Bbc Pvt. Ltd. and Working Capital Challenges

BBC PVT. LTD. AND WORKING CAPITAL CHALLENGES

Sharmistha Banik

PGDM 2014-16

Reg.no- 024

Section A

1. Summary of the case

BBC Pvt. Ltd. (BBC), a chemical manufacturing company, was established in 2004.It’s registered office was in Bangalore, while its manufacturing plant was in Lucknow. BBC was in urgent need of funds in order to secure an important contract. BBC was able to manufacture a product that involved low investment in the form of fixed assets. Although the product was of an inferior quality due to its cost-effective production, the company was able to pass on that cost advantage to its end customers, enabling BBC to maintain its position in the market. In addition, the company sold the product primarily on credit and was therefore a preferable option for buyers.

BBC followed a very conservative and traditional approach to working capital management. Its assets were 10 times its liabilities. The company repaid its creditors promptly before the credit period. However, in terms of credit management, the company followed a casual approach. It extended credit sales for large periods and its large inventory in the form of raw material and finished goods resulted in excessive blockage of working capital.

In this case, BBC had the opportunity to pursue a promising contract that would require significant investment immediately. The company’s managing director needed to make a decision about how to obtain and manage adequate funds for the upgrade that BBC needed in order to secure its contract.

1. Was BBC’s Working Capital Policy successful? Why or Why not?

No, BBC’s Working Capital Policy was not successful. BBC had been following a conservative approach to working capital, which is reflected in its high level of net working capital-more than INR 4.2 million in financial year 25010/11. BBC’s assets were more than its liabilities. These assets were mostly in the form of inventories and receivables. However, Trade Credit of the firm had become a major liability. The company’s management had been very conservative and traditional with respect to repaying loans before the credit period. This meant that BBC had been too quick in paying back its creditors. This had affected the company’s liquidity: the longer the repayment period, the lower the Net Present Value of the payment and the higher the value to the firm. The company also maintained a cash credit limit of INR 2.5 million with Union Bank of India.

Now, with the new project with Indian Railways, it was demanding an onsite office, a warehouse and a workshop within the BBC premises. In addition, the document of advance acceptance clearly outlined proposed quarterly onsite inspection. The onsite IR office would cost a onetime expenditure of approximately INR 200000, as well as an increase in administrative costs. Building of warehouse would require a cost of INR500000 as well as for a workshop. But BBC needed to maintain adequate cash reserves to meet all its payments and continue its usual production activities without any interruption. The total amount required for the upgrade-INR1.2 million- was beginning to worry Agarwal as BBC had already reached its cash credit limit of INR2.5 million and its recoverable were blocked in the form of either inventories or receivables. Thus, Agarwal realized the BBC had been short-sighted in extending liberal credits to its customers and being more prompt in repaying debts than business demanded.

1. BBC Inventory Turnover Ratio (ITR) decreases from 2009-2011. What were the actual ratios and how does this reflect on BBC’s inventory management?

Inventory Turnover Ratio = Total sales/Inventory

So, we see that there has been a sharp decrease of inventory turnover ratio from 38.51 in 2010 to 11.39 in 2011. This clearly depicts that inventory management has not been that efficient which has led to BBC finding itself short of liquidity in order to oblige the IR contract. Disadvantages of holding inventory by means of over expenditure in it have been already discussed above.

BBC’s one of the main difficulties towards working capital management was regards its inventory holding increasing exponentially eventually leading to low inventory turnover ratio. It is to be notated that holding of excess amount of inventory does not add any value, so efforts should be made towards reducing inventory holding levels to the maximum limit possible. Dangers of over investment in inventories are:-

• Blocking of firm’s fund causing loss of profit
• Excessive carrying cost viz. insurance, storage cost etc.
• Risk of liquidity crisis
• Excess inventories if stored for longer period would turn into dead/obsolete stock due to physical deterioration of quality pilferage
• Often difficult to sell and recover the purchased value.

Disadvantages of low inventory turnover ratio:-

Lost Sales: If inventory turns over too quickly, it could negatively affect sales.  Higher Expenses: Merchants who purchase in small quantities to keep inventory turnover high typically incur greater costs. They may not be eligible for volume discounts or special deals available to those who buy in bulk.  Obsolete Merchandise: In operations where inventory turnover is low, merchants run the risk of being stuck with merchandise that becomes unsalable due to obsolescence. The merchant may have to resort to selling the merchandise at greatly reduced prices, which reduces its profits. Carrying Costs: Low inventory turnover can result in higher carrying costs. Inventory needs to be stored, handled and insured, all of which represent costs to the business. Stored inventory is also susceptible to shrinkage, which is loss due to occurrences like damage and theft. As with obsolete merchandise, carrying a large volume of slow moving products also results in lost opportunities due to not being having the storage space for more rapidly turning items. So according to the case we find that BBC is in alignment with all the mentioned difficulties regarding inventory management so it can be concluded that its management is not that efficient regarding inventory holding and turnover.