Idbi Federal Life Insurance Co. Ltd. - Establishing Relationship Between Working Capital Management and Profitability of the Life Insurance Sector

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The data was collected from annual reports of 20 companies under study and ratios were computed. Further analysis was made through comparing ratios for FY2008-09 and FY2015-16 and analysis using statistical tools like correlation and regression to find changes in structure of working capital during these years. For 2nd objective, as a part of the internship, data was collected through meeting clients for making sales of Insurance products and responses were recorded accordingly through a structured questionnaire.

The analysis concludes that Profitability of Life Insurance sector can somehow be attributed to its Working Capital Structure. Further analysis shows how companies over the years have managed to turn itself profitable by altering their working capital structure. The analysis of the second objective concludes that the firm needs to restructure its marketing efforts to be more visible and exploit their position of advantage to the fullest.

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CHAPTER 1: INTRODUCTION

1.1 Working Capital Management

Working Capital Management (WCM) is a firm’s management of relationship between short term assets and current obligations. The firm needs WC to finance its daily expenses like raw material, salaries, WIP which requires the firm to maintain an adequate amount of liquid assets. Maintaining a huge pile of liquid assets can cause extra costs to the firm and no investment in long term assets which is directed for business expansion. Similarly, short term obligations are created in case of shortage of current assets or obtaining loan at a lower rate of interest than what it may be earning at investing the current assets. Financing a large part of working capital from short term loans decreases firms ability to pay for its routine operations, thus increasing their borrowing costs. A firm has to find a correct balance between maintaining current assets and current liabilities upon which the whole concept of Working Capital lies on.

Various calculations have been developed overtime to check the WCM of the firm namely Accounts Payables Turnover(APT), Accounts receivables Turnover(ART), Inventory turnover(INT), Cash conversion cycle (CCC). All the calculation of the formula have been given in the appendix. APT gives the proportion of payables still left out of the cost of the goods sold. The longer the accounts payable, better it is for the company to use its liquid assets and earn interest but too long a time can cause creditworthiness of the firm to go down and lead to stricter terms in future. ART gives the amount of goods sold recovered from the the total sales. The shorter ART days, better it is for the company to convert its sales to cash and that cash be used for earning some short term profits. Similarly INT gives speed of converting inventory to sales. All these ratios help determine the CCC of the company which tells about the time taken to restart the complete cash cycle.

The research is based on establishing a relationship between Profitability and WCM ratios. Profitability ratios include Profit margin i.e. EBIT/Sales and ROTA i.e. EBIT/ Total Assets. Various statistical tools like correlation, hypothesis testing and regression are applied to test a relationship between them.

There are 3 primary activities in accounts receivables management I.e.

Establishing credit terms, Credit balances maintenance and measuring performance. So for ease of managing the receivables receipts, various measures like Electronic fund transfer, managing funds through lock box, Cash on delivery etc. But there lies a flaw in the evaluation of receivables. The calculation gives the overall average which does not consider the age of outstanding balances i.e if the accounts receivables are 30 days old, 60 days old or 90 days old.

Inventory is also a significant cost to the company. When inventory levels are too low, the firm ca face the situation of stock out and loss of sales and huge piling of inventory adds to various costs. Maintaining inventory can become easier with strategies like EOQ and Just in time inventory which saves cost and add to sales.

Accounts payables represent an important part of the cash flow as it deals with 2 main situations i.e Paying too early can disturb the cash flow but also can attract discounts, paying too late can be fatal for creditworthiness of the firm but gives some opportunity to earn from deposits.

All these ratios depend upon different sectors, industries in which the firm is involved. For example, in Services sector, firm have a very low amount of inventory costs and in infrastructure sector, its huge capital requirement can have lower current ratio (sometimes much lower than 1). It does not necessarily mean that company is performing poorly. Important thing here to understand is how are they trying to sustain their business and eyeing to stay for a long while.

Another function of working capital is short term investments and short term financing. The main reasons for short term investments is earning some interest upon the liquid cash which can redeemed on short notice. It fulfils emergency requirements as well as generate additional funds. Mostly short term investments are done in govt. Securities, marketable securities etc. Short term financing is another component is main objective to handle peak cash needs at a lower rate. The borrowings can be taken from banks on different terms, commercial paper etc. To maintain its creditworthiness is the main function of the firm to attract funds at a cheaper rate and flexible credit terms.

1.2 INSURANCE IN INDIA

The roots of Insurance in India go back in 1818 when first Insurance company is setup in Kolkata. After that, many acts are passed to regulate the Insurance sector and no. of companies came into operation until an ordinance is passed in1956 to nationalize the life insurance sector and LIC came into existence. In year 1999, this monopoly ended with privatization of Insurance sector. Currently, 24 life Insurance companies are in operation with LIC having over 70% of the market share. The whole insurance sector is regulated by IRDAI (Indian Reguatory Development Authority)[1]. With amendments in Insurance Act 2015, the government increased FDI share in Insurance sector from 26% to 49% giving a big boost to Insurance sector.

1.3 COMPANY PROFILE

IDBI FEDERAL LIFE INSURANCE Co. Ltd.

IDBI Federal Life Insurance Co Ltd. is a joint-venture of IDBI Bank,