PROJECT REPORT

ON

Highlights of 'Financial Management' In Public Sector

Undertakings

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CONTENTS

1. Introduction

2. Highlights of financial management in public sector undertakings

- Budgets in Public Sector

- Revised Budget

- Sources of Funds in Public Sector

- Role of Financial Advisor

- Capital Budgeting

- Working Capital Management

- Financial Delegation

- Financial Reporting

- Profitability of Central Public Sector Undertakings

3. Role of financial management in the reforming of psu’s

- Performance Evaluation in PSU's

- Valuation of Public Sector Undertaking

- Valuation Techniques

- Pricing in Acquisitions

- Disinvestment

4. SWOT analysis of financial management in psu’s

5. Conclusion

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INTRODUCTION

A public sector undertaking may be defined as a business

undertaking, which is owned managed and controlled by the

State, on behalf of public at large. These undertakings have come

to enjoy a unique position in the Indian economy in the post

independence era. They have been responsible for forming a strong

industrial base and providing the basic infrastructure for development

in the country. From an investment in 5 enterprises of Rs. 29 crores in

1950-51. Investment in 242 Central PSUs has gone up to a staggering

Rs. 2.04.054 crores, the net profit they made was just Rs. 13.725

crores -a return of 6.7 per cent only.

The implicit assumption in the growth of PSU at the early stages was

that public sector would perform the role of a pathfinder and create

necessary infrastructural facilities and not be over- concerned about

profits or surpluses. This however, subsequently, gave way to the view

that even as externalities are important in the same way, profitability

was also a useful guide and self- disciplinary measure.

In respect of the area and nature of job contained in Financial

Management, there is primarily no significant difference in a private

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sector or a public sector organisation. However, since the public sector

deals with and substantially relies on taxpayer’s money, the rules,

procedures and checks for accountability of this money are

comparatively more rigid than that in the private sector.

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HIGHLIGHTS OF 'FINANCIAL MANAGEMENT' IN PUBLIC

SECTOR UNDERTAKINGS

BUDGETS IN PUBLIC SECTOR

The budget exercise in public sector is carried out in a similar manner

as in the private sector. The Budget Section of the Accounts & Finance

Department is generally responsible for coordinating the budget

exercise, collecting data from all departments/divisions concerned and

finalizing the budget for presentation to the Board of Directors.

The budget is prepared on the basis of 'Zero based budgeting'

concept. In other words, every year the revenue and

expenditure, including capital expenditure, are estimated

without any reference to the past event or amount. To put it

differently, under 'Zero based budget' concept revenue and

expenditure are estimated from scratch or afresh based only on

targets set to be achieved during the ensuing year as broadly

determined by the Board of Directors or the Management Committee.

The budget approved by the Board of Directors forms the basis for all

expenditure and yardstick for revenue earning. No expenditure can be

incurred unless it is included in the budget. Similarly, the revenue

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target set in the budget needs to be achieved, which, at times, and in

many public- sector units, are not met. This happens primarily

because the production and revenue targets are not estimated

realistically.

Under such a situation, Financial Management in a public sector unit

attains a significant dimension. It is observed that there is a general

tendency of expenditure following the budgeted pattern (except

expenses directly varying with production or sales such as

consumption of raw material, overtime of workers, selling commission,

etc.) whereas revenue declines from the budgeted target. Thus,

mismatching of inflow and outflow is a paramount issue for a public

sector finance manager.

Ways of reducing mismatch between inflow and outflow

BALANCING: A possible remedy to such a syndrome would be

to keep the expenditure trend balanced with revenue. This could

be achieved through fortnightly or monthly reporting of budget

and actuals to all departmental heads. This reporting needs to

be supported by regular interaction between the Accounts &

Finance Manager and other departmental heads.

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REGULAR REPORTING: Another constructive approach would

be regular reporting and interaction with production and sales

personnel regarding adverse deviations from the budget so as to

find out a workable solution to minimize the deviation, if not

achieved the target.

SUBMISSION OF BUDGET VARIANCE REPORT: Over and

above these approaches, budget variance report is to be

regularly submitted to the top management for its review,

decision and corrective directions, where and when necessary.

REVISED BUDGET

In public sector units, there is a convention of preparing a

revised budget, if required, after expiry of the first two quarters or

three quarters of the financial year depending upon exigencies. The

logic behind this practice of preparing a Revised Budget during the

course of a financial year is that if any material change takes

place which could not have been envisaged at the time of

preparation of the Original Budget and which is bound to

affect the budgeted estimates and actual performance, such

changes are considered and the Original

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However, it is observed that in some public sector units, the Revised

Budget is prepared when the original targets do not become

achievable. This practice is not reckoned to be healthy in the sense

that it attempts to cover up the deficiency in preparing the Original

Budget, which incorporated targets perhaps without considering

realistically achievable levels. It is, therefore, to be kept in mind that

the practice of preparing the Revised Budget should be strictly

followed only when the situation would compel such an exercise and

not to be liberally pursued.

SOURCES OF FUNDS IN PUBLIC SECTOR

In any business, fund is essential. It is said that fund is the "lifeblood"

of a business. Like in the private sector, the sources of funds are more

or less the same in case of a public sector unit. For example, funds can

be obtained by a public sector unit through internal as well as external

sources which includes

1. issue of shares or debentures

2. loans from financial institutions,

3. cash credit from commercial banks,

4. deposits from public,

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5. intercorporate loans/deposits, and

6. raising funds from international financial market, besides

internal generations like retained earnings & depreciation etc.

In short public sector undertakings in general obtain funds from the

government in the form of equity and debt, except departmental

undertakings like Railways and State Electricity Board (SEB), which

receive funds from Government exclusively in the form of loan capital.

In PSE projects are financed on the basis of half of their capital being

in the shape of equity and the rest in the shape of loans. However, the

following factors are taken into consideration at the time of designing

capital structure

Gestation period

Level of business risk

Capital intensity of project and

Freedom of pricing.

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ROLE OF FINANCIAL ADVISOR

Financial Advisor occupies an important position in all, public sector

undertakings. He functions as the principle advisor to the chief

executive--of the, enterprise on all financial matters. The Committee

on public sector undertakings has specified, the following functions

and responsibilities of a financial adviser:

Determination of financial needs of the firm and the ways these

needs are to be met.

Formulation of a programme to provide most effective cost-

profit volume relationship.

Analysis of financial results of all operations and

recommendations concerning future operations.

Examination of feasibility studies and detailed project reports

from the point of view of overall economic viability of the

project.

Conduct of special studies with a view to reduce costs and

improve efficiency and profit- ability.

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CAPITAL BUDGETING

Plan support is provided towards meeting expenditure for capital

projects such as expansion, modernization, diversification, etc. In

order to secure funds from the government for this purpose, detailed

project report containing the cost of the project, estimated

profitability, pay back period, internal rate of return and socio-

economic benefits are to be furnished to the administrative Ministry

governing the public sector unit concerned. In approving the project or

capital expenditure of this type, the administrative ministry examines

the viability of the project, its need in the overall national/state

development plan, pay back and internal rate of return. The

administrative ministry also examines the sources of funding of the

proposed project.

Apart from plan and non-plan fund support, certain public sector units

can also obtain funds specifically for capital projects from agencies

established under the agencies of their respective administrative

Ministries for furtherance of business interests and area under the

administrative jurisdiction of these Ministries. For example, Oil

Industry Development Board (OIDB) has been set up by the Ministry of

Petroleum & Natural Gas for funding projects in areas of oil

exploration, refining and other oil related activities. In order to obtain

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funds from these agencies, it is mandatory to prepare and submit a

detailed project report approved by the administrative Minis- try

concerned. The project report should, ineralia, contain details of cost

of the project, proposed funding pattern, amount of fund required

from the agency, profitability projections, pay-back and internal rate

of return. Generally, funds provided by these agencies are at a

concessional rate of interest. This is an important factor since it

enables the unit to keep' its cost low.

Previously no guidelines or manuals were provided by the Central

Government. The Planning Commission or the administrative

Ministries of public sector undertakings, for the preparation of

feasibility reports and detailed project reports. However, now a

manual issued by the Planning Commission contains following

provisions in this respect.

The manual has suggested the use of various project evaluation

techniques like, return on investment, payback period, net

present value, internal rate of return risk & uncertainty

measurement, profitability index and techniques of PERT

(Programme evaluation and Review Technique), CPM (Critical

Path Method), SWOT (Strength, Weak-nesses Opportunities and

Threats) Analysis etc.

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It also suggested placing emphasis on the computation of net

present values to be computed at a specified discount rate from

time to time and at different discount rates, to be used for

different projects.

It suggests for an analysis of cost benefit factors at the time of

project appraisals. Beside this the project should also be

appraised from technical, commercial, financial, and economic

point of views.

The Board of Directors of some of the PSUs has also been vested with

the power of deciding, small capital expenditures to a certain and

specified limit as a measure of delegation of authority.

However, projects beyond the specified limits come under the purview

of Central Government and the same is decided by the Public

investment Board (PIB). The PIB, an organ of the Central

Government comprises Secretary, Department of Economic Affairs,

and Secretary Department of industrial development, Secretary,

Planning Commission, Secretary to the Prime Minister and the

Secretary of administrative Ministry.

The PIB, has also formulated certain guidelines for project appraisal,

which inter-alia includes that:

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The project should be in consonance with plan priorities.

There is feasibility of undertaking project in public or joint

sector.

Wherein the internal rate of return is expected to be adequate.

The analysis of social cost benefits is undertaken.

Wherein the project is expected to contribute to export and

foreign exchange earnings etc.

There is a provision of funds in budgetary allocations.

Logical sequencing of project schedule has been arranged

Adequacy of safety and anti-pollution measures has been

ensured.

Marketing feasibility of project is brighter.

Once the project has been approved by PIB/Expenditure and Finance

Committee of Ministry)' of Finance, it is sent for the approval of

cabinet. After seeking approval of cabinet, the next step is to prepare

a detailed project report for implementation containing sufficient

details, plans, programmes, cost estimates, schedules and probable

dates for commencement of production.

WORKING CAPITAL MANAGEMENT

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In the context of working capital management in Public Sector

Undertakings, the following points need consideration:

(i) Public sector undertakings are often blamed for over-inventory

resulting in blocking of capital and space or, less often, for under-

inventory, up-setting production schedule. Both are signs of inefficient

inventory management.

(ii) There is generally no provision for working capital margin at the

time of estimating cost of project. Consequently, there is no provision

of long term funds for working capital and the enterprise as to obtain

financing for current assets from short term sources.

(iii) Most of the public sector units are capital intensive hence, ratio

of current assets to fixed assets is generally low.

(iv) Most of the public sector undertakings lack application of working

capital management techniques especially relating to debtors like

discount rate, credit period and credit standards. The reason being

that they sell the bulk of their output to the Government departments.

(iv) For better cash management the Central Ministries and

departments will now monitor the short-term parking of investible

funds of public sector undertakings under their administrative control.

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A radical policy decision has been taken at the highest level to

empower the Central Ministries to frame guidelines for parking of

short-term funds of the PSUs and also oversee the investment.

FINANCIAL DELEGATION

As mentioned earlier and as is evident from the foregoing discussions,

a public sector unit deals with substantial amount of taxpayers'

money. As a result accountability for proper utilization of these funds

is a significant aspect in public sector financial management.

Accordingly, depending on the nature and amount of expenditure,

every public sector unit laid down procedures for approval of such

expenditure by competent officials. For more peculiar or complicated

nature of expenditure and higher amount, the authority to approve

the expenditure vests with senior officials. In certain events where the

expenditure involved requires views of a number of departments"

comments of all heads of department concerned are obtained and

thereafter the sanction is given by the final authority based on the

collective comments/views of the official concerned.

There is a misconception that a public sector unit decides about

purchase of materials and services on lowest offer basis. Though cost

is a vital consideration, it is not always that expenditure on materials

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or services are governed by lowest offer. The over riding consideration

is "propriety". In other words, while approving expenditure, the factors

that are taken care of are:

(a) Whether the expenditure is necessary.

(b) Alternative ways to carry out the desired work to minimize cost.

(c) Overall effect of the expenditure on business.

(d) Whether the expenditure is permissible as per the internal rules of

the company and if not, the procedure that needs to be followed has

been complied with or not.

In this regard, it is worth noting that no expenditure can be incurred

unless budgeted for. Further even if budgeted, expenditure, which an

official is not, authorized to incur, as per the powers delegated, the

expenditure has to have financial sanction before it is committed. In

providing financial concurrence to expenditure, budget provision.

amount already incurred under the particular head of expense and

propriety of the expenditure have to be considered. However, at

times, if situation so warrants expenditure that has not been budgeted

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for may also be incurred with financial concurrence and approval of

competent authority.

FIANCIAL REPORTING

Financial Management is not complete without reporting. As in any

business unit, there is nom1al financial information reporting system,

the contents and details of which vary from organisation to

organisation depending upon nature of business and needs of

management. Regular financial reporting generally contains monthly

profit & loss, variance between budget and actual, funds flow

statements etc.

In addition to regular internal finance reporting, each public sector

unit is required to submit monthly report in prescribed format to its

administrative ministry.

The monthly report contains:

(a) Profit & Loss Statement

(b) Plan Expenditure. Approved and spent

(c) Cost of Production

(d) Inventory Holding and Debtors Credit Period

(e) Variance between budget and actual.

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The monthly report contains information for the month under review

and year till date. This report is usually submitted within 15th of the

following month.

Profitability of Central Public Sector Undertakings -

The table given below depicts the performance of public sector undertakings. The overall profitability of

Central Public Sector Undertakings in terms of gross margin, gross profit, pre-tax profit on capital

employed and profit after tax to net worth have increased during 1997-98.

Profitability

of central

PSU

90-91 92-93 93-94 94-95 95-96 96-97 97-98

NUMBER OF

UNIT

236 239 240 241 239 238 236

PAID UP

CAPITAL

432.4 519 559.7 570.1 595.9 624.3 657.6

NET WORTH 588.7 705.3 795.3 945.7 991.8 1138.9 1324.4

CAPITAL

EMPLOYED

1020.8 1401.1 1598.4 164.5 1739.9 2015.0 2230.5

GROSS

PROFIT

111.0 159.6 185.6 226.3 275.9 306.1 360.9

PRE TAX

PROFIT

35.0 50.8 66.6 98.0 136.2 152.1 193.8

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PROFIT

AFTER TAX

22.7 32.7 45.5 71.9 95.7 99.9 137.2

% GROSS

MARGIN YO

CAPITAL

EMPLOYED

17.9 18.0 17.3 20.6 23.1 22.2 23.6

% GROSS

PROFIT TO

CAPITAL

EMPLOYED

10.9 11.4 11.6 13.9 15.8 15.2 16.2

% PRE-tax

profit to

capital

employed

3.4 3.6 4.2 6.0 7.8 7.5 8.7

% PAT TO

NET WORTH

3.9 4.6 5.7 5.8 9.6 8.8 10.4

Profitability in the first half of fiscal 1999 was no better. Total net

profit declined to Rs.51 billion as against Rs.54.9 billion for the same

period in previous year. !!.

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ROLE OF FINANCIAL MANAGEMENT IN THE REFORM OF PUBLIC

SECTOR UNDERTAKINGS

Despite the considerable role in the economic development of the

country, the public sector has, its ills and these are many. For instance

over 100 of the 242 Central Public Sector Undertakings are loss-

making units with many of them terminally sick. In the present era of

globalization and liberalization, it is required to bring reforms in public

sector undertaking. The Government has realized the need of

reforming the public sector undertakings. Reforming Public Sector

Enterprise is neither a simple nor uniform process. Each enterprise is

different from the other. The objectives are often different and for

these reasons it is required to adopt different reform measures.

The measures for reforming the public sector undertakings are

broadly divided into following:

I. Reforming Public Sector Enterprises by signing Memorandum

of Understanding (MOUs) and Greenfield privatization.

II. Reforming Public Sector Enterprises by selling their assets

either partially or wholly to the private sector or to the

general public.

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III Close down PSUs, which cannot be revived.

Reforming public sector enterprises by signing memorandum

of understanding (MOUs) :

The system of MOUs was introduced in 1986 following the

recommendations of the Arjun Sengupta Committee (1984). While

there was no denying the fact that the PSEs had performed major role

in areas like fertilizers, ship-building, machine tools and heavy

chemicals, there was also much dissatisfaction with the fact that the

generation of surpluses by PSEs was low and that in aggregate terms

the return on total investment made by them was poor.

Two of the major causes cited for the poor financial performance of

PSEs were :

(i) The relationship between PSEs and the Government was

dysfunctional.

(ii) The PSEs had to pursue a number of objectives, which are often

conflicted with each other.

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It was against this background that the Government of India had

decided to adopt a system of Memorandum of Understanding (MOU) in

1986. The concept of MOU is very simple one. It is supposed to be a

"freely" negotiated performance agreement between a public

enterprises and Government acting as owner of the public enterprise

in which both parties clearly specify their commitment and

responsibilities.

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Performance Evaluation of PSU

The MOUs have progressively covered an increasing number of PSEs

upto 1998-99, 108 PSEs signed MOUs. The department of Public

Enterprises evaluated the annual performance of these PSEs. As per

the exercise. Out of 108 PSEs, 42 were rated excellent, 30 very

good,13 good, 21 fair and 2 poor. In 1998-99 the aggregate gross

margin of the MOO signing PSEs increased by 6% over 1997 -98 and

exceeded the target set for the year by 1.5 per cent.

The privatization emphasis so far has largely been on central PSEs,

which number about 240 and account for an aggregate investment of

over 2lakh crore of rupees. The rationale for privatizing state-owned

companies arises primarily from the question of efficiency. State run

entities- for a wide variety of factors ranging from unclear and

contradictory objectives, inappropriate incentive structures and

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multiple levels of decision making -make less than the best use of

their assets.

NUMBER OF PSU SINCE 1966

Output suffers both in quantitative and qualitative terms and

consumers tend to receive short shrift. The public sector in this

country was born in the 1950s out of a felt necessity in aver)' different

domestic and international context. By the early eighties both these

contexts had changed considerably. Curiously however, while central

PSEs numbered only 73 at the end of the third five-year plan ( 1966),

it had more than double to 179 by 1980. In the 1980s about eighty

more PSEs came into being. What might have begun as a necessity,

acquired a life of its own to eventually become something of a habit!

Privatization of public sector enterprises holds the key to getting

out of this quicksand of fiscal deficit. There is a significant amount of

shareholder value locked up in the public sector units which the

government should encash optimally and use the resulting inflows to

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payoff its debts. This requires political will and support from all major

political parties whether in power or not.

Alternative of Privatization of public enterprises

Mergers is yet another possibility………………….

Here the private sector can serve as an example. The practice

prevalent in the United States, of bankrupt companies being bought

over by the successful giants, holds an interesting lesson. 'These

mergers are manipulated partly for tax reasons (it being often

expedient to 'acquire' losses), but the net result is that a strong

programme of recovery is initiated and a turnaround quickly achieved.

There are definite possibilities of adopting this strategy in the public

sector. Successful enterprises under entrepreneurial management

might take over the weaker units and nurse them back to health. This

is a common practice, among the self managing social enterprises of

Yugoslavia.

Breaking public enterprise monopolies and allowing

private enterprises to compete is a very attractive

option……………………

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It will stimulate a competitive situation and force the public

enterprises to improve efficiency for survival.

In Japan, the Prime Minister's Commission on Administration Reform

formed in 1981 recommended the following criteria for selecting

public enterprises for "privatization" or liquidation:

a. Enterprises whose objectives were already accomplished or about

to be accomplished;

b. Enterprises whose beneficiaries had decreased in number because

of socio-economic changes and whose existence became no longer

justifiable;

c. Enterprises whose businesses could be taken over by the private

sector and carried out more efficiently;

d. Enterprises whose beneficiaries were under protected over others;

e. Enterprises whose financial rate of return became increasingly

lower than the rate originally targeted or enterprises whose socio-

economic objectives were no longer meaningful;

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f. if more than one enterprises was in operation in the same field of

business, measures should be taken to merge them as far as possible,

taking into due consideration the objectives, scope and financial

condition of the enterprises, the need of efficiency in their

performance and for simplification of their organizational structure.

Valuation of Public Sector Undertaking

As in other developing countries, public enterprises in India were

created for complex and varied reasons, which did not include

improving productivity of resources. Therefore, the government was

never worried about the poor economic performance of PSEs. Only

from mid-1980s the government started focusing on profit as a

parameter for measuring their performance. The recent burgeoning

deficits have made the government less tolerant of the losses and

economic inefficiency of public enterprises and to adopt the

privatization policy. Although several justifications are being given in

support of privatization, the major impetus has been the major impact

of privatization on public finances. This was evidenced when, in March,

2000, the government made Bharat Aluminium Company Limited

(BALCO) to buy back half of the government holding for Rs. 244.43

crore. The transaction was consummated on 30 March 2000, a day

before the close of the financial year 1999-2000. The transaction was

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aimed at padding up the fiscal deficit. The government's priority to

privatize more profitable enterprises also points to the objective of

maximizing privatization revenue rather than improving the efficiency

of PSEs.

The performance as regard privatization is not encouraging. Economic

Survey 2001 reported the dismal performance. The achievement for

2000-2001 was below the target of Rs. 10,000 crore. With this

background we shall discuss the issues involved in valuation and

corporate governance of PSEs.

VALUATION TECHNIQUES

One approach to valuation is to look at the underlying worth of the

assets of the business . The book value of net assets may be a good

starting point. The book value should be adjusted for large differences

between the book value and the market value (replacement cost) of

tangible assets. For example, value of land should be determined by

adjusting the book value for the difference between the book value

and the market value. Intangible assets should be valued at zero if

they do not have market value.

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A variant of the asset value approach is to look at the liquidation

value. Liquidation value is the net cash amount that could be realised

if the assets of the enterprise were disposed off on 'a quick sale' and

all liabilities of the enterprise were paid off. The liquidation value is

not important in transfer of ownership, as the enterprise would be

maintained as a going concern,

Another common approach to valuation is to capitalise earnings.

Future earnings under new ownership should be used to determine

the value of the enterprise. This is particularly important when the

new owner has plans to reinvigorate the enterprise that is not

performing at its potential. Historical earnings are used only as a

guide. Those should not be interpolated to project future earnings

because the pattern of future earnings will be significantly different

from the historical performance of the enterprise. The projection of

future earnings will have large elements of uncertainty, and therefore

it is helpful to use high. low and most likely out-come of performance.

Usually 'Profit before Interest and tax' (PBIT) is used as the basis

to measure the value of an enterprise. However, other measures of

earnings such as 'profit after tax' (P AT) may also be used. The

important rule is that the multiple should be consistent with the basis

for measuring earnings. One should be careful in selecting the

multiple. Factors such as the anticipated pattern of earnings, the

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nature of the industry, the likely state of the stock market are

considered in deciding the most appropriate multiple. Estimation of

future earnings and the multiple is subjective in nature, and therefore

requires clear understanding of economic factors that influence the

performance of the enterprise.

The traditional approach is to discount the projected free cash flow.

Uncertainties should be carefully dealt with in projecting free cash

flow. Statistical techniques are used to deal with elements of

uncertainty in future cash flow. The discounting rate should be

consistent with the riskiness of the assets being held by the

enterprise. Estimation of the discounting rate is a difficult task and

requires clear understanding of various factors that influence the

expected return from those assets. Therefore, in order to circumvent

the difficulties, if an established and stable market price of equity

shares is available that should be used to value the shareholders'

interest in the enterprise. Usually average market price over a

preceding period, say six months. is used. Observable market price

reflects the collective wisdom of the market in valuing the enterprise,

provided the volume and number of trades is reasonably large. In case

of change of ownership, the value so obtained is adjusted for the

present value of incremental cash flow that will arise from expected

synergy.

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No valuation model can capture the true value . Analysts use all the

models to arrive at a range of values. The value is a function of the

individual's perception of the risk, opportunity, the nature of financial

resources available to the purchaser, the alternatives available to the

acquirer and other similar factors. Therefore, no two analysts arrive

at, the same value of an enterprise. More over 'price' and value are

not equivalent. The range of estimated value provides guidance in

determining the price.

Price is a function of information, market behavior pressures forcing

either purchase or sell and negotiating skills.

Pricing in Acquisitions

Valuation is not an end in itself. It is a process of estimating how much

an acquirer is ready to pay to control the enterprise and the minimum

amount that the transferor should realise to ensure increase in her

wealth. From the purchaser's point of view, the price that she should

be ready to pay is a function of:

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(i) The estimated investment in creating similar assets. In other words,

the replacement costs of the assets, is an important factor in deciding

the price that the purchaser will be ready to pay.

(ii) Estimated value of goodwill and other intangible assets that are

not recognised in the balance sheet.

(iii) The degree of freedom that she will enjoy in formulating future

strategy and the estimated future investment to implement the

strategy. She also takes into consideration various other uncertainties

such as political uncertainty, certainty as to future competition and

government policy.

From the transferor's point of view, the price should be higher than

the present value of future cash flow that she is expected to generate.

Usually a transferor expects the transaction to generate surplus,

rather than only resulting in a change in the cash flow pattern. If the

price that she realizes is equal to the present value of future cash

flow, she is not gaining anything except a change in the cash flow

pattern. However, if the seller requires cash immediately and she has

no alternative source for the same, she will be ready to transfer the

ownership of the business even at a price lower than its fair value. The

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demand and supply of similar enterprises determine the fair value.

Usually the transfer of the control occurs at the fair value, though in

some situations the acquirer strikes a bargain price.

Pricing of PSES in a Transfer Deal

A major controversy arose as regards the valuation of BALCO. The

Business Standard in its 23 February 2001 edition, quoting the official

sources, reported the following numbers for BALCO: highest valuation

Rs. 994 crore; lowest valuation Rs. 587 crore; net worth Rs. 704 crore;

and asset value Rs. 1,072 crore. The government transferred 51 per

cent of its holding at Rs. 551.5 crore.

The bases for determining the highest and the lowest valuation or the

reserve price are not available to the public. However, it is clear that

replacement cost of assets was not considered because the

replacement cost of the captive power plant alone was estimated at

somewhere, between Rs. 1,050 to Rs. 1,100 crore. Often it is argued

that replacement cost was irrelevant because the Government's

decision was to sell the enterprise as a going concern. This argument

is not tenable because a buyer, while considering the acquisition of

controlling stake in the enterprise, always takes into account the

investment required to create similar facilities. There is always a

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possibility that the transferor would be able to realise a price close to

the replacement cost of assets. Therefore, the replacement cost of

assets should also be considered in deciding the range of values for

the purpose of negotiation, even if the proposal is to transfer the

enterprise as a going concern. However, if the government, while

transferring the ownership, imposes- restrictions on the disposal of

idle assets that are not being used in the operation of the enterprise

the acquirer would be assigning a very low value to those assets. The

best price was not realised because:

(i) The bid was not competitive. There were only three bidders.

Balco and Hindalco were the other bidders. In the absence of

many bidders, it is difficult to establish the fair value,

resulting in sub-optimal outcome.

(ii) It was similar to a distress sale. The government wanted to

have some number on its slate against realization from

disinvestment during the fiscal year 2000-2001. It is difficult

to realise the best price in a distress sale because the

transferor cannot wait for the appropriate time and finds

herself in a weak bargaining position.

(iii) The bidders quoted lower prices probably because of

uncertainty as regards the Government's objective of

continuing with 49 per cent holding.

35

uncertainty about the success of plans for improving

the productivity of resources and down sizing the

work force.

the compulsion to carry the surplus work force for a

specified period.

estimated investment on voluntary retirement

scheme (VRS).

estimated investment to modernize the operations of

the enterprise.

In order to realise the right price the government should clearly bring

out its policies and the time frame for transferring the balance holding

to the strategic partner. A better price may be realised if the

enterprise is restructured and its performance is improved before

privatization. In short, uncertainties should be minimized as far as

possible before privatization of a PSE.

An analyst in analysing the transaction compared the 'the price to

book value ratio' (PIBV) with those of Hindalco and NALCO. The

ratio of 1.51 compares well with ratios of 1.60 and 1.15 of Hindalco

and NALCO respectively. The analyst was trying to prove the point

that the transfer of control was not at a lower price. The analyst did

not realise that the PIBV ratio in a depressed capital market cannot be

36

used as a benchmark for assessing the reasonability of price realised

by the transferor in an acquisition. One should be careful in estimating

multipliers to be used in computing the value of an enterprise. It is

true that in practice the acquirer uses recent PIE and other ratios as

multipliers in determining the value of the enterprise. This works

against the interest of the transferor. Therefore, in order to realise the

right price, transferor wait until the capital market improves. .

Reforming PSEs through disinvestment:

The process of disinvestment of state owned commercial assets needs

to balance several considerations. If shares are relatively under priced

in the short run as a strategy to attract investor participation, there is

a lower realization to the exchequer, while relative overpricing may

drive away investors and jeopardize the future disinvestment process.

In particular, the reserve price for disinvestment has to be fixed in

uncertain and volatile capital markets.

The process of disinvestment also needs to balance Government's

need along with the need for equity requirements of the PSU. Given

the limited availability of investible resources in the capital market,

there is a need to balance disinvestment with the capital requirement

of the private sector.

37

Government withdrawal on specific loss making PSUs can cut down on

the non-plan budgetary support. Taken together this can help contain

fiscal deficit. This can happen if the PSUs are invested through the

most appropriate method after restructuring, if required, to enhance

share value.

38

Disinvestment- Goals

The main elements of the Disinvestment Commission's long term

goals as related to the disinvestment process will revolve around the

following core concepts:

I. Maximize Enterprise Value on along term basis;

II. Optimize intrinsic share value:

III. Augment budgetary receipts & reduce budgetary outlays for

loss making enterprises:

IV. Maintain transparency and

V. Establish credibility of the disinvestment process.

39

Progress and Problems in disinvestment:

The procedures adopted for disinvestments have suffered from

adhocism in the absence of a long term policy on disinvestment as

revealed by the Parliamentary Group on Disinvestments in its meeting

with the Minister for Slate of Disinvestments and the Secretary

Department of Disinvestments in April 2001.

DISINVESTMENT PROCEEDS TOWARDS BRIDGING FISCAL DEFICIT

Year Actual Realisation (in crores)

Rs.

1991-92 3038

1992-93 1913

1993-94 Nil

1994-95 4843

1995-96 362

1996-97 380

1997-98 902

1998-99 5371

1999-00 1892

2000-01 2600

(Sources: Complied from various issues of Public Enterprise Survey, Volume I,

Department of Public Enterprise, Govt. of India)

40

The aforesaid Table shows the actual realisation from the

disinvestment proceeds from 1991-92 to 2000-01, which was Rs.

21,238, crores. The investment in these enterprises was Rs. 2,30,140

crores as on March 31, 1999 .The total proceeds from disinvestments

turned out to be a mere 92.3 per cent of the total investments as on

March 31, 1999.

The bundling and bidding were adopted as the first method of

disinvestment, subsequently followed by the tendering and the

issuance of the global depository receipts (GDR). The auction and

public float methods were never used for effecting disinvestments.

Initially, the government placed a number of restrictions as to who

could bid for disinvestment, and also put a financial ceiling of Rs. 25

crore for the purchase of disinvested shares. The foreign financial

investors were kept out from purchasing the disinvested shares. The

government thought it prudent to allow only the mutual finds to buy

the disinvested shares in the first few rounds. It advertised for the bids

41

in select national newspapers. The Department of Public Enterprises

(DPE) was the nodal agency to steer the disinvestment process. The

Department was empowered to prepare the bundles advertise the

bids, select the bidders, finalize the price and effect disinvestments.

The disinvestment strategy of the government also aims at offering

substantial number of shares to the workers.

According to the government, "the process is conceived with its focus

of workers shareholding and mass ownership which will eventually

transform the existing state-owned enterprise into enterprise that are

truly public owned."

Major changes in the strategy are:

Government's commitment not to sell PSUs to big institutional

investors only:

"This will ensure that small applicants who have asked for a

minimum number of shares, are given priority and offered

the shares asked for".

Government thinking in terms of allowing installment purchase

of shares:

42

A chain of share shops to promote and encourage the sale of

disinvestment equities is also on the anvil.

Professional advisers for due diligence. who will be consulted on

the time, size and manner of the offering.

The Commission was to get into action from the third round

of disinvestment. As per the earlier practice the Core Group

of Secretaries was to look into the first two branches.

The government had already decided to offer only one PSU at a time.

The finance ministry had identified six enterprises, of which VSNL is

expected to go in first. The book-building method was identified. The

total target for 1996-97 was Rs.5, OOO crores. Given the new trend,

the demarcation between PSUs and private sector companies is

getting thin. In the present circumstances a private sector group or a

financing company can now own PSUs to the extent of 49 per cent.

Social Reporting

The main theme of social reporting is to evaluate social costs and

benefits concerning the socio human and environmental constraints

on organizational behaviour and to communicate the social

information to social groups both within and outside the firm. Thus,

social reporting implies the measurement and reporting, internal and

43

external, of information concerning the impact of a business

enterprise and its activities.

Indian Scene

Publication of Corporate Social Reporting (CSR) by Public Sector

Enterprises in India is very thin and blurred even today. The pioneer is

Steel Authority of India (SAIL), which has been in continuous drive for

years to prepare and publish its social reports, however, the PSUs as a

whole are reluctant to publish CSR inspite of its ever-increasing

demand. The laxity of corporate enactment and government

regulations has aggravated the picture. Although the PSUs are

reportedly paying no heed to publishing CSR, they are still

contributing much towards the shouldering and discharging their

social responsibilities as may be evident from the following highlights;

44

The details relating to value added by PSUs exhibit an overall

increasing trend over the last 10 years from 1988-89 to 1997-98

except a small decline in the year 1996-97 over the year 1995-96

(total value added amounted to Rs. 57175.60 crores in 1996-97 as

against Rs. 57773.91 crores in 1995-96) followed by a steep increase

of 27.14% in value added in the year 1997- 98 over 1996-97 as the

PSUs have generated a total value added of Rs. 72690.61 crores in

1997-98 as against Rs. 57175.60 crores in 1996-97 indicating an

increase of Rs. 15515.0 I crores (27. 14%). One of the objectives of

setting up of the public enterprises was to promote import

substitution, save and earn foreign exchange to help mobilise fund for

the economy. During the year 1997- 98 the export earnings by PSUs

have increased to Rs. 18147.20 crores as against Rs. 16358.69 crores

in 1996-97. From the details we observe a continuous increasing trend

of export earnings of PSUs from 1988-89 to 1997-98.

45

The export earnings have been classified into three broard categories

viz. Export of canalized goods, export of non-canalized goods and

export of services and others.

In this connection it is worthwhile to note that during the year 1997-98

foreign exchange amounting to Rs. 34797.39 crores was utilised by

46

the PSUs on import of capital goods, raw materials, stores, spare parts

and payment of royalties, technical services etc. as against Rs.

40149.95 crores during 1996-97, thereby registering a net savings in

foreign exchange utilization on this account by Rs. 5352.56 crores in

1997 -98 over 1996-97.

As a part of their performing social responsibilities the public sector

undertakings have been making substantial contribution to the central

exchequer through payment of corporate taxes, excise duty, custom

duty, and other duties to mobilize funds for financing the needs of the

planned development of the country. The details portrays the steady

growth of contribution to the exchequer by the PSUs over the last

eight years (1990-91 to 1997-98), During 1997- 98 such contribution

by PSUs amounted to Rs. 38665 crores as against Rs. 35454 crores

47

during~ 1996-97 registering an increase of Rs. 9,060 crores in 1997-

98 over the last year.

48

Conglomerats group

Consumption of energy

(in crores) Rs.

Energy cost as % of cost of production

STEEL 1863.49 1826.82 9.64 8.95

MINERALS & METALS 1203.12 1033.82 22.6 20.65

COAL & LIGNITE 1400.91 1220.79 8.31 7.94

POWER 6329.79 5052.1 51.2 51.5

PETROLEUM 550.96 455.61 0.55 0.46

CHEMICALS & PHARMA 535.54 350.75 12.96 10.61

HEAVY ENGINEERING 227.42 204 3.3 3.3

MEDIUM & LIGHT

ENGINEERING1141.16 128.37 2.26 2.18

TRANSPORT EQUIPMENTS 106.02 92.63 2.11 2.05

CONSUMER GOODS 270.75 339.81 13.31 17.51

AGRO BASED INDUSTRY 2.79 2.57 1.2 2.08

TEXTILES 132.53 142.63 7.44 8.31

SWOTSWOT OF FINANCIAL MANGEMENT IN OF FINANCIAL MANGEMENT IN PUBLIC SECTOR UNDERTAKINGPUBLIC SECTOR UNDERTAKING

49

STRENGTH

1. a public sector unit deals with substantial amount of taxpayers'

money. As a result accountability for proper utilisation of these

funds is a significant aspect in public sector financial management.

Accordingly, depending on the nature and amount of expenditure,

every public sector unit laid down procedures for approval of such

expenditure by competent officials. For more peculiar or

complicated nature of expenditure and higher amount, the

authority to approve the expenditure vests with senior officials. In

certain events where the expenditure involved requires views of a

number of departments" comments of all heads of department

concerned are obtained and thereafter the sanction is given by the

final authority based on the collective comments/views of the

official concerned.

2. It is worth noting that in PSU’s no expenditure can be incurred

unless budgeted for. Further even if budgeted, expenditure, which

an official is not, authorized to incur as per the powers delegated,

the expenditure has to have financial sanction before it is

committed. In providing financial concurrence to expenditure,

budget provision. amount already incurred under the particular

head of expense and propriety of the expenditure have to be

considered. However, at times, if situation so warrants expenditure

50

that has not been budgeted for may also be incurred with financial

concurrence and approval of competent authority.

WEAKNESS

1. Many public sector undertakings are characterized by over-

capitalization resulting into low capital output ratios, surplus

capacity, long gestation periods, expensive turnkey project and

large out-lays for housing and other infrastructural facilities. These

phenomena have created enormous difficulties in servicing of

debts, besides other financial problems.

2. There is generally no provision for working capital margin at the

time of estimating cost of project. Consequently, there is no

provision of long term funds for working capital and the enterprise

as to obtain financing for current assets from short term sources.

3. Most of the public sector units are capital intensive hence, ratio of

current assets to fixed assets is generally low.

4. The various studies conducted by the Bureau of public enterprises

have shown that one of the reasons of the poor performance of

public sector undertakings in our Country has been the large

amount of funds locked up in working capital. This results in over

capitalization. Over capitalization implies that a company has too

huge funds for its requirements, resulting in a low rate of return a

situation, which implies a less than optimal use of resources. A firm

51

has, there- fore, to be very careful in estimating its working capital

requirements and PSUs are no exception to this.

5. Most of Public Sector Undertakings have no systematic monitoring

of the activities. Accounting infrastructure, which could serve as an

aid to management is not strong and internal audit is at discount.

The quality of service therefore suffered while the exchequer

continued to carry, the burden of these financially weak

enterprises.

OPPORTUNITY

1. Unlike plan support, government also provides non-plan fund to a

public sector unit to sustain its day-to-day operations. Non-plan

support is in the nature of loan granted by government mainly to

subsidies cash losses and/or wages and salaries of a unit.

2. The PSU will enjoy Estimated value of goodwill and other intangible

assets that are not recognised in the balance sheet.

3. The degree of freedom that the PSU will enjoy in formulating future

strategy and the estimated future investment to implement the

strategy. It also takes into consideration various other uncertainties

such as political uncertainty, certainty as to future competition and

government policy.

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THREATS

1. It may be underlined that of late, government has, as a matter

of policy, reduced the quantum of non-plan support and in

certain instances has almost discontinued providing such funds.

This means that under the changed environment, a public sector

unit is required to generate its own resources or arrange funds

from other sources to sustain its day-to-day operations. As a

result, the thrust falls on improving performance and

profitability and arranging funds from banks or financial

institutions. This has become a thorny issue in public sector

finance because without improved performance, securing funds

from sources other than government is a rather difficult

proposition.

2. The cash rich undertakings such as the Oil Companies,

Mahanagar Telephone Nigam Ltd., Indian Railway Finance

Corporation and Power Finance Corporation have been either

sitting on their surplus funds or putting then in short-term bank

deposits, which are not profitable at all. In such short-term

parking, they are not getting more than seven or eight per cent

return which is not enough even to redeem the loan and bond

liabilities and adversely affect their profitability.

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CONCLUSION

It is also felt that there is great need for certainty in fiscal policies.

Each year's budget virtually, represents a zero-base process and there

are many reversals of previous policies and measures. There is an

urgent need for a slightly longer term fiscal roadmap, which has the

commitment of the government behind it. This will go a long way in

removing the uncertainty that business face from year to year. For

example, the introduction of surcharge came as a retrograde step in

the face of the government's promise to reduce tax rates.

This range of options gives policy makers a diversity of strategies,

aimed at strengthening public enterprises, containing the'

unmanageable' expansion of the public sector activity and creating a

climate of understanding and collaboration between the public and

private sectors. The options are not mutually exclusive. The adoption

of one or more of them would need to be dovetailed to the

circumstances and in particular, to the existing level of competence

and availability of resources in the two sectors. It necessitates

diagnostic studies, critical self analysis and, of course most important

of all, political will. The ultimate criterion must always be the choice of

the most efficient and cost effective manner of achieving the

development aims of the nation.

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