Financial Analysis of Tata Steel 1.

0 Introduction: An attempt has made to analyse Tata Steels overall performance and assess its current financial standing. The purpose of this analysis is to assess companys financial health and performance. Effective decision making requires evaluation of the past performance of the companies and assessment of the future prospects. The starting point in analysis is to look at the past record. Information about past performance is useful in judging future performance. An assessment of the current status will show where the company stands at present. To a large extent ,the expectations of investors and creditors about future performance are shaped by their evaluation of past performance and current position. Investors and creditors use information about past to assess the prospects of a company. Investors expect an adequate return from the company in the form of the dividends and market price appreciation. Creditors expect the company to pay interest and repay the principal in accordance with the terms of lending. Therefore they are interested in predicting the earning power and debt paying ability of the company. Investors and creditors try to balance expected risks and return. Needless to mention comparisons are essentially intended to throw light on how well a company is achieving its objectives. In order to decide the types of comparisons that are useful, we need first to consider what a business is all about? What its objectives are. A generalization that the overall objective of a business is to create value for its shareholders while maintaining a sound financial position; implicit to this statement is the assumption is that value creation can be measured. Our approach to financial analysis followed a comprehensive framework of looking at various parameters of company performance and use different ratios to substantiate the analysis. The framework will be as under: Top Line Growth Profit and Profitability Liquidity Analysis Assets Growth Capital Structure Analysis Assets Utilisation Ratio Fund Flow Statements Market Perception Here ratios and other qualitative aspects have been considered in a sequence intended to facilitate an understanding of the total business. As an analyst first one has to look at analyst the firms performance in the broadest terms and then worked down through various levels of detail in order to identify the significant factors that accounted for the overall results. If the values of the ratios used in this analysis are compared with their values for other time periods, the comparison is called a longitudinal, or trend analysis. Dozens of ratios can be computed from a single set of financial statements. Each analyst tend to have a set of favorite ratios selected from those described below and probably from

some which has not been described. Although here many frequently used ratios been described, the best analytical procedure is not to compare all of them mechanically but rather to describe first which ratios might be relevant in the particular type of investigation to expertise the trend and its significance. 2.0 Top-line Growth Growth rate of Sales and Income indicates whether a company is able to drive its top line up so that its market presence, share and aspects of control is retained. Higher growth rate in sales and income implicitly indicates that company will be able increase its profit at much higher rate and hence boost up its bottom line. Analysts are also interested in the growth rate of certain key products of the company to assess the potential of retaining market share of the company on its various lines of product. These growth rates are compared with the rate of growth in that particular industry or with similar product lines of other companies. For example growth of cement sales at Ultratech Ltd may be compared with Cement sales of ACC etc. Common growth rate calculations include average growth rate and compound growth rate. From the Profit and Loss Account we observe Tata Steel has registered a topline growth of 5.08 per cent in 2009-10 compared to 2008-09. In absolute terms it has achieved a topline of Rs 25875.77 crores in 2090-10 compared to Rs 24624.04 crores in the previous period. Top line of Tata Steel comprises of Sales and Other Operating Income and Other Income. Both the components have grown at different rates as could be seen from the Table-1 below. Table -2.1 2008-09 A. Income (D+E) B. Sales and Other Operating Income C. Excise Duty D. Sales and Other Operating Income net of Excise Duty E. Other Income (Rs in crores) % growth 24624.04 25875.77 5.08 26843.73 26757.80 2527.96 1735.82 24315.77 25021.98 2.90 308.27 853.79 176.96 2009-10

Sales and Other Operating Income comprise of Sale of Products , Sale of Power and Water,Income from Town Medical and Other Services and Other operating income. Table -2 below shows how all these components of sales and Other operating income has increased or decreased compared to last year.

Table - 2 .2 (Rs in Crores) 2008-09 2009-10 % growth A.Sale of Products 25945.45 25755.52 (0.74) B.Sale of Power and Water 566.31 656.80 15.98 C. Income from town , medical and other services 40.65 40.32 (0.82) D. Other Operating Income 291.32 305.16 4.75 E.Total (A to D) 26843.73 26757.80 (0.32) A further analysis of the sales portfolio indicates that four products dominate in the product portfolio of Tata Steel, they are: Salable Steel (finished), Semi finished Steel and Scrap, Welded Steel Tubes and some categories of Raw Materials. In 2009-10 they formed around 95 percent of the total products sales portfolio. All these products have suffered from certain anomalies in terms of either price reduction or quantity reduction during the period. Except one or two products most of the products faced pressures on the price front as could be scan from the Table-2.3 below: Table 2. 3:Break up sales and average unit price realized
Value Tata Steel Value Qty 2009

Rs in crores
2009 19313.4 2 116.21 1004.86 1130.92 166.07 290.73 1251.47 1879.93 465.52 144 165.17 17.08 0.07 25945.4 5

Rs in crores

Unit Price Unit Price Realised(Rs Realised(Rs Qty ) ) 2010 2010 2009 1010

Saleable Steel (Finished) Agrico Products Semi Finished Welded Steel Tubes By Products Raw Materials Ferro Manganese Charge Chrome Other raw Materials Other Products Bearings Metallurgical Machinery Others Alloy Steel Ball Bearing Total

4760572 446069 227156

19333.4 9 126.86 1554.88 1110.28 237.44 183.47 733.21 1802.44 382.58

5518047 768127 253802

40569.54 22527.01 49786.05

35036.83 20242.49 43745.91

34515 177029

38976 145899

84232.94 70692.94

47072.56 50254.63

2633966 0

166.15 116.95 7.77 0 25755.5 2

3133885 2

54.67041

53.01726

Table -3 shows that average price realization in the year 2009-10 for Saleable Steel, Semi finished Steel, Welded Steel Tubes and among raw materials Ferro Manganese 3

and Charge Chrome were lower. Since all these items taken together form 95 per cent of sales undoubtedly lesser realization would have impact on the bottom line of the company. 3.0 Profit and Profitability Ratios The ability to generate profit on capital invested is a key determinant of a company's overall value and the value of the securities it issues. Consequently, many equity analysts would consider profitability to be a key focus of their analytical efforts. Profitability ref1ects a company's competitive position to the market, and by extension, the quality of its management. The income statement reveals the sources of earnings and the components of revenue and expenses. Earnings can be distributed to shareholders or reinvested in the company. Reinvested earnings' enhance solvency and provide a cushion against short-term problems. Table 3 .1 : Categorization of different types of Profit (Rs in crs) . 2008-09 2009-10 A. Income 24624.04 25876.77 Expenditure B. Manufacturing and Other Expenses 15525.99 16396.00 C. Depreciation 973.40 1083.18 D. Capitalisation of Expenditure (343.65) (326.11) E.Net Finance Charges 1152.69 1508.40 F. Total 17308.43 18661.47 G. Profit Before Taxes(PBT) 7315.61 7214.30 H.EBDITA (G+E+C) 9441.7 9805.88 I. less: Depreciation 973.40 1083.18 J.EBIT (H-I) 8468.30 8722.7 K. Interest 1152.69 1508.40 L. PBT (J-K) 7315.61 7214.3 M. Tax 2113.87 2167.50 N. Profit After Tax(PAT) (L-M) 5201.74 5046.80 3.1 Calculation of Profitability Ratios Profitability ratios measure the return earned by the company during a period. Exhibit 12 provides the definitions of a selection of commonly used profitability ratios.

Table 3.2 :Definitions of Commonly used Profitability Ratios Profitability Ratios Return on Sales EBDITA margin EBIT Margin Pretax margin Net profit margin Numerator EBDITA EBIT PBT (Profit before tax but after interest) Profit After Tax Denominator Income Income Income Income

Return on Investment ROA EBIT Return on total capital EBIT Employed (ROCE) ROE PAT

Average total assets Short and long-term debt and equity Average total equity

Return-on-sales profitability ratios express various subtotals on the income statement (e.g., EBITA,EBIT,PBT,PAT) as a percentage of Income/(Revenue). Return on investment profitability ratios measure income relative to assets, equity, or total capital employed by the company. For ROE, return is measured as PAT (net income i.e., after deducting interest paid on debt capital as also tax ). Interpretation of Profitability Ratios In the following, we discuss the interpretation of the profitability ratios presented in Table - 5. For each of the profitability ratios, a higher ratio indicates greater profitability. 3.2 EBDITA Margin

EBDITA margin indicates the percentage of revenue available to cover operating and policy related expenditures. Higher EBDITA margin indicates some combination of higher product pricing and lower product costs. The ability to charge a higher price is constrained by competition, so EBDITA profit are affected by (and usually inversely related to) competition. If a product has a competitive advantage (e.g., superior branding, better quality, or exclusive technology), the company is better able to charge more for it. On the cost side, higher gross profit margin can also indicate that a company has a competitive advantage in product costs. 3.3 EBIT Margin This is calculated EBDITA minus operating costs in this case is only depreciation. So, EBIT margin increasing faster than the EBDITA margin can indicate improvements in controlling operating costs. In contrast, a declining/ EBIT margin could be an indicator of deteriorating control over operating costs.

3.4 Profit Before Tax Margin Profit Before Tax (also called "earnings before tax") is calculated as EBIT minus interest, so this ratio reflects the effects on profitability of leverage and other (non-operating) income and expenses. If a company's pretax margin is rising primarily as a result of increasing non-operating income, then we should evaluate whether this increase reflects a deliberate change in a company's business focus and, therefore, the likelihood that the increase will continue. 3.5 PAT Margin Net profit, or net income, is calculated as revenue minus all expenses. Net profit includes both recurring and nonrecurring components. Generally, the net profit margin adjusted for nonrecurring items offers a better view of a company's potential future profitability. 3.6 Return on Total Capital Return on total capital measures the profits a company earns on all of the capital that it employs (short-term debt, long-term debt, and equity). As with ROA, returns are measured prior to deducting interest on debt capital (i.e., as operating income or EBIT). 3.7 ROE ROE measures the return earned by a company on its equity capital, including minority shares, preference shares, and ordinary shares. As noted, return is measured as PAT or net profit (i.e., interest on debt capital is not included in the return on equity capital). A variation of ROE is return on ordinary shares, which measures, the return earned by a company only on its common equity. Both ROA and ROE are important measures of profitability and will be explored in more detail below. As with other ratios, profitability ratios should be evaluated individually and as a group to gain an understanding of what is driving profitability (operating versus non-operating activities). Extended Example of Tata Steel:Evaluation of Profitability Ratios In evaluating the profitability of Tata Steel over last two years we find the flowing a recent three-year period and collects the following profit-ability ratios: Table :3.3- Different Types of Margin (Percentage) 2008-09 0909..09.. EBDITA margin 38.34 .. EBIT margin 34.39 Profit Before Tax Margin 29.70 Profit After Tax Margin 21.12 2009-10 37.89 33.71 27.88 19.50

3.7

DuPont Analysis: The Decomposition of ROE

As noted earlier, ROE measures the return a company generates on its equity capital. To understand what drives a company's ROE, a useful technique is to decompose ROE into its component parts. (Decomposition of ROE is sometimes referred to as DuPont analysis because it was developed originally at that company.) Decomposing ROE involves expressing the basic ratio (i.e., net income divided by average shareholders' equity) as the product of component ratios. Because each of these component ratios is an indicator of a distinct aspect of a company's performance that affects ROE, the decomposition allows us to evaluate how these different aspects of performance affected the company's profitability as measured by ROE. Decomposing ROE is useful in determining the reasons for changes in ROE over time for a given company and for differences in ROE for different companies in a given time period. The information gained can also be used by management to determine which areas they should focus on to improve ROE. This decomposition will also show why a company's overall profitability, measured by ROE, is a function of its efficiency, operating profitability, taxes, and use of financial leverage. DuPont analysis shows the relationship between the various categories of ratios discussed in this reading and how they all influence the return to the investment of the owners. Analysts have developed several different methods of decomposing ROE. The decomposition presented here is one of the most commonly used and the one found in popular research databases, such as Bloomberg. Return on equity is calculated as: ROE = PAT(i.e. net income)/Average shareholders equity The decomposition of ROE makes use of simple algebra and illustrates the relationship between ROE and ROA. Expressing ROE as a product of only two of its components, we can write:

ROE

Net income Average shareholders' equity

Net income Average total assets X Average total assets Average shareholders' equity

Which can be interpreted as: ROE = ROA x Leverage In other words, ROE is a function of a company's ROA and its use of financial leverage ("leverage" for short, in this discussion). A company can improve its ROE by improving ROA or making more effective use of leverage. Consistent with the definition given earlier, leverage is measured as average total assets divided by average shareholders' equity. If a company had no leverage (no liabilities), its leverage ratio

would equal 1.0 and ROE would exactly equal ROA. As a company takes on liabilities, its leverage increases. As long as a company is able to borrow at a rate lower than the marginal rate it can earn investing the borrowed money in its business, the company is making an effective use of leverage and ROE would increase as leverage increases. If a company's borrowing cost exceeds the marginal rate it can earn on investing, ROE would decline as leverage increased because the effect of borrowing would be to depress ROA. Just as ROE can be decomposed, the individual components such as ROA can be decomposed. Further decomposing ROA, we can express ROE as a product of three component ratios:
Net income Net income Average total assets Re venue x x Average shareholders' equity Re venue Average total assets Average shareholders' equity

Which can be interpreted as: ROE = Net profit margin x Asset turnover x Leverage To separate the effects of taxes and interest, we can further decompose the net profit margin and write:
Net income Net income EBT EBIT x x Average shareholders' equity EBT EBIT Re venue

Average total assets Re venue x Average total assets Average shareholders' equity

Which can be interpreted as:

ROE Taxburden x Interestburden x EBIT m arg in x Asset turnover x Leverage

This five-way decomposition is the one found in financial databases such as Bloomberg. The first term on the right-hand side of this equation measures the effect of taxes on ROE. Essentially, it reflects one minus the average tax rat~, or how much of a company's pretax profits it gets to keep. This can be expressed in decimal or percentage form. So, a 30 percent tax rate would yield a factor of 0. 70 or 70 percent A higher value for the tax burden implies that the company can keep a higher percentage of its pretax profits, indicating a lower tax rate. A decrease in the tax burden ratio implies the opposite (i.e., a higher tax rate leaving the company with less of its pretax profits). The second term on the right-hand side captures the effect of interest on ROE. Higher borrowing costs reduce ROE. Some analysts prefer to use operating income

instead of EBIT for this factor and the following one (consistency is required), In such a case, the second factor would measure both the effect of interest expense and non operating income. The third term on the right-hand side captures the effect of operating margin (if operating income is used in the numerator) or EBIT margin (if EBIT is used) on ROE. In either case, this factor primarily measures the effect of operating profitability on ROE. The fourth term on the right-hand side is again the asset turnover ratio, an indicator of the overall efficiency of the company (i.e., how much revenue it generates per unit of assets), The fifth term on the right-hand side is the financial leverage ratio described above-the total amount of a company's assets relative to its equity capital. This decomposition expresses a company's ROE as a function of its tax rate, interest burden, operating profitability, efficiency, and leverage. An analyst can use this framework to determine what factors are driving a company's ROE. The decomposition of ROE can also be useful in forecasting ROE based upon expected efficiency, profitability, financing activities, and tax rates. The relationship of the individual factors, such as ROA to the overall ROE, can also be expressed in the form of an ROE tree to study the contribution of each of the five factors, as shown in below for Tata Steel. Exhibit below shows that Tata Steels ROE of 13.65 percent in 2009-10 can be decomposed into ROA of 7.86 percent and leverage of 1.7378. ROA can further be decomposed into a net profit margin of 19.50 percent and total asset turnover of .4028. Net profit margin can be decomposed into a tax burden of 69.96 (an average tax rate of 30 percent), an interest burden of 40.21, and an EBIT margin of 33.71 percent. Overall ROE is decomposed into five components.

DuPont Analysis of Tata Steel ROE:2010

Return on Equity: PAT Average shareholders equity = 13.65%

Return on Assets: PAT Average total assets = 7.86%

Leverage: Average total assets Average shareholders equity = 1.7378

Net Profit Margin PAT Revenues =19.50%

Total Asset Turnover Revenues/ Average total assets =.4028

Tax Burden: PAT PBT =0.6996

Interest Burden: PBT EBIT =0. 8271

EBIT Margin: EBIT Income =.3371%

The most detailed decomposition of ROE that we have presented is a five way decomposition. Nevertheless, an analyst could further decompose individual components of a five-way analysis. For example, EBIT margin (EBIT /Revenue) could be further decomposed into a non-operating component (EBIT/Operating income) and an operating component (Operating income/Revenues). The analyst can also examine which other factors contributed to these five components. For example, an improvement in efficiency (total asset turnover) may have resulted from better management of inventory or better collection of receivables . These relationships suggest the two fundamental ways that the ROI can be improved. First it can be improved by increasing the profit margin-by earning more profit per rupee of income sales. Second, it can be improved by increasing the asset turnover. In turn the asset turnover can be increased in either of the two ways: (1) by generating more sales volume

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with the same amount of investment or (2) by reducing the amount of investment in assets required for a given level of sales volume. These two factors can be further decomposed into elements that can be looked at individually. The point of this decomposition is that no one manager can significantly influence the overall ROI measure, simply because an overall measure reflects the combined effects of a number of factors. For example the manager who is responsible for the firms credit policies and procedures influences the level of accounts receivable. Thus, the outside analyst, as well as the firms management can use the ROI chart to identify the potential problem areas in the business. 4.0 Liquidity Analysis Liquidity refers to the companys ability to meet its current obligations. Thus liquidity tests focus on the size of, and relationships between current liabilities and current assets. (Current assets presumably will be converted into cash in order to pay the current liabilities.) The importance of adequate liquidity in the sense of the ability of a firm to meet current/short-term obligations when they become due for payment can hardly be overstressed. In fact, liquidity is a prerequisite for the very survival of a firm. The shortterm creditors of the firm are interested in the short-term solvency or liquidity of a firm. But illiquidity implies, from the viewpoint of utilization of the funds of the firm, that funds are idle or they earn very little. A proper balance between the two contradictory requirements, that is, liquidity and profitability is required for efficient financial management. The liquidity ratios measure the ability of a firm to meet its short-term obligations and reflect the short-term financial strength/solvency of a firm. The ratios which indicate the liquidity of a firm are: (i) Net working capital, (i) Current ratios, (iii) Acid test/quick ratios. Lets at operating cycle of a firm which indicates the pattern of liquidity and its management which gets extended from working capital management. Working capital is an operational necessity. A firm needs to invest in short term current asset such as inventory (raw materials, work in progress and finished product) and also needs debtors to allow it to perform its day to day operations. This investment in current assets is for the short term, as raw materials will be bought, converted into finished product and sold to customers who ultimately will pay. For many business this cycle will be completed within a short time frame and will be repeated many times over during the year; for some other this cycle may become considerably extended. Liquidity, or solvency, means being able to satisfy financial obligations, without difficulty, as and when they become due. A firm is considered technically insolvent if it is unable to settle its debts when they become due for payment. Liquidity is a measure of how easily or speedily an asset can be converted into cash without any significant loss of value. In liquidity management the concern is how the business manages its short-term funds. These are the funds which are continuously circulating through the business and of which it needs to have a constant flow to keep it running smoothly on a day-to-day basis. By comparison, gearing or capital structure management, is to do with managing the firms long-term funding and solvency.

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Profitability measures focus on assessing the firms return, actual or potential, in contrast liquidity measures focus more on risk assessment. Profitability ratios tell us something about a firms financial performance, what it has actually achieved. Liquidity ratios are indicative of a firms financial condition, the financial state it is in. Like an athlete, performance and condition are closely related: an athlete in poor physical condition is unlikely to achieve an outstanding performance. Effective liquidity management is of paramount importance for the survival and future development of any organization, profitmaking or not-for-profit. While profitability is clearly extremely important for a commercial enterprise, it is more often a lack of liquidity rather than a lack of profitability which causes a business to fail. For example, even though a company may be generating profitable sales, it can run into liquidity problems if credit control is weak and the cash is not being collected from customers and/or if too much money is tied up in stocks (raw materials, work-in-progress and finished goods.). In contrast, it is possible for a company to survive at least in the short-term-and weather periodic economic storms, even if it is not making profits, by exercising good liquidity management. This can be done, for example, by managing stocks and debtors efficiency and keeping the levels of both under tight control. Clearly, survival and growth in the longer term require a combination of good profitability and sound liquidity. Working capital A firms total capital is found from its balance sheet by subtracting its total liabilities from its total assets. This is represented by the balance sheet equation: Assets(A) Liabilities(L) = Capital (C) Working capital can similarly be found by subtracting current liabilities from current assets: Current assets Current liabilities = Working capital CA CL = WC Technically the difference between the current assets and current liabilities is a firms net working capital, or net current assets, assuming current assets exceed current liabilities. However, in practice, the difference between current assets and current liabilities is often simply referred to as working capital. Tata Steels working capital at the end of 2009-10. Current assets Current liabilities Working Capital Rs.12246.69 crs Rs. 8999.61 crs Rs. 3247.08 crs.

Tata Steels working capital at the end of 2008-09.

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Current assets Current liabilities Working Capital

Rs. 10268.09 crs Rs. 8957.05 crs Rs. 1311.04 crs

Working capital, also known as circulating capital, is the amount of money which a business needs to survive on a day-to-day basis. It should be sufficient to cover: 1. 2. 3. Paying creditors (without difficulty); Allowing trade credit to debtors; Carrying adequate stocks.

The key questions are: is the level of working capital positive? Is it sufficient in relation to current liabilities? Sufficient working capital is needed, not only to be able to pay bills on time (e.g. wages and suppliers) but also to be able to carry sufficient stocks and also to allow debtors a period of credit to pay what they owe. Working capital is the kind of short-term capital required to finance a firm on a day-to-day basis. It is a key measure of business liquidity. The more working capital a firm has, the less risk there is of the firm not being able to pay its creditors when the bills become due. Conversely the less working capital a firm has, the greater the risk of the firm not being able to pay its creditors when the bills are due. Current ratio The ratio, also called the working capital ratio1, measures the relationship between current assets and current liabilities. As current liabilities should technically be paid from current assets, this ratio highlights the firms ability to meet its short-term liabilities from its shortterm assets. In other words the firm should not have to sell fixed assets to pay suppliers for raw materials: if it does then it is clearly in trouble. The current ratio will be very important to anyone who is supplying short-term funds to the firm such as banks and trade creditors. It is usually shown in the following way: Current assets: Current liabilities Tata Steels current ratio is: 1.36 : 1 1.15 : 1
2009-10 2008-09

e.g.1.5:1

It is difficult to say what the ideal current ratio should be, and this can be a contentious area, but a 1.33:1 ratio where current assets are 1.33 times two times the level of current liabilities is commonly cited as desirable.2 However, a ratio less than this does not necessarily suggest that a firm is in financial trouble. It depends on the circumstances of the
1

See Mc Menamin Jim- Financial Management An introduction Pg -310

It may not be out of place to mention here that the Tandon Committee (1974) had prescribed in India the minimum scale of current asset financing by long-term funds. However business environment has charged substantially now, hence banks also do not follow those norms very strictly.

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individual firm and the normal parameters of the business sector in which the firm operates. Current ratios tend to be sector-specific, that is, different business sectors are likely to have different typical current ratios. For example, what is considered a normal or typical current ratio for a steel company, is likely to be different from a FMCG Company. Therefore care needs to be taken to ensure that like is being compared with like and that individual ratios are not being considered in isolation. It is also possible that an apparently healthy current ratio could actually indicate inefficient management of stocks and debtors as these may have been allowed to accumulate. Conversely an apparently low current ratio may be the result of efficient stock and debtor management, as these current assets are being turned over quickly and stock management systems, such as Just in Time (JIT), may be in operation.3 A firm with a higher percentage of this current assets in the form of cash would be more liquid, in the sense of being able to meet obligations as and when they become due, than one with a higher percentage of slow moving and un-saleable inventory and /or slow-paying receivables, even though both have the same current ratio. In fact, the latter type of firm may encounter serious difficulties in paying its bills even though it may have a current ratio of 2:1, whereas the former may do well with a ratio lower than the conventional norm. Besides, a higher current ratio may indicate two aspects: (a) more deployment of the long term fund of the company which is costly proposition in real sense; (b) company may not be able to draw more support from its creditors to build its current assets may be due to its creditworthiness. Thus, the current ratio is not a conclusive index of the real liquidity of a firm. It fails to answer questions, such as, how liquid are the receivables and the inventory? What effect does the omission of inventory have on the liquidity of a firm? To answer these and related questions, an additional analysis of the quality of current assets is required. This is known in Acid-Test or Quick Ratio. Quick Ratio or Acid Test ratio This is a more stringent test of liquidity than the current ratio. It is the acid test of liquidity and compares the firms quick assets (i.e. current assets less stocks) to its current liabilities. By stripping the stock figures out of the equation, it is suggested that this ratio
3

The current ratio, though superior to NWC in measuring short-term financial solvency, is rather a crude measure of the liquidity of a firm. The limitation of current ratio arises from the fact that it is a quantitative rather than a qualitative index of liquidity. The term quantitative refers to the fact that it takes into account the total current assets without making any distinction between various types of current assets such as cash, inventories and so on. A qualitative measures takes into account the proportion of various types of current assets to the total current assets. A satisfactory measure of liquidity should consider the liquidity of the various current assets per se. While current liabilities are fixed in the sense that they have to be paid in full in all circumstances, the current assets are subject to shrinkage in value, for example, possibility of and debts, unsale-ability of inventory, and so on. Moreover, some of the current assets are more liquid than others; cash is the most liquid of all; receivables are more liquid than inventories, the last being the least liquid as they have to be sold before they are converted into receivables and, then, into cash.

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gives a more immediate indication of the firms ability to settle its current debts. The acid test ratio is shown in a similar manner to the current ratio: Quick assets4 : current liabilitiee.g. 1:1 Table :4. 1 (Rs in crores) 2009-10 Rs. 12246.69 Rs 3077.75 Rs 9168.94 Rs 8999.61 1.02

1.Current Assets 2.Inventory and Spare Parts 3.Quick Assets (1-2) 4.Current Liabilities 5. Quick Ratio (3 / 4) [Times]

2008-09 Rs. 10268.09 Rs 3480.47 Rs 6787.62 Rs 8957.05 .76

The acid test ratio for Tata Steel is: 1.02 : 1 2009-10 .76 : 1 2008-09 The rationale for omitting stock figures is that they are generally considered to be the current assets which take longest to convert into cash. Stocks (raw materials, work-inprogress and finished goods) are needed to produce saleable products, which in turn are billed to customers, the customers then usually take a period of credit to pay. This conversion process of turning stocks into cash especially for a manufacturing concern can sometimes be very protracted. It should be noted that the use of different stock valuation methods (e.g. LIFO and FIFO) can distort comparison of the current ratio. Again it is difficult to give a norm for what this ratio should be, but a 1:1 ratio is commonly considered desirable: it depends on the characteristics and circumstances of the individual firm. However, the quality of current asset also needs to be examined while commenting on the current assets. Sometimes in the companies balance sheet one observes huge amount of loans and advances. These loans advances in a shorter time span can not be converted to liquidity. This point has to be kept in mind while assessing the liquidity of any company. In case of Tata Steel we find that the company has Rs 4561.04 crs in 2008-09 and Rs 5499.68 crs in 2009-10 and was locked up in loans and advances.

Here quick assets mean current Assets Inventory. The term quick assets refers to current assets which can be converted into cash immediately or at a short notice without diminution of value. Included in this category of current assets are: (i) cash and bank balances, (ii) Debtors/receivables. Loans and Advances should not form part of the quick assets, but conventionally it is kept within the quick assets. Thus, the current assets which are excluded are pre-paid expenses and inventory. The exclusion of inventory is based on the reasoning that it is not easily and readily convertible into cash. Pre-paid expenses by their very nature are not available to pay-off current debts. They merely reduce the amount of cash required in one period because of payment in a prior period. It is a rigorous measure of a firms ability to service short-term liabilities. The usefulness of the ratio lies in the fact that it is widely accepted as the best available test of the liquidity position of a firm. Some experts consider acid-test ratio is superior to the current ratio.

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5.0

Asset Growth Growth in the asset indicates that the companies are making a planned effort to ensure future revenue earning capacity as well as targeting higher profitability. Expansion or addition of fixed assets indicates future production capacity there by indicates sustainable top line growth. In case of addition of balancing equipment it will indicate the company is trying to achieve competitiveness by managing its cost structure and there by enhance its bottom line. Addition to the current asset indicates inventory and debtors build up in a systematic manner to strengthen cash to cash cycle and making the operating cycle move faster thereby trying to ensure top line growth for the current period. However, there are cases in companies where current asset is growing by default that is the company is not able to push it inventory in the market neither it is able to realize its debtors at a faster rate. Table 5.0 (Rs in crores)
Assets Fixed Assets Gross Block Less: Depreciation Net Block Investments Current Assets, Loans and Advances Current Liabilities and Provisions Net Current Assets Miscellaneous Total Tata Steel 2008-09 23544.69 9062.47 14482.22 42371.78 10268.09 8957.05 1311.04 105.07 58741.77 2009-10 26149.66 10143.63 16006.03 44979.67 12246.69 8999.61 3247.08 64232.78

Total assets of Tata Steel has been gone up from Rs.58741.77 in 2008-09 crores to Rs.64232.78 crores in 2009-10. Total asset has gone up by 9.35 percent in the current year compared to previous year. All the categories of asset has gone up during this period. Fixed asset has gone up from Rs.144482.22 crs in 2008-09 to Rs.16006.03 crs in 2009-10 registering a growth rate of 11.07 per cent. Needless to mentioned growth in the fixed assets indicates that the company has increased its capacity to produce or manufacture. The current asset of the company has gone up from Rs.10268.09 crs 2009-10 to Rs. 12246.69 crs in 2009-10 , registering a growth rate of 19.27 per cent. Current assets growth, other things remaining same, indicates effort of the company to drive up revenue and thereby profit. The company has certainly driven up revenue marginally and but built up current assets in higher proportion . Silverline in the whole approach is Cash and Bank balance has gone up by more than 200% and Loans and Advances have gone up by Rs 938.64 crores. Investments has gone up from Rs.42371.78 crores in 2008-09 to Rs 44979.67 crores in 2009-10 registering a growth rate of 6.15 per cent over the previous year. The company had already invested huge money earlier which has gone up in the current year also.

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6.0

Capital Structure Analysis Capital Structure Analysis indicates about solvency of any company. Solvency pertains to the companys ability to meet the interest costs and the repayment schedules associated with its long-term obligations. When a company borrows money, it promises to make a series of fixed payments. Because the shareholders get only what is left over after the debt holders have been paid, debt is said to create financial leverage. Capital Structure Ratios measures these leverage. From the companys standpoint the greater the proportion of its invested capital that is obtained from shareholders ,the less worry the company has in meeting its fixed obligations. But in return for this lessened worry, the company must expect to pay overall cost of obtaining capital. Conversely, the more funds that are obtained from debenture or bonds relatively low overall cost of the company. For a growing, tax paying company higher debt ensures better return for shareholders. A cursory look at the liabilities side of the Balance Sheet of a Company shows the leverage position of a company. Typically an Indian Company mobilizes fund from the sources as has happened in case of Tata Steel. As one can see the share holders fund comprises of original capital contributed by the Shareholders and various types of reserves and surplus. The Loan Fund composes of Secured Loans and Unsecured Loans. Below we find the schedule of share capital and reserves and surplus for Tata Steel. The table below gives a glimpse of the sources of long term finances of the company. The relative amount of a companys capital that is obtained from various sources is a matter of great importance in analyzing the soundness of the companys financial position. In illustrating the ratios intended for this purpose the following summary of the liabilities and owners equity side of the balance sheet will be used. Attention needed to be focused on the sources of invested capital( also called permanent capital: debt capital (loan funds) and equity capital(shareholders fund). From the point of view of the company, debt capital is risky because if the bond and debenture holders and other creditors are not paid promptly, they can take legal action to obtain payment. Table 6.0 (Rs. in crores)
2008-09 A. Shareholders Fund Share capital Reserves & Surplus B. Loan Funds Secured Loan Unsecured Loan Total (A+B) 6203.45 23972.81 30176.26 3913.05 23033.13 26946.18 57122.44 2009-10 887.41 36074.39 36961.80 2259.32 22979.88 25239.20 62201.00

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Because the shareholders have less certainty receiving dividends than the bondholders have receiving interest, investors usually are unwilling to invest in companys share unless they see a possibility of making a higher return (dividends plus share price appreciation) than they could obtain as bond holders . One can calculate a few types of ratios to measure financial leverage of a company and the most simple one would be Debt Ratio given by total long-term debt to total long term capital. Indian balance sheets do not present the Loan Funds under long-term debt and short term debt but categories them under secured and unsecured loan. Since secured and unsecured both the loans requires to be serviced we can presume this as fixed liability to be serviced by the companies as debt capital. Besides sometimes long-term lease agreements also commit the firm to a series of fixed payments it makes sense to include the value of lease obligations with a long-term debt. The debt equity ratio is an important tool to appraise the financial structure of a firm. It has important implications from the view point of lenders, owners and the firm itself. Too high and too low debt-equity ratio is not desirable. In case of high debt equity lead to inflexibility in the operations of the firm as it would face the pressures of lenders to meet its fixed commitment of interest servicing. So the firm has to sustain ever increasing top-line growth to service the debt. A low debt equity ratio does not help the equity investors to maximize their return. Hence striking a balance between debt and equity is desirable. There is no rule regarding this balance between debt and equity, however very often a 2:1 debt equity is quoted as rule of thumb in India though a large number of companies may not maintain that. Thus for Tata Steel (with some adjustments) Debt-Equity Ratio works out as below: Debt Equity Ratio. = Total Loan / Equity(i.e. Shareholders Fund).It can also written as Total Loan Equity Tata Steel Tata Steel = 68.28 percent of Equity or Shareholders Fund 2008-09 = 89.29 percent of Equity or Shareholders Fund
2009-10

Since there is no details of lease one can safely ignore value of lease. However while calculating debt/equity Ratio one must adjust equity to debit balances of profit and loss account (appearing on the asset side of the balance sheet). If any revaluation reserve is appearing under the head of reserves and surplus it is to be deducted from the shareholders fund to arrive at the right equity. Interest Coverage Ratio: This ratio is examined by the lenders to assess whether the borrowing firm is having enough earnings to meet the interest payment obligation. This can be done by comparing how much is the EBIT vs-a-vs interest payment obligation in a period. We find in the Table 6.1 Interest coverage ratio has decreased in 2009-10 compared to 2008-09.

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Table 6.1: Interest Coverage Ratio

A. EBIT B. Interest Payment During the period C. Interest Coverage Ratio (Times) 2008-09 8468.30 1152.69 7.35 2009-10 8722.70 1508.40 5.78

7.0 Asset Utilisation or Turn Over Ratios Asset utilisation ratios indicate how efficiently assets have been used to generate revenues and thereby profits and is concerned with measuring the efficiency in asset management. These ratios are also called efficiency ratios or turnover ratios. The efficiency or productivity measures outputs of a system in relation to inputs; the greater the volume outputs produced from a given level of inputs the more efficient the system and the company. This also reflects the speed with which the assets are used to convert into sales. The greater is the rate of turnover or conversion, the more efficient is the utilization/management, other things being equal. For this reason, such ratios are also designated as turnover ratios. Turnover is the primary mode for measuring the extent of efficient employment of assets by relating the assets to sales. An activity ratio may, therefore, be defined as a test of the relationship between sales (more appropriately with cost of sales) and the various assets of a firm. Depending upon the various types of assets, there are various types of activity ratios. Inventory Turnover Ratio. This ratio indicates the number of times inventory is replaced during the year. 5 It measures the relationship between the sales and the inventory level in any period. The merit of this approach is that it is free from practical problems of computation. The inventory turnover ratio measures how quickly inventory is sold. It is a test of efficient inventory management. To judge whether the ratio of a firm is satisfactory or not, it should be compared over a period of time on the basis of trend analysis. It can also be compared with the level of other firms in that line of business as also with industry average as a whole. In general, a high inventory turnover ratio is better than a low ratio. A high ratio implies good inventory management. Yet a very high ratio calls for a careful analysis. It may be indicative of under investment in, or very low level of, inventory. A very low level of inventory has serious implications. It will adversely affect the ability to meet customers demand as it may not cope with its requirements, that is, there is a danger of the firm being out of stock and incurring high stock out cost. It is also likely that the firm
5

The ratio can be computed in two ways. First, it is calculated by dividing the cost of goods sold by the average inventory. Alternatively Sales Inventory turnover = --------------------Inventory

Ideally it would have been cost of goods sold/Average Inventory. But, since financial statement does not provide the cost of goods sold data Sales /Inventory is used as a surrogate measure. In theory, this approach is not a satisfactory basis as it is not logical. For one thing, the numerator (sales) and the denominator (inventory) are not strictly comparable, as the former is expressed in terms of market price, the latter is based on cost. Secondly, the inventory figures are likely to be underestimates as firms traditionally have lower inventory at the end of the year.

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may be following a policy of replenishing its stock in too many small sizes. Apart from being costly, this policy may retard the production process as sufficient stock of materials may not be available. Table : 7.0 (Rs in crores) 2008-09 2009-10 24315.77 25021.98 3480.47 3077.75 635.98 434.83 1311.04 3247.08 6.98 8.12 38.23 57.54 20.07 7.71 52.29 44.95 9.54 6.34

1.Sales (Net) 2. Inventory 3. Sundry Debtors 4. Working Capital 5. Inventory Turnover (12) Times 6. Receivable Turnover (13) Times 7. Working Capital Turnover (14) Times 8. Days Sales blocked in Inventory 9. Days Sales in Debtors or Avg. Collection Period.

Similarly, a very low inventory turnover ratio is dangerous. It signifies excessive inventory or over investment in inventory. Carrying excessive inventory involves cost in terms of interest on funds locked up, rental of space, possible deterioration, and so on. A low ratio may be the result of inferior quality goods, over-valuation of closing inventory, stock of un saleable/obsolete goods, and deliberate excessive purchases in anticipation of future increase in their prices, and so on. Thus, a firm should have neither too high nor too low inventory turnover. To avoid both stock out costs associated with a high ratio and the costs of carrying excessive inventory with a low ratio, what is suggested is a reasonable level of this ratio. A company would be well advised to maintain a close watch on the trend of the ratio and significant deviations on either side should be thoroughly investigated to locate the factors responsible for it. The inventory turnover ratio for Tata Steel has gone up from 6.98 times in 2008-09 to 8.12 times in 2009-10 indicating higher turnover in 2009-10 with lesser inventory holding. How many days sales equivalent is blocked in the inventory can be calculated by dividing 365 days in a year by inventory turnover ratio. We can see from the Table 7.0 that last year 52.29 days equivalent of sales were blocked in inventory which has gone down to 44.95 days in 2009-10 which shows better utilization of inventory. Receivable (Debtors) Turnover Ratio and Average Collection Period. The second major activity ratio is the receivables or debtors turnover ratio. Allied and closely related to this is the average collection period. It shows how quickly receivables or debtors are converted into cash. In other words, the debtors turnover ratio is a test of the liquidity of the debtors of a firm. The liquidity of a firms receivables can be examined in two ways: (i) Debtors or receivables turnover; (ii) Average collection period. The debtors turnover shows the relationship between the sales and debtors of a firm. Average Collection period for Tata Steel were 9.54 days in 2008-09 and in 2009-10 it has reduced to 6.34 days.. This ratio also measures the liquidity of a firms debtors is the average collection period ratio, which has also improved.

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8.0

Funds Flow Management Companies mobilize funds during the year to create assets, to finance operations and to retire obligations. Sources of funds are from operation, raising of equity, debt or disposal of assets. It is possible to have an understanding and command on how the companies have mobilize resources and deployed them during a period of year. Below we have prepared sources and utilization of funds statement for Tata Steel. We find that the company has generated substantial resources from operations manifested in high growth of reserves and surplus, but substantial amount has been utilized in retiring preference shares and loans. Company did not create enough of fixed assets with long term funds , rather preferred to invest in subsidiaries and in the market. High amount of current asset has been created from its own fund , and less provided by the current liabilities. Fund Flow management Sources of Fund Reserves and Surplus Defered Tax Liability Forex Translation Diff. Forex Translation Differnce Reduction in Misc Expenses Current Liabilities Prov. Total Utilisation of Funds Conversion of Share Repayment of Secured Loans Repayment of Unsecured Loans Net Block Investments Current Assets Provision Employee Separation Total 5316.04 1653.73 53.25 1523.81 2607.89 1978.6 570.67 76.44 13780.43 Rs in Crores

12101.58 281.94 206.95 471.66 105.07 613.23 570.67 13780.43

9.0

Market Perception How a companys performance is viewed by investors is reflected in its (actual and potential) market price of share. How a company has done is reflected in its earnings per share.

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Earning per Share:The earnings per share figure is one of the most important ratios used by investment analysis, yet it is one of the most deceptive. If no dilutive securities are present in the capital structure, then earnings per share is simply computed by dividing PAT by number of ordinary shares. IF, however, convertible securities, stock options, warrants, or other dilutive securities are included in the capital structure, (1) earnings per equity and equity equivalent shares and (2) fully diluted earnings per share figures may have to be used. For Tata Steel basic earnings per share in 2008-09 were Rs.69.45 for 10 rupee fully paid up share, decreased to Rs.60.26 in 2009-10. Certain problems exist when the earnings per share ratio is computed. Often earnings per share can be increased simply by reducing the number of shares outstanding through buying back own share of the company. In addition, the earnings per share figure fails to recognize the probable increasing base of the stockholders investment. That is, earnings per share, all other factors being equal, will probably increase year after year if the corporation reinvests earnings in the business because a larger earnings figure is generated without a corresponding increase in the number of shares outstanding. Because even-well informed investors attach such importance to earnings per share, caution must be exercised, and it should not be given more emphasis than it deserves. The common problem is that the per-share figure draws the investors attention away from the enterprise as a whole which involves differing magnitudes of sales, costs volumes, and invested capital and concentrates too much attention on the single share of stock. P/E Ratio:The price earnings (P/E) ratio is an oft-quoted statistic used by analysts in discussing the investment possibility of a given enterprise. It is computed by dividing the market price of the stock by its earnings per share. A steady drop in a companys price earnings ratio indicates that investors are wary of the firms growth potential. Some companies have high P/E multiples, while others have low multiples. This measure involves an estimation not directly controlled by the company: the market price of its ordinary shares. Thus the P/E ratio is the best indicator of how investors judge the future performance (We say future performance because, conceptually the market price indicates shareholders expectations about future returns dividend and share price increasesdiscounted to a present value at a rate reflecting the riskiness of these returns.) Management is of course interested in this market appraisal, and a decline in the companys P/E ratio, if not explainable by a general decline in stock market prices is a course for concern. Also, management compares its P/E ratio with those of similar companies to determine the market places relative rankings of the firms. P/E ratios of industries vary, reflecting differing expectations about the relative rate of growth in earnings in those industries. At times, the P/E ratios for virtually all companies decline, predictions of general economic conditions suggest that corporate profits will decrease and/or interest rates will rise.

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