Z SCORE ANALYSIS FOR EVALUATION OF FINANCIAL HEALTH OF INDIAN OIL REFINERIES. Erode.

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1 Z SCORE ANALYSIS FOR EVALUATION OF FINANCIAL HEALTH OF INDIAN OIL REFINERIES Dr.T.DURAIPANDI 1 V.P.NALLASWAMY 2 1 Assistant Professor in Commerce, Government Arts and Science College (Autonomous), Karur. 2 Part-Time Ph.D Scholar & Assistant Professor in Management, Bharathidasan School of Business, Erode. ABSTRACT Altman s Z score analysis has been applied by financial analysts to evaluate the general trend in the financial health of an enterprise over a period. Some of the individual accounting ratios used frequently to predict the financial performance of an enterprise may only provide warnings when it is too late to take a corrective action. Further single ratio does not convey much of the sense. There is no internationally accepted standard for financial ratio against which the results can be compared. Therefore, Edwin I Altman combined a number of accounting ratios (liquidity, leverage, activity and profitability) to form an index of the profitability, which are effective indicators of corporate performance predicting bankruptcy well over a year or two in advance. The analysis shows that the financial health of oil refineries in India during the study period was lying in too healthy zone. It may be attributed to the positive changes in the net operating profit from the increased sales volume and market capitalization of the equity, maintaining sufficient working capital and effective utilization of capacity. Introduction Altman s Z score analysis has been applied by financial analysts to evaluate the general trend in the financial health of an enterprise over a period. Some of the individual accounting ratios used frequently to predict the financial performance of an enterprise may only provide warnings when it is too late to take a corrective action. Further single ratio does not convey much of the sense. There is no internationally accepted standard for financial ratio against which the results can be compared. Therefore, Edwin I Altman combined a number of accounting ratios (liquidity, leverage, activity and profitability) to form an index of the profitability, which are effective indicators of corporate performance predicting bankruptcy well over a year or two in advance. Review of Literature Mansur A. Mulla (2002) made a study of the financial health of Shri Venkatesh Co-operative Textile Mills Ltd., Arunageri of Dharwad District. The Z score analysis was applied to evaluate the general trend in financial health of a firm over a period by using many of the accounting ratios. From the study it was concluded that the textiles mill under study was just on the verge of financial collapse. On the one hand, current assets declined because of the negative profitability performance, on the other hand, the current liabilities were on the increase because of poor liquidity performance of the mill. Selvam et al. (2004) analyzed the financial health of India Cements Ltd. This study was mainly based on secondary data. The required accounting information about India Cements Ltd for the Z- score analysis was obtained from the Prowess Corporate Data Base of CMIE, Chennai for a period of 5 years ( ). "Z" score analysis was applied to evaluate the general trend in the financial health of India Cements Ltd by using ratio analysis. The analysis showed that the cement company under the study was just on the verge of financial collapse. The financial health of the 87 admin@icmrr.org

2 company was never in the too healthy zone during the study period. They suggested India Cements Ltd to take steps to improve the financial health of the company. Dheenadhyalan (2008) adopted Z score to predict the corporate failure of Steel Authority of India Ltd. The Z score of SAIL showed a rising trend throughout the study period and it was concluded that the financial health of SAIL was good. Srinivasan and Tiripurasundari (2011) used Z-score to measure the financial health of fourteen south Indian Cement industries. Three modes (Altman, Springate and Fulmer Model) of z- score were used in the study in order to measure the 'fiscal fitness' of the companies. According to all the three methods, Rain Commodities Ltd and Zuari Cement Ltd were rated as failure from the sample of fourteen South Indian cement companies. The possible reasons for a company to be rated as failure may be excess debt and excess working capital, that may weaken the financial health of that particular company. Maheswara Reddy and Reddy (2011) considered five ratios and assigned a weight for each ratio and produced a single number which indicates the financial health of the business concerns. He made an attempt to predict the financial health of two selected sample pharmacy companies (Aurobindo Datong Bio-Pharmacy Ltd and Ranbaxy Laboratories Ltd) for five years from 2005 to 06 to using modified Altman s model. The finding of the study was that the overall financial health of both companies was good. Vijayakumar(2012) in his study made an attempt to assessing the financial health of Indian Automobile companies using Altman Bankruptcy Model. The analyses of operational efficiency using the model revealed that except few companies, the financial health of Indian automobile companies were good during the study period. DR. A. Vijayakumar and P.Gomathi (2013) used to measure financial stability and operational health of the selected oil refineries during the post liberalization period. The study revealed that the financial health of the selected refineries was in too healthy zone. It was attributed to the to the positive changes in the net operating profit from the increased sales volume and market capitalization of the equity, maintaining sufficient working capital and effective utilization of capacity. ALTMAN Z SCORE MODEL One of the objectives of the study is to predict the financial health and viability of the selected oil refineries during the post liberalization period to improve its operational efficiency and effectiveness, productivity and profitability. The data collected are first analyzed with the help of five accounting ratios. These different ratios are combined into a single measure Z score analysis with the help of Multiple Discriminate Analysis (MDA). The formula used to evaluate the Z score analysis as established by Altman is: Z = T1 + T2 + T3 + T4 + T5 Z = 1.2X X X X X5 Where Z is the overall index X1 - ratio of working capital to total assets (WC/TA) X2 - ratio of retained earnings to Total Assets (RA/TA) X3 - ratio of earnings before interest and tax total assets (EBIT/TA) X4 - ratio of market value of equity to Total Liabilities X5 - ratio of sales to total assets (S/TA) The following accounting ratios are used as variables to combine them into a single measure (Index), which is efficient in predicting bankruptcy. X1: The ratio of working to total assets. It is the measure of the net liquid assets of a concern to the total capitalization admin@icmrr.org

3 X2: The ratio of retained earnings to Total Assets (RA/TA). It indicates the efficiency of the management in earnings after all financial expenses including dividend. X3: The ratio of earnings before interest and tax to total assets. It is a measure of productivity of assets employed in an enterprise. The ultimate existence of an enterprise is based on the earning power. X4: The ratio of market value of equity to book value of debt. It is reciprocal of the familiar debtequity ratio. This measure shows how much assets of an enterprise can decline in value before the liabilities exceed the assets and the concern becomes insolvent. X5: The ratio of sales to total assets. The capital turnover ratio is standard financial measure for illustrating the sales generating capacity of the assets. According to Altman (1968), the following three situations are considered for studying the financial health of selected oil refineries in India. i) The Z score below 1.8 units is considered to be bankruptcy zone. Failure is certain and extremely likely and would occur probably in two years. ii) If a unit s Z score is 1.8 or above but less than 3.0, its financial viability is considered to be healthy. The failure in this situation is uncertain to predict. iii) The Z scores 3.0 and above indicates too healthy zone. Its financial health is very viable and would not fall. Table 1: ALTMAN S Z-SCORE Category Z Score Zone Situation I Below 1.8 Bankruptcy Zone certain to fail II Healthy Zone Uncertain to Predict III 3 and above Too Healthy zone Not to fall Statement of the Problem Profit is a reward for risk-taken in the business. Business is the wealth- creating institution of society. The main goal of a business is making profit and every business operates in order to earn profit. A business may have other goals but if they do not make profit then they will have to end the business. Profit is an important yardstick to measure the efficiency of the business. The greater the profit, the more efficient is the business. The profit of a business may be measured by studying the profitability of investment in it. Profitability is referred to as earning power or operating performance of the investment concerned. Profitability is a relative term and its relation with the other factors by which the profit is affected. It is the test of efficiency, powerful motivating factor and the measure of performance in any business. Hence, an attempt has been made to study the profitability of selected oil refineries in India by using vital profitability ratios. In the financial statement analysis literature, more importance is given to financial ratios for assessing a firm s financial performance and condition. Items of the income statement alone or along with the items of balance sheet also can generate a number of profitability ratios. But, many ratios reveal similar things. The analyst is always at a loss to find out which ratios to use to determine the profitability of a firm. An attempt is made to find out the inter-relationship between and among the profitability ratios, in order to select a few ratios which can possibly give maximum information about the profitability of a firm. The study also 89 admin@icmrr.org

4 indents to empirically examine whether the rates of profit in selected oil refineries in India have a tendency to rise or fall over a long period of ten years from to Selection of Oil Refinery Industry Indian refining industry has done exceedingly well in establishing itself as a major player globally. India is emerging as a refinery hub and refining capacity exceeds the demand. The last decade has seen a tremendous growth in the refining sector. Petroleum Refining Industry is a generator of fuel required for energy purposes in all sorts of industry. Hence, this industry can be regarded as the heart of economy. It is a source of energy for domestic, industrial, agricultural and transport services and as feed stock for fertilizer, chemical and other industries. It has also created an impetus for allied sectors such as engineering, procurement, construction firms, project management consultancy firms and other such service providers. The country s refining capacity has increased from a modest 62 Million Metric Tonnes Per Annum (MMTPA) in 1998 to MMTPA at present, comprising of 22 refineries - 17 under Public Sector, 3 under private sector and 2 in Joint Venture (JV). The petroleum sector in India is particularly favorable to foreign investment because the industry is one of the fastest growing segments, and it has shown a staggering growth rate of around 13 per cent in the recent past. The refining capacity is not only sufficient for domestic consumption but leaving a substantial surplus also for export of petroleum products. Since , India is a net exporter of petroleum products. During , the country has exported 60.5 MMT of Petroleum products worth US Dollars 58.2 billion. As per Platts assessment, India is the largest exporter of petroleum products in Asia since August The expansion of Indian petroleum retail market is triggered by the growth in automobile sales that has resulted in major foreign investments. The growth is estimated to sustain and the market is likely to expand further by 20 million every year till 2030, placing India at the world map in terms of being the biggest automobile market. This has encouraged the researcher to analyze the Profitability and Productivity Performance of Oil Refinery Industry in India. Sampling Design Keeping in view of the scope of the study, the oil refineries operating in India were considered for the study. It was decided to include all the companies working in India under public sector from the year However, owing to several constraints such as non-availability of financial statements or non-working of the company in a particular year, merger with other companies, not listed in stock exchanges etc., it was decided to restrict the number of sample companies to five public sector refineries in India. The selected companies includes in the present study are: Indian Oil Corporation Ltd(IOCL), Bharat Petroleum Corporation Ltd(BPCL), Hindustan Petroleum Corporation Ltd(HPCL), Mangalore Refinery and Petrochemicals Ltd(MRPL) and Chennai Petroleum Corporation Ltd (CPCL). The period from to is selected for the study of selected Indian oil refineries. This 10 year period is chosen in order to have a fairly long, cyclically well balanced period, for which reasonably homogeneous, reliable and up-to-date data would be available. Source of Data The study is mainly based on secondary data. The data analyzed and interpreted in this study related to all the selected companies are collected from Capitaline and PROWESS databases, which are the most reliable on the empowered corporate database of Bombay Stock Exchange and Centre for Monitoring Indian Economy (CMIE) respectively. Besides Capitaline and PROWESS databases, relevant secondary data have also been collected from BSE Stock Exchange Official Directory, CMIE Publications, Annual Survey of Industry, Business Newspapers, Reports on 90 admin@icmrr.org

5 Currency and Finance, Libraries of various research institutions and the Internet. As the study required a variety of data, various websites have been comprehensively searched. ASSESSMENT OF FINANCIAL HEALTH The Z scores with respect to the selected oil refineries have been computed and presented in the following pages. It is imperative from the analysis that the Z scores for the oil refineries in India are more than 3.00 during the entire study period. It may be attributed to the positive changes in the net operating profit from the increased sales volume and market capitalization of the equity, maintaining sufficient working capital and effective utilization of capacity. BHARAT PETROLEUM CORPORATION LIMITED Table 2 - Z Score Table of BPCL Table 2 depicts the Z scores of Bharat Petroleum Corporation Ltd for the period from to From Table 1 it is clear that the Z score of Bharat Petroleum Corporation Ltd witnessed very good financial health as the scores obtained are more than 3.0 during the entire period of study. The Z score of Bharat Petroleum Corporation Ltd ranged from 4.58 in to 3.11 in Maximum utilization of the available capacity and avoidance of excess working capital helps to improve the operating profit and the sales have been achieved according to the target and all these helped to keep the company financially fit. CHENNAI PETROLEUM CORPORATION Table3 Z Score Table of CPCL admin@icmrr.org

6 Table 3 displays Z scores of Chennai petroleum Corporation Ltd for the period from to The Z scores of Chennai Petroleum Corporation Ltd are more than 3.0 during the entire period of study except in the first year of the study. In the year the Z score value of CPCL was 2.69 afterwards it has its financial health too healthy zone in the rest of the study period. The lower Z score 2.69 was found in and higher Z score value (5.33) registered in the year It may be inferred from the table that the company after enjoying sound financial health at the initial phase and during mid way, a sharp decline was faced at the end of the study period. It is evident from the table that the Z scores of Chennai Petroleum Corporation Ltd witnessed the very good financial health during the study period as the scores lie between 3.33 and 5.33 except the year It may be attributed to the positive changes in the net operating profit from the increased sales volume, market capitalization of the equity, maintaining sufficient working capital and effective utilization of capacity. HINDUSTAN PETROLEUM CORPORATION LIMITED Table: 4 Z Score Table of HPCL The table 4 exhibits the Z score of Hindustan Petroleum Corporation Ltd from the year to Throughout the study period the Z score of HPCL was above 3 except in the year 2010 and it denotes the financial strength of the company was in a too healthy zone except in the year The Z scores ranged from 2.94 in the year to 4.82 in the year From the year it showed a declining trend till the year and it was reached minimum Z score value After that it had a gradual improvement in the financial health of the company. In the first year of the study it was 4.72 and it denotes the financial strength of the company was in too healthy zone. It was continued almost all the years of the study period except the year It was attributed by the decreased sales on total assets. The remaining years of the study period the company was in too healthy zone in the financial strength admin@icmrr.org

7 INDIAN OIL CORPORATION LIMITED Table: 5 Z Score Table of IOCL Table 5 reveals the financial health of Indian Oil Corporation for the period from to It is evident from the table that the Z scores of IOCL witnessed a good financial strength during the first phase of the study period and normal financial health during the last phase of the study as the scores obtained in the range of 2.74 to The company remained in the healthy zone from to The highest score obtained was 3.61 in and the lowest score was 2.74 in It has shown improvement in the financial soundness at the tail end of second phase of the study period. This improvement may be attributed to the positive changes in the net operating profit from the increased sales volume. MANGALORE REFINERY AND PETROCHEMICALS LTD Table: 6 Z - score Table of MRPL The table 6 depicts the Z score value of Mangalore Refinery and Petrochemicals Ltd during the study period. It is noticed from the table that, the first year of the study the financial health of the company was in a healthy zone because the Z score was In the year , the financial health suddenly improved to 4.08 and entered into the too healthy zone. Thereafter it showed an increasing trend till the year and the firm was maintained the Z score above 5.0. In the last phase of the study the Z score of Mangalore Refinery and Petrochemicals Ltd showed decreasing trend from the year The financial health of the Mangalore Refinery and Petrochemicals Ltd come down to 93 admin@icmrr.org

8 healthy zone with the Z score value of 2.83 in the year and again it comes down to 2.63 in the last year of the study but the financial health was retained to healthy zone. Financial Health of Selected Petroleum Refineries Table : 6 Financial Health (Z score) Year BPCL CPCL HPCL IOCL MRPL Average SD Average SD The table 7 depicts that, the overall Z score of all the selected companies recorded their average more than 3 and it represents that, they are in too healthy zone during the study period. The CPCL registered high average (4.11), followed by MRPL(3.99), BPCL(3.85), HPCL(3.77) and IOCL(3.11). The standard deviation of all the selected petroleum refineries shows that there was a minimal variation in the Z score in the study period with its average. The average Z score of the select companies was above 3 during the study period. It is clear from the above table that all the selected companies were in too healthy zone during the study period. Conclusion The assessment of financial health of Indian oil refineries has been made by using Altman s Z score. The analysis shows that the financial health of oil refineries in India during the study period was lying in too healthy zone. It may be attributed to the positive changes in the effective utilization of fixed assets to increase the sales volume resulting in the increase of net operating profit and market capitalization of the equity, maintaining sufficient working capital and effective utilization of opportunities to maximize the profit earning capacity of the organization. References: 1. Mansur A. Mulla, (2002). Use of 'Z score analysis for evaluation of financial health of textile mills - A case study, Abhigyan, XIX(4) : Selvam,M,Vanitha.S.andBabu.M(2004). A Study on Financial Health of Cement Industry Z Score Analysis, The Management Accountant, 3(2): V.Dheenadhyalan (2008). Financial Health of Steel Authority of India Limited: A Z-score Approach, Indian Journal of Accounting, XXXVI(I) : admin@icmrr.org

9 4. Srinivasan and Tiripura sundari(2011). Dimension of financial performance of cement units in south India - an empirical study (Z score analysis), International Journal of research in Commerce & Management, 2(7) : Maheswara Reddy and Reddy(2011). Application of z score analysis in evaluating the financial health of pharmaceutical companies- a case study, International Journal of research in Commerce & Management, 2(5): Vijayakumar, A.,(2012), Use of Altman Bankruptcy Model to Analyse the performance of Indian Automobile Companies, College Sadhana, 4(2); Vijayakumar, A. and P.Gomathi(2012), Use of Altman Bankruptcy Model to Analyze the performance of Public sector refineries in India during the post liberalization period, International Journal of Research In Commerce, Economics & Management, volume No. 3 (2013), Issue No. 03 (March), admin@icmrr.org