CHAPTER I INTRODUCTION AND DESIGN OF THE STUDY

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1 CHAPTER I INTRODUCTION AND DESIGN OF THE STUDY INTRODUCTION Working capital is the cash available for day to day functions of a business. It is the cash that can be used to foot expected and unplanned expenses. Good working capital management will secure a company s financial stature and help build its business. It is necessary for increasing earnings and makes it easier to get business loans and attract potential investors. The main aim of a working capital management plan is to balance current assets against liabilities. This helps companies maintain its planned expenses like salaries and short term financial obligations. If a company s current liabilities are more than its current assets, it signifies a negative working capital. Hiring a good accounts manager who knows various techniques will take care of working capital management in a business efficiently. In case of deficiency, the company can increase the working capital with proper management of outstanding incomes, its creditors and of the company s inventory or by getting a short term loan. The company s growth rate can be increased with cash by regulating its investment plans and by handling profit efficiently. It is important to having good working capital management in order to identify the right time to convert the company s current assets into cash. This is called the cash conversion period. A high working capital saves the company from dire 1

2 situations involving creditors, fixed assets cannot be sold in a short period of time. The ability to manage unforeseen expenses such as these creates good reputation in the market. Working capital management always ensures sufficient cash flow in a business. This allows companies to pay their liabilities without delay and more importantly protects them bankruptcy. With an efficient working management, companies have the advantage of a positive working capital which allows them to take on higher risks in business. Companies need to analyze their current assets and liabilities regularly in order to manage their working capital. A successful working capital management can face emergencies caused by market changes and competitor activities. Good cash flow is always an asset to a company s growth and success. NEED FOR THE STUDY The purpose of the present study is to analyze the various concepts of working capital and find out the feasibility of the concept of working capital in the light of better planning and control of working capital. Problems of working capital management involve the problem of determining the optimum level of investment in each component of current assets i.e. inventory, receivables, cash, and other short term investment. The basic focus in working capital management should be to optimize the firm's investment. An expert in the financial management is of the opinion that problem of 2

3 working capital is one of the factors responsible for the low profitability in manufacturing sector. Better planning and control of working capital, or in other words, proper utilization of optimum quantity of working capital increases the earning power subject to the existence of operating margin STATEMENT OF THE PROBLEM Efficient management of working capital is one of the pre-conditions for the success of an enterprise. Efficient management of working capital means management of various companies of working capital in such a way that an adequate amount of working capital is maintained for smooth running of a firm and for fulfillment of twin objectives of liquidity and profitability. While inadequate amount of working capital impairs the firm s liquidity, holding of excess working capital results in the reduction of the profitability. But the proper estimation of working capital various across firms over the periods depending upon the nature of business, scale of operation, production cycle, credit policy, availability of raw materials, etc. For this significant amount of funds is necessary to invest permanently in the form of various current assets. For instance, due to time lag between scale of goods and their actual realization in cash, adequate amount of working capital is always required to be made available for maintaining the desired level of sales. Empirical results show that inefficient management of working capital is one of the important factors causing industrial sickness. Modern financial 3

4 management aims at reducing the level of current assets without ignoring the risk of stock outs (Bhattacharya, 1991). Profit is the engine that drives the business enterprise. It is the unalterable permanent resource for the existence of enterprise and as such it is primary and final objective. Further it is indeed, a magic eye that mirrors all aspect of the entire business operations including the quality of output. To the management, profit are the test of efficiency and measure of control, to the owners, a measure of worth of their investment, to the creditors, the margin of safety, to the employees, a source of fringe benefit to the government, a measure of tax paying capacity, to the customer, a hint to demand price cuts, to an enterprise cumbersome source of finance for growth and existence and finally for the country, profit is an index of economic progress, national income generated and rise in the standard of living of the people. Therefore, a business enterprise can discharge its obligations to the various segments of the society only through profits. In a conventional production function approach for determination of relationship between output and profit, fixed capital is taken into account as explanatory variable among others; the role of working capital is ignored. It is therefore felt that there is the need to study the important role of working capital in profit generating process. If a company desires to take greater risk for bigger prfit, it reduces the size of working capital in relation to its sales. If it is interested in improving its liquidity, it increases the level of working capital. However, this policy is likely to result 4

5 in a reduction of sales therefore profitability. The profitability of the Cement companies in India is in a fluctuating state due to the change in the cost of production and negative influence of global recession.. To be specific, the increase input cost due to inflation factors, high level of taxation, high proportion of assets to sales, high proportion of various costs components to sales are responsible for low profitability. Besides, a high proportion of working capital to sales also affects the profitability of the firm. In the light of these circumstances, the following questions were probed in the present study. 1) Whether the profitability increases with operating performance variables such as Leverage, Liquidity, Size, Growth, Capital Intensity and Fixed Assets to Total Assets Ratio, Cash Conversion Cycle, and Profitability? 2) Whether the profitability increases with economic variable Inflation? SCOPE OF THE STUDY The present study is confined to the Working Capital Efficiency and Profitability Analysis of Selected Private Sector Cement Companies In India during the period between and The working capital efficiency of these companies have been analyzed in terms of Working Capital Efficiency Index, Utilization Index and Performance Index. The study also investigates the relationship between the working capital efficiency and profitability of the selected cement companies. 5

6 OBJECTIVES OF THE STUDY The main objectives of the study are as follows: 1. To analyze the Working Capital Management of the Selected Private Sector Cement Companies In India. 2. To examine the efficiency of Working Capital Management Practices of the selected firms in Cement Industry in India. 3. To analyze the Profitability of the selected Private Sector Cement Companies in India. 4. To examine the factors determining the Profitability of the selected Private Sector Cement Companies in India. HYPOTHESES Based on the questions cited earlier, the following hypotheses are framed and tested. 1. There is no significant relationship with Profitability and Working Capital Utilization Index. 2. There is no significant relationship with Profitability and Working Capital Performance Index, 3. There is no significant relationship with Profitability and Working Capital Efficiency Index 4. There is no significant relationship with Profitability and Cash Conversion Cycle. 6

7 5. There is no significant relationship between Liquidity and Profitability. 6. There is no significant relationship between Leverage and Profitability 7. There is no significant relationship between Size and Profitability 8. There is no significant relationship between profitability and Growth of the firm. 9. There is no significant relationship between Capital Intensity and Profitability. 10. There is no significant relationship between profitability and Fixed Assets Turnover Ratio. 11. There is no significant relationship between profitability and Inflation. 12. There is no significant relationship between profitability and Fixed Assets to Total Assets Ratio. METHODOLOGY The methodology adopted in the present study is as follows: Period of the Study The present study covers a period of 15 years starting from to Sample Selection Initially it was decided to keep in the sample of twenty large scale private sector cement companies listed in Bombay Stock Exchange (BSE) of India based on their total assets. However, on further scrutiny it was found 7

8 that only some companies have the continuous data for the period of 15 years from to while the others not. The inclusion of companies, which possess data for heterogeneous period of time undoubtedly will, distort the method of study. Hence they have been excluded. The companies which are having less than Rs.100 crores of total assets are also excluded. Based on the above criteria the sample finally holds only 10 companies belonging to private sector cement industry namely Associated Cement Companies Limited, Birla Cement Corporation Limited, Chettinad Cement Corporation Limited, Gujarat Shidhee Cement Limited, India Cement Limited, JK Lakshmi Cement Limited, KCP Cement Limited, Madras Cement Limited, Shree Cement Limited and Shri Vishnu Cement Limited have been considered as samples for the present study. Sources of Data The present study is based on the secondary data. The financial data used in this study has been mainly taken from the PROWESS, the corporate database software of Centre for Monitoring Indian Economy Pvt. Ltd., Mumbai. The Annual reports of individual companies, various issues of magazines and journals, working papers and official directory of Indian stock exchanges were referred extensively for the required data. Framework of Analysis The following tools were used for the analysis and interpretation of the data: Summary Statistics 8

9 Annual Compound Growth Rate (ACGR) Correlation Matrix and Correlation Analysis Multiple Regression Analysis Analysis of Variance (ANOVA) t test Summary Statistics Summary Statistics includes many preliminary statistical tools used to determine the measure of location and variations. In this study, Mean, Standard Deviation, Coefficient of Variation, Maximum, Minimum, Range, Skewness, Kurtosis were used to determine the average value of the different parameters and their variations based on 15 years data. Annual Compound Growth Rate Annual Compound Growth Rate is computed to analyze the growth pattern of the working capital and profitability of selected Private sector cement companies in India over a period of 15 years. Multiple Regression Analysis Regression analysis involves determination of the pattern of relationship and the closeness of the relationship between two or more variables. In this study it is used to asses the relationship between working capital management and profitability and to analyse the factors determining the profitability. 9

10 Correlation Matrix and Correlation Analysis Correlation Matrix is an array of correlation coefficient values arranged in a tabular form where row and column variables show the correlation of each variables with other variables in the array. The correlation analysis was carried out between the variables for the nine industries separately, mainly to determine the degree of inter-relationship and its significance. Analysis of Variance (ANOVA) The analysis of variance, one of the most important tools of statistical analysis, has been developed specially to test the significance of the difference between more than two sample means and to make inferences about whether the sample has been drawn from the populations having the same mean. The technique of Analysis of Variance is proposed to be applied for the analysis of Working Capital Efficiency and Profitability Analysis of selected private sector cement companies in India. T test T- test is based on t- distribution and is considered an appropriate test for judging the significance of a sample mean or for judging the significance of difference between the means of two samples It can also been used for judging the significance of the coefficients of simple and partial correlations. In the present study test statistic, t is used to judging the significance of the coefficients of correlations. 10

11 LIMITATIONS OF THE STUDY The limitations of the study are as follows: 1. This study is based on the published data of banks. Hence, the study carries all the limitations inherent in the secondary data. 2. The accounting and statistical tools used in this study have their own limitations. 3. The study had been designed, a priori, identifying certain variables. One cannot claim that all the important and relevant variables have necessarily been included. Further researchers may consider whether some more variables need to be included for analysis. 4. Another limitation of the study is confined to only 10 large scale private sector cement companies drawn from the 20 large scale companies listed out by the Bombay Stock Exchange (BSE) and may not stand for the cosmos in its unqualified stipulations. But all these limitations and constraints perhaps do not in any way; affect the worth of this research work. CHAPTER SCHEME In order to present this proposed study in a lucid way, it has been divided into eight chapters. The layout of these chapters is delineated below: The First Chapter gives an Introduction and Design of the Study which includes introduction, Need for the study, Statement of the problem, 11

12 Scope of the study and Objectives the study, hypotheses, research methodology, limitations and chapter scheme. The Second Chapter Review of Empirical Works is devoted exclusively to present the review of literature on Working Capital and Profitability The Third Chapter, Profile of Indian Cement Industry, presents the origin as well as the general performance of Indian cement industry and general profile of the sample units. The Fourth Chapter, Working Capital Analysis highlights the working capital policy of the sample companies. The Fifth Chapter Analysis of Working Capital Efficiency highlights the impact of working capital efficiency on profitability of the sample companies. The Sixth Chapter, Profitability Analysis examines the financial performance of the sample firms in terms of profitability. The Seventh Chapter Determinants of Profitability investigates the factors influencing the profitability using the regression techniques. The Eighth Chapter Conclusion and Suggestions dovetails the summary of findings and conclusion arrived at tin the previous chapters. Based on the findings a few suggestions are also made for the improvement of working capital efficiency and profitability of the selected private sector cement companies in India. 12