The CFO's Need:
Reduce The Money Blocked In Both Receivables As Well As Inventories

A conservative working capital strategy carries high levels of current assets in relation to sales. Surplus current assets enable the firm to absorb sudden variations in sales, production plans, and procurement time without disrupting production rhythms. Additionally, the higher liquidity levels reduce the risk of insolvency.

But lower risk translates into lower return. Large investments in current assets lead to higher interest and carrying costs. Less obvious, but more damaging, are the complacency and pockets of inefficiency that such cushions tend to encourage. Points out V.K. Balasubramanian, 57, director (finance) of the Rs 865-crore Mafatlal Industries: "If Indian industry is to be globally competitive, corporates will have to learn to manage with a lower level of current assets."

Efficient working capital management techniques are those that compress the operating cycle. The length of the operating cycle is equal to the sum of the lengths of the inventory period and the receivables period. Just-in-time inventory management techniques reduce carrying costs by slashing the time that goods are parked as inventories. To shorten the receivables period without necessarily reducing the credit period, corporates can offer trade discounts for prompt payment.

THE STRUCTURED SOLUTIONS: More efficient management techniques are not the only way to trim operating cycles; innovative financial instruments can also be deployed to churn over the current asset portfolio with greater speed. The basic premise underlying these instruments is simply that since receivables represent a future stream of cash-flows, these cash-flows can be packaged as securities, and sold off.

BILL DISCOUNTING. This is the oldest and simplest form of securitisation. Bills arising out of trade transactions are sold to a financial intermediary at a discount, thus releasing funds immediately to the corporate. The financial intermediary can either wait until the bill matures, or it can rediscount the bill. The RBI is seeking to revive this traditional form of financing: the M&CP, 97 stipulates that with effect from January 1, 1998, of the total inland credit purchases of borrowers, not less than 25 per cent should be through bills drawn on them by sellers.

However, with discount rates at 13-14 per cent for 90-day paper, bill discounting is an expensive source of short-term funds. And the major users are likely to be confined to those corporates supplying raw materials and basic goods to industries, such as construction, steel, and infrastructure, that inherently have an elongated funds-flow cycle. Avers Hongkong Bank's Bhasin: "Corporates will reduce their dependence on bill discounting until the payment and settlement system improves."

Moreover, the status of bills as negotiable instruments rests on the continuation of the RBI's refinancing window. Remember to prop up a rediscounting chain, there has to be a lender of last resort. But with the RBI likely to focus on its role as a monetary authority, this window may soon snap shut. In an ominous harbinger of things to come, the export credit refinance window is being closed in a phased manner. And this uncertainty has caused bill volumes to shrivel from a high of Rs 8,000 crore in 1995-96 to Rs 4,500 crore in 1997-98.

FACTORING. Instead of merely discounting bills, CFOs can sell off the receivables themselves to specialised financial institutions known as factors. The factor then assumes full responsibility for sales ledger administration, including the collection of debts. Says K. Shankar Narayan, 59, the managing director of the Rs 440-crore SBI Factor & Commercial Services: "Upto 90 per cent of the sales ledger of the principal can be financed through factoring."

Of course, this array of benefits does not come free. Discounts to the face value of receivables average between 17 per cent and 18 per cent, which includes a charge for risk protection, making factoring an expensive source of short-term credit. Admits E.R. Sheshadari, 43, executive vice-president, Foremost Factors: "There is a cost, but you have to weigh that against the advantage of immediate liquidity and 100 per cent risk cover."

Indeed, the twin benefits of an immediate boost to cash-flows and the transfer of credit risk away from corporate balance-sheets have made factoring an immensely popular alternative in the developed markets. In the US, the market for factoring services amounts to a whopping $33 billion; in India, the total value of factoring deals in 1996-97 did not exceed Rs 1,000 crore.

Blame legal and procedural hassles for bogging down the growth of factoring services. Factoring involves a transfer of assets which, in turn, attracts an ad valorem stamp duty. In some states, the stamp duty can be prohibitively high, further inflating factoring costs. Unfortunately, factoring services have not acquired the status of a separate industry; instead, they have been clubbed with Non Banking Finance Companies (NBFCs), resulting in the dilution of their focus.

But the biggest roadblock is the lack of an extensive and accessible database that tracks delinquency rates, default history, and repayment performance. Therefore, to reduce credit risks, factors usually demand voluminous paper trails. Worse, since factoring services here tend to be of the full recourse variety, rather than the non- recourse variety that is the staple abroad, much of the benefits associated with the transfer of credit risks are wiped out.

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