India needs to optimise working capital management, says EY

19 March 2018 5 min. read
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Alongside a sea of non-performing assets and blockages in investment, the Indian economy appears to be suffering significantly from a lack of liquidity. A new report from global professional services firm EY on working capital in India has revealed that nearly Rs. 2 trillion could be freed if working capital practices are amended.

By virtue of sheer volume and population size, the Indian economy is among the largest in the world in terms of GDP. Over the next few years, the country is not only expected to drive growth for the surrounding Asian economy, but is expected to become the second largest economy in the world by 2050.

However, alongside heavy production volume, an economy of such magnitude brings with it a plethora of problems, mostly to do with efficiency. Economic growth in India currently takes place despite the administrative infrastructure rather than because of it, and could be reaching even higher levels if crucial inefficiencies were rectified.

One area in which conditions are particularly dismal is the banking sector. Non-performing assets in India currently amount to as much as Rs. 10 trillion; a situation that has been in the making for six years now. Loan defaults have forced major creditors to enter insolvency proceedings, and leaders of the business community have called for urgent banking reforms to free up the capital.

CF & C2C

Be it the public or private sector, such blockages are hindering cash flows to the entire economy. Similar to poor loan-management, inefficient management of working capital is also a major barrier to cash flow; one that has been put under the spotlight by a new report from Big Four professional services firm EY.

According to the report, titled ‘Are you Leaving Cash on the Table?’,  India Inc. – the name given to the formal sector of India’s economy comprising 60% of the GDP – could free up cash to the tune of Rs. 1.8 trillion just by virtue of “adopting better working capital practices.”

The metric used by the report to determine the quality of working capital management is the number of cash to cash days (C2C): the number of days lapsed between paying a supplier and receiving cash from a customer, representing the number of days that the company must support its operations.

Based on this metric, India performed poorly in 2017 compared to the previous year, registering an increase in C2C days of 4%. Correspondingly, the free cash flow (FCF), when examined as a percentage of sales, fell by 0.7% from 3.4% last year to 2.7 % this year.

Short term debt and interest coverage ratio

However, these declines are relative and come amid a strong period of performance for the economy, as both C2C and FCF have increased considerably since 2014, when FCF stood in the negative, at -0.5%, and the average C2C period stood at 45 days.

When C2C periods get drawn out, companies are forced to borrow for the short-term in order to support operations during the turnover period. Moreover, as the economy strengthens and production value increases, the magnitude of the borrowings increases to feed production.

As a result, the level of short-term debt as a percentage of sales has hit its highest level since 2014 at 12.4%. In 2014, this figure stood at 11%, following which there was a substantial and promising decline to 9.6%. Since then, short-term debt has been on the rise, reaching 11.3% in 2016 and now crossing the 12% threshold.

Working capital performance across sectors

However, the figures mentioned above represent the entire economy, and do not account for the nuances across industries. The Engineering and EPC Services sector, for instance, has a potentially high-cost C2C period of 137 days, as does the pharmaceutical industry at 102 days. The chemicals and technology sectors also have C2Cs of well over 50 days.

On the other side of the equation, automobile manufacturers have a highly impressive C2C period of -7 days. The oil and gas industry is also a good performer, at 19 days, while the accessories and luxury goods sector has a good turnover too at 20 days. Auto parts, utilities and metals & mining all have moderate C2C levels at just under 50 days.

Commenting on the findings of the report, Partner at EY and Leader of the Working Capital Advisory Services, Naveen Tiwari said, “In current times, managing cash and liquidity effectively is imperative given the significant increase in non-performing assets and ballooning corporate balance sheets. Further, the recent implementation of GST, technological advancements and alternative sources of debt-funding are providing companies with an opportunity to rethink their approaches toward resourcefully and most effectively managing their working capital.”