CHAPTER-4 ANALYSIS OF LIQUIDITY

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1 CHAPTER-4 ANALYSIS OF LIQUIDITY SR. NO. PARTICULAR P. NO 4.1 INTRODUCTION OF LIQUIDITY CONCEPT OF LIQUIDITY SIGNIFICANCE OF THE LIQUIDITY ANALYSIS LIQUIDITY ANALYSIS OF SELECTEDAUTOMOBILE INDUSTRY Current Ratio Super Quick Ratio Liquid Ratio 92

2 4.1 INTRODUCTION OF LIQUIDITY Financial liquidity indicates the capability of payment of the firm. The daily expenses of manufacturing and administrative work will be repetitive in nature. In general sense, these expenses are increasing or decreasing according to the volume of production and different policy of the firm or company. Character of management is good when maintain enough liquidity. It is extremely essential for any firm to be able to meet its obligations as they became dues. In fact analysis of liquidity needs the preparation of cash budget, cash statement as well as fund flow statements. Generally liquidity ratios measure the ability of the firm to meet its current obligations. Liquidity ratios, by establishing a relationship between cash and other current assets to current obligations provide a quick measure of liquidity. A firm should ensure that it does not suffer from lack of liquidity and also it does not have excess liquidity. Anyone company may be failure to meet its obligations due to lack of sufficient liquidity, will result in a poor credit worthiness, loss of creditors confidence or even in legal tangles resulting in the closure of the company. A very high degree of liquidity is also bad; idle assets earn nothing. The firm s funds will be unnecessarily tied up in the current assets therefore it is necessary to strike a proper balance between high liquidity and lack of liquidity. 4.2 CONCEPT OF LIQUIDITY The concept of liquidity is very important to understand from the financial management point of view, as it is the basic criteria to test the short term liquidity position of the firm. Liquidity may be defined as the ability to realize value in money the real liquid asset. It has two dimensions [A] the time required to convert the assets money and [B] The certainty of the realizable price. Generally the term liquidity means conversion of assets in to cash during the normal course of business and to have regular continuous flow of cash to meet outside current Liability (generally maturing within a year) as and when due and payable and also the ensure money for day to day business operations. Hence the flow of current assets should circulate with such a rapid speed that they are converted into cash within a year so that timely payment may be made 81

3 to outsiders for interest, dividends, etc. The quality of current assets is therefore very important for analyzing liquidity. 4.3 SIGNIFICANCE OF THE LIQUIDITY ANALYSIS 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 cash hardly is over-stressed. In fact liquidity is a pre-requisite for the very survival of a firm. The short-term creditors are interested to know the sort-term solvency or liquidity position of a firm. But liquidity implies, from the viewpoint of utilization of funds of the firm that funds are idle or they earn very little. A proper balance between the two contemporary requirements i.e. liquidity and profitability is required for efficient financial management. The liquidity ratio measures the ability of a firm to meet its short-term obligation and reflects the short-term financial strength/solvency of a firm. 4.4 LIQUIDITY ANALYSIS OF SELECTED AUTOMOBILE INDUSTRY Liquidity or short term solvency signifies the capacity to meet the financial obligation as and when required. Liquidity ratios are used to measure the shortterm solvency and indicate the ability of a firm to meet its debt requirements as and when they become due. Current liabilities are used as the denominator of the ratios because they are considered to represent the most urgent debt, requiring retirement within one year or most preciously within one operating cycle. The available cash resources to satisfy these obligations must come primarily from cash or the conversion of cash of current assets. A firm should ensure that it does not suffer from lack of liquidity, and also that it is not too highly liquid, because a very high degree of liquidity is not warranted, as funds will be unnecessarily locked up in current assets involving idle capital cost which will hamper the profitability. Hence, a sound financial management policy seeks to maintain adequate liquidity without impairing profitability. Effective management of liquidity would result in higher profit accrual, especially, if the effectiveness were due to lowering of receivable accounts and 82

4 inventories. Of course, there are examples of companies who have witnessed a decline in profits despite effective management of liquidity. But, then the rate of decline in profit probably would have been higher if not countered by effective liquidity management. It is, therefore, very important for maintaining minimum liquidity position of the firm in whatever situation in which it operates. There are two common liquidity ratios Current Ratio Super Quick Ratio Liquid Ratio CURRENT RATIO The current ratio is the most basic liquidity test. It signifies a company's ability to meet its short-term liabilities with its short-term assets. A current ratio greater than or equal to one indicates that current assets should be able to satisfy near-term obligations. A current ratio of less than one may mean the firm has liquidity issues. The Current Ratio is one of the best known measures of financial strength. It is formula as shown below: Current ratio measures firm s short-term solvency. It indicates firm s ability to cover its current liabilities with its current assets. In a more specific manner, it indicates the availability of current assets in rupees for every one rupee of current liability. A conventional rule, current ratio of 2:1 or more considered to be satisfactory. Higher the current ratio is always enviable because it indicates the greater the margin of safety, i.e., a cushion of protection for creditors and large the amount of current assets in relation to current liabilities, more the firm s ability to meet its current obligations. However, too high ratio may be favourable to creditors, but is not beneficial for the firms, because it shows poor utilization of its current assets. Lower ratio is not enviable because it indicates the less the margin of safety for creditors. Current Assets Current Ratio = Current Liabilities 83

5 The current ratio of the selected companies of automobile represents in the table 4.1., and also shows the relation between current assets and current liabilities in relative terms as times. Table 4.1 Current Ratio of the Individual Selected Automobile Companies under Study from to (In Times) Year Hind M & M Premier Tata Force Average S.D C.V Average S.D C.V Min Max Source: Appendix 3.1 to 3.5 Current ratio of Hind Motors varies from 0.95 times to 0.45 times during the period of study. It shows the overall fluctuation in the ratio within the study period. The current ratio of Hind Motors was higher in the year the value of the ratio in this year was 0.95 times, while lower was marked in the year and the value of the ratio in this year was 0.42 times. The 84

6 average value of the current ratio of Hind Motors was 0.61 times and this was the low value than the average of automobile industry. The standard deviation was 0.18 times and co-efficient of variation was percent respectively, both the value are low compare with other automobile companies. It can be said that the above analysis, company should try to maintain this with the standard norms 2:1 at least. In Mahindra & Mahindra, the current ratio ranged between 0.94 times in and 0.68 times in with an average ratio of 0.81 times. This ratio showed fluctuating trend during the period of study respectively. The standard deviation was 0.14 times which was the lower than the average of other companies and co-efficient of variation was percent respectively which is the lower value compare with other companies (31.98 percent). In Premier Motors the current ratio ranged between 1.30 times in and 1.21 times in with an average of 2.43 times. The standard deviation was 1.48 times which is higher among other companies, and coefficient of variation was percent, this is the highest value marked than the other four automobile companies. From the above analysis, it can be concluded that, this company tries to maintain this ratio more than one and which leads toward efficient management. As regard the, Tata Motors the current ratio varies from 0.68 times to 0.46 times during the period of study. It shows the overall fluctuated in the ratio within the study period. The current ratio of Tata Motors was higher in the year the value of the ratio in this year was 0.79 times, while lower was marked in the year and the value of the ratio in this year was 0.46 times. The average value of the current of Tata Motors was 0.60 times which was low than the average of automobile industry. The standard deviation was 0.10 times and co-efficient of variation was percent respectively, both the value are low compare with other automobile companies. It can be said from the above analysis; company does not use their current assets in efficient manner which affects the company reputation. To maintain the company s reputation, company should have to maintain this ratio at standard norms. 85

7 In Force Motors the current ratio ranged between 1.47 times in the year and 1.79 times in the year with an average of 1.34 times. This ratio showed fluctuated trend during the period of the study. The standard deviation was 0.47 times and co-efficient of variation was percent. This has shown lower fluctuation in current ratio. On the basis of above analysis, it can be said that the average current ratio of Premier Motors (2.43 times) was the highest in all other considered automobile companies. This was followed by Force Motors, Mahindra & Mahindra Motors, Hind Motors, and Tata Motors. From the above analysis, it be concluded, the selected automobile companies need to maintain this ratio at standard norms 2:1, this is better for the selected automobile companies because able to meet with the current liabilities. Short-term investors are always interested in the short-term financial strength of the company. Chart 4.1 Current Ratio of the Selected Automobile Company under Study ANOVA TEST OF CURRENT RATIO H 0 : There is no significant difference in current ratio between selected Automobile companies. H 1 : There is significant difference in current ratio between selected Automobile companies. Level of significance : 5% level Degree of freedom: 54 (numerator 4 and denominator 50) Critical value:

8 Table No Analysis of Variance Test Companies-wise (Anova) of Current Ratio Sum of Degree of Mean P - F Particulars F Squares Freedom Square Value Critical Between Groups Within Groups Total Since F cal > F critical at 5% significance level (in other words P value is less than 0.05), the null hypothesis is rejected. It can be concluded that there is significant difference in current ratio between considered automobile companies. H 0 : There is no significant difference in current ratio between selected years H 1 : There is significant difference in current ratio between selected years Level of significance : 5% level Degree of freedom: 54 (numerator 4 and denominator 50) Critical value: Table No Analysis of Variance Test Year-wise (Anova) of Current Ratio Sum of Degree of Mean P - F Particulars F Squares Freedom Square Value Critical Between Groups Within Groups Total Since F cal < F critical at 5% significance level (in other words P value is greater than 0.05), the null hypothesis is not rejected. It can be concluded that there is no significant difference in current ratio between considered years SUPER QUICK RATIO The measure of absolute liquidity may be obtained by comparing only cash and bank balance as well as readily marketable securities with current liabilities. This is ratio a very exact to measure standard of liquidity and it is satisfactory if the ratio is at least 0.5: 1. The current ratio is the measurement 87

9 of short-term financial solvency. But it does not measure the quality of current assets. The formula for that is following. Quick Assets = Cash & Bank Balance + Investment readily convertible in to cash Super Quick ratio helps us to determine whether a business would be able to pay off all its debts by using its most liquid assets. If Super quick ratio is 0.50 or more than means that the most liquid assets of a business are equal to its total debts and the business will just manage to repay all its debts by using its cash and marketable securities. In short, higher the Super quick ratio is always desirable because it indicates the greater the margin of safety and adequate the amount of most quick assets in relation to current liabilities. However, too high ratio may be favourable to creditors, but is not beneficial for the firms, because it affect the profitability. Quick Assets Super Quick Ratio = Current Liabilities The Super quick ratio of selected automobile companies is shown in the Table 4.3.Super Quick ratio of Hind Motors showed a fluctuating trend during the study period and fluctuated from 0.07 times in to 0.03 times in The high ratio marked in the year with 0.30 times and low ratio is marked in with 0.03 times. The average value of the super quick ratio of Hind Motors was 0.12 times which is lower than the average of selected companies of automobile industry. The standard deviation was times and co-efficient of variation was percent respectively. Super Quick ratio of Mahindra & Mahindra Motors indicated a fluctuating trend during study period. It is fluctuated from 0.21 times in to 0.23 times in with an average of 0.33 times, which is the higher than the average of selected companies of automobile industry. The standard deviation was 0.16 times which was the matched with an average value of selected companies of automobile industry. In the case of co-efficient of variation was percent which was lower than average of selected companies of automobile industry and this is indicated low variation in this ratio. 88

10 Table 4.3 Super Quick Ratio of the Individual Selected Automobile Companies under Study from to (In Times) Year Hind M & M Premier Tata Force Average S.D C.V Average S.D C.V Min Max Source: Appendix 3.1 to 3.5 Super Quick ratio of Premier Motors showed a fluctuating trend and fluctuated from 0.05 times to 0.35 times during the period of study. The higher ratio marked in the year with 0.35 times, while lower marked in the year 0.05 times in the year The average value of quick ratio was 0.15 times which was quite lower than the average value of selected companies of automobile industry. The standard deviation was 0.09 times and co-efficient of variation was percent respectively. 89

11 The Super quick ratio of Tata Motors marked a increasing trend for first three years and increased from 0.08 times to 0.33 times in to than this ratio marked a fluctuating trend and fluctuated from 0.17 times to 0.03 times ( to ) during the study of period. The average value of Super quick ratio was 0.14 times which was quite low than the average value of selected companies of automobile industry. The standard deviation was 0.08 times and co-efficient of variation was percent respectively. In case of Force Motors, this ratio indicates fluctuating trend during the period of study. The high ratio marked in the year with 1.16 times and lower marked in the year 0.03 times in the year with an average of 0.22 times, which was the higher value than the average value of selected automobile industry. The standard deviation was 0.34 times which was also higher than average value. Co-efficient of variation of quick ratio was percent, which was to be indicated a highest variation between quick assets and current liabilities. Chart 4.2 Super Quick Ratio of the Selected Automobile Company under Study From the above analysis, it can be concluded that the all the selected automobile companies need to maintain at least standard norms (0.5:1), otherwise companies may have to face lots of problems and this is not good for the company s reputation. 90

12 ANOVA TEST OF SUPER QUICK RATIO H 0 : There is no significant difference in Super quick ratio between selected Automobile companies. H 1 : There is significant difference in Super quick ratio between selected Automobile companies. Level of significance : 5% level Degree of freedom: 54 (numerator 4 and denominator 50) Critical value: 2.56 Table No Analysis of Variance Test Companies-wise (Anova) of Super Quick Ratio Sum of Degree of Mean P - F Particulars F Squares freedom Square value critical Between Groups Within Groups Total Since F cal < F critical at 5% significance level (in other words P value is greater than 0.05), the null hypothesis is not rejected. It can be concluded that there is no significant difference in super quick ratio between considered automobile companies. H 0 : There is no significant difference in Super quick ratio between selected years H 1 : There is significant difference in Super quick ratio between selected years Level of significance : 5% level Degree of freedom: 54 (numerator 4 and denominator 50) Critical value: Table No Analysis of Variance Test Year-wise (Anova) of Super Quick Ratio Particulars Sum of Squares Degree of Freedom Mean Square F P - Value F Critical Between Groups Within Groups Total

13 Since F cal < F critical at 5% significance level (in other words P value is greater than 0.05), the null hypothesis is not rejected. It can be concluded that there is no significant difference in super quick ratio between considered years LIQUID RATIO Liquid ratio explains the relationship between liquid assets and current liabilities. The liquid ratio is a tougher test of liquidity than the current ratio because current ratio does not reflect the most liquid position. A variant of current ratio is the liquid ratio which is designed to show the amount of cash available to meet immediate payments. It is obtained by dividing the liquid assets by liquid liabilities. Liquid Assets Liquid Ratio = Liquid Liabilities The ideal Liquidity Ratio is considered to be 1:1. It means that the firm has sufficient amount to pay liquid liabilities. But, whether or not a specific ratio is satisfactory depends on the nature of the business and the characteristics of its liquid assets and liabilities. Higher the liquidity ratio is desirable because it indicates that the ability to meet with liquid liabilities, while lower ratio is not desirable because it may be creates a serious problem for any firm. Liquid assets are obtained by deducting stock in trade from current assets. Stock is not treated as a liquid asset because it cannot be easily converted into cash as and when required. If current assets consist of large unit of stock it may create problem for business. Bank overdraft and unsecured loan is not included in liquid liabilities because bank overdraft is not likely to be called on demand. The liquidity ratio of selected automobiles companies is shown in table 4.5. As regards, Hind Motors the liquid ratio ranged between 0.47 times in and 0.13 times in with an average ratio of 0.31 times. The ratio showed fluctuated trend during the study period. The standard deviation was 0.13 times which was lower than the average standard deviation as well as standard deviation of other three automobile companies and co-efficient variation has been percent which has shown low fluctuation in liquidity ratio of Hind Motors than average of all considered automobile companies. 92

14 Table 4.5 Liquid Ratio of the Individual Selected Automobile Companies under Study from to (In Times) Year Hind M & M Premier Tata Force Average S.D C.V Average S.D C.V Min Max Source: Appendix 3.1 to 3.5 In case of Mahindra & Mahindra Motors, the liquid ratio ranged between 0.67 times in and 0.52 times in with an average ratio of 0.67 times. The ratio showed fluctuated trend during the study period. The standard deviation was 0.18 times which was the lower value than the average standard deviation as well as standard deviation of other two automobile companies (Premier Motors and Force Motors), and co-efficient variation has been percent which has shown lowest fluctuation in liquidity ratio of Mahindra & Mahindra Motors. 93

15 In case of Premier Motors, the liquid ratio ranged between 0.14 times in and 1.08 times in with an average ratio of 1.17 times. The ratio showed fluctuated trend during the study period. The standard deviation value 1.08 times and this was the highest value than the average standard deviation as well as standard deviation of other four automobile companies. Co-efficient variation has been percent which has shown highest variation in liquidity ratio of Premier Motors. In case of Tata Motors, the liquid ratio ranged between 0.37 times in and 0.14 times in with an average ratio of 0.28 times. The ratio showed fluctuated trend during the study period. The standard deviation was 0.09 times and this was the lowest value than the average standard deviation as well as standard deviation of other four automobile companies. Co-efficient variation has been percent which has shown lowest fluctuation in liquid ratio of Tata Motors. Chart 4.3 Liquid Ratio of the Individual Selected Automobile Company under Study The liquid ratio of Force Motors, ranged between 0.69 times in to 0.72 times in with an average ratio of 0.61 times. The ratio showed fluctuated trend during the study period. The standard deviation was 0.35 times and this was the higher value than the other three automobile companies like Hind Motors, Mahindra & Mahindra Motors and Tata Motors. Co-efficient of variation has been percent which has shown low fluctuation in liquidity ratio of Force Motors. 94

16 ANOVA TEST OF LIQUID RATIO H 0 : There is no significant difference in liquid ratio between selected Automobile companies. H 1 : There is significant difference in liquid ratio between selected Automobile companies. Level of significance : 5% level Degree of freedom: 54 (numerator 4 and denominator 50) Critical value: 2.56 Table No Analysis of Variance Test Companies-wise (Anova) of Liquid Ratio Sum of Degree of Mean P F Particulars F Squares Freedom Square Value Critical Between Groups Within Groups Total Since F cal > F critical at 5% significance level (in other words P value is less than 0.05), the null hypothesis is rejected. It can be concluded that there is significant difference in liquid ratio between considered automobile companies. H 0 : There is no significant difference in liquid ratio between selected years H 1 : There is significant difference in liquid ratio between selected years Level of significance : 5% level Degree of freedom: 54 (numerator 4 and denominator 50) Critical value: Table No Analysis of Variance Test Year-wise (Anova) of Liquid Ratio Sum of Degree of Mean P - F Particulars F Squares Freedom Square Value Critical Between Groups Within Groups Total

17 Since F cal < F critical at 5% significance level (in other words P value is greater than 0.05), the null hypothesis is not rejected. It can be concluded that there is no significant difference in liquid ratio between considered years. 96