PROFITABILITY ANALYSIS

Transcription

1 4.1 Introduction CHAPTER IV PROFITABILITY ANALYSIS 4.2 Profitability 4.3 Composite Profitability Index 4.4 Determinants of Earnings 4.5 Factors Influencing the Profitability of the Cement Companies 4.6 Annual Compound Growth Rate

2 4.1 INTRODUCTION Profit is the primary motivating force of an economic activity. Profit is the engine that drives the business enterprise. The higher the profits, the more efficient are the business considered. A company should earn profits to survive and grow over a long period of time. Profit is the difference between revenues and expenses over a period of time. Profit is the ultimate output of a company, and it will have no future if it fails to make sufficient profits. The principal objective of a business undertaking is to earn profits. A business needs profits not only for its existence but also for expansion and diversification. The investors want an adequate return on their investments, workers want higher wages, creditors want higher security for their interest and loan and so on. A business enterprise can discharge its obligations to its stake holders through earning of profits. Profits are, thus, a useful measure of overall measure of a business. Profits to the management are the test of efficiency and a measurement of control; to owners, a measure of worth of their investment; to the creditors, the margin of safety; to employees, a source of fringe benefits; to government, a measure of tax-paying capacity and the basis of legislative action; to customers, a hint to demand for better quality and price cuts; to an enterprise, less cumbersome source of finance for growth and existence and finally to the country, profits are an index of economic progress, national income generated and rise in the standard of living. Thus, profitable is the fundamental objective of every business; hence profitability is the yardstick for measuring the efficiency of such firms. Profit is indeed a magic eye that mirrors all the aspects of entire business operations. Social criteria of business performance usually relate to quality of products, rate of progress, and behavior of prices. But, these are tests of the desirability of the whole profit system. Within that system, profits are the acid test of the individual firm s performance. Recently, the financial institutions, investors and credit analysts have started paying more attention to the firm s earning capacity as a measure of its financial strength. 69

3 4.2 PROFITABILITY Profitability is a relative measure and is defined as the ability of a firm to generate revenue in-excess of expenses. It is the primary measure of the overall success of a business and measures the effective utilization of its resources. The Profit of a business may be measured by studying the profitability of investment in it. Profitability may be defined as the ability of given investment to earn a return from its use. This ability is referred to as lending power or operating performance of the concerned investment. Profitability is a relative term and its measurement can be achieved by profit and its relation with the other objects by which the profit is affected. It is the test of efficiency, powerful motivational factor and the measure of control in any business. The measurement of profitability is as essential as the earning of profit itself for a business concern. Strategic managerial decisions like, expansion of business, rising of additional finance, problem of bonus and dividend payments rest upon this measurement. Financial analysis provides essential data for measuring profitability of a company. Profits and profitability play the same vital role in business like blood and pulse in the human body. Every enterprise whether big, medium or small, needs finance to carry on its operations and to achieve its objective. A going concern needs finance for its future growth and expansion. These finances may be raised in the form of share capital, borrowings or ploughing- back of profits. Procurement of capital is an important function of management, but the dexterity of management lies in the management of earnings. The primary objective of business is to earn profits. The preservation and increase in the value of economic resources is the foremost duty of an enterprise. The enterprise must earn profits at a certain minimum rate so as to enable it to provide reward (dividends, i.e., share of profits) to the investors. Profits must also provide for economic growth of development MEASUREMENT OF PROFIT It would be quite simple to measure the profit for the entire life of a business firm. From the sum of amounts received, the amounts paid or invested in the business during the firm s entire life will be deducted. The difference thus obtained would be the profit or 70

4 loss. But, the problem of measurement of periodic profit of a going concern has always been a cumbersome affair. Such a problem arises because of the difficulty in allocating current costs and revenues to that given accounting period. In addition to this difficulty, the periodic measurement of profit requires one to distinguish and choose between ex-post and ex-ante concepts of profit. Conventional accounting is largely concerned with the past events. Thus, the profit it measures is essentially ex-post in nature and content. Again, there is a wide variety of generally accepted accounting principles which provide for different methods of treatment for certain items, namely 1). Depreciation, 2). Inventories valuation. 3). Deferred expenses allocation over time periods, and 4). Treatment of capital gains and losses. The problem is made more acute by the fact that the values involved may be so large in comparison with trading profits that relatively small variations in values can make a substantial difference in reported profit. In recent years, the tendency in business practice has been to discard the word profit and to use such a natural expression as business income MANAGEMENT OF EARNINGS The term management of earnings means how the earnings of a firm are utilized, i.e. how much is paid to the shareholders in the form of dividends and how much is retained and ploughed back in the business. The way the companies apportion their earnings between dividends and retention is known as management of earnings. Scope of Management of Earnings 1. Management of earnings includes: a) Determination of profits, b) Determination of Surplus c) Creation of Reserves 2. Provision for Depreciation and Depreciation policy. 3. Declaration of Dividend and Dividend policy 4. Retained Earnings or Ploughing - back of profits 71

5 4.2.3 SIGNIFICANCE OF PROFITABILITY The objective of a business is to provide goods and services which the society needs at an affordable price. Profit is merely a measure of the approval of the society for the work being done for it. Profits are necessary for the existence of business. A business needs profits not only for its existence but also for the expansion and diversification of its activities. A business enterprise can discharge its obligations to the various segments of the society only through earning profit. But, at the same time one should distinguish profit earning from profiteering. Profit is the barometer of the success of business. It is, indeed, a magic eye that mirrors all aspects of entire business operations including the quality of output. In this chapter the profitability, techniques of profitability, Composite profitability determinants of earnings, factors influencing the profitability of the cement companies and annual compound growth rate of cement industry in India are discussed TECHNIQUES OF ANALYSING PROFITABILITY An analysis of the profitability will reveal the position of profits as a result of total transactions made during a year. Profitability can be analysed either on the basis of operating profits or in regard to net profit. It requires information from the financial statement, which has to be methodically classified and compared in accordance with the objectives set. There are various techniques available for analyzing profitability namely, Comparative Statements, Common-size income statement Analysis, Fund flow analysis, Trend percentage analysis and Ratio analysis. Among all the techniques used in the financial statement analysis, ratio analysis is the most powerful tool of financial analysis. As ratios are simple to calculate and easy to understand, there is a tendency to over-employ them in analyzing the profitability of a business. Profitability ratios are useful in analyzing the profitability of a firm. The profitability ratios can be broadly divided into groups namely, i) Profitability in relation to sales ii) Profitability in relation to investment 72

6 Profitability in relation to sales includes gross profit margin, operating profit margin and net profit margin while profitability in relation to investment includes return on total assets, return on net assets, and return on shareholders equity. To examine the profitability of cement industry, the following accounting ratios are employed: 1. Margin on Sales i. Earnings Before Depreciation, Interest and Tax to Net Sales (EBDIT/NS) ii. Earnings Before Interest and Tax To Net Sales (EBIT/ NS) iii. Gross Profit to Net Sales (GP/NS) iv. Profit Before Tax to Net Sales (PBT/NS) v. Profit After Tax to Net Sales (PAT/NS) vi. Operating Cash flow to Net Sales (OCF/NS) 2. Return on Total Assets i. Earnings Before Depreciation, Interest and Tax to Total Assets (EBDIT/TA) ii. Operating Cash flow to Total Assets (OCF/TA) iii. Earnings Before Depreciation, Interest and Tax to Total Tangible Assets (EBDIT / TTA) iv. Profit After Tax to Total Tangible Assets (PAT/ TTA) v. Earnings Before Interest and Tax to Total assets (EBIT/TA) 3. Return on Capital Employed i. Earnings Before Interest and Tax To capital employed (EBIT/CE) ii. Retained Cash Flow to capital employed (RE/CE) iii. Earnings Before Interest to Capital Employed (EBI/CE) 73

7 4. Return on Net worth i. Earnings Before Interest and Tax to Net worth (EBIT/NW) ii. Operating Cash Flow to Net worth (OCF/NW) iii. Profit After Tax to Shareholders Equity (PAT/NW) iv. Retained Earnings to Shareholders Equity (RE/NW) MARGIN ON SALES Table 4.1 shows the Average Margin on Sales Ratios of the selected cement companies in India during the study period from to TABLE 4.1 MARGIN ON SALES Ratios Average Industry Highest Lowest Industry Highest Lowest CV EBDIT/NS (7.38) , (971.64) EBIT/NS (18.59) (1,240.93) GP/NS (18.48) (14,787.55) PBT/NS (29.68) , (282.97) PAT/NS (1.06) (32.41) (603.98) 1, (6,907.19) OCF/NS (1.89) , (678.93) Source: Compiled and calculated from the data published in CMIE. Note: Figures within bracket denotes negative value. 74

8 EXHIBIT 4 1 MARGIN ON SALES RATIOS Type of Ratio

9 i) Earnings Before Depreciation, Interest and Tax to Net Sales (EBDIT/NS) Table 4.1 reveals that the average earnings before depreciation interest and tax to net sales of all selected cement companies shows per cent during the study period. Out of 30 selected cement companies, ratios of 13 companies are above the mean value ranging from per cent to per cent. The highest mean value of the company is SAI per cent., on other hand the ratio of 17 companies are below mean value ranging from per cent to per cent. The lowest average ratio of KAL is per cent. The average co-efficient of variation between selected cement companies is per cent, out of 30 selected cement companies, co-efficient of variation of 21 companies are below the average co-efficient of variation reveals the consistency in their earning pattern and are reasonably well performing. ii) Earnings Before Interest and Tax to Net Sales (EBIT/ NS) Table 4.1 shows that the average of earnings before interest and tax to net sales of the selected cement companies is 7.74 per cent, of which ratio of the 15 companies are above the average ranging between 7.74 per cent to per cent., the highest average ratio of SAI is per cent and the other 15 companies are below the average ranging between 7.74 per cent and per cent. The least average ratio of KAL is per cent. These companies are have an average co-efficient of variation of per cent, of which 15 companies are below average shows 50 per cent of the selected cement companies earnings before interest and tax to net sales is considerably good and consistent. iii) Gross Profit to Net Sales (GP/NS) Table 4.1 reveals that the average of gross profit ratio of the 30 selected cement companies is 7.06 per cent, of that ratio of 15 companies are above the average ranging from 7.06 per cent to per cent. The highest average ratio of SAI is per cent and the ratio remaining 15 companies are below the average ranging between 7.06 per cent and per cent. The lowest average ratio of KAL is per cent. The average co-efficient of variation of these companies is per cent, of which the co-efficient of variation of 20 companies are below the average co-efficient of variation reveals the consistency. 76

10 iv) Profit Before Tax to Net Sales (PBT/NS) Table 4.1 shows that the average of profit before tax to net sales of all selected cement companies is 0.71 per cent during the study period, out of 30 selected cement companies, ratio of 19 companies are above the mean value ranging from 0.71 per cent to per cent, the highest average ratio per cent is achieved by AMB, and the ratio of remaining 11 companies are below mean value ranging from 0.71 per cent to per cent, the lowest average ratio per cent is of KAL. The average co-efficient of variation of selected cement companies is per cent, co-efficient of variation of 19 companies are below the average co-efficient of variation reveals the consistency. v) Profit After Tax to Net Sales (PAT/NS) Table 4.1 reveals that the average of net profit ratio all 30 selected cement companies is 1.06 per cent negative during the study period, of that 20 companies are above mean value ranging from per cent to per cent. The highest average ratio per cent is achieved by AMB and the ratio of remaining 10 companies are below average ranging between and per cent, the lowest average ratio per cent is of KAL. The average co-efficient of variation between selected cement companies is per cent negative that reveals inconsistency their net profit earning pattern. vi) Operating Cash flow to Net Sales (OCF/NS) Table 4.1 explains that the average of operating cash flow to net sales of the all 30 selected cement companies is per cent, out of that the ratio of 16 companies are above the average ranging between and per cent, the highest ratio per cent is achieved by AMB and the balance 14 companies are below the average ranging between and per cent, the lowest average ratio per cent is of KAL. These companies are having an average co-efficient of variation of per cent, of which 22 companies are below the average shows consistency in their performance. 77

11 4.2.6 RETURN ON TOTAL ASSETS Table 4.2 shows the Average Return on Total Assets to Sales Ratios of the selected cement companies in India during the study period from to TABLE 4.2 RETURN ON TOTAL ASSETS Ratio Average Industry Highest Lowest Industry Highest Lowest cv EBDIT/TA (0.02) ( ) OCF/TA (0.01) (858.72) EBDIT/TTA (0.02) ( ) PAT/TTA (0.00) 0.09 (0.16) ( ) (399.26) EBIT/TA (0.01) (593.30) Source: Compiled and calculated from the data published in CMIE. Note: Figures within bracket denotes negative value. 1) Earnings Before Depreciation, Interest and Tax to Total Assets (EBDIT/TA) Table 4.2 reveals the average earnings before depreciation, interest and tax to total assets of all selected cement companies is 0.09 per cent during the study period, out of 30 selected cement companies, ratio of 17 companies is above mean value ranging from 0.09 per cent to 0.18 per cent. The highest ratio 0.18 per cent is achieved of GRA and the ratio of remaining 13 companies are below mean value ranging from 0.09 per cent to per cent. The lowest average ratio per cent is of KAL. The average co-efficient of variation between selected cement companies is per cent. The co-efficient of variation of 4 companies are below the average co-efficient of variation and the rest are higher than the average shows variation. 78

12 EXHIBIT 4.2 RETURN ON TOTAL ASSET RATIOS Type of Ratio IM) iad msoiji j-j

13 ii) Operating Cash flow to Total Assets (OCF/TA) Table 4.2 shows the average of operating cash flow to total assets is 0.09 per cent during the study period, out of 30 selected cement companies ratio of 17 companies are above the average ranging from 0.09 per cent to 0.19 per cent. The highest ratio 0.19 per cent is achieved of SVC and the ratios of 13 companies are below mean value ranging from 0.09 per cent and per cent. The lowest average ratio per cent of KAL. The average co-efficient of variation between selected cement companies is per cent, and the co-efficient of variation of 9 companies are below average reveals these companies are reasonably satisfactory in comparison with the other selected cement companies. iii) Earnings Before Depreciation, Interest and Tax to Total Tangible Assets (EBDIT/TTA) Table 4.2 shows the average of earnings before depreciation, interest and tax to total tangible assets is 0.10 per cent during the study period, out of 30 selected cement companies, the ratio of 18 companies are above average ranging from 0.10 per cent to 0.19 per cent. The highest ratio 0.19 per cent is achieved of AMB and the ratios of remaining 12 companies are below average ranging from 0.10 per cent and per cent. The lowest average ratio (0.02) per cent of KAL. The average co-efficient of variation selected cement companies is per cent, out of 30 selected cement companies, co-efficient of variation of 7 companies are below the average. iv) Profit After Tax to Total Tangible Assets (PAT/ TTA) Table 4.2 shows the average of profit after tax to total tangible assets is nil during the study period, however, ratio of 19 companies out of 30 selected cement companies having the ratio of 0.1 per cent to 0.9 per cent. The highest ratio 0.09 per cent is achieved of AMB, and the ratio of remaining 11 companies are negative, which ranges between per cent and the lowest of per cent. The lowest average ratio-0.16 per cent of KAL. The average co-efficient of variation between selected cement companies is per cent negative due to very negative average of per cent PAT to TTA. 80

14 v) Earnings Before Interest and Tax to Total assets (EBIT/TA) Table 4.2 shows the average of Earnings before Depreciation, Interest and Tax to Total Tangible Assets is 0.02 per cent during the study period, out of 30 selected cement companies, ratio of 6 companies are above the mean value ranging from 0.02 per cent to 0.23 per cent. The highest ratio 0.23 per cent is achieved of GRA and the ratio of 24 companies are below the mean value ranging from 0.02 per cent to the lowest of (0.01) per cent. The lowest average ratio-0.01 per cent of KAL. The average co-efficient of variation selected cement companies is per cent RETURN ON CAPITAL EMPLOYED Table 4.3 shows the Average Return on Capital Employed to Sales Ratios of the selected cement companies in India during the study period from to TABLE 4.3 RETURN ON CAPITAL EMPLOYED Ratio Average Industry Highest Lowest Industry Highest Lowest cv EBIT/CE (0.14) , (1,368.21) RE/CE (0.02) 0.07 (0.54) (1,386.83) (1,207.08) EBI/CE (0.14) , (1,269.15) Source: Compiled and calculated from the data published in CMIE. Note: Figures within bracket denotes negative value. 81

15 EXHIBIT 4 3 RETURN ON CAPITAL EMPLOYED RATIOS Type of Ratio

16 i) Earnings Before interest and Tax To capital employed (EBIT/CE) Table 4.3 shows the average of earnings before interest and tax to capital employed is 0.07 per cent during the study period, out of 30 selected cement companies, ratio of 17 companies is above average ranging from 0.08 per cent to 0.17 per cent. The highest ratio 0.17 per cent is achieved of AMB and the ratios of remaining 13 companies are below average ranging between 0.07 per cent and per cent. The lowest average ratio per cent of KAL. The average co-efficient of variation between selected cement companies is per cent, out of 30 selected cement companies, co-efficient of variation of 17 companies are below the average. ii) Retained Earnings to capital employed (RE/CE) Table 4.3 the average of retained cash flow to capital employed is per cent during the study period, out of 30 selected cement companies, 19 companies are having positive ratio ranging from per cent to 0.07 per cent. The highest average ratio per cent is achieved by AMB, and the remaining companies having average ratio value ranging from per cent to per cent. The lowest average ratio of per cent of MAN. The average co-efficient of variation between selected cement companies is per cent negative due to negative RE/CE. ili) Earnings Before Interest to Capital Employed (EBI/CE) Table 4.3 shows that the average of earnings before interest to capital employed is 0.06 per cent during the study period, out of 30 selected cement companies, ratio of 18 companies are above average with an highest ratio ranging between of 0.06 per cent to 0.15 per cent. The highest average ratio 0.15 per cent is achieved by AMB and the ratio of 13 companies are below mean value ranging from 0.06 per cent to per cent. The lowest average ratio of per cent of KAL. The average co-efficient of variation between selected cement companies is per cent, out of 30 selected cement companies, co-efficient of variation of 20 companies are below the average co-efficient of variation RETURN ON NET WORTH Table 4.4 shows the Return on Net Worth on Sales of the selected cement companies in India during the study period from to

17 TABLE 4.4 RETURN ON NET WORTH Ratio Average Industry Highest Lowest Industry Highest Lowest CV EBIT/NW (1.65) 1, , (677.96) PAT/NW (2.61) 1, , (3,632.83) OCF/NW (0.11) 1.31 (9.76) (3,943.86) 2, (5,139.61) RE/NW (2.90) 1, (5,285.22) Source: Compiled and calculated from the data published in CMIE, Note: Figures within bracket denotes negative value. i) Earnings Before interest and taxes to Net worth (EBIT/NW) Table 4.4 reveals that the average of earnings before interest and tax to net worth is 0.61 per cent during the study period, out of 30 selected cement companies ratio of only two companies are above average with an highest ratio ranging from 0.61 per cent to per cent. The highest average ratio 0.15 per cent is achieved by per cent of MYS, and the ratio of remaining 28 companies are below mean value ranging from 0.61 per cent to per cent. The lowest average ratio of per cent of GUJ. The average co-efficient of variation between selected cement companies is per cent; this is due to lower average ratio. ii) Profit After Taxes to Net worth (PAT/NW) Table 4.4 shows the average of profit after tax to net worth is 0.95 per cent during the study period, ratio of MYS is the above mean value which is the highest of selected cement companies per cent and the lowest ratio is of GUJ the per cent. The average co-efficient of variation among selected cement companies is per cent. 84

18 1X5 oo EXHIBIT 4.4 RETURN ON NET WORTH RATIOS Type of Ratio

19 iii) Operating Cash Flow to Net worth (OCF/NW) Table 4.4 shows the average of operating cash flow to net worth is per cent during the study period, out of 30 selected cement companies ratios of 28 companies are above the average ranging from 0.06 per cent to 1.31 per cent. The highest average ratio 0.15 per cent of SVC, and the ratio of MYS is lowest 9.76 per cent. The average co-efficient of variation selected cement companies is ( ) per cent. iv) Retained Earnings to Net worth (RE/NW) Table 4.4 reveals the average of retained earnings to net worth is 0.90 per cent during the study period, out of 30 selected cement companies ratio of 2 companies are above the average ranging from 0.93 per cent to per cent of MYS, and the ratio of remaining 28 companies are below the average value ranging from 0.90 per cent to per cent. The lowest average ratio 2.90 per cent of GUJ. The average co-efficient of variation selected cement companies is per cent. 4.3 COMPOSITE PROFITABILITY INDEX Analysis of profitability of a business enterprise is a subject of much interest and research. As ratios are simple to calculate and easy to understand, there is a tendency to over employ them in analyzing the profitability of a business. A single profitability ratio in itself does not convey much of the sense. Further, there is no international standard for financial ratios against which the results can be compared. Of course, a good deal of profitability ratios does exist to measure various aspects of profitability. If several profitability ratios are used, it is possible that they may yield different conclusions for the same firm. Here it suggests the procedure of evaluating the composite profitability of a firm based on empirical analysis of the data of the individual sample companies. Based on their composite profitability, the sample companies have been ranked for the study period from to The multivariate analysis is a good method to measure composite profitability of a firm. It is an overall measure of profitability of a firm expressed by a single index. It measures the overall rating in the profitability of a company with a fair degree of accuracy. The infinite variables used in the ratio analysis may lead to innumerable parameters in assessing the financial health of the firm. As a result, there can be countless inferences and 86

20 conclusions derived from different ratios used, to strike at the right area to determine the profitability of the companies, an attempt is made to desire a composite profitability index and to rank the sample companies in the order of their composite profitability index score, for the study period. The composite profitability is an overall measure of profitability of a firm expressed in a single index, which distinguishes a profitable firm from its counterparts with high degree of accuracy. It is a multivariate approach to determine the profitability of a firm by assigning weights to the variables having less degree of association. Composite profitability index gives an overall rating for the firm SIGNIFICANCE OF COMPOSITE PROFITABILITY The most potentially important benefit of a composite scoring system is quantification of the overall profitability of a firm. Composite profitability index acts as a very effective tool for corporate planning and control as it takes into effect the essence of all the ratios which represent all aspects of profit. Using this index, the management of a firm will be able to identify its position in terms of profitability in the industry to which the firms belongs. This approach is useful to credit rating agencies, investors, lending and financial institutions, policy makers of the government, researchers and the international organizations for analyzing the financial performance of the corporate sector in India DETERMINATION OF COMPOSITE PROFITABILITY The number of profitability ratios one can compute from financial statements is obviously very high. Even within each of the main categories of profitability ratios, there are a minimum of at least three or four different ratios proposed in the literature. Further, different authorities use different bases for finding out the ratios. Most of the profitability ratios under each of the main categories overlap in the information they provide about profitability. Now a spontaneous question arises as to how many ratios to compute under each main category so that the overall profitability can be measured with a fair degree of accuracy. Keeping this in view, an attempt is made to measure the composite profitability of a firm by a single index thereby facilitating ease of comparison and ranking. 87

21 The categorization of profitability ratios although frequently exposited in the finance literature, it has little explicit theoretical or empirical underpinnings. There is little in economic theory that suggests that the profitability category constitutes either mutually exclusive or collectively exhaustive set of financial characteristics of a firm. On the basis of studies reported in the literature the following profitability ratios under different main heads have been identified which will be subject to empirical testing for their degree of association. These ratios are: A. Margin on Sales i. Earnings Before Depreciation, Interest and Tax to Net Sales (EBDIT/NS) ii. Earnings Before Interest and Tax to Net Sales (EBIT/ NS) iii. Gross Profit to Net Sales (GP/NS) iv. Profit Before Tax to Net Sales (PBT/NS) v. Profit After Tax to Net Sales (PAT/NS) vi. Operating Cash Flow to Net Sales (OCF/NS) B. Return on Total Assets vii. Earnings Before Depreciation, Interest and Tax to Total Assets (EBDIT/TA) viii. Operating Cash flow to Total Assets (OCF/TA) ix. Earnings Before Interest and Tax to Total assets (EBIT/TA) x. Earnings Before Depreciation, Interest and Tax to Total Tangible Assets (EBDIT/ TTA) xi. Earnings Before Depreciation, Interest and Tax to Total Tangible Assets (EBD1T/TTA) xii. Profit After Tax to Total Tangible Assets (PAT/ TTA) C. Return on Capital Employed xiii. Earnings Before Interest and Tax To Capital Employed (EBIT/CE) xiv. Retained Cash Flow to Capital Employed (RE/CE) xv. Earnings Before Interest to Capital Employed(EBI/CE) D. Return on Net worth xvi. Earnings Before Interest and Tax to Net worth (EBIT/NW) xvii. Operating Cash Flow to Net worth (OCF/NW) 88

22 xviii. Profit After Tax to Shareholders Equity (PAT/NW) xix. Retained Earnings to Shareholders Equity (RE/NW) and xx. Interest Coverage Ratio The composite profitability is to be computed by integrating all the above ratios into a single measure. For this purpose, weight has been assigned to the selected cement ratios. The weighting of these various ratios is systematically assigned by calculating the z-scores and percentile rank of the above financial ratios of selected cement companies. Z Scores are expressed in terms of standard deviations from their means, the formula for calculating the standard score z is (x-p)/o. All the ratios of selected cement companies during the study period are converted into standard score with the help of said formula. Percentile Rank: A percentile is the value of a variable below which a certain per cent of observations fall. The standard scores thus calculated divided into ten equal parts by percentile ranking and weights are assigned as follows. Weight 1 is assigned to the standard score z that falls within 10th percentile and weight 2 is assigned to the standard score z that fall between 10th percentile to 20th percentile and likewise weight 10 is assigned to the standard score z fall between 90th to 100th percentile. To avoid subjectivity, each ratio has been assigned weights, the maximum being 10 and minimum being 1. Ranking of individual Sample Companies In order to rank the sample in terms composite profitability, ratio-wise scores have been aggregated and the firm getting the highest total score has been ranked as 1 and the firm securing the lowest total score has been ranked as 30 (since the total number of sample companies is 30). Table 4.5 gives year-wise composite score and the overall rank of the sample companies during the study period froml to The Table 4.5 below shows year wise composite profitability index score and the overall ranking of the selected cement firms. The selected cement companies are classified into two categories Profitable and Less Profitable taking median score 15. Out of 30 selected cement companies the highest composite index score is 1,280, secured by KAT ranking first and the lowest composite index score is 1,016 secured by AMB the rank is

23 Total 1,280 1,273 1,271 1,229 1,210 1,206 1,205 1,198 1,182 O00 1,171 1, in 1,145 1,144 YEAR-WISE COMPOSITE SCORE AND OVERALL RANK OF THE SAMPLE COMPANIES Rank H IT) * 4 i co <N 4 <N in cn 4 m r ncn 4 cs m h r-» 4 H (N co ro n * < in» i ( in SO in co X CN r (N On ^ cs C\ CN o X <N <N 120 m n VO r- 00 C\ o - <N CO in o CO Name KAT PRI AND 45 MYS GJS SAG IND SHR MAN SAI KAL JKL SDV CHE CEN

24 Total 1,144 1,142 1,134 1,128 1,128 1,121 1, O 1,104 1,103 1, in 1,032 1,021 1, r- co in co «H co VO 09»n p**h »n in co Os n vo 2 Os * i in in r- Os 123 vo P H «>H Tf* mp-h in 96 <N co 145»n Os 163 Os 00 in r p*h co <N so in 144 in Os m in 00 so op*h r- in SO 64 70»-H m^h CO in P >H o t* H r- r in *n pp*h 00 p*«h i \ o\ r- >n ph (N f 4 47 o m Os r- ITS in m H co i so r H 5v - r- so on s t/1 r- oo Ov Cv <s co m vo 04 EC9 2 D < u w J u > Z vo r SO»n (N (N 00 in r*» r- 106 Os r- in 70 r- r- p~h 125 <N O* H in CO 00 Ov o m P ^ <N CnJ (N <N (N <N <N <N CO u Q < j u j < Cu < < z < az U S Q o 00 CQ < s z Q oo O < m sc9 mt o s Source: Compiled and calculated from the data published in CMIE.

25 9101 IZOI zcoi 8S0T I f90i ton V % h, S' > l Total Composite Score CM 05 WT EXHIBIT 4.5 TOTAL COMPOSITE PROFITABILITY RATIOS SCORE son 11! ini SHI sni nil i mi i mi i mi i st-n i Sill o_n T-II i os 11 i rsn 861T son oon OI T I % o* % * \ % % % % % S' > X%X Companies 6ZZ\ \JZl c.n osn ** % % % o o o00 J.IOJS

26 4.3.3 DETERMINATION OF PROFITABLE AND LESS PROFITABLE COMPANIES Selected cement companies are compared with median to distinguish the profitable companies from less profitable companies. The median of the determined composite profitability index is 15 during the study period froml to Thus companies ranked between 1 to 15 are considered as profitable companies and the remaining companies between 17 to 30l. rank are considered as less profitable which is shown in Table 4.6 below. Table 4.7 and Table 4.8 shows the top three and lthe bottom three companies TABLE 4.6 PROFITABLE AND LESS PROFITABLE COMPANIES S.No. Profitable Companies S.No. Less Profitable Companies 01 Katwa Udyog Ltd. 01 Deccan Cements Ltd. 02 Prism Cement Ltd 02 O C L India Ltd. 03 Andhra Cements Ltd 03 Sri Vishnu Cement Ltd 04 Mysore Cements Ltd 04 Tamilnadu Cements Corpn. Ltd. 05 Gujarat Sidhee Cement Ltd. 05 Birla Corporation Ltd. 06 Sagar Cements Ltd. 06 ACC Ltd. 07 India Cements Ltd. 07 Madras Cements Ltd. 08 Shree Cement Ltd. 08 N C L Industries Ltd 09 Mangalam Cement Ltd 09 Dalmia Cement (Bharat) Ltd 10 Sainik Finance and Inds. Ltd 10 Kakatiya Cement Sugar & Inds Ltd 11 Kalyanpur Cements Ltd. 11 Sanghi Industries Ltd. 12 JK Lakshmi Cement Ltd 12 Grasim Industries Ltd. 13 Shree Digvijay Cement Co. Ltd. 13 K C P Ltd. 14 Chettinad Cement Corpn. Ltd 14 Ambuja Cements Ltd. 15 Century Textiles & Inds. Ltd 16 Saurashtra Cement Ltd. 93

27 TABLE 4.7 TOP THREE COMPANIES TOP 3 COMPANIES POINTS SCORED RANK Katwa Udyog Ltd 1,280 1 Prism Cement Ltd 1,273 2 Andhra Cements Ltd 1,271 3 TABLE 4.8 BOTTOM THREE COMPANIES BOTTOM 3 COMPANIES POINTS SCORED RANK Grasim Industries Ltd. 1, KCP Ltd. 1, Ambuja Cements Ltd. 1, Referring to the table 4.7 and 4.8 the analysis of composite profitability index shows that companies KAT, PRI and AND are secured first three ranks and on the other hand AMB, KCP and GRA secured last three ranks. Profitability analysis of Cement companies has been assessed by making use of four major groups of ratios. They are Margin on Sales, Return on Total assets, Return on Capital Employed and Return on Net worth. All the ratios are taken into consideration for profitability index; the analysis reveals that 16 companies are above the standard median score, thus it is found that overall performance of selected cement companies are satisfactory and good as far as financial statement alone is considered. However, cement is a capital intensive industry and therefore investment in total assets; production capacity and technology used also have greater influence on the profitability of cement companies which is not taken into consideration in this study. 94

28 4.4 DETERMINANTS OF EARNINGS The Earnings before Interest and Taxes is the key measure used in assessing the basic earning power of cement companies. It has been taken as a representative of earnings in order to avoid distortion due to changes in the company s capital structure and income tax provisions. It is influenced by internal and external variables. External variables remain outside the purview of company s control. Efforts have been made to identify the key internal variables, which influence the EBIT of the cement companies during the period of the study. Pearson correlation coefficient has been undertaken to know the coefficient values of the variables and then multiple regression models have been applied to identify the internal determinants of the earning power. A null hypothesis has been constructed to analyse that there is no significant linear effect on EBIT by the independent variables. EBIT has been taken as dependent variable and eight internal independent variables viz.., Current Assets (CA), Current Liabilities and Provisions (CLP), Cost of Production (COP), Long Term Loans (LTL), Retained Earnings (RE), Equity Capital (EC), Gross Fixed Assets (FA) (net of revaluation and work in progress) and Gross Sales (GS) have been chosen based on the correlation analysis as detailed in the table below: The table below 4.9 reveals the correlation between the variables taken for the study. It is clear that the correlation coefficient values are above 0.3 and hence all the variables have been taken to multiple regression analysis to analyse the influence of Current Assets (CA), Current Liabilities and Provisions (CLP), Cost of Production (COP), Long Term Loans (LTL), Retained Earnings (RE), Equity Capital (EC), Gross Fixed Assets (FA) (net of revaluation and work in progress) and Gross Sales (GS) on Earnings Before Interest and Tax. 95

29 EBIT oco CD o> GS Y~* o CO 0.944** o o CO oo FA V o CO 0.947** o oo d o CO 0.866** o o od o CO CLP Y o CO 0.970** O o oco 0.967** o o od oco! 0.879** o oco TABLE CORRELATION CA COP EC RE LTL Ratios Pearson Correlation Sig. (2-tailed) -1 -I oco z r* o CO 0.494** to o od Pearson Correlation Sig. (2-tailed) LU cc oco z 0.427* 0.528** 0> T o oco o CO CO oco o od Pearson Correlation Sig. (2-tailed) o uj z T o CO 0.377* * LO o «oto 00 o o o oco o d o CO o Pearson Correlation Sig. (2-tailed) a OO oco z 0.976** * CO 00 CO d 0.467** ** o o od 9E00 oco oco oco oco O oco o od Pearson Correlation Sig. (2-tailed) <o z *to to O O) o o 0.959** 0.423* 0.526** 0.848** o o04 O o CO o od o Pearson Correlation Sig. (2-tailed) oco oco oco oco oco z 0.933** 0.926** I 0.499** 0.634** 0.887** o CO o d o CO o d to o oo o CO o o Pearson Correlation Sig. (2-tailed) o CO o CO z 0.976** 0.994** «CM T~ o 0.522** 0.871** o o tj* CM O o CO o od o o od Pearson Correlation Sig. (2-tailed) o CO oco o CO oco oco z 0.896** 0.916** o00 CO d 0.610** 0.834** a i- _i < o LL (A 0 ffi UJ o CO o o o GO CO o o o CO o CO oco CO o o Pearson Correlation Sig. (2-tailed) z Source: Compiled and calculated from the data published in CM1E. ** Correlation is significant at the 0.01 level (2-tailed). * Correlation is significant at the 0.05 level (2-tailed).

30 4.4.1 MULTIPLE REGRESSION The tables below show the multiple regression of the selected cement companies in India during the study period from to Hypothesis: There is no significant linear effect on EBIT by the independent variables. TABLE 4.10 MODEL SUMMARY Model R R2 Adjusted R2 Std. Error of the Estimate Predictors: (Constant), GS, EC, RE, LTL, CLP, FA, CA, COP The above table 4.10 represents the statistical significance of the model. The R2 value at states that all the nine independent variables that is current assets, current liabilities and provisions, cost of production, long term loans, retained earnings, equity capital, gross fixed assets and gross sales has 98.3 per cent influence on the dependent variable EBIT (Earnings Before Interest and Tax). TABLE 4.11 ANOVA Model Sum of Squares df Mean Square F Sig. 1 Regression Residual Total Predictors: (Constant), GS, EC, RE, LTL, CLP, FA, CA, COP Dependent Variable: EBIT In the above table 4.11 calculated value of F is which is more than the table value 2.42 at 5 per cent significant level hence it is clear that the independent variables GS, EC, RE, LTL, CLP, FA, CA, COP has significant effect on EBIT. Hence the hypothesis is rejected. 97

31 TABLE 4.12 COEFFICIENTS Model Unstandardized Coefficients B Std. Error Standardized Coefficients Beta t Sig. 1 (Constant) Dependent Variable: EBIT LTL 3.506E RE E EC COP * CA IE CLP 6.545E FA E GS * From the above table 4.12 it is clear that out of nine independent variables (current assets, current liabilities and provisions, cost of production, long term loans, retained earnings, equity capital, gross fixed assets and gross sales) cost of production, fixed assets and gross sales have significant influence on dependent variable EBIT. And the remaining variables such as long term loans, retained earnings, equity capital, current assets, current liabilities and provisions do not have significant influence on the EBIT. Hence the hypothesis is rejected. 98

32 4.5 FACTORS INFLUENCING THE PROFITABILITY OF THE CEMENT COMPANIES The ability of a firm to generate profits may differ between companies owing to their age, size and region. Hence profitability is analysed based on age, size and region in which they were incorporated, the well established old firms may have captured the market share, and the new firms may have upgraded technology usage that may be either improved operational efficiency or reduced cost of production. Similarly, large sized firms may earn higher return due to economies of large scale production. The regional classification too plays a vital role in providing locational advantages. Firms of different ages, sizes and regions might be expected to have different degrees of profitability. A study has been made in this part to examine the factors influencing the profitability. For the purpose of analysis, the selected cement companies are classified under three broad categories on the basis of sizes, ages and regions. For the purpose of this study selected cement companies are classified into three types based on the total assets held by those companies at the end of study period as Small, Medium and Large companies. Based on the year of incorporation, companies are classified into three types taking the age below 25 years as of 2007 as new companies, age above 25 years and below 50 years as moderately old companies and age above 50 years as old companies. Similarly, based on the place of incorporation, companies are classified into two types as South and North. Table 4.13, 4.14 and 4.15 below shows the Profitability Ratios for Selected Cement companies, Size-Wise, Age-Wise and Region-Wise during the study period from to

33 A. PROFITABILITY RATIOS FOR SELECTED CEMENT COMPANIES, SIZE-WISE TABLE 4.13 PROFITABILITY RATIOS FOR SELECTED CEMENT COMPANIES - SIZE-WISE Ratio / Statistical Tool Small Size Companies Medium Size Companies Large Size Companies EBDIT/NS Mean EBDIT/NS SD EBDIT/NS CV EBIT/NS Mean EBIT/NS SD EBIT/NS CV GP/NS Mean GP/NS SD GP/NS CV PBT/NS Mean PBT/NS SD PBT/NS CV 21, , PAT/NS Mean (1.39) 0.10 (0.90) PAT/NS SD PAT/NS CV (1,080.43) 12, (1,616.61) OCF/NS Mean OCF/NS SD OCF/NS CV

34 Ratio / Statistical Tool Small Size Companies Medium Size Companies Large Size Companies EBDIT/TA Mean EBDIT/TA SD EBDIT/TA CV OCF/TA Mean OCF/TA SD OCF/TA CV EBIT/TA Mean EBIT/TA SD EBIT/TA CV EBDIT/TTA Mean EBDIT/TTA SD EBDIT/TTA CV PAT/TTA Mean (0.00) PAT/TTA SD PAT/TTA CV (2,345.84) , EBIT/CE Mean EBIT/CE SD EBIT/CE CV RE/CE Mean (0.05) RE/CE SD RE/CE CV (921.04) ,

35 Ratio / Statistical Tool Small Size Companies Medium Size Companies Large Size Companies EBI/CE Mean EBI/CE SD EBI/CE CV EBIT/NW Mean EBIT/NW SD EBIT/NW CV 1, , PAT/NW Mean (0.12) (0.01) 2.77 PAT/NW SD PAT/NW CV (1,633.86) (3,120.90) OCF/NW Mean (0.69) OCF/NW SD OCF/NW CV (1,025.77) RE/NW Mean (0.12) RE/NW SD RE/NW CV (1,760.34) 1, Source: Compiled and calculated from the data published in CMIE. Note: Figures within bracket denotes negative value MARGIN ON SALES i) Earnings Before Depreciation Interest and Taxes [EBDIT] / Net Sales [NS] Earnings before depreciation, interest and tax to net sales indicates the manufacturing efficiency of companies. Average EBDIT to NS of large size companies is per cent, per cent of medium size companies and per cent of small size companies during the study period, which demonstrates the healthier performance of large size companies compared to small and medium size companies. 102

36 The standard deviation of medium size companies 7.57 is smaller than and of small and large size companies respectively shows stable performance of medium size companies. Similarly the lesser co-efficient of variation also substantiate the consistent performance of medium size companies. Likewise large size companies also are performing well with an average EBDIT to NS of per cent compared to small size companies. ii) Earnings Before Interest and Taxes [EBIT] / Net Sales [NS] Earnings before interest and tax to net sales denote the operating performance of companies ignoring the effect of financial leverage. Average EBIT to NS of large size companies is per cent, 7.03 per cent of medium size companies and 6.32 per cent of small size companies during the study period shows reasonably good performance of large companies against small and medium size companies. But, smaller standard deviation of medium size companies shows the stability of medium size companies performance in comparison with small and large size companies. The fact is further substantiated by lower co-efficient of variation of medium size companies. However, similar to medium companies large size companies also are performing well with slighter inconsistency year on year with an improved EBIT to NS by 2.97 per cent over medium size companies. iii) Gross Profit [GP] / Net Sales [NS] Gross profit to Net sales is an average margin obtained on goods and/or services sold, that reflects the efficiency with which management produces each unit of product. Average gross profit ratio of large size companies is 9.68 per cent during the study period against 6.32 and 5.40 per cent of medium and small size companies respectively, shows good performance of large size companies. The lesser standard deviation of medium size companies show stableness against small and large size companies performance, that is corroborated by smaller co-efficient of variation of medium sized companies, akin to medium size companies large companies also are performing well with slighter inconsistent gross profit margins throughout study period with well improved margin of 3.36 per cent over medium size companies. 103