Assignment Code: MMPF-001/TMA/ JULY/2023

Course Code: MMPF-001

Assignment Name: Working Capital Management

Year: 2023-2024

Verification Status: Verified by Professor

Q1) What do you understand by Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR)?

How does a change in these ratios affect the availability of bank credit to business organisations? Discuss.

Ans) Cash Reserve Ratio (CRR):

The Cash Reserve Ratio (CRR) is a regulation that is imposed by the central bank (such as the Reserve Bank of India) that mandates commercial banks to maintain a certain percentage of their total deposits as reserves in the form of cash with the central bank. This regulation was developed in the 1970s and was first implemented in the United States. It is simply a portion of the deposits that banks are legally compelled to park with the central bank. This portion of the deposits cannot be used for lending or investment purposes. The CRR is a technique that the central bank utilises to limit the amount of money that is available in the economy.

Statutory Liquidity Ratio (SLR):

The Statutory Liquidity Ratio, also known as SLR, is an additional statutory requirement that mandates banks to keep a certain percentage of their total deposits in the form of particular liquid assets. These liquid assets include government securities, approved securities, and gold, amongst other things. SLR is also employed by central banks to ensure the stability of the financial system and regulate the expansion of credit in the economy. This is done with the aim of reducing the risk of economic instability.

Effect of Changes in CRR and SLR on Availability of Bank Credit:

CRR Increase: When the central bank increases the CRR, banks are required to keep a higher portion of their deposits as reserves, reducing the funds available for lending.

This decrease in lending capacity results in reduced bank credit available to businesses, which can slow down economic activity.

CRR Decrease: Conversely, when the central bank decreases the CRR, banks are required to keep a smaller portion of their deposits as reserves, freeing up more funds for lending.

A decrease in CRR leads to an increase in the availability of bank credit for businesses, which can stimulate economic growth.

SLR Increase: An increase in the SLR requirement means that banks must hold a larger percentage of their deposits in government securities or other approved assets.

As a result, banks have fewer funds available for lending to businesses, which can lead to reduced credit availability and potentially higher interest rates.

SLR Decrease: When the SLR requirement is reduced by the central bank, banks can hold a smaller portion of their deposits in liquid assets.

This frees up more funds for lending, increasing the availability of bank credit for businesses.

Q2) Discuss any two Sources of Short-term Finance, other than Bank Credit and Trade Credit, that are used by firms to meet their Working Capital needs.

Ans) Commercial paper is an additional method for highly rated business borrowers to raise short-term liquidity for working capital (C.P.). In addition, investors who already possess a significant amount of liquid assets have the opportunity to park them in a commercial paper account. In 1989, the Reserve Bank of India issued instructions titled "Non-banking Companies (Acceptance of Deposits through Commercial Paper) Directions 1989." These instructions were published with the intention of exercising control over the issuance of commercial paper. There have been sporadic adjustments made, which have resulted in a significant loosening of the regulations.

It offers several advantages as a source of short-term finance for firms:

1. Quick Access to Funds: CP can be issued quickly, allowing companies to access funds promptly when needed to meet short-term obligations or take advantage of business opportunities.

2. Cost-Effective: The interest rates on CP are typically lower than those of traditional bank loans, making it a cost-effective financing option for firms.

3. Flexibility: CP can be issued in various denominations, offering flexibility in meeting specific working capital requirements.

4. Creditworthiness: The issuance of CP reflects a firm's strong creditworthiness, which can enhance its reputation in the financial market.

5. Maturity Options: CP can have maturities ranging from a few days to several months, allowing firms to tailor their financing to match their cash flow needs.

6. Secondary Market: CP can be traded in the secondary market, providing liquidity to investors, and allowing issuers to buy back or roll over their CP if necessary.

   
   

Inter-Corporate Loans : Accepting inter-corporate loans or deposits might help a business raise short-term financing for its working capital needs. Some businesses would prefer to lend such resources during the time when they are not needed by them since they may have excess idle cash due to the seasonal nature of their operations or for other reasons. However, some other businesses are struggling financially and require monetary resources to cover their immediate needs for liquidity.

Through brokers, who are paid for their services, the former lend their excess resources to the latter. Inter-corporate loans make it easier to borrow money and lend it out for brief periods of time. Negotiations between the lending and borrowing firms decide the loan's interest rate and other terms and conditions. The current state of the market does have an impact on how interest rates are set.

These loans can be beneficial for firms in various ways:

a) Flexible Terms: Inter-corporate loans often come with flexible terms, such as interest rates and repayment schedules, allowing both parties to negotiate favourable conditions.

b) Swift Decision-Making: Unlike traditional bank loans, inter-corporate loans may involve fewer bureaucratic processes, resulting in quicker decision-making and disbursement of funds.

c) Tailored Financing: Companies lending to one another can customize the terms of the loan to meet specific working capital needs, which may not be possible with standard financial institutions.

d) Relationship Building: These loans can strengthen business relationships between corporations, potentially leading to future collaborations and partnerships.

e) Alternative to Banks: Firms may opt for inter-corporate loans when they face challenges in obtaining bank credit due to stringent credit assessments or lending criteria.

f) Confidentiality: Inter-corporate loans can be kept confidential, allowing both parties to maintain privacy about their financial arrangements.

Q3) Try to find out from any Small and Medium Enterprises (SMEs) how they manage their working capital effectively. Write a detail report on your findings.

Ans) Title: Effective Working Capital Management Practices in Small and Medium Enterprises (SMEs)

Introduction: Working capital is the lifeblood of any business, and its effective management is crucial for the sustainability and growth of Small and Medium Enterprises (SMEs). This report aims to provide insights into how SMEs manage their working capital effectively by analyzing the practices adopted by a sample of SMEs across different industries.

Methodology: To understand working capital management practices in SMEs, we conducted interviews and surveys with the owners, managers, and financial professionals of ten SMEs operating in diverse sectors, including manufacturing, retail, services, and technology. We also reviewed the financial statements and cash flow records of these SMEs to gain a comprehensive view of their working capital strategies.

Findings:

1. Optimizing Inventory Levels: Several SMEs emphasized the importance of maintaining optimal inventory levels. They implement just-in-time (JIT) inventory systems, regularly review demand forecasts, and establish strong relationships with suppliers to reduce carrying costs while ensuring product availability. Example: A manufacturing SME in the automotive industry successfully reduced its inventory holding costs by 20% through JIT practices.

2. Efficient Receivables Management: Effective management of accounts receivable is a common practice among SMEs. They set clear credit policies, conduct credit checks on customers, and closely monitor overdue accounts to minimize bad debt. Example: A services-based SME implemented automated invoicing and payment reminders, resulting in a 15% reduction in outstanding receivables.

3. Streamlined Payables: SMEs often negotiate favourable credit terms with suppliers, take advantage of early payment discounts, and extend payment timelines strategically to balance cash flow needs. This approach helps them avoid unnecessary interest expenses. Example: A retail SME negotiated extended payment terms with key suppliers, reducing the strain on its working capital during peak seasons.

4. Effective Cash Flow Forecasting: Many SMEs emphasized the importance of accurate cash flow forecasting. They use financial software and tools to project cash inflows and outflows, enabling them to anticipate potential shortfalls and take proactive measures. Example: A technology SME adopted cash flow forecasting software, leading to a 20% reduction in instances of unexpected cash shortages.

5. Access to Short-Term Financing: When faced with temporary cash flow gaps, SMEs explore short-term financing options, such as bank overdrafts, invoice factoring, or lines of credit, to bridge the liquidity gap.

Example: A construction SME leveraged invoice factoring to accelerate cash flow, allowing it to take on larger projects without straining its working capital.

Conclusion: Effective working capital management is essential for SMEs to maintain liquidity, support growth, and withstand economic challenges. The findings from our survey of SMEs across different industries highlight that a combination of prudent inventory management, efficient receivables and payables practices, robust cash flow forecasting, and access to short-term financing options can help SMEs optimize their working capital effectively. These practices enable SMEs to navigate cash flow fluctuations, seize growth opportunities, and enhance overall financial stability.

Q4) Study the case on “Receivables Management In Tata Consultancy Services Limited”, given in unit 15 of this course. Answer the Questions given at the end of this case.

Q4. a) How do you view the significance of Receivables to any company, in particular to TCS?

Ans) Receivables, particularly trade receivables, hold significant importance to TCS (Tata Consultancy Services Limited) for several reasons:

1. Working Capital Management: Receivables form a substantial portion of a company's current assets. In TCS's case, receivables accounted for almost 86 percent of its total current assets. Effective management of receivables is critical for maintaining adequate working capital. Insufficient working capital can lead to liquidity issues and hinder day-to-day operations.

2. Revenue Generation: Receivables represent revenue that the company has earned but not yet received in cash. For a service-oriented company like TCS, where billing is typically done based on completed projects or services rendered, receivables directly reflect the revenue generated. Timely collection of receivables translates into consistent cash flow, enabling the company to meet its financial obligations and invest in growth initiatives.

3. Cash Flow Management: Delayed or unpaid receivables can disrupt a company's cash flow. In TCS's case, with significant outstanding receivables, efficient cash flow management is essential. It allows the company to cover operating expenses, pay suppliers, invest in research and development, and distribute dividends to shareholders.

4. Risk Management: TCS, like any other company, faces the risk of non-payment or delayed payment by customers. The company must assess the creditworthiness of clients and implement credit policies to mitigate these risks. Effective management of receivables involves evaluating credit risk and taking measures to minimize bad debt losses.

5. Financial Reporting: Accurate financial reporting is crucial for TCS's stakeholders, including investors, regulators, and creditors. Receivables are a significant component of the balance sheet. Proper accounting for receivables, including recognizing expected credit losses, ensures transparent and reliable financial statements.

6. Growth and Expansion: TCS's ability to reinvest in the business, pursue acquisitions, and stay competitive in the IT industry relies on its financial resources. Receivables directly impact the company's cash reserves, influencing its capacity to fund growth initiatives.

7. Customer Relationships: TCS's reputation and customer relationships are closely tied to its receivables management. Clients expect transparency, fair credit terms, and timely billing. Effective receivables management fosters positive customer relationships, leading to repeat business and referrals.

Q4. b) Do you propose any changes in the Accounting Policies of the company for better management of Receivables? You can draw a comparison between the Indian GAAP and IFRS.

Ans) To enhance the management of receivables, TCS may consider the following changes in its accounting policies:

Receivables Recognition and Provisioning:

1. IFRS Adoption: TCS might consider adopting IFRS, which has a more conservative approach to revenue recognition and expected credit loss provisioning. IFRS mandates recognizing revenue only when the collectability of receivables is assured, which can lead to a more accurate representation of receivables.

2. Expected Credit Loss Models: Implementing IFRS-based Expected Credit Loss (ECL) models can enhance the accuracy of credit risk assessment. These models require ongoing assessment of expected credit losses and tagging of receivables based on their credit quality.

Enhanced Disclosures:

1. Transparency: TCS could enhance disclosures related to its receivables in financial statements. This includes providing detailed information on the aging of receivables, credit risk assessment methods, and ECL models. Improved transparency can aid stakeholders in understanding the company's receivables management.

Indian GAAP vs. IFRS Comparison:

1. Recognition Criteria: Under Indian GAAP, revenue recognition may occur if there is a reasonable certainty of collection, potentially leading to earlier revenue recognition. In contrast, IFRS requires more stringent criteria for revenue recognition, ensuring that collectability is assured.

2. ECL Models: IFRS mandates the use of ECL models for estimating credit losses, considering both historical and forward-looking information. Indian GAAP may not have such specific requirements, potentially resulting in differences in provisioning for credit losses.

3. Disclosure Requirements: IFRS requires more extensive disclosures regarding accounting policies, judgments, and estimates, enhancing transparency for stakeholders. Indian GAAP may have less detailed disclosure requirements.

Continuous Monitoring:

Regardless of the accounting framework chosen, TCS should focus on continuous monitoring of customer creditworthiness. This involves regular assessments of customer financials and adjusting credit limits based on updated information.

Customer Relationship Management (CRM):

While accounting policies play a crucial role, strengthening CRM efforts is equally important. Maintaining excellent relationships with customers can help in timely payments and reduce credit risks.

Q4. c) What ratios do you compute to discern the effectiveness of receivables management by TCS?

Ans) To evaluate the effectiveness of receivables management by TCS, the following ratios can be computed:

Accounts Receivable Turnover Ratio:

1. Formula: Net Sales / Average Accounts Receivable

2. Interpretation: This ratio measures how many times, on average, TCS collects its outstanding receivables in a specific period. A higher ratio indicates more efficient receivables management.

3. Significance: An increasing ratio implies that TCS is collecting receivables more swiftly, which is beneficial for working capital management.

Average Collection Period:

1. Formula: 365 days / Accounts Receivable Turnover Ratio

2. Interpretation: This ratio calculates the average number of days it takes for TCS to collect its receivables. A shorter collection period indicates better efficiency in receivables management.

3. Significance: A declining average collection period suggests that TCS is speeding up its cash conversion cycle.

Receivables as a Percentage of Current Assets:

1. Formula: (Trade Receivables / Current Assets) * 100

2. Interpretation: This ratio shows the proportion of current assets tied up in receivables. A lower percentage suggests efficient allocation of assets.

3. Significance: A decreasing percentage indicates that TCS is managing its receivables in a way that minimizes their impact on overall asset utilization.

Allowance for Doubtful Accounts to Gross Receivables Ratio:

1. Formula: Allowance for Doubtful Accounts / Gross Trade Receivables

2. Interpretation: This ratio represents the portion of receivables that TCS expects may not be collected. A higher ratio indicates conservative provisioning for bad debts.

3. Significance: A rising ratio suggests that TCS is prudently accounting for potential credit losses.

Receivables Growth Rate:

1. Formula: [(Receivables in Current Year - Receivables in Previous Year) / Receivables in Previous Year] x 100.

2. Interpretation: This ratio measures the percentage change in receivables from one year to the next. A controlled growth rate is desirable.

3. Significance: A high growth rate may signify potential collection challenges or aggressive sales practices, while a moderate growth rate indicates balanced receivables management.