Dr. Narender L. Ahuja, Institute for Integrated Learning in Management, New Delhi, India Ms. Sweta Agarwal, Institute for Integrated Learning in Management, New Delhi, India
After running as a family business for over 100 years, when in late 1990s the management of the Dabur was handed over to a team of professional managers, the new management faced a gigantic task of improving performance in several critical areas. In particular, working capital and cost management required urgent attention as the company’s performance in these areas had been far from satisfactory. The then prevailing current ratio of 3.2 and quick ratio of 2.4 were considered too high and indicative of heavy unnecessary investments in working capital that would have a negative effect on company’s profitability.
Efforts to improve the working capital efficiency were met with stiff resistance from various quarters, but finally yielded results. The case study discusses the measures taken to improve the working capital and cost management performance, and how with concerted efforts the management turned around a highly inefficient working capital management into one of the most efficient in the FMCG sector of Indian Industry. In fact, the company seemed to have taken the matter to the other extreme of negative working capital, with the current ratio declining to 0.8 and the quick ratio to just 0.4 in 2004-05.
In 2005-06 as the company was ready to launch itself into the next phase of fast growth, several critical issues related to the liquidity and solvency of the company confront the management which are also discussed in the case study.
“How could a company have a ‘negative’ working capital and call itself successful?” Bo asked his friend Sharad. They had just joined Dabur India as Management Trainees and at the moment were having their lunch in the company’s staff canteen. Bo (nick named for Bose) had spent the morning studying the company’s balance sheets for the years 2003-04 and 2004-05 and was surprised to see that the company’s current liabilities exceeded its current assets. He remembered reading in his textbooks that such a situation indicated that the company could face difficulties in meeting its short-term liabilities. “I don’t know about that”, Sharad replied, “but I think it is a highly profitable company.” “Sure, no problem with the company’s profitability. In fact the net profit in 2004-05 jumped by as much as 46% to Rs 148 Crore from Rs 101 Crore last year.”
“Wow, that’s a lot of increase in one year,” Sharad said, “In fact I am told the company has an impressive market share in its product line and is the fourth largest FMCG company in India. But if the company is making high profits and has a good market share, then where is the problem?” Bo was ready with his reply, “The way I understand, that could be a common trap for the profitable but fast growing companies. Liquidity and profitability are two separate issues and it is naïve to assume that a profitable company would necessarily be liquid too. See, what happens is that in order to provide finance for expansion and diversification projects, a company could cut down on inventories, reduce the credit period to customers while at the same time seek extended credit facilities from its suppliers of raw materials, other goods and services. Also, it tries to manage with nil or as little cash in hand as possible. As
a result, the current assets represented by inventories, debtors and cash would be reduced and current liabilities represented by creditors would increase, culminating in a situation when the company might not have enough current assets to pay for its current liabilities if all creditors wanted them to be settled at once, what to talk about leaving some surplus to continue with its normal business operations.” Bo said emphatically.
Dabur India’s corporate office was housed in a beautifully landscaped,...