Chapter 4 Financial Strength Analysis

Transcription

1 Chapter 4 Financial Strength Analysis 4.1 Meaning of Financial Strength Finance is an essential requirement for every business enterprise. Various type of finance was needed by the concern for their activity concerned with the service. Finance is that powerful instrument which mobilises the industrial activity, develop the product and makes the man and machine to work efficiently. Finance plays a key role from commencement of business to liquidation of it. It helps in smooth operation, expansion and growth of business. At the time of liquidation money is also needed for discharging creditor and shareholders. Hence a proper plan is needs to prepare business project. Availability of sufficient fund at the time of its requirement is symbolised as financial soundness of the enterprise. Where the enterprise is able to pay its liabilities smoothly in time the firm is termed as a financially strong enterprise. The financial strength of a company is basically the strength of a finance either owned or loan from which it operates. According to Kennedy and Memullen the terms financial strength has reference to the ability of a business:- i To meet the claims of creditors not only under current economic and business conditions, but also under unfavourable situations that may occur in the future. ii To take advantages of business dealing or expansion which require presently owned resources, additional funds obtained through the sale of long term debt obligation and capital stock or a favourable credit rating and. iii To continues interest and dividend payments without interruption. 1 The combination of a good financial structure includes the optimum quantity of long term and short term sources of funds. The long term financial strength depends upon the structure of finance that has been adopted by the company in financing permanent asset requirement of business. In other words long term finance is meant to be repaid over a long period. It is used for such purpose which has long lasting offers or in construction of permanent assets. Short term finance to be returned over a period of one year to three years is spent for purchase of raw material, making wage payment to workers and meeting to short 62

2 time obligations. If the current financial strength is weak it is likely to jeopardise a sound long term financial strength. The investors may be interested in the capacity for repayment for their own financial needs. Kennedy &Memullan observe that Bankers and current creditors are more interested in the current debt paying ability of a business, bondholders and stockholders are most concerned with the long term financial position. 2 So the company has to plan an optimum structure of finance. This optimum financial structure is obtained when the market value per share is high or the average cost of capital is low. A sound capital plan must the following characteristics:- (i) (ii) (iii) Profitability: - The capital structure of the concern should be most profitable. Flexibility: - The capital structure should be flexible to meet the varying situation. Conservatism: - The capital structure should be conservative in the sense that the debt capacity of the company should not exceeded. Companies should have an adequate cash balances to pay the creditor fixed charges and the principal amount. All the above features are differs from company to company. The requirement of the company may be changed relatively. There are no hard and fast rules about what percentage of capitalisation should be represented by bonds and debentures and what part should be of equity shares and preference shares. A firm invested to money at the time of inception is call initial investment. The amount which is spent in purchase of permanent items for generating the profit is called fixed assets. Current assets are those assets which will realise within one year. 4.2 Meaning of Long Term Financial Strength Owners of the firm and creditors of the firm both are interested in analysing its capital structure. Short term creditors are most interested in the short term financial strength or liquidity ratios, whereas long term creditors, such as shareholders, debenture holders and long term lenders are most concerned with the long term financial strength. They are interested in whether the enterprise has the capability to pay regularly. These lenders would also wish to assess the economic viability or 63

3 vulnerability of the boards. Therefore, for the long-term financial strength of the enterprise, the capital structure of the enterprise is taken into consideration. According to Kennedy and Mc Mullen, There are many questions to be answered in studying the long term financial position of the business. Two such questions are: i What investment of capital has been made in the various types of assets? ii What are the sources of this capital i.e. borrowed funds or owner s equity? The analysis of long term financial strength can reply these questions. 3 There are two aspects of the long term solvency of an enterprise: ability to repay the principal when due and regular payment of the interest. These two aspects are covered under the long term solvency of the enterprise. According to Anthony and Reece, The Company s ability to meet the interest cost and repayment schedules associated with its long term obligations covers the solvency of the company. 4 To judge the long term financial strength of public and private airline companies the proportion of various components of capital structure and long term solvency ratios have been analysed in the present study. 4.3 Meaning of Capital Structure Capital structure is defined as the mix of various sources of funds in the total capital of the company. Thus it refers to the proportion of each source of fund in the total capital employed by the company. The term capital structure is used to mean the financial plan according to which the assets are financed. Capital structure is composed of owned funds and borrowed funds. Owned funds include share capital and reserve and surplus while borrowed capital represents debenture loan and long term loan provided by term financing institutions Components of Capital Structure There are four basic components of the capital structure, viz., equity share capital, preference share capital, reserve and surplus and long term debts. Analysis of these various components and their proportions to total capital employed is very important for studying key changes and trends in the financial position of a company. It is also useful in comparing two or more periods or two or more companies because 64

4 the arrangement of data in percentage form eliminates problems relating to differences in business size and the relative importance of each individual items stand out clearly. 4.5 Analysis of Components of Capital Structure Table 4.1 Components of Capital Structure of Air India (From to (Rs. in Crores) Capital Components Amount Amount Amount Amount Amount Amount Equity Share (0.63) (0.52) (3.04) (7.24) (26.26) (41.65) Capital (A) Reserve and Surplus (B) (19.45) (-10.43) (-26.63) (-51.03) ( ) ( ) Net Worth (C) = (A+B) (20.08) (-9.91) (-23.59) (-43.79) ( ) (-71.04) Long Term Debts (D) (79.92) (109.91) (123.59) (143.79) (251.37) (175.50) Total Capital (100) (100) (100) (100) (100) (100) Employed (C+D) Note: Figures in bracket shows the percentage of various components of capital structure to total capital employed. Source: Annual Reports of Air India to

5 50000 Figure 4.1 Capital Structure of Air India Equity Share Capital Reserve and Surplus Net Worth Long Term Debts Total Capital Employed Table 4.1 show that the long term debts of Air India reflects the rising trend in the starting four years of the research period (till ) but in it showed an decrease and again increase in During the study period from to , long term debt is more than the net worth, which seems to be unsatisfactory position. The long term debt was highest at Rs crores in and lowest at Rs crores in The proportion of debt to total capital employed varied in between % ( ) to % ( ). The equity share capital was constant in starting two years of the study period then increased continuously till The proportion of equity share capital to the total capital employed varied in between 0.516% ( ) to 41.65% ( ). The reserve and surplus showed a decreasing trend throughout the study period. The proportion of reserve and surplus ranged from % ( ) to % ( ). The net worth also showing a decreasing trend till and in it increases. It was highest in ( crores) and lowest in ( crores). The proportion of net worth to total capital employed varied in between % ( ) to % ( ). 66

6 Capital Components Equity Share Capital (A) Reserve and Surplus (B) Net Worth (C) = (A+B) Long Term Debts (D) Total Capital Employed (C+D) Table 4.2 Components of Capital Structure of Spice Jet (From to ) Amount (42.36) (-37.44) (4.93) (95.08) (100) Amount (416.24) ( ) ( ) (823.47) (100) Amount (257.98) (-614) ( ) (456.03) (100) Amount (99.63) (-20.71) (78.92) (21.08) (100) (Rs. In Crores) Amount (73.98) (-99.63) (-25.65) (125.65) (100) Amount (37.16) (-53.91) (-16.75) (116.75) (100) Note: Figures in bracket shows the percentage of various components of capital structure to total capital employed. Source: Annual Reports of Spice Jet to Figure 4.2 Capital Structure of Spice Jet Equity Share Capital Reserve and Surplus Net Worth Long Term Debts Total Capital Employed Table 4.2 reveals that the equity share capital of Spice Jet shows an increasing trend during the study period. It ranged from Rs crores ( ) to 67

7 Rs crores ( ). The proportion of equity share capital to total capital employed showed the increasing trend in starting two years of the study period then it was decreased continuously till Reserve and surplus shows the fluctuating trend. It was highest in (Rs crores) and lowest in (Rs crores). The proportion of reserve and surplus to the total capital employed varied in between % ( ) to % ( ). The net worth of Spice Jet demonstrates the fluctuating trend. It ranges from Rs crores ( ) to Rs crores ( ). In relative terms the proportion of net worth to total capital employed varied in between % ( ) to % ( ). Long term debt shows the decreasing trend in starting four years of study period then it showed a slight increase. It was highest in (Rs crores) and lowest in (Rs crores). The proportion of long term debt to total capital employed ranges from % ( ) to % ( ). Capital Components Table 4.3 Components of Capital Structure of Jet Airways (From to ) Amount Amount Amount Amount (Rs. in Crores) Amount Amount Equity Capital (A) Reserve Surplus (B) Share and Net Worth (C) = (A+B) Long Debts (D) Total Employed (C+D) Term Capital (0.516) (26.695) (27.212) (72.788) (100) (0.443) (15.763) (16.206) (83.794) (100) (0.522) (15.452) (15.974) (84.026) (100) (0.536) (15.622) (16.158) (83.842) (100) (0.813) (11.637) (12.450) (87.550) (100) (1.23) (-6.11) (-4.88) (104.88) (100) Note: Figures in bracket shows the percentage of various components of capital structure to total capital employed. Source: Annual Reports of Jet Airways to

8 Figure 4.3 Capital Structure of Jet Airways Equity Share Capital Reserve and Surplus Net Worth Long Term Debts Total Capital Employed Table 4.3 demonstrate that equity share capital of Jet Airways was stable (i.e. Rs crores) throughout the study period. The proportion of equity share capital to total capital employed ranges from 0.443% ( ) to 1.23% ( ). The reserve and surplus showed the decreasing trend during the study period. The proportion of reserve and surplus to total capital employed varied between -6.11% ( ) to % ( ). The net worth also showed the decreasing trend during the study period. It ranges from Rs crores ( ) to Rs crores ( ). The proportion of net worth to total capital employed showed a fluctuating trend & it varied in between -4.88% ( ) to % ( ). The long term debt showed the increasing trend in first two years then it showed a decreasing trend. It ranges from Rs crores ( ) to Rs crores ( ). In relative terms the proportion of long term debt to total capital employed varied in between % ( ) to % ( ). 4.6 Testing of Long Term Solvency Long term solvency ratio or leverage ratios measures a relative position of equity owners compared with that of the money lenders. There are three major uses of long term solvency ratios:- 69

9 (i) To Measure Financial Risk One measure of the degree of risk resulting from debt financing is provided by these ratios. If the firm has been increasing the percentage of debt in its capital structure over a period of time, this may indicate an increase in risk for its long-term finance providers. As the debt content increases most of firm s income will go for servicing the debt and net income will be reduced this will affect the long-term earnings prospects of the company as less funds are re-employed because of increased debt servicing burden. (ii) To Identify Sources of Funds The firm finances all its requirements either from debt or equity sources. Depending on the risk of different types the amount of requirements from each source is shown by these ratios. (iii) To Forecast Borrowing Prospects If the firm is considering expansion needs to raise additional money, the long-term solvency ratios offer an indication of whether debt funds could be used. If the ratios are too high, the firm may not be able to borrow. 4.7 Application of Long Term Solvency Ratios: For testing the long term financial strength the following ratios have been calculated and with a view to check the variations of ratio of the company under study. Coefficient of variation has also been calculated. To test the significance of difference between two sample means independent sample t-test is calculated. To check whether the variances are equal or not, Levene s test for equality of variance is used. ANOVA is used as an extension of independent sample t-test to know which means have to significant difference. The following hypothesis has been formulated: H 0 (1): There is no significant difference between Long Term Financial Strength of Airline Companies. H 1 (1) : There is a significant difference between Long Term Financial Strength of Airline Companies. 70

10 4.7(i) Debt Equity Ratio: Debt equity ratio is a measure of a company s long-term financial strength. Debt equity studies the relationship between borrowed funds and owners funds to determine the long term solvency of the company. It tells us how much the company owes and how much it owns. This ratio measures the extent to which the owners are using debts (i.e. trade credit, liabilities and borrowing) rather than using their own funds to finance the company. The debt equity ratio is an important tool of financial analysis to appraise the financial structure of a firm. It has important implications from the view point of creditors, owners and the firm itself. The ratio reflects the relative contribution of creditors and owners of business in its financing. A high ratio show a large share of financing by the creditors of the firm, a low ratio implies a smaller claim of creditors. The debt equity ratio indicates the margin of safety to the creditors. 6 This is a measure of owner s stake in the business. The proprietor may desire more of funds to be from borrowings because it carries two main advantages. The first advantage is that the risk of the proprietor is reduced and second advantage is that the interest on borrowings is allowed as expenditure while computing the taxable profits of the company whereas the dividend on shares is not. That is, the tax is computed on the profits before any dividend on share is declared. Irrespective of the above advantages a considerable contribution from the proprietor is necessary from the creditor s point of view to sustain the interest of the proprietor in the venture and also a margin of safety to the creditors. Debt- Equity Ratio = Outsider s Fund Shareholder s Fund This ratio is calculated the outsiders fund divided by shareholder fund. The outsiders fund includes all loans whether they are long term or short term loan. Shareholders fund denotes net worth or sum of equity share capital, preference share capital, reserve and surplus. Fictitious assets are deducted from it. The standard debt equity ratio is 1:1 which implies that outsiders fund may be equal the shareholder s funds. If the ratio is more than 1, the business would become risky. Though large capital intensive unit has been permitted higher debt equity ratio. 71

11 Table 4.4 Debt Equity Ratio of Public and Private Airline Companies (From to ) (Times) Year Public Company Private Companies Air India Spice Jet Jet Airways Mean G. Mean S.D Comb. S.D C.V G. Mean= Grand mean, SD= Standard Deviation, CV= Coefficient of variance Source: Annual Reports of the public and private airline companies under Study. Figure 4.4 Debt Equity Ratio of Public and Private Airline Companies Jet Airways Spice Jet Air India Table 4.4 showed that the debt equity ratio of public company, Air India registered a fluctuating trend throughout the study period. It was highest in (3.98times) and lowest in (-11.09times). The average debt-equity ratio was -3.30times. The private company Spice Jet showed a fluctuating trend. It ranged from 19.31times 72

12 ( ) to -6.97times ( ). The average debt equity ratio was 0.88times. Jet Airways also showed a fluctuating trend. It was highest in (7.03times) and lowest in (-21.48times). Its average ratio was 0.64times. The combined average debt equity ratio of private companies was 0.76times. It is clear from the table that the debt equity ratio of private companies is higher than the public company. This ratio is used to appraise the financial structure of the firm. Lower value of debt to equity ratios indicates less risk. Air India had a very low ratio so it is more financially stable and less risky. In private companies Jet Airways showed a highest debt equity ratio. A higher debt to equity ratio considered more risky to creditors and investors. Jet Airways shows a large share of financing by the creditors. It should try to improve their internal funds by increasing reserves or owner s funds by increasing equity. It is also observed that variation in Air India is less than Spice Jet and Jet Airways. So it is concluded that Air India is more stable than the Spice Jet and Jet Airways with respect to Debt Equity Ratio. Table 4.5 Table Showing Results of Independent Sample Test for Debt Equity Ratio Significance Level: 5 percent Equal variances assumed Equal variances not assumed Levene s Test for Equality of Variances F Sig. T df 73 t-test for Equality of Means Sig. (2- tailed) Mean Differe nce Std. Error Differ ence 95% Confidence Interval of the Difference Lower Upper

13 Financial Strength Analysis Conclusion: Since the significant þ value of Levene s test for equality of variance is more than 0.05, we assumed that the variances are equal. An equal variance t-test þ value α 0.05, df 10, we fail to reject the null hypothesis. There is no statistically significant difference between the debt equity ratio of the selected companies with mean (Public = 3.297, Private = 0.760) and standard deviation (Public = 4.915, Private = 8.200). Table 4.6 Table Showing Results of One Way ANOVA for Debt Equity Ratio Significance Level: 5 percent Sum of Mean Squares df Square Between Groups Within Groups Total F Sig Tukey HSD 95% Confidence Interval Mean (I) (J) Company Company Air India Spice Jet Jet Airways Spice Jet Air India Jet Airways Difference Std. Lower Upper (I-J) Error Sig. Bound Bound Jet Air India Airways Spice Jet

14 Tukey HSD a Company N Subset for alpha = 0.05 Air India Jet Airways Spice Jet Sig..695 Means for groups in homogeneous subsets are displayed. a. Uses Harmonic Mean Sample Size = Conclusion: Since the significant value of one way ANOVA is more than α df (2, 15). We fail to reject the null hypothesis and conclude that there is no significant difference between debt equity ratio of selected aviation companies. 4.7(ii) Net Worth to Total Assets Ratio It is commonly called as proprietary ratio and a variant of debt equity ratio. This ratio presents the relationship between proprietor fund and total assets of the business. The proprietary ratio focuses the attention on the general financial strength of the business enterprise. The ratio is of particular importance to the creditors who can find out the proportion of shareholder s funds in the total assets employed in the business. High proprietary ratio indicates relatively little danger to the creditors etc., in the event of forced reorganization or winding up of the company. A low proprietary ratio 75

15 indicates greater risk to the creditors, since in the event of loss; a part of their money may be lost, besides loss to the proprietors of the business. The higher the ratio, the better it is. A ratio below 50 percent may be alarming for the creditors, since they may have to lose heavily in the event of company s liquidation on account of heavy losses. 7 The formula for calculating this ratio is: Net Worth to Total Assets Ratio = Proprietors Fund Total Assets Proprietors fund includes equity share capital, preference share capital, reserve and surplus and it exclude fictitious assets. Total assets exclude fictitious assets and losses. This ratio shows the strength of company. Higher ratio shows the better long term solvency position of the company. A low proprietary ratio indicates more risk to the creditors. Table 4.7 Net Worth to Total Assets Ratio of Public and Private Airline Companies (From to ) (Times) Year Public Company Private Companies Air India Spice Jet Jet Airways Mean G. Mean S.D Comb. S.D C.V G. Mean= Grand mean, SD= Standard Deviation, CV= Coefficient of variance Source: Annual Reports of the public and private airline companies under study. 76

16 Figure 4.5 Net Worth to Total Assets Ratio of Public and Private Airline Companies Air India Spice Jet Jet Airways Table 4.7 displays that the net worth to total assets ratio of Air India registered the decreasing trend till and in the year it showed a slight increase. It ranged from 0.16times ( ) to -0.48times ( ). The average net worth to total assets ratio was -0.21times. Spice Jet showed a fluctuating trend. It was highest in (0.29times) and lowest in (-0.57times). Its average profit was -0.13times. Jet Airways reflects a decreasing trend. It was highest in (0.22times) and lowest in (-0.02times). Its average profit was 0.11times. The combined average net worth to total assets ratio of private companies was -0.01times. By comparing the grand means of public and private airline companies it is analysed that net worth to total assets ratio of private companies (-0.01times) is more than the public airline company (-0.21times). A low proprietary ratio of Air India show greater risk to the creditors and a high proprietary ratio of private company indicate that companies are funding its operations with a disproportionate amount of debt and debt payables. By comparing the co-efficient of variance it is examined that the variations in Jet Airways is less than Air India and Spice Jet. So it is concluded that Jet Airways is stable than Air India and Spice Jet. 77

17 Table 4.8 Table Showing Results of Independent Samples Test for Net Worth to Total Assets Ratio Significance Level: 5 percent Levene's Test for Equality of Variances t-test for Equality of Means 95% Sig. (2- Mean Differe Std. Error Differen Confidence Interval of the Difference F Sig. T df tailed) nce ce Lower Upper Equal variances assumed Equal variances not assumed Conclusion: The significance value of Levene s test is more than 0.05; we assumed that the variances are equal. An equal variance t-test þ value is more than 0.05 at degree of freedom 10, we fail to reject the null hypothesis and conclude that there is no statistically significant difference between debt equity ratio of the selected companies with mean (Public = 0.211, Private 0.008) and standard deviation (Public = and Private = 0.154). 78

18 Table 4.9 Table Showing Results of One Way ANOVA for Net Worth to Total Assets Ratio Significance Level: 5 percent Sum of Squares Df Mean Square F Sig. Between Groups Within Groups Total Tukey HSD Mean (I) (J) Difference Std. Company Company (I-J) Error Sig. 95% Confidence Interval Lower Upper Bound Bound Air India Spice Jet Jet Airways Spice Jet Air India Jet Airways Jet Air India Airways Spice Jet Tukey HSD a Company N Subset for alpha = Air India Spice Jet Jet Airways Sig..059 Means for groups in homogeneous subsets are displayed. a. Uses Harmonic Mean Sample Size =

19 Conclusion: Since the significant value of one way ANOVA α 0.05, df (2, 15). We fail to reject the null hypothesis and conclude that there is no statistically significant difference between net worth to total assets ratio of selected aviation companies. 4.7(iii) Solvency Ratio Solvency ratio is also known as debt ratio. This ratio indicates the relationship between the total liabilities to total assets of the firm. This ratio is a small variant of proprietary ratio. It is calculated as proprietary ratio. It is calculated as 100- proprietor s ratio. Solvency ratio refers to the ability of the business concern to meet its short-term and long term obligations. Lower ratio of total liabilities to total assets is quite advisable. If total assets are more than external liabilities, the business concern is treated as solvent. 8 The formula for calculating solvency ratio is as follows: Solvency Ratio = Total Debts Total Assets Total debt include all long term debts and current liabilities and it is difference of 100 and proprietary ratio. 80

20 Table 4.10 Solvency Ratio of Public and Private Airline Companies (From to ) (Times) Year Public Company Private Companies Air India Spice Jet Jet Airways Mean G. Mean S.D Comb. S.D C.V G. Mean= Grand mean, SD= Standard Deviation, CV= Coefficient of variance Source: Annual Reports of the public and private airline companies under study. Figure 4.6 Solvency Ratio of Public and Private Airline Companies Air India Spice Jet Jet Airways Table 4.10 displays that the solvency ratio of public company, Air India showed an increasing trend during the study period except It was highest in (1.48times) and lowest in (0.84times). The average mean of Air India was 1.21times. The private company Spice Jet showed a fluctuating trend. It ranged from 1.57times ( ) and 0.71times ( ). Its average ratio was 1.13times. Jet 81

21 Airways indicates an increasing trend. It was highest in (1.02times) and lowest in (0.78times). Its average ratio was 0.89times. The combined mean of private companies was 1.05times. From the table it is analyzed that the solvency ratio of public company (1.21times) was higher in comparison to that of private companies (1.05times). The total debt of Air India is more than the total assets. The company should try to decrease the ratio by providing more finance. Among the private companies, Jet Airways showed a good performance as the ratio was always lower than the acceptable norm 0.5:1. The ratio of Jet Airways Airlines was But the solvency ratio of Spice Jet was much higher than the norms. It should try to increased internal funds and to reduce debts. It is also observed that the variation in Jet Airways is less than Air India and Spice Jet. So it is concluded that the Jet Airways is much better than Air India and Spice Jet. Table 4.11 Table Showing Results of Independent Samples Test for Net Worth to Total Assets Ratio Significance Level: 5 percent Levene's Equal variances assumed Equal variances not assumed Test for Equality of Variances F Sig. T df t-test for Equality of Means Sig. (2- tailed) Mean Differen ce Std. Error Differe nce 95% Confidence Interval of the Difference Lower Upper

22 Conclusion: The significant value of Levene s test is and it is more than α value 0.05, we assumed that variances are equal. An equal variance t-test þ value is not less than or equal to So we fail to reject H 0 and conclude that there is no statistically significant difference between solvency ratio of selected companies with mean (Public = 1.21 and Private = 1.045) and standard deviation (Public = 0.228, Private = 0.319). Table 4.12 Table Showing Results of One Way ANOVA for Solvency Ratio Significance Level: 5 percent Sum of Squares df Mean Square F Sig. Between Groups Within Groups Total Tukey HSD (I) (J) Company Company Air India Spice Jet Mean Std. Lower Difference (I-J) Error Sig. Bound 95% Confidence Interval Upper Bound Spice Jet Jet Airways Air India Jet Airways Jet Airways Air India Spice Jet

23 Tukey HSD a Company N Subset for alpha = 0.05 Jet Airways Spice Jet Air India Sig..059 Means for groups in homogeneous subsets are displayed. a. Uses Harmonic Mean Sample Size = Conclusion: The significant þ value of one way ANOVA α 0.05, df (2, 15). We fail to reject the null hypothesis and conclude that there is no statistically significant difference between solvency ratio of selected aviation companies. 4.7(iv) Fixed Assets Ratio This ratio is also known as fixed assets to total capital employed ratio. This ratio is a device to find out the proportion of fixed assets financed by long term funds of a company. According to Hunt, William and Donaldeon The investment in fixed assets involves commitments of funds for longer periods into the future and usually is difficult and costly to resolve. Often they are in large increments. Hence, they should 84

24 be finance to a major by the proprietors as their state in a firm is permanent. 9 The formula for calculating the ratio is: - Fixed Assets Ratio = Fixed Assets Total Capital Employed Total capital employed includes equity share capital, preference share capital, reserve & surplus, debenture and long term loans. Fixed assets include investment or share in subsidiaries and exclude depreciation or net fixed assets. This ratio indicates the amount of security available to lenders who have financed the company for acquiring fixed assets. The higher the ratio is the greater the security to lenders. Table 4.13 Fixed Assets Ratio of Public and Private Airline Companies (From to ) (Times) Year Public Company Private Companies Air India Spice Jet Jet Airways Mean G. Mean S.D Comb. S.D C.V G. Mean= Grand mean, SD= Standard Deviation, CV= Coefficient of variance Source: Annual Reports of the public and private airline companies under study. 85

25 4.5 Figure 4.7 Fixed Assets Ratio of Public and Private Airline Companies Air India Spice Jet Jet Airways Table 4.13 reflects the fixed assets ratio of public and private companies. The public company Air India indicates an increasing trend during the study period except the year It was highest in (2.78times) and lowest in (0.95times). Its average ratio was 1.43times. The private company, Spice Jet showed a fluctuating trend. It ranged from 4.26times ( ) to 0.99times ( ). The average ratio was 2.56times. Jet Airways also showed a fluctuating trend. It was highest in (1.54times) and lowest in (0.86times). Its average ratio was 1.06times. The combined average fixed assets ratio of private companies was 1.81times. By comparing the grand means of public and private airline companies it is evident that the fixed assets ratio of private companies (1.81times) is higher than the public company (1.43times). Public company should maintain their capital employed and utilising their fixed assets in a satisfactory manner. Private companies reveals that the long term funds had been employed to finance a very large amount of current assets and very low amount had been invested in fixed assets. It is found that coefficient of variation of Jet Airways is less than Air India and Spice Jet. It is clear from the analysis that Jet Airways is more consistent. 86

26 Table 4.14 Table Showing Results of Independent Samples Test for Fixed Assets Ratio Significance Level: 5 percent Levene's Test for Equality of Variances t-test for Equality of Means 95% Sig. (2- Mean Differ Std. Error Differ Confidence Interval of the Difference F Sig. T Df tailed) ence ence Lower Upper Equal variances assumed Equal variances not assumed Conclusion: The significant value of Levene s test is more than 0.05; we assumed that variances are equal. An equal variance t-test þ value is more than α level So we fail to reject null hypothesis. There is no significant difference between fixed assets ratio of selected companies with mean (Public = and Private = 1.809) and std. deviation (Public = 0.724, Private = 0.642). 87

27 Table 4.15 Table Showing Results of One Way ANOVA for Fixed Assets Ratio Significance Level: 5 percent Sum of Squares Df Mean Square F Sig. Between Groups Within Groups Total Tukey HSD 95% Confidence Mean Interval (I) (J) Difference Std. Lower Upper Company Company (I-J) Error Sig. Bound Bound Air India Spice Jet Jet Airways Spice Jet Air India Jet Airways * Jet Airways Air India Spice Jet * *. The mean difference is significant at the 0.05 level. Tukey HSD a Company Jet Airways N Subset for alpha = Air India Spice Jet Sig Means for groups in homogeneous subsets are displayed. a. Uses Harmonic Mean Sample Size =

28 Conclusion: The significant þ value of one way ANOVA is less than α value df (2, 15). We reject the H 0 and conclude that there is significant difference between fixed assets ratio of selected aviation companies. The Tukey post hoc test indicates that fixed assets ratio is significantly differ between Spice Jet and Jet Airways. 4.7(v) Capital Gearing Ratio Capital gearing ratio is mainly used to analyse the capital structure of a company. Capital structure means the relationship between the various long terms firms of financing such as debentures, preference and equity share capital including reserve and surplus. The capital gearing ratio is mainly significant to test the capital structure of a company. It is calculated to establish the relationship between variable cost bearing capital and fixed cost bearing capital. 10 The term Capital Gearing or Leverage normally refers to the proportion of relationship between equity share capital including reserves and surplus, preference share capital and other fixed interest-bearing funds or loans. It is the proportion between the fixed interest and dividend bearing funds and non-fixed interest or dividend bearing funds. The formula for calculating the capital gearing ratio is:- 89

29 Capital Gearing Ratio = Variable Cost Bearing Capital Fixed Cost Bearing Capital Variable cost bearing capital includes net worth less preference share capital. Fixed cost bearing capital includes funds supplied by debenture holders, preference shareholders and long term loan on which interest or dividend on a fixed rate is paid. If the amount of fixed interest or fixed dividend bearing funds is less than the equity shareholders fund, the capital structure is said to be high geared. A high gearing ratio is the indicator of low financial charges to the firm. This ratio is important not only to prospective investors but also to the company. The equity shareholders get dividend only after debenture holders and preference shareholders are paid their share. The surplus available can result in a higher rate of dividend to equity shareholders than the overall rate of return on capital employed because the fixed payments to debenture holders and preference shareholders may be at a lower rate. Table 4.16 Capital Gearing Ratio of Public and Private Airline Companies (From to ) (Times) Year Public Company Private Companies Air India Spice Jet Jet Airways Mean G. Mean S.D Comb. S.D C.V G. Mean= Grand mean, SD= Standard Deviation, CV= Coefficient of variance Source: Annual Reports of the public and private airline companies under study. 90

30 Figure 4.8 Capital Gearing Ratio of Public and Private Airline Companies 100% 80% 60% 40% 20% 0% -20% -40% -60% -80% -100% Jet Airways Spice Jet Air India Table 4.16 displays that the public company, Air India showed a diminishing trend throughout the study period except the year It ranged from 0.25times ( ) to -0.60times ( ). Its average ratio was -0.22times. The private company, Spice Jet showed a fluctuating trend. It was highest in (3.74times) and lowest in (-0.88times). Its average ratio was 0.25times. Jet Airways indicates a decreasing trend throughout the review period. It was highest (0.37times) and lowest in (-0.05times). Its average ratio was 0.17times. The combined average capital gearing ratio of private companies was 0.21times. From the above it is clear that the capital gearing ratio of private companies (0.21times) is higher than public company (-0.22times). Public company had the low mean ratio which indicates more dependency on external sources of finance and thus overburden of fixed financial charges. It can be stated that the variation in Jet Airways is less than Air India and Spice Jet. Therefore it can be said that Jet Airways is more stable than Air India and Spice Jet with respect to capital gearing ratio. 91

31 Table 4.17 Table Showing Results of Independent Samples Test for Fixed Assets Ratio Significance Level: 5 percent Levene's Equal variances assumed Test for Equality of Variances F Sig. T df t-test for Equality of Means Sig. (2- tailed) Mean Differe nce Std. Error Differen ce 95% Confidence Interval of the Difference Lower Upper Equal variances not assumed Conclusion: Since the significant þ value of Levene s test is more than We assumed that the variances are equal. An equal variance t-test þ value is more than 0.05, so we fail to reject the null hypothesis. There is no significant difference between capital gearing ratio of selected companies with mean (Public = 0.221, Private = 0.211) and standard deviation (Public = 0.290, Private = 0.884). 92

32 Table 4.18 Table Showing Results of One Way ANOVA for Capital Gearing Ratio Significance Level: 5 percent Sum of Squares df Mean Square F Sig. Between Groups Within Groups Total Tukey HSD (I) (J) Company Company Mean Difference (I-J) Std. Error Sig. 95% Confidence Interval Lower Upper Bound Bound Air India Spice Jet Jet Airways Spice Jet Air India Jet Airways Jet Airways Air India Spice Jet Tukey HSD a Company N Subset for alpha = 0.05 Air India Jet Airways Spice Jet Sig..710 Means for groups in homogeneous subsets are displayed. a. Uses Harmonic Mean Sample Size =

33 Conclusion: Since the significant þ value of one way ANOVA 0.7 α 0.05, df (2, 15). We fail to reject the H 0 and conclude that there is no significant difference between capital gearing ratio of selected aviation companies. 4.8 Importance of Working Capital Working capital plays a vital role in day to day operation of a business. It is not sufficient to run the business through arranging the adequate fixed assets. It is also required to utilize them in a sufficient manner. To utilize these fixed assets in an efficient manner, working capital is needed. Business needs working capital for purchasing of raw material, expenses for converting them into finished goods like salary, wages and overhead etc. and for arrangement of credit sales. Working capital works like flow of blood in a human body. Therefore proper management of working capital is necessary for smooth functioning of the business. The disturbance in the working capital management may put the business in trouble. It fulfils the following needs of the business: 94

34 i Funds for purchasing raw materials. ii Funds for payment of expenses like salary & wages which are necessary for converting raw materials into finished goods. iii Arrangement for selling the goods. iv Funds for selling the goods on credit. Working capital is used for immediate payment of various expenses. Generally these expenses are paid before the sale of goods. In modern business competition is high, selling of goods on credit is necessary to maintain the proper volume of sales. The money blocked in credit sale is received after a gap of some time period, but expenses during this period keeps on continues. This difference of time between income and expenditure require the need of working capital. 4.9 Types of Working Capital Two types of working capital which are divided on the basis of time: (i)permanent working capital (ii)temporary/variable working capital (i) Permanent working capital:- This refers to that minimum amount of investment in all current assets which is required at all time to carry out minimum level of business activities. It represents the current assets required on a continuing basis over the whole year. This type of working capital is referred as core current assets by Tandon Committee. The following are the two characteristics of this type of working capital: a) Amount of permanent working capital remains in the business in one form or another. This is a particularly important from the point of view of financing. The suppliers of permanent working capital should not expect its return during the life time of the firm. b) It also grows with the size of the business. If the size of the company is large, the amount of such working capital should also be large and vice versa. Permanent working capital is needed for the business and therefore it should be financed out of long term funds. 95

35 (ii) Temporary working capital:- Temporary working capital fluctuates on the basis of company performance. Suppliers of temporary working capital can expect its return during off season when it is not required by the firm. Hence temporary working capital is generally financed from short-term sources of finance such as bank credit Determinants of Working Capital There is no criterion or formula to determine the amount of working capital needs that may be applied to all the firms. The amount of working capital required depends upon a large number of factors and each factor has its own importance. They also vary from time to time in order to determine the proper amount of working capital of a firm, the following factors should be considered: (i) (ii) (iii) (iv) Nature of Business: - The working capital requirement is influenced by the nature of business. Trading and financial firms does not invested in fixed assets but they are invested in working capital. Retailers need a large amount working capital because they have to maintain large stocks of a variety of goods to satisfy the varied and continuous demand of their customers. Their working capital requirements are nominal because they have cash sales only and supply services, not product. Size of Business: - The working capital requirement depends upon the size of a firm. The size of firm can be measured either on the basis of assets or sales. Large firms needs higher amount of working capital than small firms. Production Policies: - The working capital is also determined by production policy. The demand for the product is seasonal i.e. they will be purchased during certain months of the year. During the slack season the firm will have to maintain its working force and physical facilities without adequate production and sale. When the peak period arrives, the firms will have to operate at full capacity to meet the demand. Requirement of Cash: - Cash balance is a part of current assets. The cash is required for payment of salary, wages, rent, tax, sundry expenses and creditors. 96

36 (v) (vi) Banking Relations:- The firm which have good relation with banks and have good credit standing in the eyes of bank, they can operate with less funds, as whenever they needs extra fund they can procure them easily from bank. Other Factors: - There are number of other factors which affect the requirement of working capital. These factors are govt. policies, distribution policies, means of transport and communication, co-ordination of activities, political stability etc Analysis of Working Capital The working capital is the vital significance to an enterprise in several ways and it plays a greater role in earning maximum return on investment. While in excessive working capital leads to remunerative use of scare fund, where in adequate working capital interrupts the smooth flow of business activity and impair profitability. The unavailability of this fund compels the enterprise to function in a continuing atmosphere. There are two different concepts of working capital- gross concept and net concept. The gross working capital is represented by the total of all current assets of the firm and the net working capital is the difference between current assets and current liabilities. According to Samuels and Wikes Working capital is the excess of current assets over current liabilities. 11 Thus current assets represent a source of liquid resources in the company. Both the net and gross concept of working capital has own use. The choice of particular concept will depend upon the purpose. In view of the two concepts the net working capital concept is more useful to find out the short term financial strength of a concern. On the other hand the aim is find out whether total current assets of an enterprise are being put to maximum use, the gross working capital concept is preferable Measuring Working Capital Changes in working capital can be measured in rupee amount and also in percentage by comparing current assets, current liabilities and working capital over a 97

37 given period. Management sets ratio analysis as a check for the efficient use of working capital management Meaning of Liquidity Liquidity means capability to meet claims and obligations as and when they due. In the context of an asset, it implies convertibility of the same ultimately into cash and it has two dimensions in it, i.e. time and risk. Time dimension of liquidity is concerned with the speed with which an asset can be converted into cash. Risk dimension is concerned with the degree of certainty with which an asset can be converted into cash without any sacrifice in its book value. The liquidity has two dimensions viz., quantitative and qualitative concepts. The quantitative aspect includes the quantum, structure and utilization of liquid assets and in the qualitative aspect, it is the ability to meet all present and potential demands on cash from any source in a manner that minimises cost and maximises the value of the firm. Thus liquidity is a vital factor in business. 13 In the opinion of Soloman E; and Springle J; whenever one speaks of a firm s liquidity, he tries to measure the firm s ability to meet the expected and unexpected cash requirements, to expand its assets, to reduce its liabilities or cover any operating losses Application of Short Term Solvency For testing the short term financial strength the following ratios have been calculated and to test the significance of difference between two sample means independent sample t-test is calculated. To check whether the variances are equal or not, Levene s test for equality of variance is used. ANOVA is used as an extension of independent sample t-test to know which means have to significant difference. The following hypothesis has been formulated: H 0 (2): There is no significant difference between Short Term Financial Strength of Airline Companies. 98

38 H 1 (2) : There is a significant difference between Short Term Financial Strength of Airline Companies. 4.14(i) Current Ratio Current ratio is a liquidity and efficiency ratio. It measures a firm s ability to pay its short term liabilities with current assets. Current ratio explains the relationship between current assets and current liabilities. The main purpose of current ratio is to determine the ability of the organization to meet its short term obligations and to show the short term financial situation of a firm. Current ratio is an index of short term financial stability of an enterprise because it shows the margin available after paying off current liabilities and thus the extent of working capital. 15 Current ratio is used to identify the liquidity of the firm. It is also known as working capital ratio. It is used to make an analysis of the short term financial position or liquidity of the firm. It is calculated by dividing the total of current assets and current liabilities. Current ratio measures the quantity of current assets and not the quality of current assets. If a firm s current assets include debtors which are not recoverable or stock which are slow moving or obsolete the current ratio may be high, but this may not represent a good high liquidity position. Companies which have large amounts of current assets can able to pay off its current liabilities when they become due without having to sell off long-term, revenue generating assets. A current ratio of 2:1 is considered as ideal, i.e. if current ratio is 2 or more it means that the concern has the ability to meet its current obligations but if this ratio is less than 2 it indicates that the concern has difficulty in meeting its current obligations. However the ratio above the ideal ratio shows the managerial efficiency of the concern to profitability and productivity manages the current assets

39 The following formula is used to calculate the current ratio: Current Ratio= Current Assets Current Liabilities All assets that are to be converted into cash within one year is called current assets. Current assets include cash, bank balance, bills receivables, debtors, stock, short term investment, prepaid expenses, accrued incomes, advance payments, deposits kept with public bodies and other amount receivables within one year. Company debts and obligations that are due within one year are known as current liabilities. Current liabilities are bills payable, creditors, short term loans, bank overdraft, outstanding expenses, proposed dividends, unclaimed dividends, provision for bad debts etc. Table 4.19 Current Ratio of Public and Private Airline Companies (From to ) (Times) Year Public Company Private Companies Air India Spice Jet Jet Airways Mean G. Mean S.D Comb. S.D C.V G. Mean= Grand mean, SD= Standard Deviation, CV= Coefficient of variance. Source: Annual Reports of the public and private airline companies under study. 100

40 Figure 4.9 Current Ratio of Public and private Airline Companies Current Ratio Air India Spice Jet Jet Airways Table 4.19 showed the decreasing trend of Air India throughout the entire study period. It was highest in (1.21times) and lowest in (0.16times). Its average ratio was 0.69times. The private company Spice Jet showed the decreasing trend throughout the review period except in the year which showed a slight increase. It ranged from 1.00times ( ) to 0.45times ( ). Its average mean was 0.63times. Jet Airways reflects the fluctuating trend. It was highest in (1.26times) and lowest in (0.33times). Its average ratio was 0.84times. The combined average mean of private companies was 0.74times. From the table it is analyzed that the current ratio of private companies (0.74times) was higher in comparison to public airline company (0.69times). The current ratios of both the companies are less than the 1. It means current liabilities are more than the current assets which may indicate liquidity problems. Companies should maintain a current ratio of at least 1 to ensure that the value of current assets cover at least the amount of short term obligations. The variation in Spice Jet is less in comparison to Air India and Jet Airways. Therefore it can be said that Spice Jet is better than Air India and Jet Airways. 101

41 Table 4.20 Table Showing Results of Independent Samples Test for Current Ratio Significance Level: 5 percent Levene's Equal variances assumed Test for Equality of Variances F Sig. t df t-test for Equality of Means Sig. (2- tailed) Mean Differe nce Std. Error Differ ence 95% Confidence Interval of the Difference Lower Upper Equal variances not assumed Conclusion: The significant þ value of Levene s test for equality of variance , we assumed that the variances are equal. An equal variance t-test þ value α 0.05, df 10. We fail to reject the null hypothesis and conclude that there is no significant difference between the current ratio of selected companies with mean (Public = & Private = 0.733) and standard deviation (Public = and Private = 0.296). 102

42 Table 4.21 Table Showing Results of One Way ANOVA for Current Ratio Significance Level: 5 percent Sum of Squares df Mean Square F Sig. Between Groups Within Groups Total Tukey HSD 95% Confidence Mean Interval (I) (J) Difference Std. Lower Upper Company Company (I-J) Error Sig. Bound Bound Air India Spice Jet Jet Airways Spice Jet Air India Jet Airways Jet Airways Air India Spice Jet Tukey HSD a Company N Subset for alpha = 0.05 Spice Jet Air India Jet Airways Sig..573 Means for groups in homogeneous subsets are displayed. a. Uses Harmonic Mean Sample Size =

43 Conclusion: Since the significant þ value of one way ANOVA is more than α value We fail to reject null hypothesis and conclude that there is no significant difference between current ratio of selected aviation companies. 4.14(ii) Quick Ratio This ratio reveals the relationship between quick assets and current liabilities. The main purpose of this ratio is to determine the capacity of the firm to meet its short term obligations. This ratio shows the liquidity position of the firm. The quick ratio is more conservative ratio than the current ratio and it focuses on cash, short term investment and account receivable. It is also called acid-test ratio. When current ratio and quick ratio used together it gives a better picture of short term financial position of the firm. The formula for calculating the quick ratio is: Quick Assets/Current Liabilities Quick assets are those assets which can be converted into cash with in short period. All current assets except inventory and prepaid expenses are included in quick 104