BBCPvt.Ltd.andWorkingCapitalChallenges_2.pdf

W12346

BBC PVT. LTD. AND WORKING CAPITAL CHALLENGES

Nimisha Kapoor and Professor Sandeep Goel wrote this case solely to provide material for class discussion. The authors do not intend
to illustrate either effective or ineffective handling of a managerial situation. The authors may have disguised certain names and other
identifying information to protect confidentiality.

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Copyright © 2012, Richard Ivey School of Business Foundation Version: 2017-05-30

In January 2012, Arpit Agarwal, managing director of chemical manufacturing company BBC Pvt. Ltd.,
was contemplating the alternatives that he could explore before the company proceeded with its plan to sign
a contract with Indian Railways (IR). Agarwal had been a leading member of BBC since its beginnings in
2004. BBC now had an advance acceptance document confirming its contract with IR, yet the company
was suffering from a lack of working capital due to a combination of extending liberal credit to its customers
and repaying debts too quickly. Therefore, Agarwal was not sure what the company’s next step should be.

BBC

BBC Pvt. Ltd. was an Indian chemical manufacturing company established in 2004. The company’s
registered office was in Bangalore and its manufacturing plant was in Lucknow. BBC was managed by two
directors, Agarwal and Mukesh Kumar. Kumar was a science graduate and Agarwal had a degree in
management.

BBC was categorized as a small-scale industry under the domain of chemical manufacturing. It produced
and sold stable bleaching powder using the raw material liquid chlorine. Since both the raw material and
the end product were highly toxic BBC was also classified as a hazardous industry.1 A license from the
Government of India’s Department of Industrial Policy & Promotion was required in to store the
cylinders of liquid chlorine. The company usually procured its raw material from the Sonebhadra district
in Uttar Pradesh. The price of this raw material could fluctuate wildly, from as low as INR10 per tonne to
as high as INR10,000 per tonne. This wide price range was based upon suppliers’ capacity to store and sell
liquid chlorine within the limitations of licensed quantities. Any raw material exceeding these licensed
quantities had to be sold at lower a price.

1 According to the Environment (Protection) Act, 1986 any industry handling or dealing with hazardous substance which may
cause adverse effects on the health of the people and the environment may be put under the category of hazardous industry.
Thus, industries relating to the products of chemicals petroleum fertilizer, leather highly inflammable liquid gases etc. can be
classified as hazardous industries. The Environment (Protection) Act, 1986, Ministry of Environment and Forests,
www.envfor.nic.in/legis/env/eprotect_act_1986.pdf, accessed November 15, 2012.

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Stable bleaching powder could be manufactured through one of two techniques: absorption or adsorption.
The product manufactured by the absorption technique was of better quality than the product manufactured
by the adsorption technique. BBC used adsorption, which meant that its product was of an inferior quality
compared to the products of its competitors. The company’s main competitors were industry giants like the
Aditya Birla Group, the DCM Group, Grasim Industries Limited, etc.; however, these companies were also
BBC’s suppliers of liquid chlorine.

Because of the more affordable (but lower quality) adsorption technique used in production, BBC was able
to reduce its operating costs with respect to installation of equipment, maintenance and electricity
expenditure. Despite producing a bleaching powder of inferior quality, the use of adsorption allowed the
company to enjoy a favourable market share due to the cost advantage BBC was able to pass on to its
customers.

BBC’s customers could be divided into two broad categories: government accounts and private accounts.
The government placed s whenever there was a demand in any of its departments. Private contracts
were negotiated according to industry factors such as the reputation/standing of the involved party, past
dealings, size of the , etc. Orders from private customers were usually smaller than government s
and the BBC’s customer base was largely comprised of private accounts.

The company enjoyed a credible position with its bankers. Its main bank was Union Bank of India, a
nationalized bank. BBC had a cash credit limit of INR2.5 million, which had been fully utilized. During a
meeting with the bank manager regarding the IR contract, Agarwal could sense the manager’s reluctance
to extend a fresh line of credit to BBC. The bank manager mentioned that the interest on the loan required
to complete the contract with IR would be 14.5 per cent; the offer was against a pledge of share certificates
for an existing loan with the bank, in light of the fact that BBC was carrying existing unsecured loans that
resulted in interest payments of more than INR600,000 annually.

WORKING CAPITAL MANAGEMENT

BBC had been following a conservative approach to working capital, as reflected in its high level of net
working capital — more than INR4.2 million in fiscal year 2010/11 (see Exhibit 1).

The net working capital of the company had always remained positive, as reflected in its balance sheet (see
Exhibit 1). BBC’s assets were more than 10 times its liabilities. These assets were mostly in the form of
inventories and accounts receivable. 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; from 2009 to 2011, BBC’s liquid-asset-to-total-asset ratio ranged between 62 and 66 per
cent — whereas the industry benchmark was 30 per cent.

BBC’s inventory could be categorized into three groups: raw materials, finished goods and packing
materials. From 2009 to 2011, inventory in all three of these categories had risen significantly, increasing
the total inventory by almost 85 per cent. Raw material and packing material were valued at cost on a first-
in-first-out (FIFO) basis. Finished goods were valued at cost or at net realizable value — whichever was
less.

Although such high levels of inventory eliminated the possibility of disruptions in manufacturing due to a
stockout, it had led to wastage of BBC’s working capital. A large stock of finished product stored in the
company’s premises had long been a cause of concern for Agarwal (see Exhibit 2). He knew that the
company’s sales had gradually decreased. Immediate action was required as decreased sales would
negatively affect the profitability of the company and BBC’s return on capital employed in the future.

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BBC’s debtors had remained more or constant with minor fluctuations. The credit periods on the loans
ranged from 15 days to almost two years. The largest amount due on a single account was INR4 million.
Debtors/receivables turnover ratio of the company had ranged from 2.9 to 3.2 times for the last three
financial years. Despite this, BBC continued to extend liberal credit to new accounts.

The company had been maintaining adequate levels of cash but these levels would not be sufficient for
additional s like the proposed contract with IR. The cash and bank balance in BBC’s balance sheet
was inclusive of a fixed deposit maintained with the bank. The company also indulged in future commodity
trading. The profits from these activities were apparent in BBC’s profit and loss statement (see Exhibit 3).

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 INR2.5 million with Union Bank of India.

THE CONTRACT WITH INDIAN RAILWAYS

Operations were running relatively smoothly at BBC but Agarwal knew that there was an urgent need to
upgrade the company in to make it a truly competitive market player. The IR contract could prove to
be such an upgrade, and it had therefore been an aspiration of Agarwal’s since 2011. He had registered his
company for all three divisions of Indian Railways in the northern part of India (Northern Railways, North
Eastern Railways and North Central Railways). This contract would open the gates between BBC and IR
for long-term business, and could potentially act as a stepping stone for BBC to become the preferred
supplier of bleaching powder for other big players in the industry as well; however, the contract would be
a challenge and would require a professional team working to make BBC eligible. Agarwal desperately
needed a manager who could handle the administration and official correspondence of this account
efficiently, as well as monitor operations along with the floor supervisor.

As part of the contract, IR was demanding an onsite office, a warehouse and a workshop within the BBC
factory premises. In addition, the document of advance acceptance clearly outlined proposed quarterly
onsite inspections. These inspections would have to be conducted at the factory premises before any lot
was dispatched to IR. Furthermore, establishing an onsite IR office would cost a onetime expenditure of
approximately INR200,000, as well as an increase in administrative costs.

The company had to put its stock in a new warehouse as part of the proposed contract. As of January 2012,
BBC did not have any warehouse that met the required safety norms. All materials, including spare parts,
raw material, packaging material and finished products, were kept in a semi-covered storage area within
the factory premises; this often led to losses due to deterioration in the quality of material. The approximate
cost of building a new warehouse would be INR500,000.

There was also an urgent need to create a separate workshop within the factory for safety and maintenance.
Since BBC’s manufacturing process involved various hazardous chemicals, maintenance of the existing
machinery was a crucial activity. The workshop could be used to repair rusted or worn-out machine parts
that were employed in the manufacturing. Certain critical parts had to be repaired regularly. Having a
separate workshop exclusively for such activities would be very helpful in daily operations of the factory.
The company estimated an expenditure of approximately INR500,000 for establishing such a workshop.

Above all, BBC needed to maintain adequate cash reserves to meet all of 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. BBC had already reached its cash credit limit of INR2.5
million and its recoverables were blocked in the form of either inventories or receivables. In financial year

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2010/11, the company had to pay more than INR640,000 in financial charges and interest. Agarwal
regretted his previous decision to avoid putting BBC’s money in short-term investments, which could have
been a source of funding for the upgrade that the IR contract would require. Retrospectively, he realized
that BBC had been shortsighted in extending liberal credit to its customers and being more prompt in
repaying debts than business demanded.

THE WAY FORWARD

BBC was able to attain many s and manufacture its product at a cost much lower than its competitors;
this fact reassured Agarwal, although he knew that there were issues that needed immediate action. Agarwal
was aware that BBC’s gross block was continuously decreasing and the company was therefore shrinking
— rather than growing — at a rapid rate.

Agarwal knew that in to complete the contract with IR, BBC would require a significant upgrade by
December 2012. How could the finances required for this upgrade be secured? Should Agarwal seek to
improve BBC’s working capital management or pursue complete financial policy restructuring?

Nimisha Kapoor and Professor Sandeep Goel are from MDI, Gurgaon, India.

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Exhibit 1

BBC BALANCE SHEET — 2009-2011

2011 2010 2009

Sources of funds
Shareholders funds
Share capital 950,000 950,000 950,000
Reserve & surplus 439,990 370,841 307,736

Loan Fund
Secured loan 180,345 1,284,237 1,237,475
Unsecured loan 5,018,221 4,603,476 4,223,011
Total 6,588,557 7,208,556 6,718,222

Application of Funds
Fixed assets
Gross Block 2,621,861 2,944,618 3,103,368
Less: Depreciation 270,798 324,757 355,292
Net Block 2,351,064 2,619,861 2,748,076

Assets, Loans & Advances
Inventories 870,146 740,749 322,848
Sundry debtors 2,948,850 2,936,732 3,355,773
Cash & Bank Balance 453,079 815,640 554,800
Loans & Advances 252,199 356,636 272,211
Total 4,524,274 4,849,757 4,505,632

Less: Liabilities
Liabilities 130,166 135,348 363,486
Provisions 156,615 125,715 172,000
Total 286,781 261,063 535,486

Net Assets 4,237,493 4,588,694 4,047,146

Total 6,588,557 7,208,556 6,718,222

Source: BBC Pvt. annual reports, 2009-2011.

Exhibit 2

VALUATION OF INVENTORIES — 2009-2011

2011 2010 2009
Inventories 870,146.2 740,749 322,848
Raw Materials 432,071 166,573 149,924
Packing Material 85,915.2 87,976 5,624
Finished Goods 352,160 486,200 167,300

Source: BBC Pvt. annual reports, 2009-2011.

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Exhibit 3

BBC PROFIT AND LOSS STATEMENT — 2009-2011

2011 2010 2009

Income
Sales 9,544,409 8,529,838 12,539,108
Other income 602,873 176,603 250,296
Increase/ Decrease in Stock -134,040 335,549 -133,827
Total 10,013,242 9,041,991 1,265,577

Expenditure
Raw Material Consumed 4,982,486 3,412,916 5,340,943
Manufacturing Expenses 3,434,866 3,699,344 4,765,355
Directors Remuneration 360,000 432,000 360,000
Other Expenses 223,791 451,052 935,404
Depreciation 270,798 324,757 355,292
Interest & Finance Charges 641,252 628,315 674,905
Total 9,913,194 8,948,385 12,431,899

Profit Before Tax 100,048 93,605 223,676

Profit After Tax
Add: Transfer from previous year
Balance Sheet

370,841 307,736 163,044

Provision for Income Tax 30,900 30,500 57,000
Balance carried to Balance Sheet 439,990 370,841 307,736

Source: BBC Pvt. annual reports, 2009-2011.

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