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RECEIVABLES MANAGEMENT IN A PUBLIC LIMITED COMPANY - A CASE STUDY

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M. KANNADHASAN, MBA, MFT, M.Phil, (Ph.D) Faculty Member Bharathidasan Institute of Management (BIM), Post Box No.12, MHD Complex, BHEL Campus, Trichy 620 014 (Tamil Nadu)

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0431 2520502/796 0431- 2520733 9443349987 Kannadhasan_m@bim.edu

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Electronic copy available at: http://ssrn.com/abstract=1819024

RECEIVABLES MANAGEMENT IN A PUBLIC LIMITED COMPANY - A CASE STUDY

Abstract
No business can be successfully run without adequate amount of working capital which is concerned with two factors namely, current assets to be held and the type of assets and the methods by which these assets are financed. This occupies much of the finance managers time in taking decisions. Investment in current assets represents a very significant portion of the total investment in assets. The finance managers have to be very careful, while making any investment decisions especially short term i.e. working capital. Empirical results show that ineffective management of working capital is one of the important factors causing industrial sickness. There is a direct relationship between a firms growth and its working capital needs. As sales grow, the firm needs to invest more in inventories and debtors. The finance manager should determine levels and composition of current assets, which will help to run the business smoothly. Account receivables are one of the major components of working capital. Receivables are a direct result of credit sales. The sale of goods on credit is an essential part of the modern competitive economic system. The objective of credit sales is to promote sales and thereby achieving more profits. At the same time, credit sales result in blockage of funds in accounts receivable. Moreover, increase in receivables will increase the investments and also increases chances of bad debts. Hence, if the receivables is managed effectively, monitored efficiently, planned properly and reviewed periodically at regular intervals to remove bottle necks if any, the company cannot earn maximum profits and increase its turnover. With this as the primary objective of the study, the study made an effort to assess the receivables management. This study concludes that the efficiency of the receivables management of this company was satisfactory.

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Electronic copy available at: http://ssrn.com/abstract=1819024

INTRODUCTION The major objective of any organisation is to make profits regularly. The objectives can be achieved by making sufficient sales. This is possible only when there is no disruption in the supply of required goods. The required goods may be supplied to the market, only if there is no disruption in the production of these goods by the organization. There will be no disruption in the production of goods only if there is sufficient machinery through permanent capital and if the firm has enough working capital. Thus working capital forms the basis to make an organisation successful by achieving its objectives. Working capital is the life blood and controlling nerve of a firm. No business can be successfully run without adequate amount of working capital. In ordinary parlance working capital is taken to be the fund available for meeting day to day requirements of an organisation. Working capital management is concerned with two factors namely, current assets to be held and the type of assets and the methods by which these assets are financed. This occupies much of the finance managers time in taking decisions. Empirical observations show that the financial managers have to spend much of their time on the daily internal operations, relating to current assets of the firm. As the largest portion of the financial managers valuable time is devoted to working capital problems, it is necessary to manage working capital in the best possible way to get the maximum benefit (Pandey, 2005). Thus, Investment in current assets represents a very significant portion of the total investment in assets. The finance managers have to be very careful, while making any investment decisions especially short term i.e. working capital. Empirical results show that ineffective management of working capital is one of the important factors causing industrial sickness (Yadav, 1986). There is a direct relationship between a firms growth and its working capital needs. As sales grow, the firm needs to invest more in inventories and debtors. The finance manager should determine levels and composition of current assets, namely, Inventory, Receivables, Cash, and Marketable securities, which will help to run the business smoothly. Account receivables are one of the major components of working capital. The receivables are a result of credit sales which helps to increase the profits. At the same time, credit sales result in blockage of funds in accounts receivable and an increased chance of bad debts. In order to minimise the bad debts, it needs careful analysis and proper management. Evaluating the credit worthiness of the customer is one among the key factor in proper credit management. A mismatch can cause significant errors in receivables management. Therefore the finance manager should always be careful and adapt the proper evaluation before extending the credit facility to their customers. Previously, the finance manager assessed the customers character such as, financial position, liquidity position, collateral security offered and general economic conditions in which business operates. Whereas, now a days, trade reference, credit bureaus, bank reference, balance sheet information and direct information by sales men are the major indicators. However, whatever may be method; it may not be proved hundred per cent fault free. In spite of this problem, in the modern world, selling goods on credit is the most prominent force of the todays business. The purposes of adopting this method are achieving growth in sales, increasing profits and meeting competition which many research studies have proved. However, on the other hand, the longer the period of credit, the greater level of debt, and greater the strain on the liquidity of the company. Hence it is necessary to have receivables management in any organization and the need for this study.

RATIONALE FOR THE STUDY As mentioned above, Receivables are a direct result of credit sales. The sale of goods on credit is an essential part of the modern competitive economic system. The objective of credit sales is to promote sales and thereby achieving more profits. At the same time, credit sales result in blockage of funds in accounts receivable. Moreover, increase in receivables will increase the investments and also increases chances of bad debts. Hence, if the receivables is managed effectively, monitored efficiently, planned properly and reviewed periodically at regular intervals to remove bottle necks if any, the company cannot earn maximum profits and increase its turnover. With this as the primary objective of the study, the following further objectives are framed for in-depth analysis. REVIEW OF LITERATURE Many studies have been conducted on the topic of Working capital Management. An empirical research works in this area gave an outstanding view about the exploration of this topic in different dimensions. Raghunatha Reddy & Kameshwari (2004) opines that the working capital was effectively utilized for, generating funds from sales in the sample company. Santanu Ghosh & Maji (2004) assessed the efficiency of working capital management of the Indian Cement companies during 1992-93 to 2001-2002. Instead of using the common method of analyzing different working capital management ratios, three index values representing the average performance of the components of current assets, the degree of utilization of the total current assets in relation to sales and the efficiency in managing the working capital, have been computed for the selected firms over the ten year study period. They concluded that the Indian cement industries did not perform remarkably during the period. Reddy & Patkar (2004) studied the size and its components and liquidity management in factoring companies. Also they attempted to study the correlation between the liquidity and profitability of factoring companies. They concluded that the sundry debtors and amount due to creditors are three major components of current assets and current liabilities respectively in determining the size of the working capital. Prasad (2001) conducted a research study in paper industry. He found that the chief executives properly recognized the role of efficient use of working capital in liquidity and profitability, but in practice they could not achieve it. And also identified that the fifty percent of the executives followed budgetary method in planning working capital and working capital management was efficient due to sub-optimum utilization of working capital. Sarvanan (2001) made a study on working capital management in 10 selected nonbanking financial companies. He concluded that the sample firms had placed more importance upon the liquidity aspect compared to that of the profitability aspect with the help of statistical tools. Dulta (2001) observed that the various components of working capital of HPMC had not been used efficiently and net working capital position has worsened continuously during the period of the study. Debasish Sur et al. (2001) attempted to study the association between the liquidity and profitability of Indian Private Sector enterprises as a case of Alumninium producing industry. He identified that there is a very high degree of positive correlation between liquidity and profitability of selected companies. They also observed that liquidity variables jointly influences of profitability of the selected companies. Hyderabad (1999) found that long-term funds were used for working capital and observed that flexibility and adjustment in the requirement of working capital depends on the availability and cost of working capital. Debasish Sur, (1997) conducted a study about in Working capital management in Colgate (Palmolive) India Ltd. He observed that working capital management is not satisfactory while compared with the conventional standard. This study has identified that the research gap for further research from the above reviews that this study can be viewed in component wise which could be researched in this study.

OBJECTIVES OF THE STUDY Keeping the primary objective as stated above, the following are other objectives of the study. 1. 2. 3. 4. To assess the credit policy of the company. To identify the actual performance in terms of sales and profitability. To examine the major financial parameters connected to receivables management. Suggestions for better receivables management.

HYPOTHESES OF THE STUDY Having identified the objectives of this study, the following hypotheses have been formulated and tested during the period of study: 1.There is no significant difference between the five years average current ratio of this company to the standard 2.Correlation between working capital and sales of this company is not significant 3.Correlation between debtors and sales of this company is not significant RESEARCH METHODOLOGY The study had been done in one of the leading public limited company. To maintain anonymity, the name of the company is not mentioned in the study and it had been mentioned only as the company. This study was based on secondary data, which was obtained from the published sources i.e. Annual report for the period of Five years (1999 to 2003). The collected data has been analysed with the help of ratio analysis, and also through the application of statistical tools such as t test, Correlation, Mean, Standard Deviation, and Simple Percentage analysis. RESULTS AND DISCUSSIONS This part deals with results and discussions for this study. With a view to know the efficiency of the receivables management in a sample company, the evaluation was done with the financial statement for the five years which has been given in this context. Current Ratio: The current ratio is a measure of the firms short-term solvency. Current assets represent those assets which could be converted into cash within a period of one year to take care of current liabilities. A norm of 2:1 ratio represents a healthy trend in the organization. As can be clear from the above table, though the companys current ratio is increasing trend which was lower than the conventional norm. The solvency of the firm was considered satisfactory and it shows that the firm is in a position to meet its current liabilities in time. On an average this companys current ratio is 1.31 and the SD is 0.15. The CR position is tested using the following hypothesis: H0 = there is no significance difference between the 5 years average current ratio to the standard Since the calculated value (1.923) is less than the table value (2.13). Hence, Null hypothesis is accepted at 5 per cent level and hence concluded that the mean current ratio does not differs significantly for the standard.

Table 1: Selected Receivables Management Ratios and its Descriptive Statistics Year 1999 2000 2001 2002 2003 Mean SD CV CR 1.156 1.189 1.396 1.533 1.287 1.312 0.155 11.805 LR 0.940 0.824 0.875 0.992 0.814 0.889 0.076 8.577 WTR 18.26 24.55 13.32 9.16 15.23 16.104 5.760 35.768 CSTS 0.75 0.75 0.80 0.80 0.85 0.79 0.042 5.295 DTR 30.71 20.41 10.92 6.69 6.00 14.945 10.521 70.39 ACP 12 18 33 55 57 35 20.652 59.001 CTR 2.915 2.344 2.607 2.484 2.231 2.516 0.264 10.502 APP 125 155 140 146 163 146 15.55 9.979

Source: 1. Complied from annual Reports of the company concerned. 2. Statistical computations has been done through MS-Excel Spread Sheets Quick Ratio (LR): Quick ratio establishes a relationship between quick, or liquid, assets and current liabilities. An asset is liquid if it can be converted into cash immediately or reasonably soon without a loss of value. Cash is the most liquid asset. Other assets, which are considered to be relatively liquid and included in quick assets, are debtors and bills receivables and marketable securities. A quick ratio of 1:1 is usually considered adequate. In during the study period, this company maintained a satisfactory financial position in this regard. Working Capital Turnover Ratio (WTR): A firm may also like to relate net current assets (or net working capital gap) to sales. It may thus compute net working capital turnover by dividing sales by net working capital. It indicates the efficiency of the company in utilising the working capital in business. High ratio denotes more efficient use of working capital in the business and vice versa. From the table 1 indicates that the ratio varies 9.16 to 24.55 and was fluctuating every year. On an average, this companys working capital turnover ratio was 16.104 which is less than the desired level. The correlation coefficient of working capital and sales of this company was positive (0.714). It implies that as the amount of working capital increases, the amount of sales also increases which was tested with the help of the following hypothesis. H0 = Correlation between working capital and sales of this company is not significant. Since the calculated value (1.78) is less than the critical value (2.132), Null hypothesis is accepted and hence concluded the correlation between the working capital and sales is insignificant. Credit Sales to Total Sales (CSTS): This ratio portrays the impact of credit system followed by the organization in its total sales. It is safe for the organization, if it maintains 50: 50 ratios as for as cash and credit sales are consider. A higher ratio of credit sales is a result of improper credit management. Form the above table shows the ratio between sales to credit sales. It is found that credit sales range from 75 percent to 85 percent. Latest, it was 85 percent which implies that the company increases the credit sales and its affects liquidity.

Debtors Turnover Ratio (DTR): The debtors velocity indicates the number of times the debtors are turned over during a year. Generally, the higher the value of debtors turnover is the more efficient in the management of debtors. Similarly, lower debtors turnover implies less efficient in the management of debtors and less liquid debtors. Here the company, the debtors turnover ratio is decreasing every year, except 2001 and 2002 turnover more than 11 times. But at the latest, it comes to 6. It shows that the company debtors level of turnover is somewhat satisfactory level. The correlation coefficient of debtors and sales was positive and it reveals the amount of sales increases and the amount of debtors also increases. The coefficient of correlation between debtors and sales of this company was 0.95; this was tested through the following hypothesis. H0 = Correlation between debtors and sales of this company is not significant. Since the calculated value (5.51) is greater than the Critical value (2.132); Null hypothesis is rejected and hence concluded that the correlation between debtors and sales is significant. Average Collection Period (ACP): This type of ratio for measuring the liquidity of a firms debtors is the average collection period. This is, in fact, interrelated with, and dependent upon, the receivables turnover ratio. It is calculated dividing the days in a year by the debtors turnover. The table 1 shows that the firm average collection period is increasing trend in every year. It is because of the stiff market competition and also liberalizing the credit standards. On an average, the company is maintaining the credit period was 35 days; the collection effort of this company was satisfactory level and it needs more attention. Creditors Turnover Ratio (CTR): It is a ratio between net credit purchases and the average amount of creditors outstanding during the year. A low turnover ratio reflects liberal credit terms granted by suppliers, while a high ratio shows that accounts are to be settled rapidly. The creditors turnover ratio is an important tool of analysis as a firm can reduce its requirement of current assets by relying on suppliers credit. As it can be observed from the table 1, the ratio is decreasing trend. The highest ratio is 2.915 in 1999 and the lowest ratio is 2.231 in 2003 which implies that creditors tightening the credit standards. Average Payable Period: This shows the strength of the company that is avail maximum credit for its purchases and allows less credit on its sales so as to make margin out of its interest burden and cash out flow. The average payable period of this company varies from 125 days to 163 days. Generally, the companys payable period should be greater than the average collection period which will be appreciable. The company payable management was good. In addition to mean and SD, an effort has also been made to measure the consistency among all eight parameters of receivables management more precisely by applying the coefficient of variation (CV). The variable for which the CV is greater that indicates the variables is to be more fluctuating or conversely less consistent, less stable or less uniform. On the other hand, the variable for which the CV is less that indicates the variables is to be is regarded as less fluctuating, more consistent, more stable or more homogenous. Table 1 reveals that out of the eight different parameters of receivables management of the sample company, the CSTS is most consistent and stable followed by LR, CTR, APP, CR, WTR, ACP and DTR respectively. Amongst the eight variables, DTR and ACP are the highest variable and inconsistent.

DISTRIBUTION OF WORKING CAPITAL An elements wise analysis of working capital enables one to examine in which elements the working capital funds are locked up and to find out the factors responsible for the significant changes in working capital of different years. The distribution of working capital among the elements and its average calculated in percentages for the study period has been presented in the table 2. Out of the four elements of the working capital, the elements of working capital namely, inventory and debtors contributed almost equally i.e. 31.75 percent 31.07 per cent respectively, towards gross working capital whereas the last one i.e. cash & bank contributed the lowest i.e. 12.28 per cent towards gross working capital.

Computation of working capital with respective to percentage

Year 1999 2000 2001 2002 2003 Mean Inventories / Working capital 18.66841 30.75632 37.31506 35.25719 36.7575 31.7509 Debtors / Working capital 4.950404 21.6854 36.87615 45.53621 46.07504 31.02464 Cash & Bank Balance/ Working capital 49.07153 12.80247 12.41562 5.820076 6.277647 17.27747 Loans & Advances/ Working capital 27.309657 34.75580146 13.39317247 13.3865254 10.88981092 19.94699345

FINDINGS & SUGGESTIONS OF THE STUDY Here the financial position concept means only the short-term position of finance. The company has a satisfactory financial position; Short-term financial position indicates the ability of the company to pay off the current liability within a short-span of time. This company maintained satisfactory level of current position and more than the optimum level throughout the five years. Liquidity position is satisfactory and the current assets and liabilities have positive correlation. The current ratio position of the company is tested and concluded that the mean current ratio does not differ significantly from the standard. On an average, this companys working capital turnover ratio was 16.104 which is less than the desired level. The correlation coefficient of working capital and sales of this company was positive (0.714) which was tested and concluded the correlation between the working capital and sales is not significant. This company increases the credit sales every year. The company debtors level of turnover is somewhat satisfactory. The correlation coefficient of debtors and sales was positive, tested through the hypothesis and concluded that the correlation between debtors and sales is significant. On an average, the company was maintaining the credit period of 35 days; the collection effort of this company was satisfactory.

 The companys payable period should be greater than the average collection period which will be appreciable. The company payable management was good and the company sales performance is not desired level. It is because of cutthroat competition, poor collection policy and other external factors. As this business firm is a profit seeking one, it has to utilise all of its resources to achieve this goal. This company is trying to enhance the value of its own and thereby that of its shareholders. While searching for Profitability, the liquidity and solvency position are crucial elements to be watched carefully. On the basis of the analysis and observation, an attempt is made to offer some suggestions as below. The average collection period should be maintained the same level because the debtors collection period is found to be satisfactory. At the same time, this company payable period is found to be very high, this will affect the liquidity position positively and it may be call for low fewer investments in receivables will arrives. So the company should maintain a proportional changes in collection policies in order strengthen the collection department. There was decrease in trend in the net profit it is because of investment in all receivables increased substantially. So the company should increase the sales level in order to achieve the impressive profit. CONCLUSION It could be inferred from the above analysis that, the efficiency of the receivables management of this company was satisfactory. The competition is a major challenge that every finance manager encounters during their working capital decision making process for optimum utilisation of scarce resources. To examine the effects of receivables management, it is important to note the difference between liberalised credit period and the profitability. It is the change in the investments in receivables level and costs involved in that creates crucial difference between these two. Therefore, the finance manager should take into cognizance the effect of credit policy to manage effectively, monitor efficiently, plan properly and review periodically to remove bottle necks to reap maximum profits and increase its turnover.

REFERENCES 1. Debasish Sur (1997), Working capital management in Colgate Palmolive (India) Ltd. A case study, The Management Accountant, Vol.32. 11. pp 828-833. 2. Debasish Sur, Joydeep Biswas and Prasenjit Ganguly (2001), Liquidity management in Indian Private Sector Enterprises: a case study of Indian Aluminum Producing Industry, Indian Journal of Accounting, Vol. XXXII, June. 3. Dr.D.Raghunatha Reddy & P. Kameshwari (2004), Working capital Management practices in Pharma industry, The Management Accountant, Vol. 39, No. 8, pp 638-644. 4. Dr.Santanu Kr.Ghosh & Santi Gopal maji (2004), Working Capital Management efficiency: A study on the Indian cement industry, The Management Accountant, Vol. 39, No. 5, pp 363-372. 5. Dulta. J (2001), Working capital management of Horticulture Industry in H.P A case study of HPMC Finance India, Vol.XV, No, 2, June, pp 644-657. 6. Hyderabad. R.L (1999) Management of liquidity and profitability, Deep and Desh Publications Pvt. Ltd. 7. Khan M.Y.& Jain P.K (1996), Financial Management, 1st edition, Sultan Chand & Educational publication, New Delhi,pp.367-368 8. Khan M.Y.& Jain P.K.(1998), Financial Management, 3rd edition Tata McGraw-Hill publishing Co. Ltd, new Delhi, pp.230-235 9. Pandey I.M.(1992), Financial Management, 7th revised edition , Vikas publishing house pvt.Ltd.,pp.920-925 10. Pandey. I.M.,(2005) Financial Management, 9th Edition, Vikas Publishing House Pvt.Ltd, P586. 11. Prasad .R (2001), Working capital management in paper industry, Finance India, Vol.XV, No.1, March, pp185 -188. 12. Prasana Chandra (1996), Financial Management, 4th edition ,Tata McGraw-Hill publishing Co. Ltd, new Delhi, ,pp368-371 13. Reddy Y.V & S.B. Patkar (2004),Working capital and liquidity management in factoring: A comparative study on SBI and Canbank factors, The Management Accountant, Vol. 39, No. 5, pp 373-378. 14. Sarvanan P (2001), A study on working capital management in Non-Banking Finance Companies, Finance India, Vol. XV, No.3, September, pp 987-994. 15. Yadav R.A (1986), Working capital Management a parametric Approach The Chartered Accountant, May, P 952.

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