INTRODUCTION
This proposal explores how working capital is managed in a printing business that is based in India. Managing working capital effectively may lead to the success of any business.
Any business needs working capital to operate. Understanding working capital is top priority of any business that is growing. Many businesses may cease trading in spite of being profitable on paper. One reason for this could be an inability to meet short-term debts when repayment is due. Therefore, if an organisation is to stay in business, it must pay vital importance to managing its working capital.
Working capital has many definitions. The first definition is the difference between total current assets and total current liabilities. Current assets primarily consist of inventories, cash (in hand and at bank) and trade receivables. The principal components of current liabilities are trade payables and bank overdraft. As defined by Joseph (2007), current assets are those assets of the business which are expected, within a year, to be converted into cash, while current liabilities are the ones to be settled within a year.
Trade payable arises since goods and/or services are usually bought on credit by almost all businesses. Businesses do not usually function without a cash balance; however, bank overdrafts may exist in some situations. Working capital is vital for the day to day operation of any business. It is a net investment in short-term assets which repeatedly flows in and out of the business. The different elements of working capital are inter-related as suggested by Atrill & Mclaney (2009).
Working capital must be financed and therefore it has a cost. The aim of any company should be to avoid excessive working capital as it creates unnecessary cost. Inventories, receivables and payables should therefore be well-managed. Likewise having insufficient amounts of working capital can lead to cash flow difficulties and liquidity problems.
An enterprise's working capital policy is the combination of two decisions. First being the investment decision, this determines the appropriate level of investment in a mix of current assets for a given level of activity. And second, the financing decision which determines the methods of financing this investment.
For any business it is vital to calculate its working capital cycle. The working capital cycle for a business is the cycle of obtaining resources to make a product or service and sell it to the customer. The length of this cycle varies remarkably between different types of businesses. A business's operational cash flows are also affected by the length of the working capital cycle. The cash that has been paid out takes longer to recover if the length of the working capital cycle is long.
As cited by Atrill & Mclaney (2009), "the working capital needs of a business are likely to change over time" due to changes in the business environment. These changes must be identified by managers to make certain that the working capital investment is suitable for the efficient running of a business.
Main objective of this research is to investigate and to have a critical analysis of GQP's WCM practices and then to give relevant policy recommendations helpful to enhance it's value.
Gupta Quick Printers (GQP) began operating in 1982. It started with a simple hand fit trading machine and Heidelberg platen. The firm has been growing steadily and is now one of the leading print houses in Kolkata, India, using the latest Offset printing technology. GQP began with just a few Offset printing machines it now has the entire printing process done in its factory. Top quality machines like Akiyama & Heidelberg are in use and a separate design unit is there to cater to customers designing requirements. Initially operating with just one employee it now comprises of a very dedicated & specialised team of fifteen employees from reputed printing colleges in Kolkata, India.
GQP operates in an emerging market. The Indian Economic advisory Council suggested that the "Indian economy is expected to grow at 8.5 per cent in 2010/11 and 9.0 per cent in 2011/12". According to FICCI, the Paper, Paper Products, Printing, Publishing and Allied industries grew from being -0.2% to 11.5% in August 2009 and August 2010, respectively.
Doing business in an emerging market can not only bring new opportunities but it is also risky because it can be difficult to manage working capital in such a market. There can be problems related to trade receivables or to funding. Since "In India, credit is considered to be a scarce commodity and need based financing continues to be a main plank underlying the central bank's credit policy even in the liberalized regime (Chatterjee et al 2005: 214)".
This research enables to discover the problems that GQP faces with its management of working capital, in an emerging market. GQP's financial statements from the last five years will be thoroughly analysed and necessary working capital ratios will be calculated. The study proposes improvements that can be made to GQP's working capital management.
It is hoped that the research will encourage further theoretical and empirical contributions on this important area of small business research.
RESEARCH AIM & OBJECTIVES
The most important focus of the study is to analyse how GQP manages its working capital. Whether it does so effectively and if it's making the right decisions.
And to achieve the potential result there are some objectives that need to be accomplished.
Examine GQP's working capital structure, its sources and components. Is there any significant changes taking place over a period of time?
Critically evaluate the working capital management of Gupta Quick Printers and the impact of working capital ratios on profitability of the company.
Examine the WCM of GQP
Assess the WC investment Strategy
Study WC Financing Strategy
Study WC Operational strategy
Analyse what importance is ascribed to objectives related to working capital and how those objectives implemented. Review the purchasing, sales & production processes and to measure are they still managed on an isolated basis as far as working capital is concerned?
Examine the relationship between a booming economy and a small printing company's relationship and how it's affecting the management of working capital.
Construct and make recommendations for improvements in working capital management.
3. LITERATURE REVIEW
The bulk of the literature collected is from books; even electronic sources have been consulted such as Google scholar, various other web pages and journals. This research will be carried out using the deductive approach where theories will be identified and tested using the data collected.
Working capital, as suggested by Khan and Jain (2008), has two concepts. The first concept is gross working capital and the other concept is net working capital. Gross working capital can be defined as total current assets. Net working capital has two definitions. One of the definitions is the difference between the current assets and current liabilities of an organisation. Working capital is defined in the same way by Guthmann and Dougall (in Bhattarcharya, 2001).
This definition is elaborated later by Park and Gladson ( in Bhattacharya, 2001) when they define working capital "as the excess of current assets of a business (cash, accounts receivable, inventories) of a business over current items outstanding such as salaries and wages payable, accounts payable, taxed owed to the government". Accountants more commonly, use this definition of working capital.
However, according to Fitzgerald (2002) the correct definition of working capital investment is stock + trade debtors - trade creditors. He argues that working capital defined as net current assets (current assets less amounts due and payable in under one year) is a misleading definition. The latter definition fails to recognise two important aspects of working capital. The first aspect being the need to invest in stocks and in customer credit in order to fill orders from customers (the net cost of this investment can be reduced if the business can obtain credit from suppliers). The second aspect is the access to funds that will pay for the working capital investment. The definition of working capital (current assets minus amounts due and payable under one year) mixes up the funding and the investment issues.
Khan and Jain (2008) argue that it is easier to repay obligations when they are due for repayment if the difference between the current assets and the short-term obligations is quite high. Using NWC to measure liquidity is based on this idea. Due to the non-systematic cash in and outflow, NWC is very essential.
The NWC concept is also useful for comparing the liquidity in the same firm over a period of time. An acceptable level of NWC should be maintained by any organisation by managing its current assets and current liabilities well.
The other definition of net working capital in use is inventory plus trade receivables minus trade payables. This definition is used when analyzing the working capital cycle or cash operating cycle of a business. Khan and Jain (2008) define alternative NWC as "that part of current assets which is financed with long term funds". As a current liability signifies a source of short term funds, the excess must be financed with long term funds (as long as current assets are more than the current liabilities).
Since WC must be financed, it has a cost. The aim of any company should be to avoid excessive working capital, which creates unnecessary costs. Likewise, having insufficient amounts of working capital can lead to difficulties with cash flow and liquidity. An efficient working capital management requires that an organisation should operate with some amount of NWC, the exact amount of which can vary depending on the type of industry and between organisations.
Working capital is particularly of use to creditors who want to calculate the margin of safety. These interested groups, as suggested by Walker (1974), mostly composed of creditors who maybe concerned about the margin of safety available to them should the realization of current assets be delayed for some reason. But it is doubtful whether the suppliers pay too much attention to margin of safety which is commonly indicated by quick ratio or current ratio. As these two ratios based on net working capital are static ratios they may not useful for predicting bankruptcy.
Working capital liquidity ratios can be used to assess the ability of a business to generate cash from its trading operations, in order to settle its liabilities when they fall due for payment. The ability of a business to have access to cash when required can be defined as liquidity. There are two main sources of liquidity, operating profits that generate cash and access to bank borrowing facilities (such as an overdraft facility).
Working capital ratios can be used to assess the cash flow and liquidity position of a business, by looking at changes in the ratios over time or by making comparisons with other companies in the same industry. Changes in a ratio, or significant differences with similar ratios of other companies, could indicate inadequate liquidity or poor management of working capital.
Khan and Jain (2008) also suggest that although net working capital is not a good measure of liquidity for comparing the performance of different firms, it is quite useful, however for internal control. As Mathur (2002) argues, net working capital is only an accounting concept which doesn't have much of an economic or financial significance.
An enterprise's working capital policy is the combination of two decisions. The first is investment decision, which determines the appropriate level of investment in and mix of current assets for a given level of activity. The second is the financing decision, which determines the methods of financing this investment.
There are three possible working capital policies for financing decisions: conservative, aggressive and moderate as suggested by Khan and Jain (2008).
A conservative policy, for financing working capital, involves the use of short term funding to finance some of the fluctuating current assets. All the permanent assets are funded by long-term finance, also some components of the fluctuating current assets. The least risk is the conservative policy as it results in the lowest expected return. As suggested by Khan and Jain (2008), a company does not use any of its short-term borrowings. As such a firm has sufficient short-term borrowing capacity to cover unexpected financial needs and avoid technical insolvency. Conversely, a conservative working capital policy involves holding large levels of safety inventory. Generally, the expected return is lower under a conservative policy than under an aggressive policy.
An aggressive policy for financing working capital, funds not only all the fluctuating current assets but also some of the permanent part of the current assets, with short term financing. This policy has a greater risk of liquidity problems. But it also offers the possibility of the greatest return since short term debt costs are typically lower than long-term costs. Firms need to hold levels of cash and inventories based on their expected sales. Plus additional safety inventory to cope with uncertainty. The aggressive working capital policy, which involves minimum levels of safety inventory, would minimise costs, but it could lower sales because the firm may not be able to respond rapidly to increases in demand.
A moderate policy falls somewhere between the two extremes in terms of risk and returns. This policy matches long term finance to the permanent parts of current assets & the non- current assets and short term finance to the fluctuating current assets.
A business's working capital cycle is the continual turnover of inventories, receivables and payables that every business has in its trading operations. As defined by Mathur (2002), operating cycle is equal to the inventory period plus the account receivable period. The operating cycle is linked to the working capital cycle, and it provides a source of cash for a business through the profits on sales.
It is important to understand that the working capital cycle of companies can differ significantly between industries, and working capital ratios will therefore also differ. Working capital turnover and liquidity ratios can be used to assess the management of inventories, receivables and payables by comparing a company's ratios with those of other companies in the same industry. Comparing changes in a company's working capital ratios from one year to the next is useful; to identify improvements or deterioration, but comparisons with other companies can provide additional useful information for assessing performance.
A business of any size or in any industry can suffer from working capital problems. However, small businesses, usually when they start up, have the most problems. As sales increases, businesses need to acquire increased amounts of raw materials to produce enough goods to meet the rise in demand. Although the cash realised from credit sales may not be received immediately some expenses, such as, suppliers and employees have to be paid. In such a situation, a business is almost certainly dependent upon bank overdraft and loans. In the long run the problem can be reduced by negotiating improved credit terms with customers and suppliers. Any business should avoid both over-trading and over-capitalisation.
Overtrading or too little working capital occurs mostly when businesses are starting up or experiencing periods of rapid growth. Although sales might grow rapidly, this growth cannot be supported due to inadequate working capital being available.
Over-capitalisation or excess working is almost as bad. If working capital is managed badly, then excessive amounts of finance can be tied up in current assets. This might lead to lower return than what was expected. If an organisations working capital cycle is short, then the cash and profits from credit sales will be realised quite quickly. Hence, if an organisation wants to achieve this working capital must be reviewed frequently and corrective action must be taken where-ever necessary.
A business must ensure that it has adequate working capital to avoid cash flow problems. In the long run, businesses that have insufficient working capital will find it difficult to meet its current obligations and hence be forced to cease trading.
Total working capital might increase or decrease. An increase in capital is caused by any transaction that increases total current assets by more than the increase in total current liabilities or reduces total current assets by less than the reduction in total current liabilities.
An increase in total working capital might therefore be caused by any of the following: an issue of new shares for cash, a new long-term loan or an issue of bonds, the sale of a non-current asset and trading profit. Moving from one stage to the next in the working capital cycle does not affect the total amount of working capital, except to the extent that profit is created when goods or services are sold.
Overtrading occurs when a business carries on a relatively large volume of business with an insufficient amount of working capital. Companies might be at risk of overtrading when they are growing rapidly, and they do not invest more long-term capital to increase the working capital. Instead, they might buy more goods on credit. The increase in inventory is matched by the increase in trade payables, and there is no increase in working capital.
A serious risk with overtrading is that the liquidity position of the business might deteriorate to the point where the business is not able to pay its short-term liabilities when they fall due. According to Fitzgerald (2002), there are five major approaches to tackling an over-trading crisis. First, get the owners to invest more capital (difficult in small businesses as the owner has already invested all the funds possibly could). Second, attract a minority shareholder who will bring in more capital. Third, dispose of surplus assets. Fourth, assess the profitability of each group of working capital. And fifth, by slower down supplier payments, reducing stock holding period and put pressure on customers to pay more quickly.
METHODOLOGY
Kumar (2008) defines Research Methodology as an organized enquiry that is undertaken to establish facts or principles. It is both an original input to the already existing collection of knowledge and a research into a subject or a specific field of knowledge.
According to Saunders et al (2007), this research is based on the principles of positivism. Existing theory will be used to develop the hypothesis. This hypothesis will then be tested which might lead to the further development of theories which might be tested by further research again. The researcher is not affected by the subject of the research.
As can be seen from figure 1.1, The Research Onion, Saunders et al (2007), a research has two different approaches, the deductive approach and the inductive approach. The deductive approach sometimes is called a top-down approach where the conclusion follows rationally from the available facts. This is a more structured approach unlike the Inductive reasoning which permits a more flexible structure as the research progresses. It moves to broader generalizations and theories from more specific observations. Sometimes referred to as the bottom up approach here conclusion is based on available facts and it involves a degree of uncertainty.
As the researcher will be collecting quantitative data, the deductive approach is best suited to her study (the inductive approach uses qualitative data). The researcher has chosen quantitative research method as it generates results in Statistics (Dawson 2002, Saunders et al 2007). Whereas qualitative research attempts to get an in-depth opinion from participants. The Research will be conducted by a case study method as it enables a detailed analysis into the business.
Case studies are;
"A detailed intensive study of a unit, such as a corporation or a corporate division, that attempts to determine what factors led to its success or failure"
(wordnetweb.princeton.edu/perl/webwn)
Morris and Wood (in Saunders et al, 2007) suggest that a case study method is useful if the researcher wants to expand one's understanding of the framework of the research. Various data collection techniques can be used in a case study method. Yin (in Saunders et al, 2007) asserts that there are four different types of case study strategies, single v multiple and holistic v embedded case. As the researcher wishes to examine different departments within GQP for working capital management it'll be an embedded case study as it involves more than one unit of analysis.
The quantitative data that will be collected is the financial statements for GQP over a five year period. It'll be longitudinal which will take place over a period of time rather than cross-sectional which is just a snapshot moment in time. This will assist the researcher to study change and development in GQP. She will be evaluating the working capital cycle and calculating relevant ratios such as:
Working capital (WC) to total assets ratio
Short term debt to total assets
Composition of WC
Liquidity Ratios
Profitability Ratios
F:\Powerpoint\pe_uk\PE083-Saunders\Final_Files\Gif\ch04\C04NF001.gif
Figure 1.1 The research 'onion'
Source: © Mark Saunders, Philip Lewis and Adrian Thornhill 2006
ACCESSIBILITY & ETHICAL ISSUES
When carrying out a research, a number of things have to be considered. For instance, the amount of time to be spent on it, money and other resources available, accessibility of the research subjects and any ethical issues.
Since the main focus of this project is a company located in India, much of the research will be conducted in that country. The owner of GQP will provide some necessary data for this research. As it's a family business, access will be provided to any financial information.
As the researcher has interned in GQP for a year (after graduation in 2005), she is well versed in the company's modus operandi. Data collection and analysis will take at least two months; time also has been allocated to report all the results and findings. Also extra time will be allocated for any unanticipated events.
There are, however, some problems that the data collection entails. Financial statements were prepared in the first three years (of the five that is being examined) manually. GQP converted to a computerised accounting system in 2007 by using TALLY (accounting software used in India). This software will make it easier to calculate working capital ratios for this research from 2007. As accounts were maintained manually prior to 2007 research will be tedious and time consuming.
The researcher has a Bachelors degree in Accountancy and has completed the CIMA (Chartered Institute of Management Accountants) qualification in London. The courses undertaken in investments, finance, risk and business (whilst studying for the CIMA qualification) will help to undertake this research. This project will give a further opportunity to demonstrate the skills and the knowledge acquired in this field. She has always had a strong interest in small companies. The researcher enjoys taking on responsibilities and fulfilling them to the best of her abilities. The researcher has the diligence and perseverance to ensure that this project is completed on time.
Ethical issues are also an important consideration when carrying out a research project. Part of the reason this project avoids any issues of plagiarism is because the firm researched (i.e. GQP) has not been written about before. This research will not be causing any material disadvantage or embarrassment to anyone in the process.
This research has not been copied from any other work. The data collected from Gupta Quick Printers will be kept confidential and it will not be passed onto third parties.
A complete analysis of working capital management of the entire printing industry in Kolkata would have been interesting, but due to time and monetary constraints this will not be possible. Therefore, the conclusions drawn are tentative in nature and firm generalisations should be avoided for the entire printing industry. It is hoped that these limitations do not weaken either the scope of the study or the analysis.
EXPECTATIONS & FINDINGS
This project essentially aims to understand how a small family owned business like GQP is negotiating its working capital management in a booming economy like India. By the end of the project the researcher expects to find a relationship between a booming economy and working capital management of a small printing company. Although this research is based on one small company in India, as all economies don't boom in the same way, this research aims to find out how the Indian economy's growth is affecting the management of working capital in a printing firm.
This project is using a different accounting software from India, TALLY. The researcher's main objective is to improve analytical skills. As she has not done any work at Master's level before, this research presents a new challenge to her. Also academic research has not been conducted on this particular organization before. Therefore, the researcher hopes her findings can contribute something new to the academic body of knowledge.
Working capital management is extremely crucial to any type of organization. WCM is very flexible in nature. This means it can be easily adapted to suit different conditions, such as, changes in economic climate and market conditions, as cited by Mathur (2002). It is for this reason that the researcher wants to study the WCM of a small business that is operating in an emerging market. The objective of her research will be to find out whether the changing market is affecting GQP's WCM in any way.
As Mathur (2002) suggests, WCM not only includes current assets and current liabilities but also a portion of long term or deferred liabilities. To conclude, the progress and prosperity and the financial stability of any organisation largely depends on controlling and managing the different aspects of WC effectively.
In any changing economic environment, manufacturing industries, in order to survive, have to become more competitive. Costs have to be kept in control which can be done by adopting the latest tools and techniques to suit the business requirements. An efficient use of working capital would release the funds that are blocked in current assets. This not only improves the liquidity position of the company but also contributes towards an improved profitability.
The Indian printing industry's growth rate has been more than 12% over the last 15 years and the current annual turnover is in the region of USD 11 billion, (Source: www.drupa.de). As in most areas consumers are getting products at the most competitive prices, the printing industry is no exception. To meet this challenge, the printing industry has to find the solutions and not worry on the decline in prices.
My research findings will focus on what the optimal level of short and long term funds required to finance a company's working capital requirements and how the different aspects of WCM can lead to the success of a small business in the printing industry in India, a country that is experiencing rapid growth at this point in time.
