F Ashima Forth Chapter-114-148 36shodhganga.inflibnet.ac.in/bitstream/10603/27799/8/08_ chapter 4.pdf · 2 Welsch G.A. and Anthony, R.N.: “Fundamentals of Financial Accounting”,

Chapter-IV Efficiency and Leverage Analysis of the Sampled Units under Study

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Prologue: The forth phase of the Study is also significant in this researcher has

taken various types of ratios to discuss the Efficiency and Leverage analysis of the

MSIL and HMIL. She has gathered data from the CMIE database PROWESS and

from the Capitaline.com, and then with the help of statistics calculated various types

of ratio as per the need of the study. The purpose of this chapter is to know how

efficiently companies use their assets in their business and how these companies

manages their equity funds and borrowed funds.

4.1 Efficiency Analysis of MSIL & HMIL: - Efficiency analysis shows

how assets are being utilized in the company. For this purpose various ratios i.e.

FATR, STR, DTR & WCTR can be calculated. Leverage analysis means to know the

long term solvency position of the company. It means that is company able to pay off

its long term creditors or not on time. For this CGR, DER & ICR ratios can be taken

to arrive at definite conclusion.

4.1(1) Fixed Assets Turnover Ratio:-

Fixed Assets Turnover Ratio is also known as sales to fixed assets ratio. This ratio

measures the efficiency and profit earning capacity of the concern. 1 Changes in this

ratio over time reflect whether or not firm the firm is becoming more efficient in the

use of fixed assets. The fixed-asset turnover ratio measures the company's

effectiveness in generating from its investments in plant, property, and equipment

(PP&E). It is especially important for manufacturing firms that uses a lot of plant and

equipment in its operation.

For most companies, their investment in fixed assets represents the single largest

components of their total assets. This annual turnover ratio is designed to reflect

company’s efficiency in managing these significant assets.

1 Myer, John N.: “Financial Statement Analysis”, (Prentice-Hall of India Pvt. Ltd., New Delhi, Ed.1972, P.184)


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A higher fixed-asset turnover ratio shows that the company has been more effective in using the investment in fixed assets to generate revenues. Higher the ratio, greater is the intensive utilization of fixed assets. Lower ratio means under-utilization of fixed assets.The formula is: - Fixed assets turnover ratio:-Sales or cost of sales/ Net fixed assets

Table No. IV-1 (Figures in Crore)

Fixed Assets Turnover Ratio of MSIL & HMIL (In No. of Times)

MSIL HMIL Year NS NFA FATR NS NFA FATR 2000 6989.50 2175.70 3.21 1671.48 160.02 10.45 2001 6716.90 2247.10 2.99 2202.47 299.22 7.36 2002 7074.60 2430.10 2.91 2609.97 496.81 5.25 2003 7180.10 2255.70 3.18 3085.14 662.55 4.66 2004 9104.40 1830.80 4.97 4800.48 839.00 5.72 2005 10923.80 1873.70 5.83 6305.90 1079.03 5.84 2006 12015.90 1695.20 7.09 7339.14 1371.42 5.35 2007 14696.30 2659.70 5.53 8762.49 1721.90 5.09 2008 17891.60 3296.50 5.43 10118.87 2178.69 4.64 2009 20530.10 4070.80 5.04 15522.55 4716.36 3.29 Average 4.62 5.77 SD 1.57 1.59 COV 33.99 27.58

Source: - Computed with the help of Statistics Data taken from the CMIE database PROWESS from 2000 to 2009 CH-IV-1 Diagram depicting Fixed Assets Turnover Ratio of MSIL & HMIL


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Interpretation

MSIL: - During the time of study the Fixed Assets Turnover Ratio of MSIL varied in

a range of 4.62 times, the lowest being 2.91 times in 2002, while the highest ratio was

7.09 times in 2006. From the year 2007 to 2009 it started decreasing it was not as

much as it was in the year 2006 itself. From the year 2002 to 2006 there was an

increasing trend which shows the effective utilization of fixed assets in the company.

HMIL:-During the time of study the Fixed Assets Turnover Ratio of HMIL varied in

a range of 5.77 times, the lowest being 3.29 times in 2009, while the highest ratio was

10.45 times in 2000. The highest ratio shows the highest efficiency in the utilization

of fixed assets. The fixed turnover ratio of the company during the plan period

registered a fluctuating trend after the year 2000 it was not as higher as in the year

2000 itself but it shows the sufficient utilization of fixed assets in the company.

On overall satisfactory ratio can be observed in both the company during the study

period, which indicates the sufficient utilization of fixed assets in the companies.

Consistency can be observed in the FATR of MSIL from the last three years 2007-

2009 and HMIL’s from the years 2004 to 2007.


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4.1(2) Stock Turnover Ratio/Inventory Turnover Ratio: - Stock turn

over ratio and inventory turnover ratio are the same. This ratio is a

relationship between the cost of goods sold during a particular period of time and the

cost of average inventory during a particular period. It indicates the number of time

the stock has been turned over during the period and evaluates the efficiency with

which a firm is able to manage its inventory. This ratio indicates whether investment

in stock is within proper limit or not.

Inventory turnover ratio measures the velocity of conversion of stock into sales.

Usually a high inventory turnover/stock velocity indicates efficient management of

inventory because more frequently the stocks are sold; the lesser amount of money is

required to finance the inventory. A low inventory turnover ratio indicates an

inefficient management of inventory. A low inventory turnover implies over-

investment in inventories, dull business, poor quality of goods, stock accumulation,

accumulation of obsolete and slow moving goods and low profits as compared to total

investment.

The inventory turnover ratio is also an index of profitability, where a high ratio

signifies more profit; a low ratio signifies low profit. Sometimes, a high inventory

turnover ratio may not be accompanied by relatively a high profit. 2

The formula is:-

Stock turnover ratio:-Sales or Cost of Sales/ Average Stock

There are no rules of thumb or standard for interpreting the inventory turnover ratio.

The norms may be different for different firms depending upon the nature of industry

and business conditions.

2 Welsch G.A. and Anthony, R.N.: “Fundamentals of Financial Accounting”, (Richard, D. Irwin, Inc.

Homewood, Illinois, Ed. 1977, P.646)


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Table No. IV-2 (Figures in Crore) Stock Turnover Ratio of MSIL & HMIL (In No. of Times)

MSIL HMIL Year NS AS STR NS AS STR 2000 6989.50 990.20 7.06 1671.48 195.77 8.54 2001 6716.90 865.50 7.76 2202.47 195.84 11.25 2002 7074.60 681.10 10.39 2609.97 254.78 10.24 2003 7180.10 487.00 14.74 3085.14 253.98 12.15 2004 9104.40 439.80 20.70 4800.48 466.90 10.28 2005 10923.80 666.60 16.39 6305.90 634.15 9.94 2006 12015.90 881.20 13.64 7339.14 741.54 9.90 2007 14696.30 701.40 20.95 8762.49 1280.59 6.84 2008 17891.60 1038.00 17.24 10118.87 1532.24 6.60 2009 20530.10 902.30 22.75 15522.55 2126.47 7.30 Average 15.16 9.30 SD 2.98 1.78 COV 19.65 19.13

Source: - Computed with the help of Statistics Data taken from the CMIE database PROWESS from 2000 to 2009

CH-IV-2 Diagram depicting Stock Turnover Ratio of MSIL & HMIL


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Interpretation

MSIL: - During the time of study the Stock Turnover Ratio of MSIL varied in a range

of 15.16 times, the lowest being 7.06 times in 2000, while the highest ratio was 20.95

times in 2007.In MSIL during the period of study from 1999 to 2009 the inventory

turnover ratio indicated a rising trend except 2005, 2006 and 2008. This shows

efficient management of inventories in the company. Efficient management of

inventories shows effective utilization of inventory in the management. It shows that

the company does not face any problem in financing its inventory because of the

frequently sale of inventory.

HMIL: - During the time of study the Stock Turnover Ratio of HMIL varied in a

range of 9.30 times, the lowest being 6.60 times in 2008, while the highest ratio was

12.15 times in 2003.The higher ratio indicates better utilization of inventory in this

company. C.V (19.13) shows consistency in the Stock Turnover Ratio of the

company. From the year 2000 to 2003 there is fluctuation in the Stock Turnover Ratio

of the company after this from the year 2004 to 2008 there was decreasing trend in

stock turnover ratio of the company which shows that inventory was not being used in

proper way. Low Stock Turnover Ratio can be the result of so many factors i.e. stock

accumulation, slow movement of goods and more funds invested in the inventory of

the company.

On overall, STR of MSIL can be said satisfactory but STR of HMIL can’t be said

satisfactory due to its decreasing trend during the study period.


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4.2(3) Debtors Turnover Ratio or Accounts Receivable Turnover

Ratio: Debtor’s turnover ratio indicates the relation between net credit sales and

average account receivables of the year. This ratio is also known as Debtors

Velocity.3

It shows the number of times the debtors are turned over a year. The higher the value

of debtor’s turnover the more efficient is the management of debtors or more liquid

the debtors are. Similarly, low debtors turnover ratio implies inefficient management

of debtors or less liquid debtors.

It is the reliable measure of the time of cash flow from credit sales. There is no rule of

thumb which may be used as a norm to interpret the ratio as it may be different from

firm to firm. The formula is: - Debtor’s Turnover Ratio: - Net credit sales/ Average

accounts receivables

The Debtors / Receivable Turnover ratio when calculated in terms of days is known

as Average Collection Period or Debtors Collection Period Ratio. The

average collection period ratio represents the average number of days for which a

firm has to wait before its debtors are converted into cash.

This ratio measures the quality of debtors. A short collection period implies prompt

payment by debtors. It reduces the chances of bad debts. Similarly, a longer

collection period implies too liberal and inefficient credit collection performance.

3 Pyle, William W. White, John A. and Larson, Kermit D: “Fundamental Accounting Principles” (Richard D. Irwin, Inc, Home wood, Illinois, Ed. 1978, P.15)


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Table No. IV-3 (Figures in Crore) Debtors Turnover Ratio of MSIL & HMIL (In No. of Times)

MSIL HMIL Year NS AD DTR NS AD DTR 2000 6989.50 466.30 14.99 1671.48 2.06 811.40 2001 6716.90 675.50 9.94 2202.47 19.71 111.74 2002 7074.60 839.30 8.43 2609.97 101.27 25.77 2003 7180.10 671.10 10.70 3085.14 54.79 56.31 2004 9104.40 689.40 13.21 4800.48 114.76 41.83 2005 10923.80 599.50 18.22 6305.90 306.34 20.58 2006 12015.90 646.10 18.60 7339.14 224.88 32.64 2007 14696.30 747.40 19.66 8762.49 431.06 20.33 2008 17891.60 655.50 27.29 10118.87 842.99 12.00 2009 20530.10 918.90 22.34 15522.55 1915.04 8.11 Average 16.34 114.07 SD 3.12 16.70 COV 19.10 14.64


CH-IV-3 Diagram depicting Debtors Turnover Ratio of MSIL & HMIL


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Interpretation MSIL: - During the time of study the Debtors Turnover Ratio of MSIL varied in a


27.29 times in 2008. During the period form 2000 to 2002 there is decreasing trend in

the Debtors Turnover Ratio of the company which shows the company’s inefficiency

in collecting money from its debtors, after that from the year 2003 to 2008 Debtors’

Turnover Ratio shows an increasing trend. Again in the year 2009 it was lower as

compared to the year 2008. High Debtors Turnover Ratio of the company indicates

that the company is more efficient in the collection of money from its debtors.

Overall it shows the efficient management of debtors in the company.

HMIL: - During the time of study the Debtors Turnover Ratio of HMIL varied in a

range of 114.07 times, the lowest being 8.11 times in 2009, while the highest ratio

was 811.40 times in 2000. Highest debtor’s turnover ratio indicates the efficient

management of debtors; Fluctuating trend can be observed during the study period of

the company. Except 2003 and 2006 there is a decreasing trend can be seen in the

Debtors Turnover Ratio of the company. C.V (14.64) consistency in the debtors

turnover ratio of the company.

Overall, DTR of MSIL can be said satisfactory during the study period, it shows

effective utilization of management in the collection of money from its debtors,

whereas the DTR of HMIL in comparison to MSIL can not be satisfactory because

decreasing trend was observed during the study period.


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4.1(4) Working Capital Turnover Ratio:-

Working capital turnover ratio establishes a relationship between net sales and

working capital. It is also referred to as net sales to working capital. It indicates

company effectiveness in using its working capital.

A company uses working capital (current assets - current liabilities) to fund

operations and purchase inventory. These operations and inventory are then converted

into sales revenue for the company. The working capital turnover ratio is used to

analyze the relationship between the money used to fund operations and the sales

generated from these operations. In a general sense, the higher the working capital

turnover, the better because it means that the company is generating a lot of sales

compared to the money it uses to fund the sales.4

The working capital turnover ratio measures the efficiency with which the working

capital is being used by a firm. A high ratio indicates efficient utilization of working

capital and a low ratio indicates otherwise. But a very high working capital turnover

ratio may also mean lack of sufficient working capital which is not a good situation. It

can be a sign of over trading and puts the firm in financial difficulties.

Working capital measures how much in liquid assets a company has available to build

its business. The number can be positive or negative, depending on how

much debt the company is carrying. In general, companies that have a lot of working

capital will be more successful since they can expand and improve their operations.

Companies with negative working capital may lack the funds necessary for growth.

The formula is: - Working Capital Turnover Ratio: - Sales or Cost of Goods

Sold/ Net Working Capital

4 Brandit L. Business Finance:“Management Approach”, (Prentice Hall, Inc, Englewood Cliffs, New Jersey, Ed. 1966, P. 353)


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Working Capital Turnover Ratio of MSIL & HMIL (In No. of Times)

MSIL HMIL Year NS WC WCTR NS WC WCTR 2000 6989.50 598.60 11.68 1671.48 216.89 7.71 2001 6716.90 984.90 6.82 2202.47 238.49 9.24 2002 7074.60 644.80 10.97 2609.97 391.78 6.66 2003 7180.10 1304.20 5.51 3085.14 488.74 6.31 2004 9104.40 487.10 18.69 4800.48 305.39 15.72 2005 10923.80 1364.00 8.01 6305.90 481.19 13.10 2006 12015.90 1763.80 6.81 7339.14 860.24 8.53 2007 14696.30 1332.60 11.03 8762.49 991.58 8.84 2008 17891.60 272.20 65.73 10118.87 1635.79 6.19 2009 20530.10 2093.50 9.81 15522.55 2536.21 6.12 Average 15.51 8.84 SD 4.62 2.14 COV 29.80 24.20


CH-IV-4 Diagram depicting Working Capital Turnover Ratio of MSIL & HMIL


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Interpretation

MSIL: - During the time of study the Working Capital Turnover Ratio of MSIL

varied in a range of 15.51 times, the lowest being 5.51 times in 2003, while the

highest ratio was 65.73 times in 2008.During the period of study the working capital

turnover ratio registered a fluctuating trend, in the year 2008 one of the most

important observations is that it was 65.73 and a very high Working Capital Turnover

Ratio is also not a good situation for any firm. It can be the sing of over trading for

any firm. It is evident from the table that there is fluctuation in the Working Capital

Turnover Ratio of the company. C.V. (29.80) shows consistency in the Working

Capital Turnover Ratio of the company.

HMIL: - During the time of study the Working Capital Turnover Ratio of HMIL

varied in a range of 8.84 times, the lowest being 6.12 times in 2009, while the highest

ratio was 15.72 times in 2004. Working Capital Turnover Ratio indicates the effective

utilization of working capital in the firm. In 2005 there can be seen a decreasing trend

in comparison to its previous year. From 2006 to 2009 there is consistency in the

Working Capital Turnover Ratio of the company. In comparison to the ratio of MSIL

the ratio of HMIL is lower which shows less utilization of working capital in the

management.

On an average, fluctuation trend can be seen in the ratio of MSIL, but while observing

the ratio of HMIL consistency was found during the study period. Fluctuating trend

can be the signal of not effective utilization of working capital in the company while

consistency indicates that the company is well enough to handle its working capital

requirement.


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4.1(5) Sales Efficiency Ratio: - This ratio explains per rupee profit generating

capacity of the sales. This ratio is main component of the ROI; it can be measured

with the help of net profit and net sales. If higher is the net profit per rupee of sales,

higher will be the sales efficiency, if lower is the net profit per rupee of sales, lower

will be the sales efficiency.

The formula is:-

Sales efficiency ratio: - Net profit/ Net sales

4.1(6) Assets Turnover Ratio:-This is also the main component of ROI. This

ratio measures the efficiency of the assets use. The efficient use of assets will

generate greater sales per rupee invested in all assets of the company. The inefficient

use of the assets will result in low sales volume coupled with higher overhead charges

and under utilization of the available capacity. The management must strive for using

of total resources at optimum level, to achieve higher ROI.

The formula is:-

Assets turnover ratio:-Net sales/ Total Net Assets


Sales Efficiency Ratio of MSIL & HMIL (In No. of Times)

MSIL HMIL Year NP NS SER NP NS SER 2000 2502.80 6989.50 0.36 0.00 1671.48 0.00 2001 2233.20 6716.90 0.33 0.00 2202.47 0.00 2002 2269.90 7074.60 0.32 0.00 2609.97 0.00 2003 2335.90 7180.10 0.33 0.00 3085.14 0.00 2004 2757.40 9104.40 0.30 0.00 4800.48 0.00 2005 3442.10 10923.80 0.32 654.98 6305.90 0.10 2006 4393.90 12015.90 0.37 1180.08 7339.14 0.16 2007 5637.30 14696.30 0.38 1646.82 8762.49 0.19 2008 7025.70 17891.60 0.39 2157.45 10118.87 0.21 2009 8004.20 20530.10 0.39 2200.70 15522.55 0.14 Average 0.35 0.08


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Interpretation MSIL: - During the time of study the Sales Efficiency Ratio of MSIL varied in a range of 0.35 times, the lowest being 0.30 times in 2004, while the highest ratio was 0.39 times in 2008 and 2009.From the year 2004 to 2009 there was an increasing trend in the sales efficiency ratio of the company which shows the higher profit generating capacity from the sales.

HMIL:-During the time of study the Sales Efficiency Ratio of HMIL varied in a range of 0.08 times, the lowest being 0.14 times in 2009, while the highest ratio was 0.21 times in 2008.From the year 2000 to 2004 the ratio was NIL after that if started increasing.


Assets Turnover Ratio of MSIL & HMIL (In No. of Times)


Interpretation MSIL: - During the time of study the Assets Turnover Ratio of MSIL varied in a range of 2.07 times, the lowest being 1.79 times in 2001, while the highest ratio was 2.33 times in 2004 and 2005. From the year 2005 to 2008 there was decreasing trend in this ratio but in the next year in 2009 it showed increasing trend.

HMIL:-During the time of study the Assets Turnover Ratio of HMIL varied in a range of 2.00 times, the lowest being 1.05 times in 2000, while the highest ratio was 3.24 times in 2005.During the study period assets turnover ratio showed fluctuating trend, it shows a mixed trend.

MSIL HMIL Year NS NTA ATR NS NTA ATR 2000 6989.50 3458.20 2.02 1671.48 1594.04 1.05 2001 6716.90 3754.60 1.79 2202.47 1670.82 1.32 2002 7074.60 3363.30 2.10 2609.97 1759.96 1.48 2003 7180.10 3554.00 2.02 3085.14 1592.47 1.94 2004 9104.40 3903.10 2.33 4800.48 1858.30 2.58 2005 10923.80 4686.40 2.33 6305.90 1948.01 3.24 2006 12015.90 5524.30 2.18 7339.14 2576.97 2.85 2007 14696.30 7480.70 1.96 8762.49 4411.43 1.99 2008 17891.60 9315.60 1.92 10118.87 6137.11 1.43 2009 20530.10 10043.80 2.04 15522.55 7274.59 2.13 Average 2.07 2.00


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4.1(7) Creditors Turnover Ratio/Accounts Payable Turnover Ratio: -

This ratio is similar to the debtor’s turnover ratio. It compares creditors with the total

credit purchases. It signifies the credit period enjoyed by the firm in paying creditors.

Accounts payable include both sundry creditors and bills payable. Same as debtor’s

turnover ratio, creditor’s turnover ratio can be calculated in two

forms, creditors’ turnover ratio and average payment period.

This ratio indicates the speed with which the trade creditors/suppliers are paid. A low

turnover ratio reflects liberal credit terms generated by the suppliers, while a high

ratio indicates settlement to creditors rapidly.5

This ratio determines the financial stability of the company with a good accuracy. A

high creditor’s turnover ratio signifies that creditors are being promptly. The situation

enhances the credit worthiness of the company. It signals that the company produces

cash fast. If this is low, it suggests that the company is in serious cash trouble. Creditors Turnover ratio is used to measure the length of time that is needed for a

company to repay its liability (Suppliers). The main purpose of this is to measure

short term liability, as suppliers allows usually 30-90 business days, however this

period is dependent on many factors, such as industry norms, relative size of the

supplier to that company and the financial condition of the supplier.

The ratio is workout as under:-

Creditor Turnover Ratio: - Net Credit Purchase or Total Purchase/

Average Creditors & Bills Payable

5 Bringham, E.F.: “Fundamentals of Financial Management”, (The Dryden Press, Hinsdale, Illionois, Ed. 1987, P. 168)


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Creditors Turnover Ratio of MSIL & HMIL (In No. of Times)

MSIL HMIL Year NP AC&BP CTR NP AC&BP CTR 2000 5616.10 443.80 12.65 1247.03 120.96 10.31 2001 5889.80 376.80 15.63 1582.83 122.44 12.95 2002 5839.60 477.50 12.23 1849.59 205.14 9.02 2003 5563.40 619.60 8.98 2191.16 318.66 6.88 2004 6973.30 405.00 17.22 3531.86 674.29 5.24 2005 8563.20 463.70 18.47 4931.09 739.55 6.67 2006 9335.60 555.10 16.82 5678.32 872.26 6.51 2007 10739.00 909.60 11.81 6941.66 1260.95 5.51 2008 13791.50 1696.20 8.13 8234.49 1932.28 4.26 2009 15763.10 2569.60 6.13 13118.60 2655.35 4.94 Average 12.81 7.23 SD 2.60 3.04 COV 20.30 42.05


CH-IV-5 Diagram depicting Creditors Turnover Ratio of MSIL & HMIL


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Interpretation

MSIL: - During the time of study the Creditor’s Turnover Ratio of MSIL varied in a


18.47 times in 2005. A very High Creditors Turnover Ratio indicates that creditors

are paid rapidly, which means that the suppliers have provided a short period of time

for the repayment of goods supplied by them. After 2005 there can be seen a

decreasing trend in the creditors turnover ratio of the company which indicates the

liberal period provided by the suppliers. It means that the company does not have to

face any problems in the repayment of its suppliers during the study period.

HMIL: - During the time of study period from 2000 to 2009 the Creditors Turnover

Ratio of HMIL varied in a range of 12.95 times, the lowest being 4.26 times in 2008,

while the highest ratio was 7.23 times in 2001. It is evident from the table that there is

fluctuation in the Creditors Turnover Ratio of the company. On an average it is lower

in comparison to the Creditor’s Turnover Ratio of MSIL. From the year 2003 to 2007

the Creditors Turnover Ratio of the company is around 5-6 times. In comparison to

the Creditors Turnover Ratio of MSIL it is always lower which indicates the liberal

period provided by the suppliers. It shows that this company also does not face any

problems in the payment of its suppliers.

On an overall a satisfactory creditor’s turnover ratio can be said for both the company

which means that both the companies get an easy period of time span in the payment

of its creditors.


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4.2 Leverage Analysis of MSIL & HMIL: - The leverage ratios explains

the extent to which, the debt is employed in capital structure of the companies. Companies want to use debt fund along with equity funds, in order to maximize the profit after tax, earning available for equity shareholders. To analyze the leverage position of the companies, we have made using the following ratios:-

4.2(1) Capital Gearing Ratio:- Capital gearing ratio is mainly used to analyze the capital structure of a company. The term "capital gearing" or "leverage" normally refers to the proportion of relationship between equity share capital including reserves and surpluses to preference share capital and other fixed interest bearing funds or loans.

It shows the relationship between owner’s funds and non owner’s funds. This proportion is known as leverage. If this ratio is high, the capital gearing is said to be high, if this is low, the capital gearing is said to be low. Further high gearing means trading on thick equity and low gearing means trading on thin equity. High geared capital structure may be indicator of under capitalization and low geared capital structure indicates over capitalization.6

Capital gearing ratio is important to the company and the prospective investors. It must be carefully planned as it affects the company's capacity to maintain a uniform dividend policy during difficult trading periods. It reveals the suitability of company's capitalization.

The formula is:- Capital Gearing Ratio:-Equity Share Capital +P&L balance+ Reserves/ Fixed Cost bearing Capital whereas Fixed Cost bearing Capital means

Preference Share Capital+ Debentures+ Long Term Loans

The capital gearing reveals:-Equity Capital=Loan Capital=Even Gear Equity Capital is more than Loan Capital=Low Gear=Over Capitalization Equity Capital is less than Loan Capital=High Gear=Under Capitalization

6“Bierman Managerial Accounting”, (Machmillan, N.Y. 1959, P.232)


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Though it is difficult to determine a standard capital gearing ratio, according to Securities and Exchange Board of India (SEBI), a ratio of 1:4 between equity and preference capital is considered reasonable.


Capital Gearing Ratio of MSIL & HMIL (In No. of Times)

MSIL HMIL Year Esc+Res

+Pl+Sp Psc+LTL+Deb

CGR Esc+Res+Pl+Sp

Psc+LTL+Deb

CGR

2000 2912.10 546.10 5.33 816.45 777.64 1.05 2001 2642.50 1112.10 2.38 988.41 682.41 1.45 2002 2707.30 656.00 4.13 1142.14 617.82 1.85 2003 3098.00 456.00 6.79 1020.93 571.54 1.79 2004 3591.20 311.90 11.51 1261.97 596.33 2.12 2005 4378.80 307.60 14.24 1529.92 418.09 3.66 2006 5452.60 71.70 76.05 2055.02 521.95 3.94 2007 6853.90 630.80 10.87 2521.76 1889.67 1.33 2008 8415.40 900.20 9.35 3032.39 3104.72 0.98 2009 9344.90 698.90 13.37 3051.67 4222.92 0.72 Average 15.40 1.89 SD 4.92 1.27 COV 31.95 67.20


CH-IV-6 Diagram depicting Capital Coverage Ratio of MSIL & HMIL


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Interpretation MSIL: - During the time of study the Capital Gearing Ratio of MSIL varied in a


76.05 times in 2006. In 2001, the CGR of MSIL was much lower in comparison to its

previous year which indicates the over utilization of capital structure of the company.

From the year 2002 to 2006 there was an increasing trend in this ratio. In 2007 and

2008 also low CGR was observed which was the result of over utilization of the

company. But in the very next year in 2009 the ratio increased in comparison to its

previous year which indicates the under utilization of capital structure of the

company. C.V. (31.95) shows consistency in the capital gearing ratio of the company.

HMIL: - During the time of study the Capital Gearing Ratio of HMIL varied in a


3.94 times in 2006.From the year 2000 to 2006 except 2003 there was an increasing

trend in this ratio after that it started decreasing. After that there is a sharp decline in

the CGR of HMIL in the year 2007, 2008 and 2009.

Overall CGR of MSIL can be said satisfactory in all the years in comparison to CGR

of HMIL which is below the recommended value of 1:4 in 2000 and from 2007 to

2009.


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4.2(2) Debt-Equity Ratio:-

Debt to equity ratio indicates the proportionate claims of owners and the outsiders

against the firm’s assets. The purpose is to get an idea of the cushion available to

outsiders on the liquidation of the firm. It is a very significant factor for measuring the

long term solvency position of the concern. It shows the favorable or unfavorable

position of the concern. The low ratio is viewed as favorable and high ratio is viewed

as unfavorable.

However, the interpretation of the ratio depends upon the financial and business

policy of the company. The owners want to do the business with maximum of

outsider's funds in order to take lesser risk of their investment and to increase their

earnings (per share) by paying a lower fixed rate of interest to outsiders. The outsiders

(creditors) on the other hand, want that shareholders (owners) should invest and risk

their share of proportionate investments.

A ratio of 1:1 is usually considered to be satisfactory ratio although there cannot be

rule of thumb or standard norm for all types of businesses. Some business says

financial institutions favors high ratio of 2:1.7 Theoretically if the owner’s interests

are greater than that of creditors, the financial position is highly solvent. In analysis of

the long-term financial position it enjoys the same importance as the current ratio in

the analysis of the short-term financial position.

The formula is:-Debt-Equity Ratio:-Long Term Debt/ Shareholder Funds+

Long Term Debt

7 Lerner, Eugene M.: “Readings in Financial Analysis and Investment Management”, (First Edition, 1963, Richard D. Irwin, Inc, Homewood Illinois, P. 7.)


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Debt-Equity Ratio of MSIL & HMIL (In No. of Times)

MSIL HMIL Year Debt Equity DER Debt Equity DER 2000 546.10 2912.10 0.19 774.64 816.45 0.95 2001 1112.10 2642.50 0.42 682.41 988.41 0.69 2002 656.00 2707.30 0.24 617.82 1142.14 0.54 2003 456.00 3098.00 0.15 571.54 1020.93 0.56 2004 311.90 3591.20 0.09 596.33 1261.97 0.47 2005 307.60 4378.80 0.07 418.09 1529.92 0.27 2006 71.70 5452.60 0.01 521.95 2055.02 0.25 2007 630.80 6853.90 0.09 1889.67 2521.76 0.75 2008 900.20 8415.40 0.11 3104.72 3032.39 1.02 2009 698.90 9344.90 0.07 4222.92 3051.67 1.38 Average 0.14 0.69 SD 0.41 0.73 COV 284.34 105.79


CH-IV-7 Diagram depicting Debt Equity Ratio of MSIL & HMIL


136

Interpretation

MSIL: - During the time of study the Debt Equity Ratio of MSIL varied in a range of

0.14 times, the lowest being 0.01 times in 2006, while the highest ratio was 0.42 times

in 2001.It measures the extent of equity covering the debt. Normally 2:1 debt equity

ratio is considered to be standard. In all the years during the study period debt equity

ratio registered lower than 2:1 which is a good situation for any company, it means

the company is not highly dependent on the debt for its capital requirement. Less debt

equity ratio indicates conservative’s approach of financial management and high debt

equity ratio shows moderate approach of financing of organization need.

HMIL:-During the time of study the Debt Equity Ratio of HMIL varied in a range of


in 2009. In all the years during the study period the DER was observed less than 2:1,

which indicates that the HMIL is not much dependent on external sources for its long

term cash requirement. Except 2008 and 2009 it was less than even 1, which can be

said a very good signal for any company because it shows that the company is

capable enough to manage its cash requirement in long term future.

Overall, DER of both the companies can be said satisfactory during the study period

which indicates that companies are less dependent on external sources for their cash

requirement. In all the years DER was observed less than 2:1, which can be said a

good signal for any company because it indicates that the companies use internal

sources for meeting their capital requirement.


137

4.2(3) Interest Coverage Ratio or Debt Service Ratio:-

This ratio relates the fixed interest charges to the income earned by the business. It

indicates whether the business has earned sufficient profits to pay periodically the

interest charges. The Interest Coverage Ratio is very important from the lender's

point of view. It indicates the number of times interest is covered by the profits

available to pay interest charges. It indicates the extent of which earnings are

available to meet interest payments. It is an indicator of company’s safety margin

when deciding if the business is good credit risk.

It is an index of the financial strength of an enterprise. A high debt service ratio or

interest coverage ratio assures the lenders a regular and periodical interest income.

But the weakness of the ratio may create some problems to the financial manager in

raising funds from debt sources. A higher ratio indicates a better financial health as it

means that the company is more capable to meeting its interest obligations from

operating earnings.

The lower the ratio, the more the company is burdened by debt expense. When a

company's interest coverage ratio is 1.5 or lower, its ability to meet interest expenses

may be questionable. An interest coverage ratio below 1 indicates the company is not

generating sufficient revenues to satisfy interest expenses.8 The Company would then

have to either use cash on hand to make up the difference or borrow funds.

The formula is:-Interest Coverage Ratio: - Net Profit before Interest &

Taxes/ Interest on Long Term Loan & Debentures

8 Korn, S. Winton and Boyd, Thomas, “Accounting for Management Planning and Decision Making”,(Jojn Willedy and Sons, Inc, New York, 1969, P. 143.)


138


Interest Coverage Ratio of MSIL & HMIL (In No. of Times)

Source: - Computed with the help of Statistics Data taken from the CMIE database PROWESS from 2000 to 2009 CH-IV-8 Diagram depicting Interest Coverage Ratio of MSIL & HMIL

MSIL HMIL

Year NPBIT Int.on LTL +Deb

ICR NPBIT Int.on LTL +Deb

ICR

2000 445.30 60.20 7.40 136.04 68.43 1.99 2001 -193.30 75.90 0.00 247.34 59.38 4.17 2002 195.30 77.00 2.54 329.51 32.81 10.04 2003 334.80 52.70 6.35 274.03 16.82 16.29 2004 813.20 43.40 18.74 586.83 14.71 39.89 2005 1340.90 36.00 37.25 624.32 13.21 47.26 2006 1770.40 20.40 86.78 808.23 3.55 241.26 2007 2317.40 37.60 61.63 728.91 14.06 51.84 2008 2562.60 59.60 43.00 795.25 75.89 10.48 2009 1726.80 51.00 33.86 532.19 226.51 2.35 Average 33.06 42.56 SD 6.78 9.22 COV 20.51 21.66


139

Interpretation

MSIL: - During the time of study the Interest Coverage Ratio of MSIL varied in a


86.78 times in 2006.Highest interest coverage ratio shows that the company can pay

its loan amount and interest on time and lowest interest coverage ratio shows the

inefficiency to pay off company’s interest on time. In 2001 the company’s interest

coverage ratio was lower (0.00), it shows the inability of the company to pay its

interest on loan on time. On an average it seems satisfactory level of the company to

pay off its interest on loan on time.

HMIL:-During the time of study the Interest Coverage Ratio of HMIL varied in a


241.26 times in 2006.In the years 2007, 2008 and 2009 there can be observed a

declining trend in this ratio. Otherwise, in all the years a satisfactory ratio (>1) was

observed which can be a good signal of the company’s capacity to repay its loan

amount and interest their on. A low ICR can not be said satisfactory for any company

because it shows the inability to repay the loan amount and interest.

Overall, ICR or KR can be said satisfactory of both the companies because it was

observed more than 1:1 in all the years during the study period from the years 2000 to

2009. It indicates that both the companies are capable enough to repay its loan

amount as well as interest amount on times. Less than 1:1 can be a bad signal for any

company because it indicates the inability to repay the loan amount and interest

amount on time.


140

4.2(4) Debt to Total Funds Ratio

This ratio gives same indication as the debt equity as this is a variation of debt equity

ratio. This ratio is also known as solvency ratio. This is a ratio between long term debt

and total long term funds. It shows the proportion of long term funds, which have

been raised by way of loans. It measures the long term financial position and

soundness of long term financial policies. It is also known as Debt to Capital Ratio. It

is a measurement of company financial leverage, calculated as the company’s debt

divided by its total capital.

The debt-to-capital ratio gives users an idea of a company's financial structure, or

how it is financing its operations, along with some insight into its financial

strength. The higher the debt-to-capital ratio, the more debt the company has

compared to its equity. This tells investors whether a company is more prone to using

debt financing or equity financing.

In India debt to total funds ratio of 2:3 or 0.67 is considered satisfactory. A higher

proportion is not considered good and treated an indicator of risky long term financial

position of the business. It indicates that business depends too much upon outsider’s

loans.9

The formula is:

Debt to Total Funds Ratio: - Debt/Debt+ Shareholder Funds

9 Wessel, Robert, H.: “Principles of Financial Analysis”, (Macmillan N.Y.1961, P.29)


141


Debt to Total Funds Ratio of MSIL & HMIL (In No. of Times)


CH-IV-9 Diagram depicting Debt to Total Funds Ratio of MSIL & HMIL

MSIL HMIL Year Debt Debt+Sh

fund DFR Debt Debt+Sh

fund DFR

2000 546.10 3458.20 0.16 774.64 1594.09 0.49 2001 1112.10 3754.60 0.30 682.41 1670.82 0.41 2002 656.00 3363.30 0.20 617.82 1759.96 0.35 2003 456.00 3554.00 0.13 571.54 1592.47 0.36 2004 311.90 3903.10 0.08 596.33 1858.30 0.32 2005 307.60 4686.40 0.07 418.09 1948.01 0.21 2006 71.70 5524.30 0.01 521.95 2576.97 0.20 2007 630.80 7484.70 0.08 1889.67 4411.43 0.43 2008 900.20 9315.60 0.10 3104.72 6137.11 0.51 2009 698.90 10043.60 0.07 4222.92 7274.59 0.58 Average 0.12 0.39 SD 0.36 0.43 COV 303.42 111.43


142

Interpretation

MSIL: - During the time of study the Debt to Total Funds Ratio of MSIL varied in a


0.30 times in 2001.It measures the extent of equity covering the debt. Normally

0.67:1 debt to total funds ratio is considered to be standard. In all the years during the

study period debt to total funds ratio registered lower than 0.67 which is a good

situation for any company, it means the company is not highly dependent on the debt

for its capital requirement.

HMIL:-During the time of study the Debt to Total Funds Ratio of HMIL varied in a


0.58 times in 2009.A decreasing trend can be seen in this ratio from the year 2001 to

2006.After that it started increasing in the years 2007, 2008 and 2009. In all the years

during the study period from 2000 to 2009 the ratio was registered less than 0.67:1,

which can be a good signal of the long term solvency position of the company

because it means that the company has less debts in comparison to its owner funds or

it other words it can be said that the company has more owner funds in comparison to

its borrowed funds.

Overall, DTFR of both the companies can be said satisfactory which indicates that the

companies have more owner funds in comparison to its borrowed funds and the

companies are less dependent on outsiders funds.


143

4.2(5) Proprietary Ratio/Equity Ratio

This is a variant of the debt-to-equity ratio. It is also known as Equity Ratio or Net

Worth to Total Assets Ratio. This ratio relates the shareholder's funds to total

assets. Proprietary / Equity Ratio indicates the long-term or future solvency position

of the business.10This ratio throws light on the general financial strength of the

company. It is also regarded as a test of the soundness of the capital structure.

Higher the ratio or the share of shareholders in the total capital of the company better

is the long-term solvency position of the company. The higher this Proprietary Ratio

denotes that the shareholders have provided the funds to purchase the assets of the

concern instead of relying on other sources of funds like bank borrowings, trade

creditors and others. A low proprietary ratio will include greater risk to the creditors.

This may be further analyzed in the following ratio: - Fixed Assets to Proprietor’s

Funds.

The formula to calculate Proprietary Ratio is:-

Proprietary Ratio: - Proprietor’s Funds/ Proprietor’s Funds+ Debt or Total

Assets

This ratio indicates the general financial position of the business concern. The ratio

has a great importance for the creditors who can ascertain the proportion of the

shareholders funds in the total assets of the business. Higher the ratio, greater the

satisfaction for all types of creditors. It can be used as an indication of how much

security is available to unsecured creditors in the event of company ceasing of trade.

10 Block, Stanley B. and Hirt, Geofforey A., “Foundations of Financial Management” (Richard Q. Irwin, Inc, Homewood, Illinois Ed. 1978, P. 28)


144


Proprietary Ratio of MSIL & HMIL (In No. of Times)


CH-IV-10 Diagram depicting Proprietary Ratio of MSIL & HMIL

MSIL HMIL Year Equity Equity+Debt PR Equity Equity+Debt PR 2000 2912.10 3458.20 0.84 816.45 1594.09 0.51 2001 2642.50 3754.60 0.70 988.41 1670.82 0.66 2002 2707.30 3363.30 0.80 1142.14 1759.96 0.65 2003 3098.00 3554.00 0.87 1020.93 1592.47 0.64 2004 3591.20 3903.10 0.92 1261.97 1858.30 0.68 2005 4378.80 4686.40 0.93 1529.92 1948.01 0.79 2006 5452.60 5524.30 0.99 2055.02 2576.97 0.80 2007 6853.90 7484.70 0.92 2521.76 4411.43 0.57 2008 8415.40 9315.60 0.90 3032.39 6137.11 0.49 2009 9344.90 10043.60 0.93 3051.67 7274.59 0.42 Average 0.88 0.62 SD 0.34 0.43 COV 38.58 69.24


145

Interpretation

MSIL: - During the time of study the Proprietary Ratio of MSIL varied in a range of


in 2006. Normally 0.33:1 Proprietary ratio is considered to be standard. In all the

years during the study period Proprietary ratio registered more than 0.33 which is a

good situation for any company, it means the company is not highly dependent on the

debt for its capital requirement. Because higher PR indicates the security available to

the creditors of the company out of proprietor funds of the company and lower PR is a

signal of greater risk to the creditors.

HMIL:-During the time of study the Proprietary Ratio of HMIL varied in a range of


in 2006. In all the years during the study period from 2000 to 2009 PR was registered

more than 0.33:1, which can be said a good signal for the company. In the year 2008

and 2009 decreasing trend can be observed during the study period in comparison to

its previous years, in 2007 it was 0.80 which came down to 0.42 in the year 2009. It

can not be said a good signal of the soundness of capital structure of the company

because it means that the company has to depend more upon its outsiders for meeting

its capital requirement.

Overall, PR of both the companies can be said satisfactory because in all the years

during the study period from the years 2000 to 2009 it was registered more than 0.33

which is a good sign for the long term solvency position of the companies.


146

4.2(6) Fixed Assets to Proprietor’s Fund Ratio:-It establishes the

relationship between fixed assets and the shareholders funds. The ratio of fixed

assets to net worth indicates the extent to which shareholder's funds are sunk into

the fixed assets. Generally, the purchase of fixed assets should be financed by

shareholder's equity including reserves, surpluses and retained earnings.

If the ratio is less than 100%, it implies that owner’s funds are more than fixed

assets and a part of the working capital is provided by the shareholders. When the

ratio is more than the 100%, it implies that owner’s funds are not sufficient to finance

the fixed assets and the firm has to depend upon outsiders to finance the fixed assets.

There is no rule of thumb to interpret this ratio by 60 to 65 percent is considered to be

a satisfactory ratio in case of industrial undertakings. 11


Fixed Assets to Proprietor Fund of MSIL & HMIL (In No. of Times)

Source: - Computed with the help of Statistics Data taken from the CMIE database PROWESS from 2000 to 2009 11 Philips Toyley: “Balance Sheets-How to Read and Understand Them”, (Pitam London, 1934, P.5.)

MSIL HMIL Year FA PF FPF FA PF FPF 2000 2175.70 2912.10 0.75 1372.82 816.45 1.68 2001 2247.10 2642.50 0.85 1321.14 988.41 1.34 2002 2430.10 2707.30 0.90 1199.11 1142.14 1.05 2003 2255.70 3098.00 0.73 1263.63 1020.93 1.24 2004 1830.80 3591.20 0.51 1709.84 1261.97 1.35 2005 1873.70 4378.80 0.43 1680.24 1529.92 1.10 2006 1695.20 5452.60 0.31 1736.15 2055.02 0.84 2007 2659.70 6853.90 0.39 1748.63 2521.76 0.69 2008 3296.50 8415.40 0.39 3440.50 3032.39 1.13 2009 4070.80 9344.90 0.44 3051.67 3051.67 1.55 Average 0.57 1.20 SD 0.61 0.68 COV 107.26 56.77


147

CH-IV-11 Diagram depicting Fixed Assets to Proprietor Fund of MSIL& HMIL

Interpretation

MSIL: - During the time of study the Fixed Assets to Proprietor Fund of MSIL


ratio was 0.99 times in 2006. From the year 2000 to 2003 the FAPF was registered

more than 0.65 but after that sharp decline was observed in the ratio. Which means

the company has to depend on the outsiders for because owners funds are not

sufficient to finance its fixed assets.

HMIL:-During the time of study the Fixed Assets to Proprietor Fund of HMIL


ratio was 0.80 times in 2006. In all the years during the study period Proprietary ratio

registered more than 0.65 which is a good signal of the soundness of any company.

Fluctuating trend can be observed in the FAPF of the company.


148

Summary: In the forth chapter we have discussed various ratios related to the

Efficiency and Leverage of the companies to know the efficiency & solvency position

of both the companies. FATR of MSIL from 2000-2004 and of HMIL except in

2003,2008 and 2009 was not around 5-6 times, it indicates the under utilization of

fixed assets in the companies. STR was of HMIL except in 2000 & 2001 was better in

comparison to MSIL. In the case of DTR except in 2008 & 2009 of HMIL was sound

as compared to MSIL.

In the next chapter we will try to evaluate the position of both the companies in the

market on the basis of some selected parameters. Growth Rate, Market

Capitalization, Average R&D expenditure, Cash flow and Sales will be taken into

study to know the market position of both the companies.

Documents

F Ashima Forth Chapter-114-148 36shodhganga.inflibnet.ac.in/bitstream/10603/27799/8/08_ chapter 4.pdf · 2 Welsch G.A. and Anthony, R.N.: “Fundamentals of Financial Accounting”,