Chapter 5 Analysis of capital structure and long- term liquidity of NTPC Ltd.

Transcription

1 Chapter 5 Analysis of capital structure and long- term liquidity of NTPC Ltd.

2 5.1 Introduction Finance is the lifeblood and backbone of a business enterprise. No organization can prosper until it has got sufficient funds at its disposal. The primary aim of any business enterprise is to earn profit. To achieve this objective, there should be a sound financial plan for proper utilization of various sources of finance. The progress and the prosperity of a business concern depends upon the sound financial plan. Financial plan should be formulated in the light of present and prospective requirements of the business because financial principles that are appropriate for one stage in the life of an enterprise may not be as suitable in a later stage, nor in the same stage if the economic environment undergoes significant change. Financial plan is a broad term. It consists of determination of total finance, financial structure and financial policies. So, determination of financial structure is the part of overall financial plan. 5.2 Financial structure and Capital Structure Financial structure refers to the way as to how the firm s assets are financed. It includes both, long-term as well as short-term sources of funds. In other words, it refers to the left hand side of the Balance Sheet as represented by total liabilities. However, a more frequently used term is capital structure which is slightly different from financial structure. If short-term liabilities are removed from firm s financial structure, what one obtains is its capital structure. So, financial structure is defined as the amount of current liabilities, longterm debt, preferred stock and common stock used to finance a firm. In contrast, capital structure refers to the amount of long-ten^^ debt, preferred stock and 117

3 common stock used to finance a firm s assets. Thus, capital structure is only a part of the financial structure and it represents the permanent financing of the company. Another term Capitalization refers to total long-term funds required by the firm. Whereas, capital structure refers to make-up of capitalization i.e. types and proportion o f different securities to be issued. There cannot be a uniform financial structure which suits the requirements of all firms. In other words the financial structure has to be formed in such a way that it suits the needs of a particular firm meaning thereby that the firm should seek an optimum or an ideal financial structure for itself. Financial structure particularly the capital structure decision is a significant financial decision since it affects the shareholders return and risk and consequently the market value of the firm. The use of fixed charges capital like debt with equity capital is described as financial leverage or trading on equity. The main reason for using financial leverage is to increase the shareholders return. The concept of financial structure can be studied initially from the point of view of the length of time for which money is needed. The requirement of finance of an enterprise can be divided into three parts, i.e. long-term finance, medium-term finance and short-term finance. However, opinion is not consistent regarding the duration of each type of finance. The dividing line amongst these types of finance is thin and arbitrary. But generally, the need of funds for not more than one year is included in short term finance, for more than one year but not exceeding five years are included in medium term finance and those for over five years are included in long term finance. Long-term finance consists of equity share capital, preference share capital (except redeemable preference shares), irredeemable debentures and long term loans from government, financial and commercial institutions. It is invested in permanent and semi-permanent assets. For a new concern this is required for purchase of fixed assets, meeting the 118

4 requirement of some part of working capital and for raising the structure of the organization. For an existing company, it is required for expansion, development, modernization, industrial research, special campaign like advertisement etc. The medium term finance occupies the in between position. It is that finance which is to be retained in the business enterprise for a period longer than one year but it is not intended to retain permanently. It is defined as debt originally scheduled for repayment in more than one year but not more than five years. Some Management Accountants are of the opinion that it must not exceed five years while others assert this limit as ten years. The major sources of medium term finance are term loans and advances and redeemable preference shares and debentures. Commonly, medium term finance is used for tools, office equipment, furniture, additions and alterations in building etc. Short-term finance refers to the finance required for use in the business for not more than a year. The main sources of short-term finance are commercial banks, credit facilities between firms and acceptance credits. Current liabilities and provisions represent these sources of short- term finance. The basic characteristics of the short-term finance are that ones which primarily stand for very low cost and low risk capital. Short -term finance is invested in the current assets as a matter of policy, because the current assets are automatically converted into cash during routine business operations. AH the industries require more or less long term and medium term debt capital. Apart from ovm capital, it is advantageous to use debt capital as a matter of policy in order to avail the benefit of trading on equity. Similarly, long-term funds should be used prudently in order to avoid lack of liquid sources for current liabilities. Thus, optimum financial structure consists of proper mix among longterm, medium-term and short-term finance. 119

5 5.3 Analysis of Long-term and Short-term funds Long-term Funds The financial requirements of a business enterprise are of two types viz. permanent funds or fixed capital and temporary funds or working capital. The outlay of permanent fund goes for the procurement of fixed assets, both tangible and intangible. Tangible assets are those which can be seen e.g. land &building, plant &machinery and furniture & fittings. Intangible assets cannot be seen but they exist in the form of assets. These are preliminary expenses, goodwill, patent and copyrights Factor determ ining long-term funds In estimating the requirements of long-term funds to a business enterprise or an industry, the following factors should be taken into consideration: 1. Nature of business: The requirement of long-term funds will be more in the manufacturing sector like cement, steel etc. and infrastructure sector like power, roadways etc. than in the trading and distribution industry. 2. Volume of activity: An increase in the volume of sale may ask for additional long-term funds for capacity expansion. 3. Rapidity of technological changes: Fast technological changes turn the plant &machinery into obsolete ones which in turn increase the demand of longterm fund. 4. Trends in the cost of industrial equipment: If the prices of industrial equipment are going up and not keeping pace with the general price level, the investment in capital expenditure shall be greater. 120

6 5. Government Policies: Investment allowance and taxation policies of the government use to change the requirement of long-term fund for investment in fixed assets Short-term funds: The amount of money required for holding current assets is termed as temporary fund or short-term fund or working capital. It is required to meet day to day needs e.g. purchase of raw materials, work-in-progress, finished goods, book debts, cash in hand, salaries and wages and other daily working expenses. The need of temporary funds is satisfied partly out of credit given by suppliers and partly out of long and short tem fund Factors determ ining short-term funds The determination of the quantity of short-term funds is most essential so that a business enterprise may not face financial crises. In estimating the short-term requirement of funds, following factors should be considered: 1. Nature of business: Manufacturing and trading company requires more working capital, while railways and public utilities like power company require more long tem funds. 2. Time of manufacturing: The industry, which takes more time in manufacturing, requires more short-term funds. 3. Terms of purchases and sales: If a business concern makes cash purchases and credit sales, it will require more short-term funds. 4. Cycle of business or trade: More short-term funds are required in depression period and which are less during the boom period. 5. Reputation: The industry or a business concern, having good reputation, requires less working capital because it can get easy credits from the suppliers and service providers. 121

7 5.3.5 Analysis of Long-term and Short-term Funds of NTPC Ltd. The financial structure of NTPC Ltd can be broadly divided into long-term funds (LTF) and short-term funds (STF). The LTF of NTPC includes net worth as represented by equity shares, reserve funds and long-term liabilities. The long-term liabilities of the company represent loan taken from various foreign and domestic financial institutions, loan from government of India and issued debentures. The short-term funds are loans from commercial banks, sundry creditors. It also includes various provisions. NTPC s financial structures in terms of LTF and STF are depicted in Table 5.1. The Table shows the percentage contribution of each type of fund in the financial structure of the company. LTF were the major sources of financing of the company during the study period. Table 5.1 shows that the average contribution of the LTF was per cent of the total fund with a coefficient of variation (C.V.) of 4.55 per cent during the study period. However, the average contribution of LTF declined from per cent during the eighth plan period to per cent during the ninth plan period. But the C.V. stepped up fi*om 1.5 per cent to 2.82 per cent in the consecutive plan period under study. The LTF declined due to efficient utilization of short-term funds during the study period. The STF, which usually bear no cost or little cost, increased from 9.53 per cent from the starting year of the study period to per cent in the ultimate year. The mean STF for the entire period was per cent with a C.V. of per cent. The variation was significant during the study period. The average contribution of STF increased from 8.16 per cent in the eighth plan period to 14.96per cent in the ninth plan period with a C.V. of per cent and per cent respectively. In the eighth plan period contribution of STF dropped from 9.53 per cent in to 6.32 per cent in However, firom the first year of ninth plan period STF shown a 122

8 continuous rising trend for the first three years. It reached as high as per cent in the year In the last year of the study period the contribution of STF came down to per cent. The composition of long-term funds both in absolute figures and in percentage is shown vide Table 5.2. The amount of equity share capital showed a fluctuating trend within a range of Rs crore to crore during the period under study. However, in terms of percentage it declined sharply from per cent of the total fund in to per cent of the total fund in In the eighth and ninth five-year plan the mean proportion of the share capital in the total fund of the company were per cent and per cent with the C.V per cent and per cent respectively. The mean contribution of share capital for the entire study period was per cent of the total fund with a C.V. of per cent. Due to adequate operating profit the company managed to increase its reserve & surplus by almost five times during the study period. The reserve & surplus made a significant contribution towards the total fund of the company on a regular basis. The mean contribution of reserve & surplus in the total fund of the company for the period under study was per cent with a C.V. of per cent. It increased from Rs 4, crore in the year to Rs 20, crore in the ultimate year of the study period with a continuous increasing trend. In percentage it increased from 17.52per cent in to per cent in The average share of reserve & surplus in the eighth & ninth plan periods were 24.01per cent and 38.04per cent with a C.V. of 23.25per cent and 12.63per cent respectively. The growth of reserve and surplus during the study period was incredible and commendable. It was due to steady growth rate in sales and appropriate tariff structure. The propagator of privatization of Government 123

9 Company can be challenged only by this paramount financial performance of nationalized NTPC Ltd. The long-term borrowed funds show a continuous decreasing trend except in the last year of the study period. The proportion of the said fund to the total fund was per cent with a C.V. of per cent for the entire period. The longterm borrowed fund was per cent of the total fund in and decreased steadily to reach per cent of the total fund in the year However, it increased marginally by 2 per cent in the year In the eighth and ninth five year plan period the average contribution of long-term borrowed fund in the total financial structure were per cent and per cent with a C.V. of 7.62per cent and 8.84per cent respectively. Out of long-term borrowed fund secured loan showed a fluctuating trend during the study period. The maximum secured loan in absolute amount was Rs 3, crore in the year and in percentage it was in The proportion of secured loan had touched as low as 3.57 per cent in the last year of the Study period. Through out the study period secured loan had a meager participation in overall financial structure with a mean and C.V. of 8.90 per cent and 34.9Iper cent respectively. The mean contribution of unsecured loan was per cent of the total fund with a C.V. of 21.6Iper cent during the study period. The proportion of it declined sharply fi'om per cent in to per cent in In the eighth and ninth plan periods the mean contribution of unsecured loan to the total fund were per cent and per cent with a C.V per cent and 6.47 per cent respectively. The analysis reveals the fact that the company had convincingly managed to increase its credibility to procure funds as unsecured loans. Analysis of long-term and short-term fund position clearly reveals that the company has strengthened its position over the years in terms of long-term 124

10 financial solvency. The long-term creditors has been quite safe from the viewpoint of margin of safety during the study period Adequacy of long-term funds of NTPC Ltd. The funds, which are raised from long-term sources, should not only be sufficient to invest in fixed assets but also in current assets. The adequacy of LTF are to be judged in relation to quantum of the fimds invested in fixed and current assets as a percentage of total assets in NTPC Ltd. Table 5.3 shows the comparative position of long-term funds available and investment in fixed and current assets as a percentage of total assets in NTPC Ltd. It is clear from the Table that the amount of LTF exceeded the fixed assets. It means that long-term funds were adequate not only to finance entire fixed assets but also to finance part of current assets of NTPC Ltd. during the period under study. The company registered an average investment in the tune of per cent of its total fund in fixed assets with C.V. of per cent compared to LTF of per cent available for investment. Further, the investment in fixed assets had declined sharply from the average of per cent of the total fund in the eighth plan period to per cent of the total fund in the ninth plan period with a C.V. of 2.83 per cent and 4.98 per cent respectively. The mean investment in current assets was per cent during the study period with a C.V. of per cent. The mean investment in current assets increased piercingly from per cent in the eighth plan period to per cent in the ninth plan period with the C.V. of 7.57 per cent and 7.77 per cent respectively. This was because of increase in sundry debtors in successive year. The correlation coefficient between long-term fund and investment in fixed assets was It proves the fact that there was a strong relationship between available long-term fund and investment in fixed assets. Through out the study period, the company recorded an ideal financial structure 125

11 where long term funds were not only sufficient to cover up fixed assets but also a part of the current assets. It is such a highlighting situation where real working capital exists. Thus, from the above view point the situation of the company can be taken as healthy and encouraging. 5.4 Gearing of Capital of NTPC Ltd. Business firm usually uses debt fund for its potential lower cost. From shareholders perspective, debt is less expensive than that of equity for at least two reasons: Interest on most debt is fixed, and provided interest is less than the return earned from debt financing; the excess return goes to the benefit of equity investors. Interest is a tax-deductible expense whereas dividend is not. Capital gearing is very helpful in designing a sound and economical capital structure of a business enterprise. The term capital gearing is used to indicate the relative proportion of fixed interest bearing capital as represented by preference share capital and loan capital to the equity share capital fund in the capital structure. In calculating the equity share capital fund, the amount of retained earnings and other undistributed profits is taken into consideration. The capital structure may be low geared or highly geared. If the proportion of fixed interest bearing capital is more than the equity share capital, it is called highly geared. On the other hand, if the equity share capital is more than the preference share capital and loan capital, the capital structure is called low geared. The role of capital gearing in the successful running of a business enterprise is as important as the use of gears in the speed of an automobile. Gears are applied in an automobile for maintaining the desired speed. Initially an 126

12 automobile starts with a low gear and gradually, as it gets momentum, low gearing is changed to high gearing. In the same manner, the beginning of a concern may start with a larger amount of equity share capital i.e. low gear. As it gets momentum, subsequently the proportion of preference shares and debentures are desired to be increased in order to attain high gear. Consequentially it brings additional benefits to the stakeholders. An optimum capital gearing is very much helpful for the smooth and profitable running of the business. It helps the enterprise to navigate successfully in the period of trade cycles. A successful blending of different sources of fund in appropriate proportion is very much desirable from the viewpoint of investor, the creditors and the concern itself Capital gearing ratio is calculated as per the following formula. Capital Gearing Ratio Equity Capital Fund Preference Share Capital +Borrowed Capital NTPC Ltd. did not have any type of preference share capital through out the study period. Though NTPC Ltd. was in a favourable position in terms of longterm financial solvency; the company did not utilize the long-term debt source properly. The company had surprisingly turned into a low-geared company over the passage of time. The mean gearing ratio throughout the study period was 1.83 with the C.V. of per cent. It is clear from the Table 5.4 the proportion of equity share capital fund was large comparison to borrowed capital fund throughout the years under study. The capital-gearing ratio touched as high as 2.63 in with a continuous upward trend. In the last year of the study period it 127

13 decreased marginally to In the eighth and ninth plan periods the average gearing ratio were 1.37 and 2.29 with a C.V. of per cent and per cent respectively. 5.5 Financial Leverage of NTPC Ltd Gearing ratio is a popular term in U.K. It is also known as leverage in U.S.A. Financial leverage means use of debt capital in order to increase earnings. Leverage magnifies both managerial success (profits) and failures (losses). It increases risks of the equity holders due to the factors like commodity price fluctuations, loss of demand, technological obsolescence. Companies with financial leverage take the advantage of trading with equity. Generally, an unlevered company s return on assets is identical to its return on equity. A levered company is said to be successful in trading on equity when return on assets exceeds the after-tax cost of debt. At the same time a levered company is unsuccessful in trading on equity when return on assets is less than the-after-tax cost of debt. Thus effects of leveraging are magnified in both good and bad years. Leverage refers to the action of a lever, which provides some mechanical advantage in doing some work. In business terminology the term leverage is used to describe the ability of a firm to use fixed expenses to magnify the return to the shareholders. Financial Leverage attempts to find out the impact on earning of equity shareholders by using a policy of debt financing. The sources from which funds can be raised in view of the cost, be categorized into (1) Fixed cost bearing fund and (2) variable cost bearing fund. The former category consists of various types of long-term debt, including bonds, debentures, and preference shares. The long-term debts carry a contractual right of getting a fixed rate of interest. Dividend payable to preference shareholders is also payable at a fixed rate before 128

14 distribution of equity or ordinary shareholders. The equity shareholders are entitled to receive the reminder of the operating profit of the firm after meeting all obligations. The basic disadvantage is that a financial risk is associated with the use of debt capital. The use of debt capital increases the chances of variability of the return to the shareholders and the probability of being insolvent when the income of the firm goes down. Financial leverage can be measured in terms of degree of financial leverage. It is calculated as follows: Percentage change in EPS Degree of financial leverage = > 1 Percentage change in EBIT Alternatively, DFL can be measured at any level of operating profit (EBIT) as follows: EBIT DFL = >1 EBIT - Interest The higher degree of financial risk is associated with the greater degree of financial leverage and vice versa. DFL 1.05 means that for every Iper cent increase in EBIT, EPS will increase by 1.05per cent or for every Iper cent decrease in EBIT, EPS will decrease by 1.05 per cent. Under favourable operating and market situation, high degree of financial leverage is all time welcome. Again financial risk due to fall in sales can be minimized if there is low financial risk. It is a double-edged sword. It is therefore advisable that policy of financial leverage or trading on equity should be adopted only when there is a stability, certainty and continuity of earnings. 129

15 Table 5.5 exhibits return on capital employed (ROCE), rate on interest paid on debt and degree of financial leverage. It is apparent from the Table that the company had paid interest on loan at the lower rate than the ROCE throughout the study period. This resulted in the increase in shareholders flmd. During the eighth five -year plan the mean ROCE was per cent with a C.V. of 3.42 per cent. For the ninth plan period average ROCE had improved by 1.58 per cent. The return was found increased with continuity except in the year and The rate of interest paid on debt followed fluctuating trend during the study period. The highest and the lowest rate of interest paid on debt were per cent in the year and 7.73 in the year respectively. The mean rate of interest paid on debt was 9.42 during the study period with a C.V of per cent. The average degree of financial leverage dropped from 1.63 times in the eighth plan period to 1.35 times in the ninth plan period. As the earning of the company was steady and rising during the study period, company used the financial leverage prudently in order to increase the earnings of the shareholders. 5.6 Analysis of Long-term solvency of NTPC Ltd. Solvency refers to a company s long-run financial viability and its ability to cover long-term obligations. Solvency has a close relation with the operating results as well as capital structure of the company. Unlike equity capital, both short-term and long -term debt capital must be repaid. If longer is the debt repayment period and the less demanding is its repayment provisions, the easier it is for a company to service debt capital. Still debt must be repaid at specified times regardless of a company s financial condition and too much periodic interest of most debt. Failure to pay principal or interest typically results in proceedings where common shareholders can lose control over the company and all or part of their investment. When the proportion of debt in the total capital structure of a 130

16 company is larger, the higher are the resulting fixed charges and repayment commitments. This also enhances the likelihood of a company s inability to pay principal and interest. Solvency can be judged from three angles. These are Capital structure measure, Asset coverage measure and Earning coverage measure Capital Structure measure of solvency Debt-equity ratio and total debt equity ratio are used under capital structure measure. (i) Debt-Equity ratio Debt-equity ratio is generally acknowledged as a relevant and significant element or aspect of the capital structure of a business enterprise. It attempts to measure the balance between the two important components of capital structure. The balancing act translates itself into solving an optimization problem between maximising the wealth of the shareholders and risk associated with debt. Traditionally, it was believed that judicious use of the debt-equity combination could increase the total value of a firm. Modigliani and Miller in the year 1958 broke the long-established belief by declaring that no matter how one divides up the capital structure of a firm between debt, equity and other claims, there is a conservation of investment value. Debt-equity ratio also measures the risk taking capacity of an individual enterprise. It expresses the relationship between borrowed capital and owners equity. Here, Debt means all long-term borrowings like debentures, term loans from financial institutions and banks, deferred payment credits, long -term incentive loans from government, but excludes equity -oriented loans like convertible debentures. In India, companies can issue fixed deposits for a maximum period of three years. As per Capital Issue (Control) Act these do not qualify as long -term debt. The Controller of Capital Issues regards all preference shares redeemable not later than 12 years as debt and beyond 12 years as equity. 131

17 But as per RBI views Preference share capital should be included in debt to show the effect of the use of fixed interest/ dividend sources of funds on the earnings available to the ordinary shareholders. Equity includes: paid-up ordinary share capital, share premium, capital subsidies by government, free reserves, and all other equity-type loans and debenture. There are two views regarding revaluation reserve. Some experts are of the view that since revaluation reserve is neither a free reserve nor is there any cash flow to the business, it should not be treated as a part of net worth. Other contend that since lenders are interested with the present value of the business at current prices for any lending decision, there is nothing wrong of recording this value in the books of accounts and thus include in the net worth for the purpose of debt-equity ratio calculation. The ratio is ascertained as follows: Debt Debt-Equity Ratio = Equity The debt-equity ratio thus indicates the relative proportions of debt and equity in financing the assets of a firm and the extent to which the firm depends upon debt capital for its existence. It also indicates the margin of safety to the creditors, i.e. the extent to which the creditors face risk in getting their due money back. The higher is the ratio, the greater will be the risk to the creditors and this indicates too much dependence of firm on debt capital. The equity shareholders of the firm would, however, stand to gain in two ways: (i) with a limited stake, they would be able to retain control of the firm and most importantly, (ii) the return to them would be magnified. On the contrary, a low ratio reveals a high margin of safety to creditors. But, the shareholders (equity) would be deprived of the benefit of trading on equity or leverage., Debt equity ratio is found to vary within a wide range, from less than 1 to 3. In India, the average debt equity ratio across industry is found to have moved from a conservative initial level of below 1 to 1.5 and finally to 2. The general debt-equity norms as per financial institution for medium 132

18 and large -scale projects are 2: 1. This serves as broad guidelines against which variations are permitted on the merit of the case. Other things being (i) a highly capital-intensive project is eligible for a significantly higher debt-equity ratio, (ii) a project in a backward area qualifies for a higher debt-equity ratio, (iii) a project manufacturing a product included in Appendix I of the Industrial Licencing Policy is entitled to a hi'gher debt-equity ratio, and (iv) a project promoted by FERA/MRTP company is eligible for a lower debt-equity ratio. There is no rigid rule regarding debt-equity ratio though a ratio of 2: 1 is generally accepted as an ideal one for a country like India. But for highly capitalintensive projects, a higher ratio is allowed depending upon the nature of the industry and the circumstances prevailing thereon. It may go to 4: 1 or even 6: 1 in exceptional circumstances. As per Table 5.6 the debt-equity ratio of NTPC Ltd. declined from 0.89 in to 0.40 in with a continuous decreasing trend except in the year The mean ratio was with a C.V per cent. In eighth and ninth plan periods, the mean debt-equity ratios were and 0.44 respectively with a C.V per cent and 11.59per cent respectively. Higher debt-equity ratio indicates a greater flexibility in operation of the undertaking. But, shareholders lose the benefits of their trading on equity. It is clear fi*om the table that NTPC did not heavily rely upon debt capital throughout the study period and deprived the shareholders from getting the benefit of low cost debt. (ii) T o ta l D e b t E q u ity R a tio This ratio takes into account the entire financial structure of the business, divided broadly between owner s equity and the outside liabilities. This ratio is not widely used in India. The ratio is more prevalent in the industrialized countries like the United State, Canada and Japan. As the current liabilities are not a permanent part of the capital employed, some experts are against the inclusion of current liabilities in debt category. Again, current liabilities are also the obligation of the 133

19 firm. So, it is judicious to include all types of debts in order to reflect total debts owned by the firm. In India where there is a dearth of risk capital, the maximum limit of the ratio may be 3. It means that 25 per cent of the capital requirement should be provided by net worth. Historically Japan has evolved the highest total debt equity ratio, of around 5. On the other hand, in U.S. where there is a glut of risk capital, the preferred value of the ratio is 1. The total Debt-Equity ratio of NTPC Ltd. is shown in Table 5.6. The ratio registered a downward trend over the period except in the year and The trend is similar to that of the long-term debt equity ratio indicating the company s increasing reliance on equity. In the eighth plan period the mean ratio was.90 with a C.V. of per cent. In the ninth plan period the ratio fell drastically to 0.69 with a C.V. of 9.59per cent. The overall total debt-equity ratio during the study period was with the C.V. of 18.56per cent. So, Capital structure measure of solvency, though static in nature, asserts the fact that NTPC Ltd. is a long-term solvent company A sset co verage m e a s u re o f solvency Assets represent secondary sources of security for lenders which range from loans secured by specific assets to assets available as general security to unsecured creditors. Long-term financial strength can be measured through fixed assets to debt ratio and fixed assets to net worth ratio. (i) Fixed Assets to Debt Ratio This ratio indicates how far the long-term debt funds are secured with the fixed assets. Fixed assets are those which are not meant to be sold but to be utilised in the firm s business. The amount invested in them is more or less permanently blocked or sunk. They produce income indirectly through their use in operation. Therefore, existence of higher amount of fixed assets ensures the long-term 134

20 creditors regarding tlie repayment of their debt. If the fixed assets are more than debt, it becomes a favourable sign from the viewpoint of fund providers. On the other hand, if fixed assets are too little compared to debt it poised as a danger signal from the viewpoint of long-term creditors. The ratio is calculated as follows: Fixed Assets Fixed Assets to debt ratio = Long-term Debt The fixed assets to debt ratios are shown in table 5.7. The Fixed Assets to debt ratio of NTPC Ltd. registered a continuous rising trend in the eighth plan period. It had increased from 1.66 times in to 2.04 times in Mean ratio and the C.V. during the period were 1.87 times and 7.8per cent respectively. However, the ratio fluctuated during the ninth plan period. The ratio decreased from 2.23 times in to 2.16 times in The position improved slightly in the year and in which the fixed assets were 2.28 times and 2.68 times respectively in comparison to debt. In the last year of the study period it decreased fiirther to 2.44 times. The overall mean ratio during the study period was 2.16 with a C.V. of 14.5 per cent. On this basis, however, it can be concluded that the principal amount of long-term creditors was secured to a considerable extent. (ii) F ix e d Assets to N e t W o r th R a tio The fixed assets by their very nature require capital which is more or less permanently sunk them. Management should be cautious in deciding about the investment in fixed assets as it involves commitments of fiinds for longer periods in the fiiture and usually are difficult and costly to reverse the decision. Fixed Assets to Net Worth ratio aims to find out whether the owners have provided enough funds to finance fixed assets. It is calculated as follows: 135

21 Net Fixed Assets Fixed Assets to Net Worth = Net Worth Here, net fixed assets means gross bloclc minus depreciation. If the ratio is less than 100 per cent, it indicates that the net worth finances the entire fixed assets and part of the current assets. On the other hand, if the ratio is more than 100 per cent it indicates that the borrowing is required to finance fixed assets and the entire working capital. Therefore, a smaller percentage is desirable in respect of fixed assets to net worth ratio. For a manufacturing concern, the ratio should be ranging between 0.67 and It means that the owners contribution towards current asset finance may vary within 25 per cent to 33 per cent of the required fund. As per Table 5.8, NTPC Ltd. registered a declining trend in respect of fixed assets to net worth ratio except in the year In the eighth five-year plan the ratio decreased over the period from 1.47 times in to 1.22 times in with a mean and C.V. of 1.39 times & 7.23per cent respectively. In the ninth five year plan the ratio decreased similarly from 1.11 times in to 1.00 times in However, it stepped up marginally to 1.08 times in It, however, came down to 0.99 times in the last year of the study period. The mean ratio during the ninth plan period was 1.04 times with a C.V. of 4.91 per cent. During the entire study period the mean ratio was 1.22 with a C.V. of per cent. It is to be noted that the ratio was far below the standard value during the entire study period. But efforts were made by the company to equalise the standard norm In te re s t co verag e m easure o f solvency Earnings coverage measures focus on the relation between debt-related fixed charges and a company s earnings available to meet these charges. These measures are important factors in debt ratings. Bond indentures often specify minimum 136

22 levels of earnings coverage for additional issuance of debt. Regulatory authorities always require the ratio of earnings to fixed charges be disclosed in the prospectus of all debt securities registered. Hence, interest coverage ratio is an important measure of long-term solvency. (i) In te re s t c o verag e ra tio As the interest on long -term and short -term debts and the dividend on preference share capital is a fixed burden on the profits of the firm, it is reasonable to find out the extent to which earnings cover the fixed financial charges. Interest coverage Ratio is one of the most conventional ratios used for testing firm s debt servicing capacity. It is computed by dividing earnings before interest «&taxes by fixed interest charges. Interest Coverage Ratio = EBIT Fixed Interest Charges The ideal norm for interest coverage ratio is 4 times. A high ratio is a sign of low burden of borrowings of the business and lower utilization of borrowing capacity. As per Table 5.9, the interest coverage ratio of NTPC was 1.68 only in the year In a period of ten years it jumped up by more than two and half times. The ratio touched to 4.39 times in the year In the eighth plan period the mean interest coverage ratio was only It was only fifty per cent of the standard norms. The C.V. was per cent during the period. The position started improving from the last year of the eighth plan period. It was due to decrease in loan fund in the capital structure of the company from the year onwards. In the ninth plan period the mean ratio was 3.67 times with a C.V per cent. The mean ratio through out the study period was 2.79 with a C.V per cent. A linear trend has been fitted to figure 5.4 in order to show upward trend 137

23 of Interest coverage ratio throughout the study period. The equation of the linear interest coverage is y=0.345x where y denotes times of interest coverage and Xdenotes the period in number. NTPC consolidated its position in respect of interest coverage ratio over the period of times. In the last two years it crossed the ideal norm. So, it can be said that NTPC is in a comfortable position to pay interest to its creditors. 138

24 References Bernstein, L A and Wild, J J (2004), Analysis o f financial Statements, New Delhi, Tata Mcgraw Hill Publishing Co. Ltd., pp Bhattacharya, H (1995), Total management by ratios: an integrated approach, New Delhi, Sage Publication India Pvt. Ltd., pp Bhattacharya, H (2004), Working Capital M anagement- strategic and techniques. New Delhi, Prentice Hall of India Pvt. Ltd. pp Chandra, P (2004) Financial Management- theory and practice, New Delhi, Tata Mcgraw Hill Publishing Co. Ltd., pp Foster, G (2002), Financial Statement Analysis, Delhi, Pearson Education (Singapore) Pvt. Ltd. pp Goel, S (2001), Management o f Finance in Public Enterprises, New Delhi, Deep & Deep Publication Pvt. Ltd. pp Gupta, R K {\99{i). Profitability, Financial Structure and Liquidity, Jaipur, Prinwell Publishers, ppl-84 ibid pp Khan, M.Y and Jain, P.K. (2005), Financial Management- Text, Problems and Cases, New Delhi, Tata Mcgraw Hill Publishing Co. Ltd., pp Kumar, P {\9% ), Analysis o f financial statement o f Indian industries, Delhi, Kanishka Publishing House pp Pandey, I. M. (2004), Financial Management, New Delhi, Vikas Publishing House Pvt. Ltd. pp

25 TABLE 5.1 QUANTUM OF LONG-TERM AND SHORT-TERM FUND OF NTPC LTD. DURING EIGHTH & NINTH FIVE YEAR PLAN PERIODS AS A PERCENTAGE OF TOTAL FUND Eighth plan Ninth plan Year Long-term Short-term Year Long-term Short-term Fund Fund Fund Fund ' Mean Mean C.V 1.5% 16.84% C.V 2.82 % 15.84% Overall mean 'or long-term fund Overall mean for short-tem fund Overall C.V for long-term fund 4.55 % Overall C.V for short-term fund % Source: Computed and compiled from published Amiual Reports of NTPC Ltd. 140

26 STRUCTURE OF LONG-TERM AND SHORT-TERM FUND OF NTPC LTD. DURING EIGHTH &N1NTH Year Long-term Fund Short-term Fund Owned Borrowed Current eighth Share Plan Capital (30.46) (30.57) (29.10) (27.10) (26.57) Mean (28.76) C.V. 6.47% (24.65) Reserve Total Secured Unsecured Total Liabilities & & Loans Loans Provisions Surplus (17.52) (47.98) (9.74) (20.38) (50.94) (11.30) (23.01) (52.11) (11.65) (27.78) (54.96) (11.92) (31.37) (57.95) (11.75) (24.01) (52.77) (11.27) 23.25% 7.24% 7.86% (33.78) (58.43) (9.81) (32.75) (42.49) (9.53) ,05 (29.55) (40.85) (8.21) (26.81) (38.46) (9.43) ,84 (26.80) (37.99) (6.32) (22.97) (34.72) (7.33) (27.78) (39.05) (8,18) 13.09% 7.62% 16.84% (19.34) (29.15) (12.42) Total 24785,66 (100,00) (100.00) (100.00) (100.00) (100.00) % (100.00) (21.75) (35.07) (56.82) (8.60) (18.60) (27.20) (15,98) ' (100,00) ,14 (19.45) (37.57) (57.02) (6.04) (19.04) (25.08) (17.90) (100,00) (18.44) (42.52) (60.96) (4.64) (18.51) (23.15) (15.89) (100.00) (16.97) (45.26) (62.23) (3.57) (21,58) (25.15) (12.62) (100.00) Mean (20.25) (38.84) (59.09) (6.53) (19.41) (25.94) (14.96) C.V % 12.63% 13.47% 40.22% 6.47% 8.84% 15.84% 15.48% Mean & (24.51) (31.42) (55.94) (8.90) (23.60) (32.42) (11.57) C. V % 29.44% 8.02% 34.91% 21.61% 22.43% 34.78% 23.31% For Two Plans Source: Computed and compiled from published Armual Reports of NTPC Ltd. Note: Figures in parentheses show percentage of respective item taking Total liabilities as hundred. 141

27 Capital Structure of NTPC LTD. during 8th & 9th plan periods - -Share Capital - -Reserves Surplus -n-r-secured Loans -»«-Unsecured Loans -^-Current Liablities Linear (Reseive & Surplus) -----Linear (Share Capital) Linear (Unsecured Loans) Linear (Current Liabilities) Linear (Secured Loans) Year Figure

28 TABLE: 5.3 LONG-TERM FUNDS, FIXED ASSETS AND CURRENT ASSETS AS A PERCENTAGE OF TOTAL ASSETS DURING EIGHTH & NINTH FIVE YEAR PLAN PERIODS Year Long-term Fund Fixed Assets Current Assets EIGHTH P T L, A N N I N T H K T> T L A N Mean C.V. 1.50% 2.83% 7.57% Mean C.V. 2.82% 4.98% 7.77% Overall Mean Overall C.V. 4.56% 10.04% 20.26% Source: Computed and compiled from published Amiual Reports of NTPC Ltd. 143

29 Table: 5.4 Capital Gearing Ratio of NTPC Ltd. during eighth & ninth FIVE YEAR Plan Periods Year Equity Share Capital Pref Shares & Borrowed Capital Gearing (RS IN CRORE) Fund (Rs IN CRORE) Ratio (In times) eighth P L A N Mean C.V % ninth P L A N Mean C.V. Overall Mean Overall C.V % % Source: Computed and compiled from published Annual Reports of NTPC Ltd. 144

30 TABLE 5.5 RETURN ON CAPITAL EMPLOYED, RATE ON INTEREST PAID ON DEBT AND DEGREE OF FINANCIAL LEVERAGE OF NTPC LTD. DURING EIGHTH & NINTH FIVE Year Return on Capital employed ( in percentage) YEAR PLAN PERIODS Rate of interest paid on debt (in percentage) Degree of financial leverage (in times) Mean C.V 3.42% 15.09% 2.89% Mean C.V 6.79% 15.47% 11.55% Mean for the study period C.V of the study period 8.56% 14.48% 12.31% Source: Computed and compiled from published Armual Reports of NTPC Ltd. 145

31 1 TABLE: 5.6 DEBT- EQUITY RATIO AND TOTAL DEBT-EQUITY RATIO OF NTPC LTD. DURING EIGHTH & NINTH FIVE YEAR PLAN PERIODS Eighth Plan Period Ninth Plan Period Year Debt-Equity Ratio (in number of times) Total Debtequity ratio (in number of times) Year Debt-Equity Ratio (in number of times) Total Debtequity ratio (in number of times) Mean Mean C.V 14.55% 14.84% C.V % 9.59% Overall Mean Overall C.V 30.35% 18.56% Source: Computed and compiled from published Amiual Reports of NTPC Ltd. 146

32 147

33 Total Debt-equity ratio of NTPC LTD.(in number of times) -Total Debt-equity ratio(in number of times) Year Figure

34 TABLE5.7 FIXED ASSETS TO DEBT RATIO OF NTPC LTD. DURING EIGHTH AND NINTH FIVE YEAR PLAN PERIODS. (IN NUMBER TIMES) EIGHTH PLAN PERIOD NINTH PLAN PERIOD Year Fixed Assets to debt Year Fixed Assets to debt ratio ratio Mean 1.87 Mean 2.36 C.V. 7.8% C.V. 8.8% Mean for the study period 2.16 C.V. for the study period 14.5% Source; Computed and compiled from published Annual Reports of NTPC Ltd. 149

35 TABLE 5.8 FIXED ASSETS TO NET WORTH RATIO OF NTPC LTD. DURING EIGHTH AND NINTH FIVE YEAR PLAN PERIODS. (IN NUMBER TIMES) EIGHTH PLAN PERIOD NINTH PLAN PERIOD Year Fixed Assets to net worth ratio Year Fixed Assets to net worth ratio Mean 1.39 Mean 1.04 C.V. 7.23% C.V. 4.91% Mean for the study period % C.V. for the study period Source: Computed and compiled from published Annual Reports of NTPC Ltd. 150

36 TABLE: 5.9 I INTEREST COVERAGE RATIO OF NTPC LTD. DURING EIGHTH &NINTH FIVE YEAR PLAN PERIODS Year Interest Coverage Ratio ( In number of Times) EIGHTH P L A N Mean 1.90 C.V % NESTTH P L A N Mean 3.67 C.V % Overall Mean 2.79 I Overall C.V % Source: Computed and compiled from published Annual Reports of NTPC Ltd. 151

37 Interest Coverage Ratio of NTPC Ltd. during 8th & 9th Plan Periods Interest Coverage Ratio Linear (Interest Coverage Ratio) Year Figure