Working capital management advisory
Criticality of working capital
In many businesses working capital forms a large chunk of initial funds required. Apohan has observed in its market survey that many small and medium enterprises of the first generation businessman are not aware of the concept of working capital. Rather, they are not aware of the seriousness the concept of working capital provisioning. Small and medium enterprises live under the misconception that working capital is a short-term finance and it is at a constant level for every year. They also use 100% CC and OD limits with the bank which should be actually reserved for seasonal fluctuations and occasional credit crunch. SMEs run a business with the lower working capital at operating capacities much below the break even capacity and are not able to meet all the liabilities of the business.
A break-even operating capacity is the capacity at which a business generates sufficient cash to exhaustively meet its all operational, financial and any other kind of liabilities. Operating the plant below break even capacity leads to liquidation of the company in the long-term. A company always must operate much beyond its break even working capital city. But, this requires ample amount of working capital. Companies requiring very high level of working capital can finance the same through equity funding through mergers and acquisitions.
Importance of the fixed component of working capital:
Subject to the technical limitations, immediately after the commissioning of a manufacturing facility, the plant should start operating about break even operating capacity. Required working capital for operating beyond break even operating capacity, should be made available as a part of project management and not as a part of operations management. A manufacturing facility can reach hundred percent operating capacity from the break even capacity only if it starts operating beyond break even capacity right from the beginning. If a plant operate below break even capacity for a substantial period of time in the beginning, the company makes losses and subsequently may have to be closed. In the Indian small and medium enterprises, it has been observed that the working capital is misconstrued as short term capital. The banks provide cash credit and overdraft limits based on the existing level of inventory or any other security. A business cannot borrow working capital without providing existing inventory for new security. In the project planning, if provisions are not made for this, the plant starts operating at very low capacity in the initial period; pet me not be able to recover the fixed costs; it may not be able to to generate sufficient cash to serve the date of the banks. Can be termed as infant mortality e of a small and medium Enterprise.
Once the initial long term fixed component of working capital for operations level break even are taken care, the internal accruals of the operations can provide the increase in working capital every year to reach hundred percent operating capacity. If it is impossible for a business to make available all this working capital because it is too huge, then such business should negotiate a Moratorium of 6 months to a couple of years till the company starts operating beyond the break even operating capacity. Initial amount of working capital should be treated as part of the main capital in the process of capital structuring.
The cash credit and overdraft limits available from a bank are supposed to be used frugally
And should not be treated as if they are long term-capital. The rates for these loans are high and if a certain minimum amount is going to be permanently needed, it should be replaced with the long term loan.
Management of bank guarantees, L/c
Adequate guarantees & credits should be available for:
1. Bank relations should be developed to get margin based BGs in place deposit based BGs
2. BGs should be collected back from tenderer in time.
3. Terms of BG should be favourable
When quantum of working capital is less, it becomes difficult to bid for new tenders due poor management of BGs, especially in India where government bodies, PSUs, etc don’t promptly return BGs.
Apohan’s working capital related services:
1. Estimation of Working Capital planning phase
2. Estimation of Working Capital for different operating levels for an operational plant
3. Estimation of upfront working Capital at the commissioning
4. Equity funding of fixed, long-term working capital