Dr. Reddy's'ROA' and Its Working Capital Management

Transcription

1 Excellence Financial Results - How to Improve? A NEW APPROACH By Dr. GBRK Prasad, CFPIIM Introduction: Michael Dell said Keep raising the bar, for the industry and for you. This approach enables any company to perform better every Year/quarter as far as Return on capital is concerned And also share concepts on better working capital management. Organizational Excellence: Financial Performance Work Ethics & Culture Corporate Governance standards Contribution to Society, Environment My presentation would focus only on the first part i.e. Financial Performance World s top 25 Supply chains working capital management

2 Working capital management Working Capital Management of Dr. Reddy s over the Years

3 Working Capital Management of Hindustan Unilever over the Years How the 3 companies compare?

4 Inventory turns How to improve it: Start measuring Raw materials inventory turns WIP Turns Finished goods inventory turns Determine which is bottleneck and then improve that. The case of Dr. Reddy s: RM turns WIP turns FG turns As you can see it is raw materials that is the bottleneck to improve the inventory turns Return on assets world s best supply chains:

5 Concept on return on Assets. ROA = (NPM) * (SALES/GFA) {1+ [(COGS/SALES)*(1/IT) + (1/RT) (RM/SALES)*(P) + other current assets]*(sales/gfa)}

6 WHEREIN IT = inventory turns, RT= receivables turns and P = Payment period to suppliers, RM = raw materials consumption per day We can select ROA and then determine what combination of IT, RT and P can give that result from the above equation. Expanding the n : Now if we define the following ratios X = cost of goods sold /sales Y = 1/Inventory turns Z=1/Receivables turns U = Raw materials consumption per day / sales C=credit period to suppliers DRIVERS OF RETURN ON Assets:

7 Insights of this formula: ROA is NPM* Sales/GFA when working capital is ZERO. Impact of payment terms to suppliers can be predicted with accuracy. Step by Step improvement plan for ROA can be worked out using this formula. Net profit margin impacting performance measures which have to be Incorporated in individual KRA across the company IMPORTANCE OF SALES/GROSS FIXED ASSETS:

8 The Case of Dr. Reddy s: SBU specific More complex interaction of cross functional requirements Do we need to improve this parameter at all? Can we deliver sustainable process for this parameter? Manufacturing cycle time reduction who owns it? RA processes hinders this Without improving NPM and Sales/GFA, It would be difficult to improve ROCE by a great margin in Pharmaceutical industry. Sensitivity Analysis for Dr. Reddy s ROCE:

9 Graphical Representation: OBSERVATIONS: SENSITIVITY OF ROCE TO CURRENT ASSET MANAGEMENT IS POOR DUE TO Dr.REDDY S COST STRUCTURE. NET PROFIT MARGIN IMPROVEMENT PERFORMANCE INDICATORS LISTED HEREIN. SAVINGS IN RAW MATERIAL CONSUMPTION SHOULD DRIVE INCREASE IN R&D, SGA EXPENSES.THEN BALANCE SHEET REMAINS HEALTHY.

10 What the Chairman, Sona Koyo, said about this methodology Sona Koyo about ROCE:

11 Explanation on Why ROCE has decreased in

12 Action Plan proposed for Sona: Inventory turns How to improve it Start measuring Raw materials inventory turns WIP Turns Finished goods inventory turns Determine which is bottleneck and then improve that Submission is to adopt the formula Use this methodology in company s performance monitoring system Consistently tracking the variables accounting wise is important. Cross functional interaction of company s should capture these Parameters Being optimistic about the future WORKING CAPITAL- A NEW LOOK: PROBLEM: how to calculate working capital required and link up With payment terms to suppliers. Conclusions: companies can decide on payment terms to suppliers To make working capital required as zero. Weak areas: variability in funds flow on day to day basis is not Considered and can form further scope for research. Highlights:HDFC Bank s Head Credit Risk, in Bombay studied this Formula and suggested to take up with Indian banks association.

13 Sent the article to them. They will review the book and publish the Same. MODEL HOW TO JUDGE WORKING CAPITAL EFFICIENCY Definitions N = operating cycle in days P = number of days to to pay to creditors RM= raw materials consumption per day Cost added= cost added in business per day (other than Depreciation) Working capital required can be estimated as WC= RM*(N-P) + cost added * N Defining alpha= cost added / RM We can write it as WC= RM*N (1+alpha) - RM * P Further this can be written as WCth = RM * N + RM * (N* alpha- P) Compute WC act = cash + inventories + receivables creditors from annual report Working capital efficiency = WCth // WC act Fix supplier payment terms as N * CA / RM to eliminate second term in the formula 1. Calculate supplier payment terms to make theoretical working capital as ZERO is N * (1+ CA /RM)

14 The Case of Dr. Reddy s : The case of Dr. Reddy s for working capital management Source: Annual report Raw material conversion period: 96 days WIP conversion period 30 days Finished goods conversion period-14 days Debtor s collection period days Current payment period to suppliers 100 days Gross operating cycle 241 days Theoretical working capital 142 Crores Efficiency of working capital 0.82 Sales/capital employed 0.65 Working Capital management of M&M

15 Working Capital management of Tata Motors How the 3 companies compare?