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Importance of Managing Working Capital and Its Impact on the Profitability of Automobile Industry of India

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Abstract

Working Capital (wc) is the flow of ready funds necessary for the working of a concern. It comprises funds invested in Current Assets , which in the ordinary course of business can be turned into cash within a short period without undergoing diminishing in value and without disruption of the organization. Current Liabilities are those which are intended to be paid in the ordinary course of business within a short time.This paper highlights the importance of managing working capital requirements to ensure an improvement in firm’s market value and profitability and this aspect must form part of the company’s strategic and operational thinking in order to operate effectively and efficiently.. Main purpose of the study is to identify the impact of working capital management on profitability of selected listed manufacturing companies .Correlation and regression analysis were performed. Results reveals that cash conversion cycle (CCC) and return on assets (ROA) are negatively correlated the value of -0.127 which is highly significant at 1 percent level of significance, which means that as the cash conversion cycle increases ROA decreases. The study results advocated that the financial planning of selected firms is influenced by WCM. By validating the findings with previous researchers, this endeavor will contribute to the literature. It will be beneficial to the academic, social and practical department. The study findings endowed with deeper insights into WCM practices and present recommendations that in turn bring improvements in the Financial planning of the targeted firms.

KEYWORDS – Cash conversion cycle,working capital,financial planning,correlation and regression analysis

1. Introduction

Working capital is the difference between the current assets and current liabilities. Current assets consist of all those assets that transformed to the form of cash within a year and all those investment that may be easily altered into cash without any hassle when needed. Working capital management is “The management of the short-term investment and financing of a company”. Working capital management plays an important and vital role in the firm growth and profitability and it affect the success and failure of a firm because of its influence on firm’s growth and profitability

A key factor in the working capital management is the cash conversion cycle (Deloof, 2003). Cash conversion cycle is defined as the time lag between the purchasing of raw materials or rendering of services and the collection of cash from the sale of goods or services rendered. The longer the lag, the greater the investment in working capital, and thus the financing needs of the firm will be greater. Interest expense will be also higher, which leads to higher default risk and lower profitability

The ultimate objective of any firm is to maximize the profit, but, preserving liquidity of the firm is also an important objective. The problem is that increasing profits at the cost of liquidity can invite serious problems to the firm. Therefore, there must be a tradeoff between these two objectives of the firms. Firms may have an optimal level of working capital that maximizes their value

A financial manager takes decisions regarding the current assets and current liabilities this is called working capital management. While making decisions he must consider the fact that a certain level of current assets is necessary to meet the short term liabilities and liquidity. On the other hand Current assets also play a role to freeze the capital of a company. As a result of which profitability is affected. Profitability or rate of return on investment is suffered by the decision of management about working capital. Profitability can also termed as the rate of return for particular investment. Imbalance of current assets and liabilities can negatively affect the rate of return. This is the basic purpose of managing working capital so that to control the current financial resources of a firm in such a way that a balance is created between profitability of the firm and risk of insolvency.

So, the objective of this study is to find out “Does efficient working capital management have any impact on the profitability of AUTO MOBILE INDUSTRY OF INDIA.

2. Indian automobile industry.

The Indian auto industry became the 4th largest in the world with sales increasing 9.5 per cent year-on-year to 4.02 million units (excluding two wheelers) in 2017. It was the 7th largest manufacturer of commercial vehicles in 2017.

The Two Wheelers segment dominates the market in terms of volume owing to a growing middle class and a young population. Moreover, the growing interest of the companies in exploring the rural markets further aided the growth of the sector.

India is also a prominent auto exporter and has strong export growth expectations for the near future. Automobile exports grew 20.78 per cent during April-November 2018. It is expected to grow at a CAGR of 3.05 per cent during 2016-2026. In addition, several initiatives by the Government of India and the major automobile players in the Indian market are expected to make India a leader in the two-wheeler and four wheeler market in the world by 2020.

Here are some leading two wheeler companies of India who are gaining more business for their products:

1. Hero MotoCorp

It is the largest and most popular two wheeler manufacturing company in the world. According to studies, rural population of the nation has always prefered Splendor when looking to buy a two wheeler. It is still the popular choice for many because of the company’s consistency in delivering quality products and sturdy construction. The company made headlines with their most innovative fuel-efficient vehicle, Splendor iSmart, which promises to deliver a mileage of 102 km per litre. This year, the sales percentage of Splendor and Splendor iSmart have increased by 10% making them the leader of the board. All though Hero Glamour sales have declined by 35%, other models like Passion, HF Deluxe, CBZ, Karizma, and Achiever have managed to do good business. Initially, the company was known as Hero Honda Motors Ltd, but the partnership between Honda Motors of Japan and Hero Cycles of India ended in the year 2010 and the companies have been competitors ever since.

2. Honda Motorcycle & Scooter India

Everyone who opts to buy a moped range, instantly thinks of Honda Activa which has been in the lead since early 2000s. It has dominated the scooter segment ever since and no other model has come close to Activa’s popularity. This model alone has a domestic monthly sales of over 2.15 lakh units. Honda is the second largest two wheeler manufacturer in the country. The company in the late 1980s had dominated the market with the manufacturing of the evergreen Kinetic Honda. This was in with Kinetic Engineering Limited and it was on every other street in the city. HMSI (Honda Motorcycle & Scooter India)ended its partnership with Honda MotoCorp in 2010 and ever since then the company has been responsible for its own manufacturing of vehicles. Some of their other models are Unicorn, Shine, CBR 150R, Dream Yuga, Aviator, etc.

3. Bajaj Automobiles

Bajaj Chetak is perhaps the oldest and favorite model of our parents and why not, seeing dads drop off their kids on Chetak is one of the fondest childhood memories we have. It was also considered to be the coolest model of that time and we all know the legendary bike even today. Bajaj is one of the oldest automobile company in the country which is successful and still popular among the youth crowd pleaser even today. The company has reinvented itself constantly since 1930s (the year of establishment), one can still see the quality and commitment to customer service being the same over the years. Bajaj came back into the market with its winner Pulsar variants which was the ‘it’ 2 wheeler among the youth. Its stylish and sleek looks swept everybody off their feet and it’s still the third popular choice for bike in the country. Vespa 150 is one of the top 3 best-selling scooters in the country. Most of the vehicles from Bajaj Automobiles is in the top of the board. Their other bikes include Avenger, Platina, Discover, CT100, Kawasaki Ninja and KTM Duke.

4. TVS Motor Company

Since 19s55, TVS has focused only on automobile industry alone from finance and insurance (It also use to operate for automobiles as well in the 1870s). It partnered with Suzuki motors and gained worldwide recognition for its mammoth collaboration. Suzuki Samurai, Shogun and Fiero were top selling models back then. How can we miss their scooter range! It is a popular choice among the youngsters and working women. Models like Jupiter, Wego, Scooty Pep and Zest are very common among women. They are light, stylish and gives great performance. Their yearly production is nearly 3.2 million units and you can imagine the demand they have in the market. Some of their other top selling models are Apache RTR, Star City+ and TVS Sport.

5. Royal Enfield

No one owns this beast until and unless you a area motorcycle rider. It was earlier known as Enfield Cycle Company. But it was crowned as ‘Royal’ in the late 1890s by the queen of England for its performance and looks. Since then the English company is known as Royal Enfield. Owning this bike is a dream of every two wheeler rider, such is the magic of this bike. Its performance, suspension, looks, engine capacity and performance; everything is topnotch with this handsome looking two wheeler. This makes it one of the leading bike manufacturers of the country and the world. Its masculine looks is appealing to everyone and it is the best bike if you want to go on off roads, long rides, etc. All of their model is similar yet different in their feel. Some of their top selling variants are, Cruiser, Retro Street, Himalaya café racer, Classic 350, Thunderbird 350, Classic Desert Storm and the brand new Continental GT 650 and Interceptor 650.

The number of 2 wheeler fanatics has increased in India with more models and companies coming in. The world favorite, Harley Davidson has steadily increased its number on Indian roads in the last 3 years. Some of the other popular bike manufacturers are Triumph Motorcycles, Piaggio, Mahindra and Yamaha.

2. Research Objective

General objectives-

The objective of this research is to discover if the working capital management has an impact on the profitability of the firm and its growth. The main objective is to find out the important variables that might affect the profitability and risk situation of the firm so that they can be included in the firms’ financial planning. Certain variables in the field of financial management have a cause and effect relationship. Thus, those variables must be identified that affect the firms’ profitability and growth.

Specific Objectives –

General objectives are further divided in to specific objectives which are as follow-

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  • To determine whether there is significant relationship between Inventory turnover ratio and profitability of the firm
  • To examine the significant relationship between current ratio and firms profitability
  • To evaluate the significant relationship between debt to equity ratio and profitability of the firm
  • To ascertain if there is significant impact of operating cash flow to debt ratio on profitability of the firm

3. Literature review

Many previous research studies have indicated the relations between working capital management, liquidity, profitability, risk and many more factors of a company in different environments-

Deloof (2003) advocated firms attempt to maintain a most favorable level of WC that in turn enhances the wealth of shareholders. The results of this study found that WCM has a negative relation between firms performance. The major part of literature review mentioned above typically focuses on the association of the WCM with firms’ FP. Most of the researchers have applied correlation and multiple regression analysis to empirically test the impact of WCM elements on f irms’ performance. In several studies they have applied CCC, RCP, inventory turnover (ITO), average payment period (APP), as key measures of WCM whereas for measuring FP ROA, ROE, and EBIT, GOP.

(Dong & Su, 2010) observed the significant positive association of cash conversion cycle with the return on assets of the firms. (Kumar & Sharma, 2011) observed that in India cash conversion cycle has positive significant relationship with profitability of the firm. (Johnson & Templar, 2011) Stated that there is passively significant impact of current assets on the return on capital employed

Kruti A. Patel (2015) studied on impact of working capital management on profitability of Indian Oil Corporation. The study was based on secondary data and study period was 2009-10 to 2013-14. Pearson correlation, descriptive statistic and INM SPSS were applied as research methodology. The results show that there is significant negative correlation between working capital management and net profit and it also indicates that there is negative relationship between liquidity and profitability.

Kaushik Chakraborty [5] checked the various studied done on management of working capital and its components. The studies related to working capital management as a whole would necessarily discuss the individual components of working capital and thus exclusive studies on individual factors of current assets and current liabilities were found to be very few. A deeper look into survey indicated that there were only a few studies available abroad and plentiful of studies in India. The survey also revealed that, though a few case studies on individual components automobile companies were present, there was no attempt in India to study the working capital management in any specific industry

(Napompech, 2012)Argued that working capital is needed for day-to-day operations of a firm. The regression analysis was based on a panel sample of 255 companies listed on the Stock Exchange of Thailand from 2007 through 2009.The result showed significant negative relationship between gross operating profits and inventory conversion period and the receivables collection period.

4. Research Methodology

The methodology states that managing the working capital is an atmost important part of short-term financial management. The long-term financial management often receives more attention although many researchers, Jose et al. (1996) ²⁹, Deloof (2003) ³⁰ have shown that short-term financial management also has a clear effect on the profitability of a firm. Mulins (2004) ³¹ noted that the working capital management often can be used to gain successful competitive advantage. In India the corporate sector often seems to have awonderful and satisfactory level of working capital as it has been reflected in their liquidity ratios. The foreign based companies are placed in a better relative than the domestic companies. There is a wide inter-industry variation in liquidity ratios and performance of the working capital requirements of the corporate enterprises.

4.1 Concepts and Its Importance

The management of working capital is essential for a company to remain liquid, and to meet its short-term obligations. Continuous and efficient management of working capital will make the company more profitable. The company always needs to know about the metrics and techniques which are going to be used to manage the working capital in order to meet the competition as well as to maximize profitability. This article’s main aim is to concentrate on the different metrics and process around the working capital management in automobile sector and to find out how companies can manage the working capital in a better way. The method used in this study will be quantitative in nature of how the working capital management affects the profitability of automobile sector.

4.2 Objective for the study

To study the relationship between Working Capital Management and Profitability of Leading Listed Automobile companies at S&P CNX top 500 in India from (2006-2012).

4.3. Methods of Data Collection

The purpose of this research is to contribute towards a very important aspect of financial management known as the working capital management with reference to India. The research intends to reveal relationship between the working capital management and its effects on the profitability of 10 automobile manufacturing firms from CMIE prowess Database for a period of 2006 – 2012. This section of the paper discusses the firms and variables included in this study the distribution patterns of data and applied statistical techniques in investigating the relationship between the working capital management and the profitability. This is important as the Indian economy endured the 2008 financial crisis and it’s after effects which drained liquidity out of the system. In addition, to that the annual reports of companies have been used in order to understand the company back ground and industry type. The study involves only secondary data.

. The Secondary Sources To achieve the above noted objectives, extensive use of libraries was done. This study is based on the secondary data. The secondary data were collected through the Government reports, official records, Journals ,magazines, Books, websites of Internet and financial statements, such as income statements, balance sheets of S&P CNX 500 companies. For the purpose of arriving at meaningful inferences a six-year period beginning with 2006-2012 was derived from CMIE Prowess Database listed in NSE from the top S&P CNX 500 companies. There are about 10 automobile companies listed in the top S&P CNX 500 companies has been shortlisted which had similar business module and the financial information pertaining to income statements, balance sheets, and cash flow statements etc. and also supports the study variables. The other non-financial firms which lack in data were eliminated from this study.

4. Analysis and Interpretation

This chapter deals with the analysis and interpretation of data obtained from 10 automobile manufacturing companies from CMIE PROWESS DATABASE in India which is listed in National Stock Exchange. The secondary data includes Income Statements, balance sheets, Profit and Loss Accounts and Cash Flow Statements etc. The data collected has been dealt with the descriptive and inferential statistics on the sample which is based on the following tools like Mean, Standard deviation, forWorking capital components for the selected 15 manufacturing sectors

4.1. Table showing the Descriptive Statistics (Mean and Standard Deviation) of 162 Firms, (i.e) 15 Manufacturing Sectors, for a period of 2006-2012

AUTOMOBILE SECTOR DCP ITP APP CCC

MEAN 45.48 67.4 160.31 155.4

S.D 16.43 27.7 253.66 271.29

The above has arrived at the descriptive statistics (i.e) Mean and standard deviation for Working capital components such as DCP, ITP, APP, and CCC. Among the working capital components, the Average payment period has got the highest mean of 160.3, followed by the Cash conversion cycle 155.4, Inventory turnover period 67.4 and Debtors conversion period 45.48etc. This implies that automobile sector takes too long time to pay for its suppliers.

5. Findings and Recommendations

On the whole the study identifies the issues related to the working capital management undertaken by manufacturing industries through various secondary data analysis. The findings of the sector –that is a wise study based on the secondary data have now been discussed below. From the study it has been significantly found that among the working capital components, inventory turnover period is affecting the Net Operating profitability of automobile sector. It has been found that there is a negative relationship exists (i.e) reduction in the inventory days will increase the company’s profitability. The Inference stated that an increase in the number of Inventory turnover days (i.e) if inventory takes more days to sell then it results in decrease in profitability or vice versa. Because it would lead to increase in the storage and insurance cost and as a result the profitability may decrease. Highly expensive Inventories’ tied up in the firm may cause severe loses in the business because the amount of capital would be blocked. So the study states that decrease in the inventory days will increase the profitability. So, the automobile firms should concentrate more on reducing the Inventory turnover days. Hence from the study it is evident that inventory plays a major role in automobile sector. The results for the Inventory turnover period are consistent with the studies of Kaddumi and Ramadan (2012), Ganesan (2007), Khamrui (2012), Bieniasz & Golas (2011). Whereas the study on the effect of independent variables such as current Ratio, Quick Ratio, Firm Size, Fixed Assets to total Assets and Debt to Equity Ratio on Net Operating Profitability.

5.1. Conclusion

The Government of India plans to make automobile manufacturing the main driver of ‘Make in India’ initiative, as it expects the passenger vehicles market to triple to 9.4 million units by 2026, as highlighted in the Auto Mission Plan (AMP). In any sector efficient management of working capital has been recognized as one of the basic and most important function of finance for the successful conduct of business operation. Thus this strategy not only influences profit earning capacity of business undertakings, but also includes the content of operations of automobile sector. The present study pertaining to working capital management is an attempt to examine the structure of working capital in such a way as to assess the performance of inventory management, investigate the credit periods, to examine the utilization of cash resources, to check periodically the payment received before and after the due date, to frequently prepare the inventory budgets, to assess the inventory levels, to verify the liquidity position and to identify to what extent working capital financing impacts the profitability of selected automobile companies in India. Also the implementation of inventory models such as JIT, EOQ, FSN will also help to reduce the overstocking of inventories in the automobile enterprises in India. So, the automobile firms should focus more on managing and reducing the Inventory turnover days in order to maximize profitability and to withstand the competitive environment in today’s competitive era .

5.2. Scope for Future Research

The Present study aims to investigate the impact of working capital management and profitability considering the various parameters such as working capital components, Liquidity, solvency and profitability. The research was undertaken in 10 automobile companies, and the companies considered for the study falls under S&P CNX 500 companies alone. The area working capital is Vibrant and has its significance not only in top performing firms, but also in the Small and medium sized firms. The idea or the framework adopted for the study can be applied to SME’s as well as Distressed firms, to find out their performance in working capital management and also to test their significance. This framework will be helpful for future researchers to find out the issues relating to liquidity and profitability associated with the management of working capital in detail and also by exploring more variables in various sectors.

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Importance of Managing Working Capital and Its Impact on the Profitability of Automobile Industry of India. (2022, September 27). Edubirdie. Retrieved February 3, 2023, from https://edubirdie.com/examples/importance-of-managing-working-capital-and-its-impact-on-the-profitability-of-automobile-industry-of-india/
“Importance of Managing Working Capital and Its Impact on the Profitability of Automobile Industry of India.” Edubirdie, 27 Sept. 2022, edubirdie.com/examples/importance-of-managing-working-capital-and-its-impact-on-the-profitability-of-automobile-industry-of-india/
Importance of Managing Working Capital and Its Impact on the Profitability of Automobile Industry of India. [online]. Available at: <https://edubirdie.com/examples/importance-of-managing-working-capital-and-its-impact-on-the-profitability-of-automobile-industry-of-india/> [Accessed 3 Feb. 2023].
Importance of Managing Working Capital and Its Impact on the Profitability of Automobile Industry of India [Internet]. Edubirdie. 2022 Sept 27 [cited 2023 Feb 3]. Available from: https://edubirdie.com/examples/importance-of-managing-working-capital-and-its-impact-on-the-profitability-of-automobile-industry-of-india/
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