FINANCIAL MANAGEMENT II

WORKING CAPITAL MANAGEMENT AT TATA - STEEL

Presented by: Group 2 Section D AbhimanyuSukhwal2010181 Ahefaz Khan 2010182 KetanGhatkar 2010203 KirtiTiwari 2010205 Nishankumar Patel 2010213

WORKING CAPITAL MANAGEMENT AT TATA-STEEL

INTRODUCTION
Firms need money to pay for their day to day activities. They have to pay salaries, bills, suppliers& so on. The funds available to do this, is known as the firms working capital. Managing the working capital needs of the organization is important, because shortage offunds could disrupt the day to day operations whereas by holding excess funds theinterest burden of the firm starts mounting & eating into its profits. There are two concepts of Working Capital, Gross Working Capital & Net WorkingCapital. Gross working capital is the sum total of all Current Assets, Inventories, Debtors,Loans & Advances & Cash & Bank balances. Net Working Capital is the differencebetween Current Assets & Current Liabilities & therefore represents the funds which thefirm has to finance through Borrowings. A firm needs to invest in Current assets toensure Smooth and Uninterrupted Operations. How much the firm invests will depend onits operating cycle. Cash flows in a cycle into, around and out of a business. It is the life blood of thebusiness and it is the primary responsibility of the management to keep it flowing togenerate profits. A profitable business generates cash surpluses, which is used to expandthe business. The faster the Business Expands, the more funds it will require for meetingits working capital needs. Good management of working capital will generatecash, helpto improve profits and reduce risks. The two most important elements in the business cycle that absorbs cash areinventory (Stocks of Raw Materials and Spares, Work in Progress and FinishedGoods) and Debtors (Money to Be Collected from Customers). Tata Steel endeavor to shorten the cycle by (i) collecting money from debtors quickerand (ii) reducing inventory levels relative to sales, so that they have to borrow less moneyto meet their working capital needs. As a consequence, the aim is to reduce the interestburden and free additional funds to support growth in its Operations and Sales. Working Capital Management includes the following at Tata Steel: a) Debtors Management b) Bank / Cash Management 1

c) Inventory Management In order to analyze these, we need to go to the nitty-gritty s of mode of financing by TataSteel. These can be explained by the following: 1) Factoring or Bill Discounting 2) Receivable Purchase 3) L/C and Bill Discounting 4) Overdraft Management The art of managing credit risk is becoming more challenging than ever. Even a singleevent of default of a customer carries huge implications on the bottom line. The closure of a transaction from Customer Order to Payment realisation is becoming more and moreimportant in the context of strategic benefits and achieving effective customer satisfaction. Thus, there is growing need for new tools in order to better understand,quantify and manage credit risk. Thus, it becomes very important for a corporate todecide how it shall be satisfying its customers along with managing its impact on thebottom line.

1) FACTORING OR BILL DISCOUNTING

Tata Steel has two types of customers: i) Original Equipment Manufacturers and other manufacturing companies ii) Distributors Whatever be the size of business of the customers, there is a persistent risk of failure of the customers to the company. The larger the volume of debtors, the larger would be the exposure of the company to the market. Thus, any company would try to convert its debtors to cash. This can be done either by restricting credit sales to cash sales or by selling its debtors to various factoring agencies most of which are banks. If sales are made on cash basis, then the customer can pay the money within 7 days of raising the invoice, in which case the customer would also be given a cash discount. For sales made on credit, the company can sell off their debtor which is known as factoring. Factoring helps the company by providing protection against the bad-debts. Bad-debts result in blocking of funds of the company and leads to non-conversion of debtors. They act as hindrances in the existing or new or expanding business. Thus, factoring is used to restrict the bad-debts and to protect the cash flow of the business. Factoring has the following advantages a) Risk free sales b) Accelerated cash flow c) No bad-debt d) Saves time spend by CAM s following up for payment 2

e) No legal cost as assignment of Legal Rights will be on Bank f) Overdue interest is charged on the Bank s account. FACTORING FOR THE MANUFACTURING CUSTOMERS The factoring facility that has been designed for customers which are big manufacturers and high-valued customers is known as OE Finance or Receivable Purchases. Tata Steel enters into an agreement with a Bank that it would sell off its bills of the debtors. This agreement is known as the Tripartite arrangement which is an arrangement between Tata Steel, the Bank and the Customer. At the time when the agreement is made, all the specifications are made clear to Tata Steel and the customer. When an invoice is raised in the name of a customer, within a day or two it is sent to the bank for discounting. As per agreement, the Bank entertains these invoices of the specified parties and makes an upfront payment to Tata Steel of the corresponding amount. For providing the facility of discounting of the bills, the Bank charges certain interest known as the discounting charges. This discounting charge is borne by Tata Steel. Thus, Tata Steel gets the debtors money and the debtors have to pay the Bank at a later date, according to the agreement. However, the debtors shall be paying after the expiry of the credit period. At the end of the credit period if the customer fails to pay on time, then Tata Steel is not liable to pay any overdue interest. This entire arrangement of factoring is without recourse in nature i.e. if there is any problem from the side of the customer, then Tata Steel will not take the responsibility for compensation. Thus, the Bank has to deal with the entire process of the transaction thereafter. Calculation of Discounting Charges The number of days for which the bill has been discounted is the difference between the due date when the bill expires and the discounting date. The amount of discounting charges is calculated on the basis of this along with the rate at which the bank discounts the bill. Discounting Charges = Bill Amount * Days Discounting * Rate of discounting. FACTORING FOR DISTRIBUTORS The factoring facility that is extended for the distributors of Tata Steel is known as CHANNEL FINANCE. It helps in meeting the financing needs of the distributors. This has helped to reduce the capital outlay and improve cash flow position. It provides the distributors with new sources of funds which help them in carrying out their business with instant payment being made in cash. It reduces the interest rates that the distributors have to bear and also the facility of upfront cash discount. Tata Steel carries out its channel financing activities with the help of a separate companynamed Metaljunction.com. Thus, the entire factoring of distributors has been 3

outsourcedto an external entity. By doing this, Tata Steel has benefited in the sense that now they can get the entire payment without the delay due to credit limit, thereby reducing the overall exposure to uncertainty and chances of bad-debt. The quick receipt of money hasnow been possible because of the electronic transfer of money. The arrangement of Channel Financing is also carried on a non-recourse basis. In case of default by any of thedistributors, Metaljunction.com shall have to handle it. Thus, Tata Steel can very successfully reduce its working capital in the form of debtors where the chances of becoming bad if high. Ultimately all this leads to reduction of the cost of capital and specialization in hedging of financial risk of the company. How does Channel Finance work? 1. Distributor submits documents to Bank 2. TISCO provides LOR & LOC to Bank 3. Bank assigns credit limit to distributor 4. Distributor registers on Metaljunction for transaction 5. Raises a finance request 6. Bank confirms by giving an MRX no. Credits Tata Steel s account & debits Distributor account 7. Finance manager makes a Money Receipt 8. Distributor pays bank after credit period along with Interest.

2) RECEIVABLE PURCHASES
Factoring of the receivables Factoring: A financing method in which a business owner sells accounts receivable at a discount to a third-party funding source to raise capital One of the oldest forms of business financing, factoring is the cash-management tool of choice for many companies. Tata Steel sells its receivables of the debtors which are outstanding to the bank on a particular date. This factoring is done on WITHOUT RECOURSE to TISCO as regards the Principle and Overdue Interest. PROCEDURE OF FACTORING AT TATA STEEL Unlike OE Finance, the debts are not sold off prospectively. In this the invoices which are to be factored are issued invoices. The company sells a set of receivables to the bank and gets the discounted amount on the date of discounting and also debits Tata Steel s account by theamount of interest charges. The date of discounting is the date on which the agreement issigned between the company and the bank. When the bank pays the money to thecompany, the company gives a debit authorization for the discount amount to the bank. 4

The bank charges an interest on discounting @ 7.5% which is borne by Tata Steel which is the same as OE Finance. The interest shall be calculated from the date of discounting till the Tuesday following the due date of the said invoices. Currently, Tata Steel is dealing its RPs with HDFC Bank. HDFC Bank shall conduct a due diligence audit of the invoices to be sold to the Bank and satisfy itself that the invoices existed on the day.

PROCEDURE OF COLLECTION OF MONEY FROM CUSTOMERS In order to ease the collection efforts from the customers on the due date, Tata Steel collects the money from the customers and pays the same to the bank. The payment for the RP to the bank is made on a weekly basis on very Wednesday. By every Monday, all 25 branches, from all over the country, are intimated to forward the details of the invoiceswhich are paid in a particular week. All invoices collected by Tata Steel from its customers throughout the week ended Tuesday is to be paid to the bank on Wednesday. These details are compiled at the Tata Centre, Kolkata Office, Head of Marketing and Sales and then the Payment is forwarded to the bank along with a debit authorization to them. This payment is done through a High Value Cheque so that the bank can get the credit on the same day. Interest on discounting is charged by the bank on the difference of the number of days of Payment Date and Discounting Date. Amount of interest = Invoice amt.* Int. Rate* No. of discounting days

THE FACILITY OF RECEIVABLE PURCHASE It is present for both the Long Product and the Flat Product Department of Tata Steel. All the receivables from each of the department is handled by the Finance & Accounts Department at Tata Centre.

3) LETTER OF CREDIT (L/C) AND BILL DISCOUNTING L/C is a document issued by a bank that guarantees the payment, for a specified time period, of a customer's drafts up to a stated amount. It is a commercial instrument through which a bank or other financial institution instructs a correspondent institution to advance a specified sum of money to the bearer which can be an individual or a 5

company. The document is called a circular letter of credit when it is not addressed to any particular correspondent. Letter of Credit is always raised for a particular amount. The institution drawing a L/C from a bank shall do it for a particular amount. Thus, this L/C can then be used maximum till that specified amount and cannot exceed it. It is used as an instrument for payment by most of the companies nowadays. Those who issue such letters are usually so well known that any bank will honor the letter upon proper identification. L/C is of two types: inland payment and foreign payments. It is largely used in case of international trade. It is considered to be one of the most secured means of obtaining prompt payment for the sale of goods. In Tata Steel, most of the payments from customers, in the Ferro Alloys and Manganese Division (FAMD), are received with the help of L/C. It is a kind of credit payment made to the company which is secured in nature. The entire procedure of operating through a L/C shall be explained with an example. One of the customers in the FAMD department is M/S Jindal Stainless Ltd. We take a scenario where Tata Steel has raised 7 invoices in the name of Jindals and payment is to be made through L/C. One L/C can have several invoices but one invoice corresponds to only on L/C. Tata Steel charges a certain amount of interest of the customer, say 8.5% to 10%, because the payment is a kind of delayed payment. Issuance of L/C and the instructions that are made for payment by the customer are as follows: 3) Jindals shall approach its bank, also known as the opening bank, for the issuance of a letter of credit. This L/C value can be greater than or equal to the value of the sum of invoices raised by Tata Steel. Assume that the opening bank for Jindals is Canara Bank. 4) Every L/C has separate specifications such as the name of the beneficiary, advising bank, negotiating bank, L/C number, date and amount, Analysis Test Certificate. In this case, the name of the beneficiary is Tata Steel. The advising bank is Tata Steel s bank, to which the opening bank shall make the payment. Here the advising bank for Tata Steel is HSBC Bank. The negotiating bank as mentioned in the L/C is any bank in Kolkata. Every L/C has a period of validity after which it becomes expires. At the end of such a period the opening bank shall have to make the payment to the beneficiary. A part of the validity days of L/C is free of interest to the opening party and the remaining is charged a fixed interest. Other additional conditions that need to be mentioned in the L/C are whether partial shipment and transshipment is permitted or not, the latest date of dispatch of goods to the Jindals and the date of negotiation. Opening bank charges shall be charged to the opener s bank account and the beneficiary bank charges shall be charged to the account of the beneficiary. The L/C shall be payable and reimbursable at Canara Bank. 5) After the L/C has been made it is sent to Tata Steel along with the entire invoice and other required documents. 6

6) At the end of the credit period of the letter of credit, the opening bank shall have to issue a payment in the name of the beneficiary. When Tata Steel accepts to receive the payment of its bills (several invoices make up a bill), it sells it off to its bank i.e. the opening bank, HSBC. For such a transaction HSBC charges Tata Steel certain interest. This interest is charged for duration from the date of drawing of invoices or bill to the date of expiry of the L/C. According to the arrangement with Tata Steel in the FAMD department, the company shall not bear the overdue charges in case of late receipt of payment from the customer s bank. Thus, HSBC would transfer this burden on the issuing bank by charging a certain interest for late payment.

4) OVERDRAFT MANAGEMENT Tata Steel takes services of various banks for managing its financing activities. The State Bank of India and the Central Bank of India, together, account for 90 percent of Tata Steel s financial operations. In the past, Tata Steel had witnessed the problem of large overdraft balances, which resulted into a number of issues for the company. The situation was however successfully addressed by the company officials. As per the new practice, whatever cash is received from Jamshedpur is immediately deposited into the current account in the bank and the all the payments are payments are made from that account. Special care is taken to see that overdraft limit is not reached. The exhibit (no to be given later) shows the overdraft situation for the eight months starting September 2004. It is apparent that for five months, there was no overdraft balance, whereas for the remaining three months, the total numbers of days with overdraft balance were just six.

Conclusion
A company of a turnover of Rs. 12070 Crores is expected to have a good management of its Working Capital. Working Capital of a company is the difference between its current assets and the current liabilities. It includes the company s debtors, bank/cash, creditors,inventory, outstanding and other miscellaneous expenses. Each of these needs to bemanaged separately so as to have a control over the liquidity of business. The customer base of Tata Steel is found in the construction, auto and auto ancillary, white good appliance and the general engineering sector. Thus, in order to control the Working Capital of the company, they need to control their exposure in terms ofextending credit to its customers. They need to reduce the customer s day s sales outstanding and manage the overdue that accrues to them. The working capital management have been good but very fluctuating as seen by the exhibit 3. The fluctuating working capital requirement actually increases the risk of the business as well as increase in the cost of capital.

(Exhibit: 01) Tata Steel s number of overdraft days with State bank of India
Month September 2004 October 2004 November 2004 December 2004 January 2005 February 2005 March 2005 April 2005 Number of days 0 0 1 0 0 0 2 3 Amount 0 0 28937061.97 0 0 0 23065575.95 46728341.5

(Exhibit: 02): Overdraft situation for eight months starting September 2004
3.5 3 3 2.5 2 2 1.5 1 1 0.5 0 0 Sep-04 Oct-04 Nov-04 Dec-04 Jan-05 Feb-05 Mar-05 Apr-05 0 0 0 0

Number of days

(Exhibit: 03): Working capital requirement fluctuations 9

NET INCREASE / (DECREASE) IN WORKING CAPITAL (Cr)

30,000.00 20,000.00 10,000.00 0.00 -10,000.00 -20,000.00 -30,000.00 -40,000.00 2009-10 2008-09 2007-08 2006-07 2005-06

10