A PROJECT REPORT ON STUDY OF WORKING CAPITAL

SUBMITTED TO:

SUBMITTED BY:

ACKNOWLEDGEMENT

I would like to thank my project guide Prof. Rakhi Sharma for her

support & guidance at every stage of my project.

Finally my deepest regards for the Finance faculty at IMCOST for

strengthening my fundamental concepts in financial management,

which helped me successfully, complete this project.

I also take this opportunity to thank all my faculty members and library

staff without whose support this work would not have been possible.

I am grateful to my parents and my friends for always supporting me in

all my endeavors.

Dhananjay Shirke

MFM

MET Institute.

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YAMAHA COMPANY PROFILE

Yamaha corporate identity

Yamaha motors corporate mission is “We Create Kando: Touching your heart”

Kando is the Japanese word to express feelings of excitement and deep

satisfaction.

For them the forms that these feelings can take are as varied as the peoples all

around the world for experience then with Yamaha products in their lives and work on

land, on sea and in air.

And as their progress and the concerns of the environment change, the standard

by which they measures true satisfaction in their lives has also changed. That is why at

Yamaha motors they know that they must constantly evolving as a company. And

therefore they are passionately dedicated to the challenge of being a company that creates

‘Kando’.

At Yamaha Motor, are committed to creating a higher level of customer

satisfaction using their ingenuity and enthusiasm to enrich people’s lives.

YAMAHA MANAGEMENT PRINCIPLES-

Surpassing customer expectations

They remain keenly aware of their customers’ evolving needs and provide them

with quality products and services of exceptional value that surpass their expectations.

Establishing a corporate environment that fosters self esteem

They believe in nurturing and empowering their employees to the fullest. Whilst

cultivating their employees’ creativity and all-round abilities, they have also established

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an equitable system of evaluation and rewards to encourage their people to strive towards

newer benchmarks.

Fulfilling social responsibilities

As a good corporate citizen, they continually strive towards creating a better

social as well as natural environment.

IN ORDER TO ATTAIN TOUCHING YOUR HEART MISSION, THEY WORK BY

THE FOLLWING PRINCIPLES.

Innovation

Their goal is to enhance the enjoyment that people find in mobility.

At Yamaha, they constantly attempt to innovate to make this possible and continue their

pursuit to seek an ideal harmony, between people and machines and create new thrills.

Challenge

Fresh challenges have always helped them open up new world of excitement for

them, as well as, for their customers. This is readily evident from Yamaha’s history and

the many ‘Firsts’ that go along with Yamaha name. It is the ame spirit of challenge that

fuses the Yamaha world, year after year, even today.

Emotion

The products they provide- motorcycles, water and recreational vehicles- add to

life’s fun and excitement. At Yamaha they are committed to ignite the sense of adventure

in their customers, and support people who take the challenge for seeking new heights.

Yamaha motor India

Yamaha Motor India Private Limited (YMI) is 100% subsidiary of Yamaha Motor

Corporation limited (YMC), Japan.

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Incorporated in August 2001, YMI manufactures and markets a wide range of

motorcycles that meet international Yamaha technology standards. Aimed, at both the

domestic and international markets, each Yamaha motorcycle that rolls out of YMI plants

is suitably designed to perform under demanding Indian and global conditions.

Eighteen motorcycle models currently roll out of YMI’s state –of –the-art manufacturing

facilities at Faridabad and Surajpur. Of these, eleven models are sold in the country,

while the rest feed Yamaha’s global markets.

Having operated in India through various joint ventures for nearly two decades, Yamaha

Is today in the process of reorienting all its business process to cater to the evolving needs

of the discerning global motorcycle buyer.

1960: Indian partners, escorts group secured license under technical

Collaborations with CEKOP Poland.

1979: entered into technical collaborations with YMC of Japan for

manufacturing 350 cc motorcycles.

1983: obtained letter of intent for 100 cc motorcycles. launched 350cc

motorcycles in market all over India. Setup CNC cell in the

organization.

1985: started manufacturing of RX-100 motorcycle in technical

Collaborations with YMC, Japan at Surajpur plant.

1995:50 joint venture Company formed an escorts group.

1996: Added Faridabad plant under joint venture.

2000 : Share holding of YMC increased from 50% to 74%.

2001 : 100% of YMC, Japan

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Research & development:

Environment

R&D efforts are targeted at building vehicles that have the least possible impact

on the physical environment, both in emission and conservation-fuel economy being a

major thrust. Our aim is to continue to see ever higher levels of environment friendliness

in our products, our manufacturing facilities and distribution processes.

Technology

The R&D center is continually engaged in attempting the latest cutting-edge

technologies to suit Indian conditions. This stems from YMI’s desire to continually bring

better products to the customers.

The ongoing research programme also provides the starting point to YMI’s

diversification strategy. At YMI, they believe technology is a means to provide joy to the

customer, and our products are the torchbearers of this philosophy.

Challenge of competition

Constantly upgrading the 4ms- man. Machine, material &method, is a challenge

to our R&D team. Even as they help develop better products to our consumers, the team

strives to ensure that the Yamaha offering meets every challenge in the market place. It is

only natural, therefore, that Yamaha bikes are the hot favorites in the global motorcycle

racing circuit.

SALE’S NETWORK

YMI currently boasts of a strong dealer network of 406 dedicated dealers across

the country.

YMI points go far beyond showcasing the latest range of Yamaha products and

providing easy finance options. YMI dealers are taken through series of programmes to

upgrade knowledge and technical skills on all the aspects of the product line. Training

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support from the company is extended to technician and customer support staff so as to

ensure a completely satisfying experience for the customer. YMI is in a process of

establishing a strong authorized service centers and sales management system across the

length and breath of the country.

Exports

YMI is on the fast track to making its presence felt in all segments of the two

wheeler industry, offering exiting machines not only to Indian customers but also to also

to export markets around the world.

Motorcycles manufactured at the YMI facilities are exported to over 50 countries

including Argentina, Mexico, Bangladesh, Sri Lanka, Colombia, Dominican Republic,

Nigeria, and the Ivory Coast.

To reinforce its foray into global markets, YMI is rapidly expanding its manufacturing

presence in Asia, Africa and central and South America. In the process YMI is

strengthening its reputation in high quality products and services, while catering market

needs around the world.

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TABLE OF CONTENTS

1. Objective of the study 01

2. Methodology 02

3. Working Capital Management 03

4. Cash Management 11

5. Inventory Management 21

6. Receivables Management 36

7. Payables Management 49

8. Working Capital Finance 55

9. Role of Banks 60

10. Citibank 61

11. Recommendations 69

12. Limitations 70

13. Bibliography 71

14. Annexure 72

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EXECUTIVE SUMMARY

Title Of The Project

Working Capital Management in Yamaha

The objective of this project is to find out the short-term liquidity of the firm by

analyzing the various aspects of the operating cycle i.e. the cash operations, inventory,

reivables and payables. Also what role can the bank play in helping the firm in managing

the working capital efficiently.

The various aspects of the operating cycle have been analyzed through the data given in

the balance sheet of the company.

As far as the company’s cash position is considered, the firm maintains a low level of idle

cash balance since sufficient working capital limit is available to it and as a result of

which it can borrow from the bank as in when the need arises.

The firms inventory turnover ratio has improved over the years but still more attention

needs to be paid on finished goods inventory turnover. The firm’s average collection

period has gone up and the firm is trying to reduce its cost of debtors further through

outsourcing receivables to banks.

There has been an increase in the creditors turnover ratio and it has been suggested that

the firm should go in for the certain services offered by Citibank to reduce it’s cost of

debtors.

Also there is a close relationship among the various aspects of the operating cycle. As

sales of the company goes up the debtors or receivables also go up, whereas the inventory

of finished goods go down.

Further since the sales are going up purchases of raw materials is going up and as a result

the creditors for purchase of raw materials also go up. Thus sales, debtors and creditors

move in the same direction, where is the inventory move in the different direction.

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Thus it can be concluded that the overall position of the firm in terms of working capital

requirements is quite satisfactory and it can be made more efficient by utilizing offered

byCitibank.

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OBJECTIVES OF THE STUDY

The main objective of this study is to have an insight into the

practices of the company with regards to management of various

elements of working capital.

An attempt will also be made to find out whether or not, to what

extent, the working capital management is efficient and effective in

Automobile industry, more specifically in Yamaha motors and in Bajaj

Motors. Ways and means to improve working capital management

would also be suggested which lead to better productivity.

Apart from the above, more specifically the present study is

conducted to find out as follows:

Whether the firm has adequate liquidity throughout the

period which leads to risk return trade off.

To study management’s policies regarding inventory

management

How far has the firm has being successful in managing and

collection of receivables in time?

How far the firm has been successful in managing accounts

payables.

1

METHODOLOGY

Both primary and secondary sources of information have been used. Primary data

has been collected regarding the role of Citibank in working capital management by

visiting their office. For all other data, secondary sources of information such as

company’s annual reports and other journals have been referred to.

Various techniques such as ratio analysis, comparative statements, graphs etc

have been used.

2

WORKING CAPITAL MANAGEMENT

Working capital management is concerned with the problems that arise in attempting to

manage the current assets, the current liabilities and the interrelationship that exist

between them. The term current assets refer to those assets, which in ordinary course of

business can be, or will be, converted into cash within one year without undergoing

diminution in value and without disrupting the operations of the firm. The major current

assets are cash, marketable securities, accounts receivable and inventory. Current

liabilities are those liabilities, which are intended, at their inception, to be paid in the

ordinary course of business, within a year, out of current assets or earnings of the

concern. The basic current liabilities are accounts payable, bills payable, bank overdraft,

and outstanding expenses. The goal of working capital management is to manage the

firm’s current assets and liabilities in such a way that a satisfactory level of working

capital is maintained. This is so because if the firm cannot maintain a satisfactory level of

working capital, it is likely to become insolvent and may even be forced into bankruptcy.

There are two concepts of working capital: gross and net. The term gross working capital,

also referred to as working capital, means the total current assets. Net working capital is

commonly defined as the difference between current assets and current liabilities.

Efficient working capital management requires that firms should operate with some

amount of NWC, the exact amount varying from firm to firm and depending, among

other things, on the nature of the industry. The theoretical justification for the use of

NWC to measure liquidity is based on the premise that the greater the margin by which

the current assets cover the short term obligations, the more is the ability to pay

obligations when they become due for payment. The NWC is necessary because the cash

outflows and inflows do not coincide. NWC can alternatively define as that part of the

current assets which are financed with long term funds. Since current liabilities represent

sources of short term funds, as long as current assets exceed the current liabilities, the

excess must be financed with long term funds.

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In evaluating a firm’s NWC position, an important consideration is the trade off between

profitability and risk. The term profitability used in this context is measured by profits

after expenses. The term risk is defined as the probability that a firm will become

technically insolvent so that it will not be able to meet its obligations when they become

due for payment. The relationship between liquidity, NWC and risk is such that if either

NWC or liquidity increases, the firm’s risk decreases.

Need for working capital

Given the objective of financial decision making, it is necessary to generate sufficient

profits. The extent to which profits can be earned will naturally depend, among other

things, upon the magnitude of the sales. A successful sales programme is, in other words,

necessary for earning profits by any business enterprise. However, sales do not convert

into cash instantly; there is invariably a time lag between the sale of goods and the receipt

of cash. There is, therefore, a need for working capital in the form of current assets to

deal with the problem arising out of the lack of immediate realization of cash against

goods sold. Therefore, sufficient working capital is necessary to sustain sales activity.

Technically, this is referred to as the operating or cash cycle. ‘the continuing flow from

cash to suppliers, to inventory, to accounts receivable and back into cash is what is called

the operating cycle’. The term cash cycle refers to the length of time necessary to

complete the following cycle of events:

1. Conversion of cash into inventory;

2. Conversion of inventory into receivables;

3. Conversion of receivables into cash.

Therefore the three important components of working capital management are cash

management, inventory management and receivables management.

To carry on business, a certain minimum level of working capital is necessary on a

continuous and uninterrupted basis. This requirement has to be met permanently as with

other fixed assets and is referred to as permanent or fixed working capital. Any amount

over and above the permanent level of working capital is temporary, fluctuating or

variable working capital.

4

Determinants of working capital

A firm should plan its operations in such a way that it should have neither too much nor

too little working capital. The total working capital requirement is determined by a wide

variety of factors. These factors, however, affect different enterprises differently. They

also vary from time to time. Some of these factors are:

1. General nature of business: the working capital requirements are basically related

to the conduct of business. For instance, public utilities have certain features which

have a bearing on their working capital needs. The two relevant features are: the cash

nature of business, that is, cash sale, and sale of services rather than commodities. In

view of these features, they do not maintain big inventories and have, therefore,

probably the least requirement of working capital. At the other extreme are trading

and financial enterprises. The nature of their business is such that they have to

maintain a sufficient amount of cash, inventories and book debts. They have to

necessarily to invest proportionately large amounts in working capital.

2. Production cycle: the term ‘production or manufacturing cycle’ refers to the time

involved in the manufacture of goods. It covers the time span between the

procurement of raw materials and the completion of the manufacturing process

leading to the production of finished goods. The longer the time spans (i.e. the

production cycle), the larger will be the tied up funds and, therefore, the larger is the

working capital needed and vice versa.

3. Business cycle: business fluctuations lead to cyclical and seasonal changes which,

in turn, cause a shift in the working capital position, particularly for temporary

working capital requirements. The variations in business conditions may be in two

directions: (1) upward phase when boom conditions prevail, and (2) downsizing

phase. During the upswing of business activity, the need for working capital is likely

to grow to cover the lag between increased sales and receipt of cash as well as to

finance purchases of additional material to cater to the expansion of the level of

activity. Additional funds may also be required to invest in plant and machinery to

meet the increased demand. The need for working capital is likely to decline in

recessionary conditions.

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4. Credit policy: credit policy relating to purchases and sales also affects the

working capital. The credit terms granted to customers have a bearing on the

magnitude of working capital by determining the level of book debts. The credit sales

result in higher book debts (receivables). Higher book debts mean more working

capital. On the other hand, if liberal credit terms are available from the suppliers of

goods (trade creditors); the need for working capital is less. Thus, adoption of

rationalized credit policies will be a significant factor in determining the working

capital needs of an enterprise.

5. Growth and expansion: as a company grows a larger amount of working capital is

required.

6. Vagaries in the availability of raw material: the availability or otherwise of certain

raw materials on a continuous basis without interruption would sometimes affect the

requirement of working capital. To sustain smooth production, therefore, the firm

might be compelled to purchase and stock them far in excess of genuine production

needs. This will result in an excessive inventory of such materials and also working

capital requirements will be more.

7. Profit level: higher profit margin would improve the prospects of generating more

internal funds thereby contributing to the working capital pool. The net profits are a

source of working capital to the extent that it has been earned in cash.

8. Price level changes: rising prices necessitate the use of more funds for

maintaining an existing level of activity. For the same level of current assets, higher

cash outlays are required.

The liquidity of working capital is an important aspect to be analyzed by the management

for maintaining proper liquid resources to meet both operational requirements as well as

financing commitment of repayment of borrowed funds.

In order to understand the net working capital requirements of Yamaha and its liquidity

position ratios such as current ratio, quick ratio, what percentage of the total assets do the

current assets form, etc have been calculated and the conclusion regarding its liquidity

position has been made.

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Current Ratio

This ratio gives the relationship between current assets and current liabilities.

Current Ratio = Current assets

Current liabilities

The current ratio of a firm measures its short-term solvency, that is, its ability to meet

short term obligations. As a measure of short-term/current financial liquidity, it indicates

the rupees of current assets available for each rupee of current liability/obligation. The

higher the current ratio, the larger is the amount of rupees available per rupee of current

liability, the more is the firm’s ability to meet current obligations and greater is the safety

of funds of short-term creditors. In simple words, higher the value of the current ratio,

more liquid the firm is and more ability it has to pay its bills and vice-versa. Thus, in a

way it is a measure of margin of safety to the creditors. A current ratio of 2:1 is

considered satisfactory. It indicates that in the worst situation even if the value of current

assets goes down by half, management would still be able to repay the debts and meet its

obligations. However a relatively very high ratio indicates slackness of management

practices as reflected in excessive holding of current assets.

Yamaha’s current ratio for the past three years has been as follows:

Years Yamaha Bajaj

2008 2.1290 0.8818

2009 2.2442 0.9228

2010 2.5705 0.6966

Its current ratio has been more than 2:1 for 2003 and 2005 which indicates that it had no

problems in discharging its short-term obligations in the past. However it also indicates

that the firm has not been able to manage its current assets most effectively. It seems that

more amounts are invested in current assets than is desirable. The reason for high current

ratio is storing of excessive inventory for the current requirements and/or poor credit

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management in terms of overextended accounts receivables. Also it’s quite possible that

it has not made full utilization of its current borrowing capacity. But in the year 2004,

Yamaha’s current ratio went slightly below 2:1 (1.81:1), the reason being a fall in current

assets because of a fall in inventory of finished goods and also an increase in current

liabilities, which was because of an increase in sundry creditors.

Acid Test Ratio

One defect of current ratio is that it fails to convey any information on the composition of

the current assets of the firm. A rupee of cash is considered equivalent to a rupee of

inventory or receivables. But it is not so. A rupee of cash is more readily available to

meet current obligations than a rupee of, say, inventory. This impairs the usefulness of

the current assets. The acid test ratio is a measure of liquidity designed to overcome this

defect of the current ratio. It is often referred to as quick ratio because it is a measurement

of a firm’s ability to convert its current assets quickly into cash in order to meet its

current liabilities.

The acid test ratio is calculated by dividing the quick assets by the current liabilities.

Acid Test Ratio = Quick Assets

Current Liabilities

The term quick assets include cash and bank balances, short-term marketable securities

and debtors/receivables. The usefulness of the ratio lies in the fact that it is widely

accepted as the best available test of liquidity position of a firm. An acid test ratio of 1:1

is considered satisfactory.

Years Yamaha Bajaj

2008 1.148 0.65

2009 0.977 0.73

2010 1.037 0.55

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Yamaha’s acid test ratio shows a fluctuating trend over the past three years though it is

more than 1:1. Thus we can say that Yamaha does not face any problems on liquidity

front. It has sufficient assets to discharge its short-term obligations as an when they

become due.

Thus, it can be concluded that Yamaha’s liquidity ratios like current ratio, liquid ratio are

satisfactory and it can be inferred from them that the firm will be able to meet its short-

term obligations as an when they become due.

Another ratio which is important is current assets as a proportion of total assets. This ratio

tells us how much funds of the company are employed in current assets as compared to

the total amount of funds invested in total assets.

Years CA To TA% Change

2003 0.313 1002004 0.26 -0.0532005 0.354 0.094

It is very clear from the above figures that the proportion of current assets in the asset

portfolio of the company is not high. Infact, it is not even fifty percent of the total assets.

There has been a fall in the proportion of current assets by almost five percent in 2004.

However, in 2005 the proportion of current assets again went up and increase has been

around nine percent.

The efficiency with which working capital is being used by the management can also be

analyzed in terms of the overall working capital ratio.

It is calculated by dividing the amount of net sales by average amount of net working

capital during the year.

Working Capital Turnover Ratio = Net Sales

Average net working capital

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This ratio indicates the rate of working capital utilization in the firm.

Years

Working capital

turnover ratio

%

Change

2003 4.842 100

2004 10.232 5.39

2005 5.247 -4.985

The firm’s working capital turnover ratio has declined as compared to 2004. This implies

that in 2005 more amount of working capital has been required or the investment in

working capital has been more than what is required. A decreasing net working capital

turnover ratio is indicative of relative inefficiency in the use of working capital.

A variant of this ratio is current asset turnover ratio.

Current asset turnover = cost of goods sold

Average current asset

It again indicates the rate at which working capital has been used. A higher ratio is

considered an indicator of better efficiency and a lower one the opposite.

Years

current asset turnover

ratio

%

Change

2003 2.379 100

2004 3.916 1.54

2005 2.989 -0.93

Yamaha’s current asset turnover ratio has been around three to four percent for the past

few years.

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CASH MANAGEMENT

Cash management is one of the key areas of working capital management. Apart from the

fact that cash is the most liquid current asset, cash is the common denominator to which

all current assets can be reduced because the other major liquid assets, that is, receivables

and inventory get eventually converted into cash. There are four primary motives for

maintaining cash balance: (1) Transaction motive, (2) Precautionary motive, (3)

speculative motive (4) Compensating motive.

The basic objectives of cash management are two fold: (a) to meet the cash disbursement

needs (payment schedule); (b) to minimize funds committed to cash balances.

Meeting payments schedule

Firms have to make payments of cash on a continuous and regular basis to supplier of

goods, employees and so on. Also there is a constant inflow of cash through collection

from debtors. A basic objective of cash management is to meet the payment schedule,

that is, to have sufficient cash to meet the cash disbursement needs of a firm.

The advantages of adequate cash are: (1) it prevents insolvency or bankruptcy arising out

of the inability of a firm to meet its obligations; (2) the relationship with the bank is not

strained; (3) it helps in fostering good relations with trade creditors and suppliers of raw

materials, as prompt payment may help their own cash management; (4) a cash discount

can be availed of if payment is made within the due date; (5) it leads to strong credit

rating; (6) the advantage of favorable business opportunities; (7) the firm can meet

unanticipated cash expenditure with a minimum of strain during emergencies. Keeping

large cash balances, however, implies a high cost.

Minimizing funds committed to cash balances

A high level of cash balances will, ensure prompt payment together with all the

advantages. But it also implies that large funds will remain idle, as cash is non earning

11

asset and the firm will have to forego profits. A low level of cash balances, on the other

hand, may mean failure to meet the payment schedule. The aim of cash management,

therefore, should be to have an optimal amount of cash balances.

Factors determining cash needs:

1. Synchronization of cash flows: the need for maintaining cash balances arises from

the non-synchronization of the inflow and outflows of cash: if the receipts and

payments of cash perfectly coincide or balance each other, there would be no need

for cash balances. The first consideration in determining the cash need is,

therefore, the extent of non synchronization of cash receipts and disbursements.

2. Short costs: another factor is the cost associated with a shortfall in the cash needs.

Every shortage of cash-whether expected or unexpected – involves a cost

‘depending upon the severity, duration and frequency of the shortfall and how the

shortage is covered. Expenses incurred as a result of shortfall are called short

costs. Transaction costs, borrowing costs, loss of cash discount, cost associated

with deterioration of the credit rating, penalty rates are included in short costs.

3. Excess cash balance costs: the cost of having excessively large cash balances is

known as the excess cash balance cost. If large funds are idle, the implication is

that the firm has missed opportunities to invest those funds and has thereby lost

interest which it would otherwise have earned. This loss of interest is primarily

the excess cost.

4. Procurement and management: these are the costs associated with establishing

and operating cash management staff and activities. They are generally fixed and

mainly accounted for by salary, storage, handling of securities and so on.

5. Uncertainty and cash management: the impact of uncertainty on cash

management strategy is also relevant as cash flows cannot predict with complete

accuracy. The first requirement is precautionary cushion to cope with

irregularities in cash flows, unexpected delays in collection and disbursements,

defaults and unexpected cash needs. The impact of uncertainty on cash

management can, however, be mitigated through improved forecasting of tax

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payments, capital expenditure, dividends, increased ability to borrow through

overdraft facility and so on.

Cash Management: Basic Strategies

The broad cash management strategies are essentially related to the cash turnover

process, that is, the cash cycle together with the cash turnover. The cash cycle refers

to the process by which cash is used to purchase materials from which are produced

goods, which are then sold to the customers, who later pay the bills. The firm receives

cash from customers and the cycle repeats itself. The cash turnover means the number

of times cash is used during each year. The steps involved in cash cycle starts with

materials ordered, materials received, payments, cheque clearance, goods sold,

customer mails payment, payment received, cheques deposited and finally funds

collected.

The cash cycle of the firm can be calculated by finding the average number of days

that elapse between the cash outflows associated with paying accounts payable and

the cash inflows associated with collecting accounts receivable. The cash turnover is

found by dividing the number of days in a year by the cash cycle.

The higher the cash turnover, the less is the cash the firm requires. However a

minimum amount of operating cash balance should be maintained.

Cash management strategies are intended to minimize the operating cash balance

requirement. The basic strategies are as follows:

1. Stretching accounts payable: a firm should pay its accounts payable as late as

possible without damaging its credit standing. It should, however, take advantage

of the cash discount available on prompt payment.

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2. Efficient inventory-production management: another strategy is to increase the

inventory turnover, avoiding stock outs. This can be done by increasing the raw

materials turnover or decreasing the production cycle or increasing the finished

goods turnover.

3. Speeding collection of accounts receivable: another strategy is to collect accounts

receivable as quickly as possible without losing future sales because of high

pressure collection techniques.

4. Combined cash management strategies: all the above three strategies can be used

together.

There are some specific techniques and processes for speedy collection of receivables

from customers and slowing disbursements.

For speedy cash collections the customers should be encouraged to pay as quickly as

possible. One way of this is to ensure prompt billing. What the customer has to pay

and the period of payment should be notified accurately and in advance. Another

technique is to offer cash discounts. Also the payment from customers should be

converted into cash without any delay. Once the customer makes the payment by

writing a cheque in favour of the firm, the collection can be expedited by prompt

encashment of the cheque. Usually there is a lag between the time a cheque is

prepared and mailed by the customer and the time the funds are included in the cash

reservoir of the firm.

For slowing disbursements also there are various techniques such as avoidance of

early payments, centralized disbursements, floats and accruals. The term float refers

to the amount of money tied up in cheques that have been written, but have yet to be

collected and encashed. There are two ways of doing it: paying from a distant bank

and scientific cheque-cashing analysis. Accruals are defined as current liabilities that

represent a service or goods received by a firm but not yet paid.

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As far as Yamaha’s cash position is considered and how strong it is, it can be determined

by analyzing the size of cash that the company has, the ratio of cash to current assets,

cash turnover ratio and cash flow statement.

Cash is considered an idle asset as it does not earn any return. Therefore, a balance has to

be struck between too much and too less an amount of cash that a firm should have.

Efficient management of cash requires that there should be a proper balance between

cash needs of the concern to the average balance of cash held by it during the year.

Cash turnover ratio = cash operating expenses during the year

Average cash balance during the year

YearsCash turnover

ratio

Bajaj

2008 18.67

2009 24.77

2010 128.98

Yamaha’s cash ratio shows an increasing trend over the years. Normally, an increase in

this ratio reflects intensive utilization of cash. However, in this case the reason for the

increase is a decrease in the denominator of this ratio i.e... the average balance of cash

held during the year. The reason for a five times increase in the ratio in 2005 is a

tremendous decrease in the average balance of cash held during that year.

Another tool used for this purpose is cash ratio. It is an absolute liquidity ratio. It is the

most rigorous test of the liquidity position of business unit. It determines how many times

cash and other marketable securities cover current liabilities. It is calculated as

15

Cash Ratio = Cash and marketable securities

Current liabilities

Years Cash ratio % Change Bajaj

2008 0.572 100

2009 0.078 -0.494

2010 0.049 -0.029

Cash ratio for Yamaha over the past few years shows a declining trend indicating that

over the years less amount is being held in form of cash and bank balance and marketable

securities and more is being invested in other current assets such as debtors or

inventories. Ideally cash ratio should be fifty percent of current assets or 1:2. But for

Yamaha it is less than even 1:1 for all the years.

Another ratio that indicates the cash position of the firm is cash to current asset ratio.

This ratio indicates the amount of money that has been held in the form of cash and bank

balance as compared to total amount invested in current assets.

YearsCash to

CA ratio % Change

2008 0.269 100

2009 0.043 -0.226

2010 0.02 -0.023

As clear from the above table, the proportion of cash to current assets has been declining

over the years. Less and less amount is being invested in cash over the years.

Whether low cash balance is a problem for the company or not depends upon the

company’s working capital limits. Since Yamaha has sufficient working capital limit

available, it can borrow from the bank and pay off its current liabilities as and when the

16

need arises. There is no need for the company to keep its cash idle for this purpose. It can

invest it somewhere else and earn a return on it. When the rate of borrowing from the

bank is lower than rate of earning from the investment, it is always advantageous to

borrow from the bank and pay rather than keeping your cash idle for the same.

Another important tool is cash flow statement analysis. An increase or decrease in the

individual elements of current assets (other than cash) and liabilities affect cash in

different ways. For example an increase in sundry creditors and bank overdraft has

different implications in terms of repayment of cash. Sundry creditors’ bill may fall due

after one month or two months. But bank overdraft facility may be for a longer duration.

Thus, it is possible that the firm is in a sound financial position as reflected by the amount

of net working capital but it has difficulty in meeting its short-term commitments. For

this purpose cash flow statement is prepared and its analysis is conducted to assess the

ability of the firm to meet its obligations to trade creditors, bankers and to pay interest to

debenture holders and dividend to its shareholders. Cash flow analysis takes a more

conservative approach about the liquidity position of the firm by taking a limited view of

the pool of the funds available to the firm. It is cash and cash equivalent items only that

form the liquidity position of the firm according to this view.

Yamaha’s cash flow statement is as follows:

  PARTICULARS  

31st DEC'

05

31st DEC'

04  

31sT DEC'

03

A. Cash Flow from Operating      

  Activities      

  Loss for the year before extra      

  Ordinary expenditure but      

  After prior expenses -116.88 -39.02 -148.01

  ADD:      

  Depreciation 34.43 30.01 29.93

17

  Interest n prepayment charges 29.58 24.39 53.8

  Loss on sale of assets 0.19 0.15 0.3

  Provision for doubtful debts 3.9 1.92 0.63

  Provision for doubtful advances 0.34 0.6 2.38

  Assets written off 2.4    

  Operating profit before      

  Working capital changes -46.04 18.05 -60.97

  Adjustments for:-      

  Inventories -52.49 35.7 36.06

  S.debtors 4.62 -42.39 -39.96

  Current liabilities -20.95 -6.82 -31

  Provisions -1.62 2.03 3.96

  Other current assets -1.52 -8.72 0.7

  Loans n advances 2.67 -2.1 8.72

  Direct taxes receipt/(paid) 0.11 1.23 -0.55

  Cash flow from operations -115.22 -3.02 -83.04

  Adjustments for:-      

  Movement in deferred revenue      

  Expenditure -2.2 5.86 -12.02

 CASH FLOW FROM

OPERATING      

  ACTIVITIES -117.24 2.84 -95.06

         

         

B CASH FLOW FROM INVESTING      

  ACTIVITIES      

  Purchase of fixed assets -21.07 -27.73 -57.34

  Sale/disposal of fixed assets 0.44 0.44 0.68

 Purchase of shares in subsidiary

co. - -0.1 -

         

18

  NET CASH FROM INVESTING      

  ACTIVITIES -20.63 -27.39 -56.66

         

C CASH FLOW FROM FINANCING      

  ACTIVITIES      

  Interest -29.58 -25.43 -52.53

  Proceeds from shares receipts/      

  Conversion of loan into equity - - 400

  Proceeds from borrowings 162.44 -21.58 -128.16

         

  NET CASH FROM FINANCING      

  ACTIVITIES 132.86 -47.01 219.31

         

DIncrease/Decrease in cash n

cash      

  Equivalents -5.01 -71.56 67.59

E Cash n cash equivalents as at the      

  Beginning of the year 10.64 82.2 14.61

F Cash n cash equivalents as at the      

  Close of the year   5.63 10.64   82.2

Analyzing Yamaha’s cash flow statement we will find that there has been a tremendous

decrease in the cash balance of the firm. Cash balance at the end of year 2005 has gone

down by half as compared with the closing balance of 2004 and has become one-

fourteenth of what it was in 2003. The firm’s liquidity position is not as strong as was

depicted by net working capital.

There is no proper balance between various sources of cash rather there is just one source

of cash inflows. There has been a loss on account of operations of the business and the

loss has been as high as Rs 117.24 crores in 2005. Most of the cash inflows are a result of

19

financing activities such as proceeds from borrowing, conversion of loan into equity,

proceeds from share receipts etc.

The firm should try to bring about a proper balance between various sources of cash

before it gets too late. Instead of depending upon the financing activities to generate cash

and also absorb the loss from operating activities, the firm should try to generate funds

through operating and investing activities. The least it can do is to minimize the loss from

operating activities. If the firm keeps on raising funds from financing activities it will

have an adverse effect on the prices of shares and also it will have trouble in raising loans

in the future.

20

INVENTORY MANAGEMENT

The term inventory refers to the stockpile of the products a firm is offering for sale and

the components that make up the product. In other words, inventory is composed of

assets that will be sold in future in the normal course of business operations. The assets

which firms store as inventory in anticipation of need are: (i) raw materials, (ii) work-in-

progress, (iii) finished goods.

Reasons for holding inventory: firm holds each type of inventory for different reasons. A

manufacturing firm may have inventories at different stages in the production process:

1. Inventories of raw materials are held to ensure that the production process is not

disrupted by a shortage of these materials. The amount of raw material inventory

held will depend on:

The speed with which the firm can re-stock raw materials, the greater the

speed, the lower the required inventory for raw materials.

The uncertainty in the supply of these raw materials; the larger the

uncertainty, the greater the need for inventories of these materials.

2. Inventories of partially finished goods (W-I-P) arise in the process of production.

As the production process becomes more complicated and lengthier, the W-I-P

inventory will also increase.

3. Inventories of finished goods arise because of the time involved in the production

process and the need to meet customer demand promptly. The magnitude of the

finished goods inventory will depend on:

The time it takes to fill an order from a customer. If orders cannot be filled

quickly and at a low cost, the firm will maintain a large finished goods

inventory. A clothing manufacturer, for instance, can maintain a lower

21

inventory than an automobile manufacturer because it can meet sudden

demand much more easily.

The diversity of the product line. Firms that sell a range of goods generally

need to invest more in finished goods inventory than do firms that have a

single line or only a few lines of goods.

The strength of competition. When competitors offer close or perfect

substitutes at similar prices, the firm is much more likely to suffer from

lost sales if it does not have sufficient inventory.

Costs of holding inventory

One operating objective of inventory management is to minimize cost. Excluding the cost

of merchandise, the costs associated with inventory fall in to two basic categories:

ordering or acquisition cost and carrying costs.

Ordering costs: this category of costs is associated with the acquisition or ordering of

inventory. Firms have to place orders with suppliers to replenish inventory of raw

materials. The expenses involved are referred to as ordering costs. Included in the

ordering costs are costs involved in (i) preparing a purchase order or requisition form and

(ii) receiving, inspecting, and recording the goods received to ensure both quantity and

quality. These are generally fixed per order placed, irrespective of the amount of the

order. The larger the orders placed, or the more frequent the acquisition of inventory

made, the higher such costs.

Carrying costs: these can be divided into two categories:

Those that arise due to the storing of inventory. The main components are

(i) storage cost, that is, tax, depreciation, insurance, maintenance of

building; (ii) insurance of inventory against fire and theft; (iii) serving

costs, such as, labour for handling inventory, clerical and accounting costs.

The opportunity cost of funds: this consists of expenses in raising funds

(interest on capital) to finance the acquisition of inventory. If funds were

22

not locked up in inventory, they would have earned a return. This is the

opportunity cost of funds or the financial cost component of the cost.

There are various methods of determining the optimal level of inventory:

1. A B C System: the first step here is to classification of different types of

inventories to determine the type and degree of control required for each. This

technique is based on the assumption that a firm should not exercise the same

degree of control on all items of inventory. It should rather keep a more rigorous

control on items that are (i) the most costly, and/or (ii) the slowest turning, while

items that are least expensive should be given less control effort. Inventories are

classified into three classes: (i) A (ii) B and (iii) C. The items included in-group A

involves the largest investment. Therefore, inventory control should be the most

rigorous and intensive and the most sophisticated inventory control techniques

should be applied to these items. The C group consists of items of inventory,

which involve relatively small investments although the number of items is fairly

large. These items deserve minimum attention. The B group stands midway. The

task of inventory management is to properly classify all the inventory items.

However, it should be used with caution.

2. Economic Order Quantity Model: EOQ refers to the optimal level of inventory

that should be ordered every time so as to keep the entire cost minimum. It is

based on the assumption that the firms know with certainty its annual usage of a

particular item of inventory; the rate at which the firm uses inventory is steady

over time. EOQ can be determined either through a trial and error approach or

through a simple mathematical approach.

In order to understand Yamaha’s inventory position, we will study the inventory turnover

ratio, the inventory holding period; break up of inventory into various sub parts etc.

Inventory constitutes an important part of the total working capital. Many a firm in actual

practice faces serious problems due to slow moving out-dated inventory. Inventory, is an

23

essential item in the business operations. But if too much amount is invested in this for

too long, it poses a serious threat to the profitability as well as solvency of the concern.

The ratios that are normally being used as indicators of the quality of management

exercised over inventory as a whole and its parts are as follows:

Overall inventory turnover ratio: inventory (stock) turnover reflects the efficiency with

which the inventory is being managed in the concern. It’s calculated by dividing the cost

of goods sold by average inventory. Thus,

Inventory turnover = Cost of Goods Sold

Average inventory

Many a times the figure of net sales is used in the numerator, as the figure of cost of

goods sold is not generally available in the financial statements.

This ratio indicates the way management has used inventory to conduct the operations of

the business. It shows how rapidly the inventory is being turned into sales. A low

turnover implies an excessive level of inventory than warranted by production or sales

operations. This may also indicate the presence of slow moving or obsolete inventory.

Yamaha’s inventory turnover ratio for the various years is as follows:

ParticularsYamaha Bajaj

2008 2009 2010 2008 2009 2010

 

COGS 727.97 970.69 861.83

Average inventory 144.02 111.62 120.115

Inventory turnover

ratio5.05 8.70 7.18

Average holding

period72.21 41.97 50.87

24

As can be seen, the inventory turnover ratio has gone up as compared to 2003. Inventory

has converted into sales faster in 2005 as compared to 2003.

Another useful way to evaluate how inventory management is done in the concern is to

look at the average period for which inventory is being held. Average holding period of

inventory can be calculated by dividing the number of days in a year (365) by inventory

turnover ratio.

Average holding period = 365/ inventory turnover

= (365 x average inventory)/cost of good sold

= Average inventory/COGS per day

Normally, a lower holding period reflects efficient utilization of inventory by

management. That is, it indicates that inventory is held for shorter duration in the godown

and is fast converted into receivables/cash through sale. But management must be

cautious in aiming for too low a holding period. This is because with too low inventory

holding period, the management may risk its product going out of market if some

disruption occurs in its production schedules. And this may prove costly. Again, too high

an inventory-holding period is not considered good due to its impact on profitability and

liquidity of the concern. If inventory is held for a longer duration than desired, more

funds will be locked up earning nothing.

In 2003, Yamaha’s holding period was very large; it was almost seventy-two days

whereas in 2004 it was low at forty-two days. In 2005, it was fifty-one days and we can

say that this is the appropriate holding period as it is neither too large nor too small.

Apart from the turnover and holding period of overall inventory, management might be

further interested to know about the efficiency with which various types or components

of inventory have been used. Inventory comprises raw material, work-in-process, finished

goods and spare parts etc... All the components should form a reasonable part of the total

25

inventory. Therefore, all components should be related individually to the total inventory

to find out the proportion of each of them. The following ratios are used for this purpose:

Raw Material Inventory Turnover

This ratio reflects the way raw materials have been used in the business as compared with

its average inventory stock during the year. It is calculated by dividing the raw materials

consumed during the year by average balance of raw material inventory during the year.

Raw material inventory

Turnover = raw materials consumed during the year

Average raw material inventory

It indicates the rate of utilization of raw material. A higher turnover ratio of raw material

inventory over a period of time indicates its increasing utilization. But too high a ratio

may indicate that proportionately less raw materials were held in order to carry out the

production which may be quite risky.

Another way to indicate efficiency of raw material is to express it in terms of number of

days of holding raw material turnover ratio

Raw materials holding period = 365/ raw material inventory turnover

(Days)

The expression of the efficiency of raw material i.e., raw materials storage period in

terms of days can be compared with the predetermined standard set up by management or

with the industry standard or with the past performance.

YearsRaw material turnover ratio

Average age of raw material inventory

2003 7.45 49 Days2004 13.35 27.34 Days

26

2005 13.23 27.59 Days

Yamaha’s raw material inventory turnover ratio has increased over the past three years;

rather it has almost double since 2003. Yamaha’s inventory of raw materials on an

average turned 13.23 times a year in 2005 compared to only 7.45 times a year in 2003.

The higher turnover ratio over the years indicates increasing utilization of raw materials.

The raw material holding period has been 27 to 28 days for 2004 and 2005. This implies

that on an average the company holds stock of raw materials for about 27 to 28 days. It

was very high for year 2003(49 days). The firm has drastically improved its holding

period for raw material inventory.

Work-in-process inventory turnover

This ratio establishes a relationship between the value of goods produced and the value of

average work-in-process.

Work-in-process inventory = cost of goods manufactured

Turnover average W.I.P. inventory

A higher turnover ratio indicates lower inventory accumulation and lesser tied-up

working capital. A falling turnover means either the management has become lax in

controlling the productive processes or some external factors have retarded the

production movement at its final turn-up.

If work-in-process inventory turnover ratio is divided into the number of days in a year it

will give the conversion period, which can be compared with some standard.

Conversion period = average W.I.P inventory

(In number of days) cost of goods manufactured per day

Years W-I-P turnover ratio Average age of W-I-P

27

inventory2003 90.42 4.04 Days2004 113.53 3.22 Days

2005 114.76 3.19 Days

Over the past few years Yamaha has become more efficient in work-in-process inventory

management. The work-in-process inventory turnover ratio has continuously been

increasing over the years and this trend is likely to remain for certain time. In 2005, the

company’s turnover ratio was 114.26(times) indicating that in the entire year 114.26

times work-in-process inventory is converted into finished goods inventory. This

turnover ratio was 90.42 in 2003. Thus it can be clearly seen that in the past two years

there has been lower inventory accumulation and lesser working capital was tied-up.

However, there has not been much change as far as number of days for which work-in-

process inventory is held. Earlier it was around four days and recently it has been around

three days.

Finished goods inventory turnover

There is a limit to the period for which finished goods should be in store. If the finished

goods are turned over faster, the amount of locked-up funds would be less; otherwise it

will be more. It is for this purpose that finished goods inventory turnover ratio is

calculated.

Finished-goods inventory = cost of goods sold

Turnover average finished goods inventory

The same can be converted into finished goods storage period if the number of days in a

year is divided by the finished goods inventory turnover ratio.

Finished goods storage period = average finished goods inventory

(In number of days) cost of goods sold per day

28

Generally, lower storage period is considered good. But, too low a storage period is risky.

If we will have a look at Yamaha’s finished goods turnover ratio, we will find that in

2004 the company’s turnover ratio doubled as compared to 2003 but it again reduced in

2005. Also the number of days for which finished goods were stored was less in 2004 as

compared to other years. It was around 15 days in 2004 as compared to 28 days in 2001

and 23 days. One obviously wonders what the reason is for the increase in finished goods

holding period in 2005.

YearsFinished goods turnover

ratio

Average age of finished goods

inventory

2003 12.83 28.45 Days

2004 24.423 14.94 Days

2005 15.51 23.53 Days

It can be said that this change or this increase in the number of storage days of finished

inventory or decrease in the finished goods turnover ratio is probably because the firm

had found it riskier to maintain such a high turnover ratio. It is quite possible that the firm

had faced problems in meeting the demand of motorcycles because it did not had

sufficient amount of finished goods inventory and thus in order to avoid a similar

problem in future it has decided to maintain the finished goods turnover ratio at a

reasonable figure, which is neither too low nor too high.

Yamaha’s current policy as regards Inventory can be stated as follows:

At Yamaha, inventories are divided into six main components namely raw materials,

work-in-process, finished goods, goods in transit, stores and spares and tools, jigs and

dies. Inventories are valued at the lower of cost and net realizable value. The basis for

determining cost for various categories of inventories is as follows:

→ Raw materials, components, stores and machinery spares on weighted average cost.

29

→ loose tools: purchased loose tools are valued at weighted average cost; manufacturing

loose tools are valued at material cost (plus appropriate share of labour and other

overheads including depreciation.)

→ W-I-P and finished goods on material cost (plus appropriate share of labour and other

overheads including depreciation.)

→ jigs, dies and fixtures. Here the original purchase cost is written off over a period of

nine years from the year of purchase.

Provision for obsolescence relating to slow moving/non moving inventories is determined

based on management’s assessment and is charged to p/l account.

If we will study the break-up of inventory we will find that as far as inventory in absolute

terms of work-in-process, goods in transit, stores and spares, tools, jigs and dies is

concerned its more or less stable over the year. Inventory of finished goods do fluctuate

over the year. It goes up during the months of July and august and comes down during

November and December. Inventory of raw materials also fluctuate but the fluctuation is

less volatile than that of finished goods.

The fact that finished goods constitute a major portion of inventory is also very clear

from the ratio of finished goods to inventory. Finished goods constitute almost fifty five

percent of inventories in 2005. The ratios of various components of inventory-to-

inventory are as follows:

  2003 2004 2005

Stores n spares to

inventory 0.118 0.149 0.111

Raw material to inventory 0.441 0.453 0.299

W-I-P to inventory 0.056 0.082 0.034

Finished goods to

inventory 0.385 0.316 0.557

Another important point to be considered is that ratio of raw material to inventory has

gone down from forty four percent in 2003 to just thirty percent in 2005.

30

Thus, it can be concluded that basically changes in the level of inventory are caused by

changes in the level of inventory of finished goods and to some extent by the level of

inventory in raw materials.

In general, level of inventory is high during July and august and low during October and

November. However, in 2005 the trend of inventory was completely opposite to as what

it was in 2004.

Break up of inventory for 2004:

  JAN FEB MARCH APRIL MAY JUNE JULY

Finished

Goods 51.05 48.81 48.94 44.69 41.3 38.3 58.94

Work-in-

Progress 8.36 7.21 7.21 7.21 7.21 7.21 6.3

Raw

Materials 60.23 46.63 42.53 38.75 38.29 35.72 37.45

Goods in

Transit 4.29 4.75 5.06 5.19 6.69 6.15 5.05

Stores n

spares 11.18 10.71 9.45 9.56 10.03 10 10.9

Tools, jigs n

dies 52.52 44.63 44.41 44.21 43.71 43.71 44.78

               

TOTAL 187.63 162.74 157.6 149.61 147.23 141.09 163.42

  AUGUST SEPT OCT NOV DEC

Finished Goods 58.5 52.47 44.51 33.06 29.39

Work-in-Progress 6.3 6.3 6.3 6.3 6.26

Raw Materials 37.65 36.39 33.27 33.01 34.44

Goods in Transit 6.32 7.14 10.73 6.24 6.71

Stores n spares 10.7 10.87 10.67 10.85 11.11

31

Tools, jigs n dies 44.86 44.87 44.9 44.91 43.59

           

TOTAL 164.33 158.04 150.38 134.37 131.5

Similarly, break up of inventory for 2005 is as follows:

  JAN FEB MARCH APRIL MAY JUNE JULY

Finished

Goods 90.9 109.56 123.95 125.3 162.63 169.69 157.12

Work-in-

Progress 7.71 7.71 7.71 8 8.51 8.19 8.13

Raw

Materials 34.49 35.58 32.99 36.63 40.93 41.34 40.84

Goods in

Transit 9.51 8.35 12.83 9.54 4.14 4.31 4.48

Stores n

spares 10.54 10.62 9.89 11.23 11.72 11.34 11.26

Tools, jigs n

dies 48.35 48.51 48.53 47.97 47.98 48.07 48.11

               

TOTAL 201.5 220.33 235.89 238.67 275.91 282.94 269.94

  AUGUST SEPT OCT NOV DEC

Finished Goods 134.85 113.72 83.29 109.66 83.15

Work-in-Progress 8.13 8.13 8.13 8.13 3.09

Raw Materials 40.03 41.16 39.79 42.98 43.85

Goods in Transit 6.58 5.45 4.48 2.44 1.75

Stores n spares 11.34 11.21 11.61 11.98 12.23

Tools, jigs n dies 48.43 48.46 49.22 49.98 49.84

32

           

TOTAL 249.36 228.13 196.52 225.17 193.91

This break up can also be shown in the form of a graph for the two years separately as

follows:

Break up of Inventory 2002

0

10

20

30

40

50

60

70

JAN FEB MAR APRIL MAY JUN JULY AUG SEPT OCT NOV DEC

months

amo

un

t(R

s cr

ore

s) Finished goods

Work-in-progress

Raw materials

Goods in transit

tools,jigs n dies

stores n spares

33

Break up of inventory 2003

0

20

40

60

80

100

120

140

160

180

JAN FEB MAR APRIL MAY JUN JULY AUG SEPT OCT NOV DEC

months

amo

un

t(R

s cr

ore

s) Finished goods

Work-in-progress

Raw Materials

Goods in transit

tools,jigs n dies

stores n spares

Apart from this, the total month-wise break up of inventory for the two years 2004 and

2005 can be shown in the same graph to compare the movement of inventory in the two

years.

34

INVENTORY CHART

0

50

100

150

200

250

300

JAN FEB MAR APRIL MAY JUN JULY AUG SEPT OCT NOV DEC

AMOUNT(Rs crores)

MO

NT

HS

2002

2003

It can be seen from the above diagram that inventory follows a completely different

movement in 2005 as compared to 2004. The reason for this is that in 2005 the company

has increased its production. Moreover sales have not increased at the same pace as

production and as a result inventory of finished goods has increased.

Thus, in conclusion we can say that the firm has improved its utilization of inventory. It

should concentrate more on finished goods inventory as that is the most important

component of inventory and that is where the problem still lies.

35

RECEIVABLES MANAGEMENT

The term receivables is defined as ‘debt owed to the firm by customers arising from sale

of goods or services in the ordinary course of business’. When a firm makes an ordinary

sale of goods and services and does not receive payment, the firm grants trade credit and

creates accounts receivable which could be collected in future. Receivables credit is also

called trade credit management. Thus, accounts receivable represent an extension of

credit to customers, allowing them a reasonable period of time in which to pay for the

goods received.

As a marketing tool, they are intended to promote sales and thereby profits. However,

extension of credit involves risk and cost. Management should weigh the benefits as well

as cost to determine the goal of receivables management. The objective of receivables

management is ‘to promote sales and profit until that point is reached where the return on

investment in further funding receivables is less than the cost of funds raised to finance

that additional credit’.

Three crucial aspects of management of receivables are: credit policies, credit terms and

collection policies.

CREDIT POLICIES

The credit policy of a firm provides the framework to determine whether or not to extend

credit to a customer and secondly how much credit to extend. The credit policy decision

of the firm has two broad dimensions: credit standards and credit analysis.

Credit standards: they represent the basic criteria for the extension of credit to

customers. The quantitative basis of establishing credit standards are factors such as

credit ratings, credit references, average payments period and certain financial ratios. The

36

standards can be divided as (a) tight or restrictive, and (b) liberal or non restrictive. The

trade off with reference to credit standards covers the following factors:

1. Collection costs: the implications of relaxed credit standards are: more credit; a

large credit department to service accounts receivable and related matters;

increase in collection costs. The effect of tightening of credit standards will be

exactly the opposite. These costs are likely to be semi-variable.

2. Investments in receivables or the average collection period: the investment in

receivables involves a capital cost, as funds have to be arranged by the firm to

finance them till customers make payments. The higher the average accounts

receivable, the higher is the capital or carrying cost. A change in the credit

standards-relaxation or tightening-leads to a change in the level of accounts

receivable either (a) through a change in sales, or (b) through a change in

collections.

A relaxation in credit standards implies an increase in sales, which, in tur

n, would lead to higher average accounts receivable. Further, relaxed standards

would mean that credit is extended liberally so that it is available to even less

credit-worthy customers who will take a longer period to pay overdue and this

would result in higher level of account receivable. A tightening of standards will

have an opposite effect.

3. Bad debt expenses: they increase with relaxation in credit standards and decrease

if credit standards become more restrictive.

4. Sales volume: as standards are relaxed, sales are expected to increase; conversely,

a tightening is expected to cause a decline in sales.

Cost of marginal/incremental investment in receivables

The second variable relevant to the decision to relax credit standards is the cost of

marginal investment in accounts receivable. Marginal investments represent the amount

of additional funds required to finance incremental accounts receivable if the proposal to

relax the credit standards is implemented.

37

The credit analysis: the second aspect of credit policies of a firm is credit analysis and

investigation. Two basic steps involved in the credit investigation process: (a) obtaining

credit information, and (b) analysis of credit information. Credit information can be

obtained either internally or externally through financial statements, bank references,

trade references etc. once the information has been collected, it should be analyzed to

determine the credit-worthiness of the applicant. The analysis should cover two aspects:

(i) quantitative (ii) qualitative.

CREDIT TERMS

After the credit standards have been established and the credit worthiness of the

customers has been assessed, the management of the firm must determine the terms and

conditions on which trade credit will be made available. The stipulations under which

goods are sold on credit are referred to as credit terms. Credit terms have three

components: (i) credit period, in terms of the duration of time for which trade credit is

extended-during this period the overdue amount must be paid by the customer; (ii) cash

discount, if any, which the customer can take advantage of, that is, the overdue amount

will be reduced by this amount; and (iii) cash discount period, which refers to the

duration during which the discount can be availed of.

The credit terms, like the credit standards, affect the profitability as well as the cost of a

firm.

Credit period: an increase in the credit period results in an increase in sales volume,

average collection period and bad debt expenses. While increase in sales volume results

in an increase in profits the other two have an adverse impact on profits. A reduction in

the credit period is likely to have an opposite effect.

Cash discount: the implications of increasing or initiating cash discount are as follows:

38

1. The sales volume will increase.

2. Since the customers, to take advantage of the discount, would like to pay within the discount period, the average collection period would be reduced.

3. The discount will have a negative effect on the profits.4. Bad debt expenses will also go down.

COLLECTION POLICIES

These refer to the procedures followed to collect accounts receivable when, after the

expiry of the credit period, they become due. These policies cover two aspects: (i) degree

of effort to collect the overdues, and (ii) type of collection efforts.

Degree of collection effort: the collection policy would be tight if very rigorous

procedures are followed. A tight collection policy has implications which involve

benefits as well as costs. In the first place, the bad debt expenses would decline.

Moreover, the average collection period will be reduced. As a result of these two effects,

the firm will benefit and its profits will increase. But, there would be a negative effect

also. A very rigorous collection strategy would involve increased collection costs. Yet

another negative effect may be in the form of a decline in the volume of sales. The effect

of the lenient policy will be just the opposite.

Type of collection efforts: the second aspect of collection policies relates to the steps

that should be taken to collect overdues from the customers. A well-established collection

policy should have clear-cut guidelines as to the sequence of collection efforts. After the

credit period is over and payment remains due, the firm should initiate measures to

collect them. The effort should in the beginning be polite, but, with the passage of time, it

should gradually become strict. The steps usually taken are (i) letters, including

reminders, to expedite payment; (ii) telephone calls for personal contact; (iii) personal

visits; (iv) help of collection agencies; and finally, (v) legal action. The firm should take

resource to very stringent measures, like legal action, only after all other avenues have

been fully exhausted. They not only involve a cost but also affect the relationship with

the customers.

39

In order to know Yamaha’s strategy regarding debtors we will study ratios like debtors

turnover ratio, average collection period of the firm, the proportion of current assets that

is held in the form of receivables and also the month- wise break up of debtors to

understand the movement of debtors across the year.

Receivables (debtors) Turnover Ratio

With the increasing competition in the business, management sometimes offers liberal

credit terms to its customers, thereby increasing sales and total profits. Thus, the number

of times the management is able to turn the receivables into sales indicates the efficiency

with which the receivables are being managed. The debtors turnover ratio is a test of the

liquidity of the debtors of the firm.

Debtors turnover ratio = total sales/ credit sales

Average receivables

A low turnover ratio is an indicator of the firm’s increased reliance on credit sales in its

marketing efforts. If this is not backed up by timely and efficient collection of

receivables, it may jeopardize the solvency of the firm.

For getting additional into the managerial aspects of receivables, this ratio can be divided

into the total number of days in a year, to give average collection period.

Average collection period = 365 x average receivables

Total sales

Average collection period indicates the number of days for which receivables remain

uncollected. It is not very prudent for a firm to have either a very short collection period

or a very long one. A very long collection period would imply either poor credit selection

or an inadequate collection effort. The delay in the collection of receivables would mean

that, apart from the interest cost involved in maintaining a higher level of debtors, the

liquidity position of the firm would be adversely affected. Moreover, there is the

40

likelihood of a large number of accounts receivables becoming bad debts. Similarly, too

short a period of average collection or too high a turnover ratio is not necessarily good.

While it is true that it avoids the risk of receivables being bad debt as well as the burden

of high interest on outstanding debtors, it may have an adverse effect on the volume of

sales of the firm. Sales may be confined only to such customers as make prompt

payments. The credit and collection policy of the firm may be very restrictive. Without

reasonable credit sales will be severely curtailed. Thus, a firm should have neither very

low nor very high receivables turnover ratio.

Years

Debtors

turnover ratio

Average collection

period

2003 9.93 36.3 Days

2004 11.01 33 Days

2005 7.6 48 Days

Yamaha’s turnover ratio was 9.93, 11.01, and 7.6 for the years 2003, 2004 and 2005

respectively. This indicates that debtors were converted into cash 11 times in the year

2004, 10 times in the year 2003 and around 8 times in the year 2005. The average

collection period has been 36, 33 and 48 days for the years 2003, 2004 and 2005

respectively. One thing can be clearly seen that the average collection period has gone up

by almost 12 to 15 days in 2005. This indicates that recently the firm has followed a more

liberal policy of extending trade credit and also delayed payments by debtors. Moreover,

we can also examine this in relation to the credit terms and policy of the firm itself.

Yamaha usually gives a credit for a period of 30 days. Now if we compare, we will find

that the firm is not able to collect its receivables well within the due dates. The debtors

are outstanding for a period longer than warranted by the firm’s credit policy. This

reflects the inefficiency of the credit collection department; it has made either poor credit

selection or inadequate collection effort. The firm can reduce its average collection

period considerably by availing the facilities provided by the banks.

41

Another ratio used is proportion of receivables to current assets.

Years Debtors to CA ratio

2003 0.27

2004 0.497

2005 0.397

This ratio basically helps in understanding the shifts and changes that occur over the

years in receivables as compared to the current assets. It can be said that this ratio has

increased over time but a word of precaution is that it should not go any further than fifty

percent of the current assets.

Yamaha’s current policy as regards debtors can be stated as follows:

The firm offers different credit terms to different customers. The time period for which it

extends credit varies from between one to thirty days to over one twenty days, the most

common being one to thirty days. The firm’s average collection days varies between

thirty to forty-five days as shown by the calculations.

Around ten to fifteen percent of Yamaha’s sales are exports. Out of this percentage nearly

ninety percent (90%) is done to the parent company, Yamaha Japan which then further

sell it to other clients and the rest ten percent (10%) is done to neighboring countries like

Bangladesh, Sri Lanka etc.. In this case the credit policy is to receive payments within

thirty days from the receipt of document by the other party.

Remaining ninety percent (90%) of the total sales are domestic sales. Here Yamaha offers

different credit period to its dealers depending upon factors like its relationship with

them, their liquidity position, their past records as regards payments etc. At any time of

the year that is in any month sixty-five percent (65%) of the dealers are outstanding for a

42

period of one to thirty days, twenty-three (23%) for a period of thirty to sixty days and

around six percent (6%) each for up to ninety days and over one-twenty days.

In order to understand the trend of how debtors or receivables move in a given year, it is

necessary to study the month wise break up of debtors. Based on this break-up, estimates

for the amount that will be required in future for investment in receivables can be made.

It also helps in knowing the months of peak and sluggish demand respectively.

The usual trend in an automobile industry is that sales are highest during months of

October and November and lowest in the months of July and August. The same trend has

been found in Yamaha and since higher the sales, higher the debtors and vice-versa, the

debtors are also expected to follow the same trend as sales. The reason for high sales in

the months of October and November is the festive season. During the festive season

there are lots of offers in terms of cash discounts or free insurance for one year or interest

subsidy and people usually wait for a while (one or two months) to avail these benefits.

Thus, before the festive season the demand and sales are generally lower. The sales are

lowest in the months of July and August because in these months there is a lot of

transportation problem due to the rainy season.

Another important thing is that better the monsoons better the chances of sales going up

in the rural areas as motorcycles are the most preferred two-wheeler vehicles here. This is

because better the monsoons better the chances of agricultural growth and better the

procurement prices and more the disposable income in the hands of the people of rural

areas.

On an average, investment in receivables in 2005 has been higher as compared to 2004.

Break up of debtors for the year 2004:

  JAN FEB MARCH APRIL MAY JUNE JULY

EXPORTS 8.5 10.41 12.01 11.02 15.04 16.1 16.79

DOMESTIC        

(A) 1 TO 30 DAYS 48.84 57.08 69.67 56.96 49.58 46.77 39.1

(B) 31 TO 60 DAYS 17.62 20.59 25.15 20.56 17.95 16.93 14.15

( C) 61 TO 90 DAYS 4.32 5.05 6.16 5.04 4.39 4.14 3.46

(D) 91 TO 120 DAYS        

(E) OVER 120 DAYS 4.16 4.86 5.93 4.85 4.22 3.98 3.33

         

43

         

TOTAL

RECEIVABLES 83.44 98 118.92 98.43 91.18 87.92 76.83

  AUGUST SEPTEMBER OCTOBER NOVEMBER DECEMBER

EXPORTS 22 18 23 21.01 18.34

DOMESTIC      

(A) 1 TO 30 DAYS 44.15 55.35 67.72 77.23 66.76

(B) 31 TO 60 DAYS 15.98 20.03 24.52 27.96 24.17

( C) 61 TO 90 DAYS 3.91 4.9 6 6.84 5.91

(D) 91 TO 120 DAYS      

(E) OVER 120 DAYS 3.76 4.71 5.76 6.57 5.68

       

           

TOTAL

RECEIVABLES 89.8 103 127 139.61 120.86

Break up of debtors for 2005

  JANUARY FEB MARCH APRIL MAY JUNE JULY

EXPORTS 19.8 25.98 26.9 24 23.79 25 25

DOMESTIC        

(A) 1 TO 30 DAYS 47.77 60.49 57.38 56 82.16 76.65 66.43

(B) 31 TO 60 DAYS 17.3 21.91 23 23 29.74 27.75 24.05

(C ) 61 TO 90 DAYS 4.23 5.36 5.45 5.4 7.28 6.79 5.88

(D) 91 TO 120 DAYS        

(E) OVER 120 DAYS 4.06 5.14 5.7 5.65 6.98 6.51 5.64

               

TOTAL

RECEIVABLES 93.16 118.87 118.43 114.05 149.95 142.7 127

44

  AUGUST SEPTEMBER OCTOBER NOVEMBER DECEMBER

EXPORTS 15 12 9 4 6

DOMESTIC      

(A) 1 TO 30 DAYS 78.15 111.36 113.97 88.57 75.54

(B) 31 TO 60 DAYS 28.29 40.32 41.26 32.06 27.35

( C) 61 TO 90 DAYS 6.92 9.86 10.09 7.84 6.69

(D) 91 TO 120 DAYS      

(E) OVER 120 DAYS 6.64 9.46 9.68 7.52 6.42

           

TOTAL

RECEIVABLES 135 183 184 140 122

This movement of debtors can also be shown in the form of graph as follows:

45

DEBTORS

0

20

40

60

80

100

120

140

160

180

200

JAN FEB MAR APRIL MAY JUN JULY AUG SEPT OCT NOV DEC

AMOUNT(Rs CRORES)

MO

NT

HS

2002

2003

We can also determine the relationship between the debtors of a firm and the firm’s

inventory. This will be further clear from the following two diagrams:

46

Relationship between debtors and finished goods 2004

0

20

40

60

80

100

120

140

160

JAN FEB MAR APRIL MAY JUN JULY AUG SEPT OCT NOV DEC

Months

Am

ou

nt

(Rs

cro

re

s)

Debtors

FINISHED GOODS

Relationship between debtors and finished goods 2003

0

20

40

60

80

100

120

140

160

180

200

JAN MAR MAY'JUN AUG OCT DEC

Months

Am

ou

nt

(Rs

cro

re

s)

Debtors

FINISHED GOODS

47

Ideally debtors and inventory move in opposite directions. When sales are high debtors

are high but inventory is low and similarly when sales are low debtors are low but

inventory is high. Thus, the investment in debtors and investment in inventories are

inversely related. In 2004, the firm’s debtors and inventory move in the opposite

direction but as we can see in 2005, debtors and inventory of finished goods move almost

in the same direction till the month of September. The reason for this could be that the

company is producing more finished goods each month than is being actually sold and as

a result inventory of finished goods is getting accumulated and going up. Now since we

producing more, we must be purchasing more raw materials and therefore the creditors

for the period should also be going up. However, if we see the creditors trend for 2005,

we will find that instead of increasing they have been going down for months of April to

August. This implies that are purchases have not gone up. Thus, it is the debtors that are

not going down and the reason for this is that the company is not able to collect its

receivables on time.

Thus, it can be concluded that though the firm had been managing its receivables well,

recently there has been an increase in the average collection period. The firm should try

to bring this down as it directly affects the operating cycle, which in turn affects the cash,

or the working capital cycle.

48

PAYABLES MANAGEMENT

Creditors are a vital part of effective cash management and should be managed carefully

to enhance the cash position.

In order to understand Yamaha’s payables it is necessary to analyze the various ratios

such as creditors turnover ratio, the average payment period, the ratio of current liabilities

to total liabilities and so on.

Payables/creditors turnover ratio

Accounts payables and creditors constitute an important source to provide spontaneous

working capital finance for the firm. To what extent management is able to use it

properly is an important area worth probing.

49

Payables turnover ratio = annual purchases

Average payables

Payables turnover ratio expresses the number of times accounts payables are converted

into purchases by management during the year. Normally, a higher turnover ratio is

preferred. This means that with a smaller amount of payables, management could

purchase more material during the year. This, therefore, reflects efficiency on the part of

the management.

A variant of this ratio is average payment period.

Average payment period = 365(days in a year)

Payable turnover ratio

This can be observed for a period of time to find out how management has fared on this

front.

Years

Creditors

turnover ratio

Average payment

period

2003 4.11 88.8 Days

2004 5.43 67.24 Days

2005 5.23 69.4 Days

Yamaha’s creditors turnover ratio has increased over time but still it is not very high.

Moreover its average payment period has come down from around eighty nine days to

seventy days.

If we examine the ratio of current liabilities to total liabilities we will find that over the

years this ratio has been more or less the same. Current liabilities form fourteen percent

of the total liabilities.

Years CL TO TL ratio

50

2003 0.147

2004 0.144

2005 0.142

The month wise break up of creditors of Yamaha for the years 2002 and 2003 is as

follows:

 

CREDITORS

2004

CREDITORS

2005

     

JANUARY 53.44 77.57

FEBRUARY 61.38 75.21

MARCH 65.62 73.84

APRIL 82.21 69.05

MAY 82.21 67.05

JUNE 89.89 51.55

JULY 89.89 39.87

AUGUST 63.7 47.47

SEPTEMBER 75.92 78.49

OCTOBER 90.94 75.21

NOVEMBER 87.79 77.83

DECEMBER 60.34 34.76

This data can also be depicted in the form of a line diagram:

51

CREDITORS

0

10

20

30

40

50

60

70

80

90

100

JAN FEB MAR APRIL MAY JUN JULY AUG SEPT OCT NOV DEC

MONTHS

AM

OU

NT

(Rs

cro

res)

2002

2003

As can already been seen, Yamaha’s creditors have fluctuated widely not only month-

wise but year wise as well. Creditors have followed an entirely different direction in the

beginning of 2005 as compared to 2004 and moreover the increase or decrease in 2003

has been much more as compared to 2004.

52

We can also show the relationship between inventory, receivables and creditors.

Relationship betweem inventory, debtors, creditors for 2002

0

20

40

60

80

100

120

140

160

180

200

JAN FEB MAR APRIL MAY JUN JULY AUG SEPT OCT NOV DEC

Months

Am

ou

nt(

Rs

cro

res)

INVENTORY

DEBTORS

CREDITORS

53

Similarly for 2005,

Relationship between inventory, debtors, creditors for 2003

0

50

100

150

200

250

300

JAN FEB MAR APRIL MAY JUN JULY AUG SEPT OCT NOV DEC

Months

Am

ou

nt(

Rs

cro

res)

INVENTORY

DEBTORS

CREDITORS

It is very evident from the above two figures that creditors movement is more or less

similar to that of the debtors. Though at certain points it moves in the opposite direction

of debtors the magnitude is not very large. Based on this we can conclude that the debtors

and creditors are positively related whereas creditors and inventory are negatively related.

Since we have already discussed the various aspects of working capital such as inventory,

receivables and payables we can now discuss the concept of operating cycle and cash or

working capital cycle.

Operating cycle

Days of operating cycle (DOC) refer to the time period between the acquisition of

inventory and the collection of cash from receivables. It has two distinct components:

inventory period which is the time it takes to acquire and sell inventory and the accounts

54

receivable period which is the time between sale of inventory and collection of the

receivables.

    2003 2004 2005

1 Average age of inventory 81.49 Days 45.5 Days

54.31

Days

2 average collection period 36.3 Days 33 Days 48 Days

3 average payable period 88.8 Days

67.24

Days 69.4 Days

       

4

Days of operating

cycle(1+2) 117.8 Days 79 Days

102.31

Days

5 Days of working cycle(4-3) 29 Days 12 Days 33 Days

Yamaha’s operating cycle has been more than 100 days except for the year 2004 when it

was only 79 days. The lesser the number of days, quicker is the conversion of inventory

and receivables into cash.

Working capital / cash cycle

Cash cycle is the difference between operating cycle and average payment period. In

other words, it is the time period from when cash is paid out to when cash is received.

The firm’s working cycle has been between 28 and 35 days except for the year 2004

when it was just 12 days. The increase in the cash cycle has been because of an increase

in the inventory and receivables period and a decrease in payables period. It can also be

said that the cash cycle has decreased because the company has been able to defer

payment of payables and thereby lengthen the payables period.

The longer the cash cycle, the more financing is required. Changes in the firm’s cash

cycle are often monitored as an early-warning measure. A lengthening cycle indicates

that the firm is having trouble moving inventory or collecting on its receivables.

Thus, it can be said that all other things being the same, the shorter the cash cycle is, the

lower is the firm’s investment in inventories and receivables. As a result, the firm’s total

assets are lower, and total turnover is higher.

55

WORKING CAPITAL FINANCING

The need for financing arises mainly because the investment in working capital/current

assets that is, raw materials, work/stock in progress, finished goods and receivables

fluctuates during the year. The main sources are mainly trade credit, bank credit,

factoring and commercial papers.

Trade Credit

Trade credit refers to the credit extended by the supplier of goods and services in the

normal course of transaction/business/sale of the firm. It is an informal arrangement

between the buyer and the seller. There are no legal instruments/acknowledgements of

debt, which are granted on an open account basis. Such credit appears in the records of

the buyer of goods as sundry creditors/accounts payable.

A variant of accounts payable is bills/notes payable. Unlike the open account nature of

accounts payable, bills/notes payable represent documentary evidence of credit purchases

and a formal acknowledgement of obligation to pay for credit purchases on a specified

(maturity) date failing which legal action for recovery will follow. Although most of the

trade credit is an open account like accounts payable, the suppliers of goods do not

extend credit indiscriminately. Their decision as well ad the quantum is based on factors

such as earnings record over a period of time, liquidity position of the firm and past

record of payment.

Its biggest advantage is that it is easily, almost automatically, available. Also it is a

flexible and spontaneous source of finance. Though it does not involve any explicit

interest charge, there is an implicit cost. It depends on the credit terms offered by the

supplier of goods. If the terms of the credit are, say, 45 days net, the payable amount to

the supplier of goods is the same whether paid on the date of purchase or on the 45 th day

and, therefore, trade credit has no cost, that is, it is cost free. But if the credit terms are,

56

say, 2/15, net 45, it implies that the firm (buyer) is entitled to 2 percent discount for

payment made within 15 days when the entire payment is to be made within 45 days.

Failure to take the discount means paying an extra 2 percent for using the money for an

additional 30 days. This represents an annual interest rate/cost of 24 percent. The smaller

the difference between the payment day and the end of the discount period, the larger is

the annual interest/cost of trade credit.

Bank Credit

It is the primary institutional source of working capital finance in India. It is the most

important source for financing of current assets. Banks in five ways provide working

capital finance:

1. Cash credit/overdrafts : under cash credit/overdraft form of bank finance, the bank

specifies a predetermined borrowing/credit limit. The borrower can draw/borrow

up to the stipulated credit /overdraft limit. Within the specified limit, any number

of drawls/drawings is possible to the extent of his requirements periodically.

Similarly, repayments can be made whenever desired during the period. The

interest is determined on the basis of the running balance/amount actually utilized

by the borrower and not on the sanctioned limit. However, a minimum charge

may be payable on the unutilized balance irrespective of the level of borrowing

for availing of the facility. It is attractive to the borrowers because it is flexible in

that although borrowed firms are repayable on demand, banks usually do not

recall cash advances/roll them over as secondly the borrower has the freedom to

draw the amount as and when required while the interest liability is only on the

amount actually outstanding. However it is inconvenient for the banks and

hampers credit planning. Cash credit cannot at present exceed 20 percent of the

maximum permissible bank finance to any borrower.

2. Loans: under this arrangement, the entire amount of borrowing is credited to the

current account of the borrower or released in cash. The borrower has to pay

interest on the total amount. The loans are repayable on demand or in periodic

installments. At least 80 percent of MPBF/credit limit must now be in the form of

loans.

57

3. Bills purchased/discounted : bank credit is made available through discounting of

usance bills by banks. The bill financing is intended to link credit with the sale

and purchase of goods and, thus eliminates the scope for misuse or diversion of

credit to other purposes. The amount made available under this arrangement is

covered by the cash credit and overdraft limit. Before discounting the bill, the

bank satisfies itself about the credit worthiness of the drawer and the genuineness

of the bill. The discount rates are fixed at lower rates than those of cash credit.

The discounting banker asks the drawer of the bill (i.e. seller of goods) to have his

bill accepted by the drawee (buyers) bank before discounting it. The latter grants

acceptance against the cash credit limit, earlier fixed by it, on the basis of the

borrowing value of stocks. Therefore, the buyer who buys goods on credit cannot

use the same goods as a source of obtaining additional bank credit.

4. Working capital term loans : under this arrangement, banks advance loans for 3-7

years repayable in yearly or half yearly installments.

5. Letter of credit : letter of credit is an indirect form of working capital financing

and bank assumes only the risk, the credit being provided by the supplier himself.

The purchaser of goods on credit obtains a letter of credit from a bank. The bank

undertakes the responsibility to make payment to the supplier in case the buyer

fails to meet his obligations. Thus, modus operandi of letter of credit is that the

supplier sell goods on credit/extends credit to the purchaser, the bank gives a

guarantee and bears risk only in case of default by the purchaser.

Commercial Papers

Commercial paper (CP) is a short term unsecured negotiable instrument, consisting of

usance promissory notes with a fixed maturity. It is issued on a discount on face value

basis but it can also be issued in interest bearing form. A CP when issued by a company

directly to the investor is called a Direct Paper. When CPs are issued by security dealers

on behalf of their corporate customers, they are called dealer paper. They buy at a price

less than the commission and sell at the highest possible level. The maturities of CPs can

be tailored within the range to specific investments.

58

It is a simple instrument and does not need any documentation. It is additionally flexible

in terms of maturities, which can be tailored to match the cash flow of the issuer. A well-

rated company can diversify its short-term sources of finance from banks to money

market at cheaper cost. The investors can get higher returns than what they can get from

the banking system. Companies, which are able to raise funds through CPs, have better

financial standing. As negotiable transferable instruments, they are highly liquid.

Factoring

Factoring provides resources to finance receivables as well as facilitates the collection of

receivables. It can be broadly defined as an agreement in which receivables arising out of

sale of goods/services are sold by a firm (client) to the ‘factor’ (a financial intermediary)

as a result of which the title of the goods/services represented by the said receivables

passes on to the factor. Henceforth, the factor becomes responsible for all credit control,

sales accounting and debt collection from the buyer(s). In a full service-factoring concept

(without resource facility), if any of the debtors fails to pay the dues as a result of his

financial inability/insolvency/ bankruptcy, the factor has to absorb the loss.

Credit sales generate the factoring business in the ordinary course of business dealings.

Realization of credit sales is the main function of factoring services. Once a sale

transaction is completed, the factor steps in to realize the sales. Thus, the factor works

between the seller and the buyer and sometimes with the seller’s banks together.

Depending on the type/form of factoring, the main functions of the factor, in general

terms, can be classified into five:

1. Financing facility/trade debts,

2. Maintenance/administration of sales ledger,

3. Collection facility/of accounts receivable,

4. Assumption of credit risk/credit control and credit restrictions; and

5. Provision of advisory services.

59

Factoring has several advantages such as off-balance sheet financing, reduction of current

liabilities, improvement in current ratio, higher credit standing, improved efficiency,

reduction of cost and expenses etc.

60

ROLE OF BANKS

In today’s increasingly competitive world, where the firms are trying their best to manage

their working capital requirements most effectively the role of Bank in helping the firm in

its Working Capital management has become of crucial importance. Today Banks not

only provide short term or working capital loans but also play a major role in receivables

and payables management. Thus the basic questions, which need to be addressed with

regard to Bank’s role, can be stated as follows:

- What facilities does/can the Bank provide the firm to reduce its days of working

cycle? i.e. what can the firm do to reduce firm’s average collection period and

increase its average payable period.

- How can the Bank help the firm in reducing the cost of Debtors and Creditors

without having an adverse impact on average collection and average payable

period respectively?

Before going ahead and discussing what the Bank can “do” and “not do” in receivables

and payables management, lets make certain facts clear about Banking infrastructure

available in India.

As far as Banking System is concerned we have 27 public sectors Banks, 10 private

sector Banks, 26 foreign Banks, large number of cooperative Banks, regional rural Banks.

The clearing system in predominantly paper based with over 10,000 clearing zones. Out

of this 15 major zone clearing is done by RBI and in the most of other by SBI and its

associates.

The major constraints in the entire procedure are geographically spread (banks all over

India), low levels of Banking automation and poor communication and postal

61

infrastructure. As a result of this there are delays receiving credits, uncertainty of

payments, Reconciliation issues, high potential and lots of administrative burden.

CITIBANK

Yamaha’s Working Capital Management is basically done by Citibank. Citibank has been

playing a major role in Yamaha’s Working Capital Management and recently it has come

up several new products some of which will help Yamaha in reducing its cost of Debtors

and Creditors.

We will first discuss services related to receivables and then services related to payables:

RECEIVABLES

Normally, the procedure in this cases as follows:

Yamaha or the client makes sales and on being presented invoice updates its a/c ledger

Client

Make Sale

Ship Goods

Update a/c ledger

Present Invoice

Active Collection

Channel Financing- o/d

Funding

Reconcile Payments

Receive Payments

BuyerCollection Mgt

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and ship goods to the dealer. For this it requires funding which the Bank does. This could

be either in the form of overdraft or bill based. After the agreed period Yamaha will

receive payments from the dealer (sales were credit sales) and then it will be reconcile

payments.

Thus the client’s/Yamaha’s needs can be stated as

▪ Invoice presentation to buyer ▪ follows up for payment (including due date reminder)

▪ dispute resolution ▪ funding ▪ reconciliation.

Though this process may look simple but in reality it’s very long and complicated process

particularly the collection management process. This is where in the Banks steps to

reduce the firm’s average collection period.

Initially what use to happen was that, the dealers used to send cheques to the company

through courier (the dealers are not always at same location). This process takes 2-3 days.

By the time the cheque gets cleared and funds are credited to the client’s a/c it takes

another 4-5 days. Thus the entire process of getting the cheque and depositing and getting

the funds credit to the a/c takes about 9-10 days. And if the dealer sends a draft payable at

Delhi (assuming the company is in Delhi and dealer is situated somewhere else) then this

entire process takes 4-5 days.

Now what the Bank has offered is that instead of dealers sending cheques/drafts to the

company, the Bank will directly collect cheques from the dealers. Citibank through its

own branches and tie up with correspondent banks offer to collect cheques drawn in more

than 2500+ locations and sent them for collection. This facility offered by the Citibank

helps the firm in reducing their average collection period considerably from usual 9-10

days (cheques) or 4-5 days (drafts) to 2-3 days. This is because the Bank Agent collects

the cheques from the day zero and deposits them in the Citibank branch or corresponding

Bank on that day itself. By the day zero evening only, the cheques are sent to clearing

house and then the entire process takes about 2 days. Thus there is reduction in average

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collection period by almost 6-7 days in case of cheques and 2-3 days in case of drafts by

outsourcing B/R collection process to the Bank.

Another product/facility offered by the Citibank is purchase of client’s receivables.

In this the Bank buys client’s receivables and pay the client the discounted value (day

zero). The client continues its collection process as usual. On Day, the client pays Bank

1st installment and on Day B, the 2nd installment. Even if actual collection is less than the

installment sold, the client has to bear/borne the shortfall up to FLDG (first loss

deficiency guarantee) given by it and the rest has to be reimbursed by the Bank. This

facility offered by the bank enables companies to achieve off balance sheet treatment for

trade receivables. It is a kind of factoring facility, which is given by the bank to the firm.

The main benefit to the client in this is that firstly it is getting money on the very first day

and thus its funds are not stock up in Debtors for the usual 30 or 60 days as the case may

be. Though the Bank does charge firm for this facility, it should be kept in mind that the

presented value of discounted the firm will receive on the day zero will be almost equal

to or could even be more than the present value of funds that the firm will receive on

30th /60th day from the dealer. Thus it is definitely advantageous for the firm to get

discounted funds from bank on day zero (it can utilize these funds somewhere else).

Secondly, if there is default in payment by some debtors then the entire shortfall is not

borne by the client (only FLDG).

Moreover contigent liability for FLDG amounts only has to be reported as against Balance Sheet.

Another advantage is that it does not disturb the clients existing structure for collection and recover

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Payment Reconciliation

If actual collection is < invoices sold

Shortfall up to FLDG, borne by client

Balance shortfall reimbursed by Citigroup

However, certain conditions are to be kept in mind:

→ Securitization of receivables is done through assignment of debtors and

assignment of debts is done under a standard irrecoverable receivables agreement.

→The Company is the collection agent throughout the tenure of the deal. Recourse to

the company in the event of default (Pre-determined recourse level- FLDG limit)

→Selection of poor of receivables is based on pre defined criteria’s such as

▪Authorized dealers

Client

Client Citigroup

Citigroup Day o

Day B

Day A

Assigns Receivable

Discounted value paid

Pay 1st Installment

Pay 2nd Installment

Client Citigroup Day C Pay shortfall in excess of FLDG

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▪No over dues greater than 90 days and no re-structuring of debts

▪Minimum association of 2 years

▪Consistent profitability record

▪Receivables pertains only to the sale of client’s products

▪Receivables do not present disputed amounts

▪Not from negative locations as specified by bank.

Another facility offered by banks for receivables is simple B/R discounting. In this the

Bank takes the bill from the client and in return pays it the discounted amount on first day

and on the due date it collects the amount from the dealer. Thus in this way the firm is

getting the funds on the very first day.

PAYABLES

Recently, Citibank has come up with some new products/facilities in Payables

Management, these products/facilities basically deals with pre-delivery finance and post

delivery finance.

Pre-delivery finance is basically providing financing to the key suppliers of clients.

Usually, if a supplier will borrow from some other Bank, he will pay an interest rate of

say X% on the total amount. Now what Citibank has proposed that if the supplier

borrows money or loan from Citibank on the client’s name then he will have to pay an

interest rate of say (X-3) %. As a result of this the supplier is directly saving 3% interest

rate on the entire amount. The benefit to the client is that the supplier will pass on his

2%out of this 3% savings to the client in the form of reduced cost. Thus the firm’s cost of

its Raw Material and eventually it is going down without having an adverse effect on the

average payable period.

Moreover though this system supplier payments can be automated. It includes no

additional or financial liability for the client.

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On the other hand, the major benefit to the supplier is the cheaper source of finance for

pre shipment stage. Moreover the bank is providing him funding of working capital

requirement without any collateral.

Next facility which post delivery financing implies financing the purchase of critical raw

materials. In the normal course of business, the client or the vendor usually pays the

supplier after the expiry of pre-determined period. Since the supplier is not getting the

money immediately on delivery but after 2 or 3 months as the case may be, he will

charge an interest rate that will be included in the cost of materials.

What Citibank has proposed is that it will pay the supplier discounted proceeds (i.e. after

deducting cash discount) on the very first date. Thus if the supplier was suppose to get Rs

100 from the client after one or two months as the case may be, now he will get Rs 93

from the Bank on the very first date (The Bank is charging an interest rate of 7%). On the

due date the Bank will debit the clients a/c by Rs 93 plus the interest rate on Rs 93 (say

CLIENT

CITIBANK

SUPPLIER

1.Purchase order

2.Accepted P.O+ pre loan application

3.Loan created & Cr.20% margin

4.Supply made as per P.O

5.Hundi issued for the supply

6.Accepted Hundi/invoice

7.Accepted Hundi/invoice

8.Preshipment converted to post

9.Loan liquidated any excess credit to supplier

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7%). The benefit to the client is that earlier he was paying the supplier Rs 100 + 7% =

Rs 107, whereas now it is paying only Rs 99.51 to the Bank. Thus the entire extra cost of

interest that the client was paying earlier has now been passed on to the supplier and in

this way firm’s cost of creditors has gone down without having an adverse effect on

payment period.

For this there are certain documentation requirements:

One time documentation

→Citibank offer letter to be duly accepted by the client.

→Board resolution from the client for signature verification on the transaction does.

Transactions based Documents

→Request letter from client

→Accepted B/E

→Original invoice

→Transport Documents.

CLIENT SUPPLIER

CITIBANK

Purchase Order

Supply made as per P.O

Invoice issued for the supply

Discounted proceeds paid after deducting cash discount

A/c debited on due date

Request to discount and pay post verification of supplies

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Another facility offered by the Citibank is managing the entire payment process of the

client.

In other words the Bank works as a “Bank Office”. It involves everything from printing

cheques, electronic authorization to payment advice generation and delivery.

Citibank also offers various Integration options such as Host-to-Host (H2H), ERP

integration and Electronic Banking.

H2H is basically a standalone system. In this the continues to run its existing program

and then at a later stage (after funding has been organized by treasury department and

files encrypted on server) posts them on Citibank’s server, there on Bank manages the

payment procedure.

However in ERP, the client put the payment file on Citibank’s site in the morning from

where the Citibank picks it up. It carries out the entire payment process such as printing

of cheques authorization and so on. In the evening it put this file on the site and the client

picks it up. When the client put this file in his system, it automatically updates the

payment file.

The advantage to the client in this are that it allows for paper based invoices and purchase

orders to be replaced by electronic surrogates including file dumps, print screen and other

electronic advices generated from client’s ERP.

(Which of them is the best option depends upon various factors but usually ERP is

considered better as it has its own inherent advantages, the business rules are pre-defined

and there are less chances of error)

Apart from these, Citibank also provide services in import and export finance by giving

credit to both suppliers and buyers and they directly benefit, as their cost of borrowing is

lower in this case.

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RECOMMENDATIONS

The following conclusions have been drawn about the various elements of working

capital:

There has been an improvement in overall inventory as well as other turnover

ratios like raw material turnover, W-I-P turnover, and finished goods turnover

over the years but still more concentration should be paid on inventory of finished

goods as this is a problem area. The inventory of finished goods is not getting

converted into sales as fast as it should be.

The average collection period has gone up considerably in 2005. The firm should

go for automation and outsourcing of receivables to banks in order to improve the

position of its receivables. By outsourcing receivables, Yamaha’s collection

period will come down considerably.

Lastly, as far the creditors are concerned there has been a reduction in average

payment period and an increase in creditors turnover ratio. In order to improve the

current position of payables the firm should avail Citibank’s services of pre and

post delivery financing (purchase of critical raw materials or paying the supplier

the amount for the goods he has supplied to Yamaha on the very first day). The

advantage to Yamaha is that its cost of creditors will go down without having an

adverse effect on its payment period. The reason is that this service will have a

direct impact on the costs of the supplier (his costs will go down) and as a result

of this he will lower the cost of materials that he is supplying to Yamaha.

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LIMITATIONS

The study has been done only over a short period of time from year 2003 to

2005 and it is very difficult to give the exact trend.

The recommendations are based on past data and are situation based.

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BIBLIOGRAPHY

1. M.Y. KHAN & P.K.JAIN: “FINANCIAL MANAGEMENT”, THIRD EDITION, TATA Mc-GRAW HILL.

2.I.M. PANDEY: “THEORY OF FINANCIAL MANAGEMENT”, THIRD EDITION.

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ANNEXURES

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