Perspective Suvojoy Sengupta

Piyush Doshi

The Smart Route

Out of the Cash Crunch
Managing Working
Capital for Competitive
Advantage in India
Contact Information

Mumbai
Suvojoy Sengupta
Partner
+91-22-2287-2001
suvojoy.sengupta@booz.com

Piyush Doshi
Principal
+91-98101-73341
piyush.doshi@booz.com

Booz & Company

EXECUTIVE As the mood in corporate India grows more somber by the
day, leaders’ attention has turned from determining how to
SUMMARY
deploy surplus cash to finding enough cash to keep the busi-
ness going. Booz & Company recently studied the balance
sheets of about 80 leading companies in India in a number of
industries, including cement, chemicals, consumer products,
engineering, and metals sectors. The results were striking:
Companies became complacent about managing working
capital during the boom period of 2005-08 and are now sitting
on a major problem (or opportunity) in the form of cash tied
up in inventory and receivables. The gap between the best and
worst performers in each industry suggests that this is a good
time for some companies to get their finances in order so they
can deal with the downturn and prepare for the upturn.

We have spoken recently to many companies about their priori-

ties for the coming months. The good news is that the focus is
where it needs to be, frequently with adequate senior sponsor-
ship. Managing for cash is increasingly the topmost priority for
most companies, and many have formed task forces to specifi-
cally go after a targeted reduction in cost as well as working
capital. The bad news is that many companies are cutting their
working capital with a ruthless top-down approach that applies
cuts indiscriminately. This can be effective in the short term, but
in the long term it could do more harm than good. Based on
our experience of working with leading companies around the
world, we have distilled the best practices for each dimension of
working capital management—managing inventory, receivables,
and payables—that can separate the winners from the losers.

Booz & Company 1

THE The period of 2005-08 was one of
exceptional growth in India. The
WORKING economy grew at more than 8 percent
CAPITAL per year for the first time in the coun-
try’s history, and the value of the stock
HANGOVER market almost tripled. Companies
focused on maximizing output and
sales, as capital was abundant, and the
management of costs and cash took a
backseat for some time. As the party
ended in late 2008, the hangover from
excesses of the recent years started to
hurt. The data from our study of the
working capital situation of 80 lead-
ing Indian companies speaks for itself.
• At the end of fiscal year 2008,
the 80 companies we studied had
approximately Rs 330,000 Crore
blocked in inventory and receiv-
ables and about Rs 150,000 Cr
in net working capital. To put the
numbers in perspective, the total
profit of these companies for FY08
was about Rs 130,000 Cr. Clearly,
managing cash smartly is one of the
most significant ways to navigate
through this downturn, character-
ized by an acute liquidity crunch.
• In recent years, companies’ work-
ing capital has grown significantly
faster than their sales. The inventory
and receivables of the 80 companies
we surveyed increased by about 30
percent per year beginning in 2005,
while sales increased by only about
21 percent. Some of the increase
in working capital was justified by
increasing complexity in the business,
but a lot of it was a result of compa-
nies taking their eyes off cash while
chasing top-line growth. We sum-
marize industry-by-industry data on
growth in working capital position
compared with sales (see Exhibit 1).

Exhibit 1
Annual Growth in Working Capital vs. Sales, 2005–08

53%
51%
Growth in Sales
Growth in Working Capital

42%
39%

35%

29% 30%
27%

21% 21%
20% 19% 19% 20%
17% 16%
15%
13%

Auto Capital Goods & Cement Chemicals Consumer Energy & Utilities Power Steel Total
Construction Products

Source: Booz & Company

2 Booz & Company

• While the overall increase in work-
ing capital was substantial, a more
detailed analysis indicates signifi-
cant differences among companies.
Laggards’ net working capital in
days is three to eight times that of
the leaders in the same industries
(see Exhibit 2). The difference
in performance is too great to be
explained by structural differences in
the nature of the business. Based on
a simple calculation, if the compa-
nies in the bottom half managed to
bring their working capital to the
industry average, they could release
about Rs 75,000 Cr in cash.
Exhibit 2
Working Capital Days: Best vs. Worst Performers
205
117
77
37
-10
-20
Auto Cement Chemicals
Source: Booz & Company
Booz & Company
As it becomes clear that this
downturn will be long and painful,
most companies have rightly turned
their attention to a more stringent
management of cash. However,
reducing working capital smartly
is a challenge, as indiscriminate,
top-down reductions can do more
harm than good in an already
challenging environment. Our work
with companies over the years in
helping them reduce working capital
has revealed some common pitfalls in
managing each of the three elements
of working capital: inventory,
receivables, and payables.
Best Performer
Worst Performer
152
126
47
28
-3
20 -22
-52
Consumer Energy Power Steel
Products
3
MANAGING One of the biggest mistakes in
managing inventory is to treat it as
INVENTORY a homogenous entity. The optimum
SMARTLY amount of inventory that a business
must hold depends on a number of
variables, particularly economic batch
quantity, supply lead times, desired
service level, predictability of demand,
and predictability of supply. The
desired service level, in turn, should
be a consequence of product margin
as well as competitive benchmarking.
Therefore, the ideal level of inventory
is different for each SKU, and getting
it right is difficult. Typically, when we
take a snapshot of a business, only 30
to 40 percent of SKUs are found to be
at the level justified by the nature of
the business. In one example from an
industrial products company, fewer

Some companies have let

sophisticated supply chain tools
lull them into complacence
about their inventory management.

4 Booz & Company

than one-third of the company’s SKUs Several companies have been lulled
were at the optimal inventory level into complacence about granular
(see Exhibit 3). management of inventory following
implementation of sophisticated
Many businesses make the mistake supply chain tools. The best ones
of setting a high level (e.g., 30 days) realize that a tool cannot make
for their target inventory and are management decisions (e.g., on
satisfied if this level is not exceeded. the right service level), which is
However, a company can be achieving the critical starting point for smart
the target perfectly at an aggregate management of inventory.
level but still be suffering from serious
shortage situations as well as dead
inventory overhangs.

Exhibit 3
Inventory Distribution for an Industrial Products Company

60%
Deficit Surplus Country 1
Country 2
Country 3
49%
50%
45%

41%
40%
Percentage of items

32%
29% 29%
30%

20%

14%
12%

10% 9% 9%
8% 8%
6%
5%
3%

0%
Stock-Outs Potential Within Range Excess Dead Stock
Stock-Outs (1-5 weeks) Inventory (No demand)
(<1 week) (>5 weeks)

Source: Booz & Company

Booz & Company 5

 MANAGING The fundamental challenge in manag-
ing receivables smartly is in some
RECEIVABLES ways similar to that of managing
SMARTLY inventory. Once again, a macro view
of receivables can be rather mis-
leading, as detailed analysis of data
often reveals significant outliers and
persistent late payers. The distor-
tions creep in over a period of time as
salespeople, when pushed, often find
changes to payment terms a conve-
nient way of closing the deal. The
real impact of distortions in payment
terms and impact of late payments

Detailed analysis of receivables

data often reveals significant
outliers and persistent late payers.

6 Booz & Company

 can be understood by mapping total of an industrial products company
customer profitability, including costs proved unprofitable after specific
of logistics and payment terms. In one working capital charges were taken
example, almost half of the customers into account (see Exhibit 4).

Exhibit 4
Contribution by Customer

1000

800 Before WC charge

After WC charge

600
Contribution ($/unit)

400

200
Direct Overheads
($70/unit)

0
1 51 101 151 201 251 301 351

Customer

-200

-400

Source: Booz & Company

Booz & Company 7

MANAGING Stretching the payables is universally
treated as the easiest route to manag-
PAYABLES ing net working capital. It is par-
SMARTLY ticularly easy with suppliers that are
small and depend on the company for
a substantial portion of their business.
Ironically, this is also the most inef-
ficient place to find working capital,
even if it makes the balance sheet
look pretty. The smallest suppliers are
likely to have the least access to and
therefore the highest cost of funds.
A large company may be able to
procure funds at a significantly lower
cost than a small and weak supplier
Smart techniques for managing
payables focus on large, powerful
suppliers and avoid false efficiencies.
8 Booz & Company
and more than make up for this cost
through better price discounts. There
are rarely any free lunches, and this
is a classic example of a strategy that
might look free in the short term but
will cost a lot in the long run.
Smarter techniques for managing
payables center on focusing on large,
powerful suppliers and avoiding false
efficiencies. These may include batch
processing of payment, which some-
times results in a number of suppliers
getting paid far in advance of their
due dates.
GOING In summary, companies have a
great opportunity to use the current
FORWARD downturn to get their balance sheets
in order, particularly around working
capital. However, they must avoid a
slash-and-burn approach that could
end up doing more harm than good
in the long term. The smart way to
address working capital issues is a
customized approach by products
and customers with judicious use of
historical data. The choice one way or
another could be a critical differentia-
tor between winners and losers on the
other side of the downturn.

Booz & Company 9

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