WORKING CAPITAL MANAGEMENT IN RELIANCE INDUSTRIES LIMITED (RIL)

What is Working Capital Management?

Working capital management is mainly concerned with the decisions regarding current assets and current liabilities. The main difference between long term financial management and working capital management is in terms of Timing of cash flows Large holdings of current assets strengthens liquidity but reduces profitability Only current assets can be adjusted with sales fluctuations

Types Of Working Capital Gross working capital is the total of all the current assets. Net working capital is the difference between the current assets and current liabilities. Two main issues that should be addressed are How to optimize investment in current assets How current assets should be financed.

The level of investment in current assets should avoid both excessive and inadequate investments. The goal of working capital management is to ensure that the firm is able to continue its operations and that it has sufficient cash flow to satisfy both maturing short-term debt and upcoming operational exImplementing an effective working capital management system is an excellent way for many companies to improve their earnings. The two main aspects of working capital management are ratio analysis and management of individual components of working capital. A few key performance ratios of a working capital management system are the working capital ratio, inventory turnover and the collection ratio.

Ratio analysis will lead management to identify areas of focus such as inventory management, cash management, accounts receivable and payable management. Working capital management entails short term decisions - generally, relating to the next one year period - which is "reversible". These decisions should be based on cash flows and / or profitability. One measure of cash flow is provided by the cash conversion cycle or the operating cycle - the net number of days from the outlay of cash for raw material to receiving payment from the customer. The most useful measures of profitability is Return on capital (ROC) and Return on equity (ROE) Objectives of working capital management The main objectives of WCM are profitability and solvency. Maximise productivity and profits by maintaining a optimum ratio between working capital and fixed capital. Ensure smooth and rapid flow of funds to enhance efficiency of working capital or profitability. Ensure synchronization between cash receipts and cash outlay or have sufficient cash reserves.

Adequate working capital is important due to the following reasons Protects a business from the adverse effects of shrinkage in value of current assets Makes it possible to pay current dues promptly and take advantage of cash discount Ensures maintenance of companys credit standing Provides for emergency cash expenses Allows inventories to be at levels needed for continuous sales. Enables efficiency of operations Enables favorable credit terms to be extended to customers Enables an organization to withstand periods of depression Enables to withstand operating losses or reduction in earnings Enables to withstand non procurement of short term funds Factors influencing working capital requirements

Nature of the business Size of the business Seasonality of operations Production policy Proportion of raw material to total cost Market conditions Conditions of supply Turnover of inventories Cash requirements Banking facilities

Risk return trade off in WCM Given a firms technology and production policy, sales and demand conditions, operating efficiency will depend upon its working capital policy. It may follow a conservative or aggressive policy A conservative or flexible policy is when the firm maintains a huge balance of cash and marketable securities carries large amounts of inventories and grants generous terms of credit to debtors. An aggressive or restrictive policy, the investment in current assets is low, with small balances of cash, low inventories and stiff terms of credit to debtors. A conservative policy results in fewer production stoppages, ensures quick deliveries to customers and stimulates sales. These benefits come at a cost of higher investment in current assets. An aggressive policy may lead to frequent production stoppages, delayed deliveries and loss of sales. A conservative policy indicates greater liquidity, lower return and lower risk An aggressive policy indicates poor liquidity, greater return and greater risk. Profitability is measured by profits after expenses.

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. Effect of level of current assets on the Profitability-Risk Trade-off The effect can be shown by the ratio of current assets to total assets. An increase in the ratio will lead to a decline in profitability. This is so because current assets are assumed to be less profitable than fixed assets. A second effect of the increase in the ratio will be that the risk of technical insolvency would also decrease because the increase in current assets, assuming no change in current liabilities, will increase NWC. A decrease in the ratio will result in an increase in profitability as well as risk. Determining the optimal level of current assets involves a trade of between costs that rise with current assets and costs that fall with current assets. The first is called the carrying costs and the second is the shortage costs. Carrying costs are mainly the cost of financing a higher level of current assets. Shortage costs are mainly in the form of disruption of production schedule, loss of sales, loss of customer goodwill, etc. To determine the optimum level of current assets, the firm should balance the profitability solvency tangle by minimizing total costs carrying costs and shortage costs. The minimum cost level indicates the optimum level of current assets. This is not so easy to determine in practice. Current assets financing policy How should current assets be financed? Fixed assets are assumed to grow at a constant pace and reflects the rate of growth in sales and earnings. Current assets also grow over time, but they exhibit substantial variation due to seasonal or cyclical patterns in sales and purchases. The investment in working capital may be in two parts Permanent working capital Temporary working capital

The firm can finance its capital through Long term financing for fixed assets and working capital Long term financing for fixed assets, permanent working capital and part of temporary working capital and short term financing for part of temporary working capital Long term financing for fixed assets and permanent working capital and short term financing for temporary working capital