g Ultim ate Ranki ng Ranking S V CoOp Sugar fatory Ltd., Total ranki ng CS S CSS Liquidity ranking Liquidity ranking B B B 1 A2 B2 A3 B3 A1 A2 A3 B Ultimate Ranking Page 121

12 ISSN: , EISSN Conclusion: On the basis of above data analysis, one can conclude that : Inventory ratios of both companies have improved during the study period but this position of CCS is far better than SVCo op Sugar factor Limited. Growth of inventory is more compared to working capital in both the companies but the inventory of SVCo operative Sugars has increased sharply during the study period and the contribution in working capital is more than 50 per cent in both companies. Trend of inventory and working capital follow the opposite direction especially in the case of SVCo op Sugar factory shows positive trend. All the working capital ratios are less than the standard norms which reveals the liquidity positions of the companies concerned are not satisfactory. This size of inventory in Gross working capital has increased regularly which directly affects the liquidity position of the company when the size of the inventory is higher in current assets, its ultimate ranking is not good, which shows poor liquidity position. In this study it is clear that the overall position of working capital of both concerns is not satisfactory, so there is s need for improvement in Inventory because a major portion of the current assets are in the form of Inventory, whereas other current assets are properly utilized and maintained. The liquidity position mainly depends up on the size of the inventory, other components like debtors, shortterm loans and advances and cash and bank balances etc., are also reasonable. However, this study found that there is need for an immediate improvement in inventory. Bibliography 1. Annual reports of CCS Ltd., and SVCo op Sugar factory Ltd., from to Bhalla VK (1997), Financial Management and Policy, First Edition, Anmol publications, New Delhi. 3. Khan & Jain (2004), Financial Management, Fourth Edition, Tata Mc Graw Hill Publishing company, New Delhi. 4. Pandey IM, (2005), Financial Management Theory and Practices, Vikas Publishing House Pvt Ltd., New Delhi 5. Rustagi RP (2000), Finacial Management Theroy concepts and problems, Second Edition,Galgotia Publishing Company, New Delhi. Page 122