Keywords: NBFC, Solvency, Current ratio, Liquid ratio, Debt equity ratio and Proprietary ratio

Transcription

1 Solvency Analysis of Non Banking Financial Companies in Tamilnadu Dr. D. VENKADESH, M.Com., M.B.A., M.Phil., PGDCA., Ph.D., Assistant Professor & Research Advisor PG & Research Department of Commerce A.V.V.M. Sri Pushpam College (Autonomous), Poondi Thanjavur, Tamil Nadu, India. Mobile: Abstract: In recent times, non-banking financial companies (NBFCs) have emerged as substantial contributors to the Indian economic growth by supplementing the efforts of bank and other development financial institutions. NBFCs play a key role in the direction of savings and investments. On the basis of their legal status and their principal activities, the NBFCs have been classified as Loan Company, Hire purchase finance company, Equipment leasing company, Investment Company and Residuary non-banking company. The scope of the NBFCs is fast growing with the multiplication of financial services. Some of the NBFCs are also engaging in underwriting through subsidiary units, and by offering allied financial services including stock broking, investment banking, asset management and portfolio management. In this paper discussed to appraise the solvency of selected NBFCs. Solvency is a vital indicator of economic performance of an economic system. In fact, it is a mechanism for improving the material quality of life. Solvency is fundamental to progress throughout the world. It is at the heart of economic growth and development, improvements in standards of living and quality of life. In this paper mainly focused on branch productivity and employee productivity of selected NBFCs. Keywords: NBFC, Solvency, Current ratio, Liquid ratio, Debt equity ratio and Proprietary ratio 1. INTRODUCTION Non-banking financial company is a company registered under the Companies Act, 1956 and is engaged in the business of loans and advances, acquisition of shares, stock, bonds, debentures or securities issued by government or local authority or other securities of like marketable nature, leasing, hire-purchase, insurance business, chit business but does not include any institution whose principal business is that of agriculture activity, industrial activity, sale/purchase/construction of immovable property. A non-banking institution which is a company and which has its principal business of receiving deposits under any scheme or arrangement or any other manner, or lending in any manner is also a non-banking financial company. The term solvency refers to the ability of a concern to meet its financial obligations. In finance or business, it is the degree to which the current assets of an individual or entity exceeds the current liabilities of that individual or entity.1 Solvency ratios include all ratios which highlight upon the financial position of the concern. But the financial position may mean differently to different persons interested in the business concern. Management, banker, trade creditors, investor and auditor all have different views about the concept of the financial position. Thus, each person keeping into account his own interest uses such ratios which may enlighten him about the financial position of the concern. Solvency can also be described as the ability of a corporation to meet its long-term fixed expenses and to accomplish long-term expansion and growth.2 generally, the examination of financial position involves the analysis of facts relating to proper and judicious use of funds, short-term and long-term solvency of the concern, safety of the interest of shareholders, etc. This is best measured by using the NLB formula. In this formula solvency is calculated by adding cash and cash equivalents to short-term investments, then subtracting notes payable.3 2. STATEMENT OF THE PROBLEM The following as the common problems faced by NBFCs. i. Stiff competition among NBFCs as well as with banking sector; ii. Small balance sheet size resulting in high cost of funds and low asset profile; iii. Prudential norms, especially, non-performing assets; iv. Inadequate expertise in asset and liability management; v. Lack of experience in lending and recoveries; and vi. The interest rates charged by NBFCs for financial assistance are higher than those charged by commercial banks and other organized financial institutions. The problems are common to all NBFCs. Still, there are some NBFCs which are thriving well and keep on progressing. They develop their performance making appreciable improvements in all parameters of business, such as, deposit mobilization, credit deployment, income generation, control of expenses, low level of NPA, capital adequacy ratio, comfortable liquidity, etc. There are also some NBFCs which are straggling a lot to make progress. Hence it is attempted in this study to analyze the solvency performance of sample NBFCs in detail, applying systematic analytical approach and find out the valid 95

2 causes in order to bring out possible remedial measures, so that NBFCs can prepare themselves to solve the problems and to make continuous progress. 3. OBJECTIVES OF THE STUDY The study covering a period of ten years from to has the following objectives: 1. To analyze the short term solvency of the selected NBFCs; and 2. To appraise the long term solvency of the selected NBFCs 4. METHODOLOGY Survey method has been followed for this study. Secondary information has been collected through various sources. Data collected from secondary sources includes annual reports of selected NBFCs, RBI reports and leading journals in the field of commerce and management and related websites. In the course of the analysis in this study, the use of various accounting and statistical techniques has been made. Ratio analysis, mean, standard deviation, coefficient variation and ANOVA test have been applied. 4.1 Sampling Stratified random sampling method has been followed for this study. The registered NBFCs with RBI stratified into NBFCs which accept deposits and NBFCs which do not accept deposits. Two companies from accepting deposits category and two companies from not accepting deposits category were selected for this study using the above sampling method. Thus four companies are considered, they are Sundaram Finance Limited (SFL), Sriram City Union Finance Limited (SRFL), Cholamandalam Investment and Finance Company Limited (CFL) and Darani Finance Limited (DFL). First two companies have been registered with RBI under accepting deposits category and other two companies have been registered with RBI under not accepting deposits category. 4.2 Solvency of NBFCs Solvency of the selected NBFCs is analyzed in this paper in two sections viz., short term solvency and long term solvency. 4.3 Short-term Solvency The short-term creditors of a company, like suppliers of goods on credit and commercial banks providing short-term loans, are primarily interested in knowing the company s ability to meet its current or short-term obligations as and when these become due. The short-term obligations of a firm can be met only when there are sufficient liquid assets. Therefore, a firm must ensure that it does not suffer from lack of liquidity or the capacity to pay current obligations. If a firm fails to meet such current obligations due to lack of good liquidity position, its goodwill in the market is likely to be affected beyond repair. It will result in a loss of creditor s confidence in the firm and may cause even closure of the firm. Even a very high degree of liquidity is not good for a firm because such a situation represents unnecessarily excessive funds of the firm being tied-up in current assets. Therefore, it is very important to have a proper balance in regard to the liquidity of the firm. Short-term solvency is also called as liquidity. According to Herbert Mayo, Liquidity is the ease with which assets may be converted into cash without loss.4 the short-term obligations are met by realizing amounts from current, floating or circulating assets. The current assets should either be liquid or near liquidity. These should be convertible into cash for paying obligations of short-term nature. The sufficiency or insufficiency of current assets should be assessed by comparing them with short-term liabilities. If current assets can pay off current liabilities, then liquidity position will be satisfactory. On the other hand, if current liabilities may not be easily met out of current assets then liquidity position will be bad. The bankers, suppliers of goods and other short-term creditors are interested in the liquidity of the concern. They will extend credit only if they are sure that current assets are enough to pay out the obligations. To measure the liquidity of a firm, the following ratios can be calculated: 1. Current ratio and 4.4 Current ratio 2. Liquid ratio This ratio is also called as working capital ratio. It is used to assess the short-term financial position of the business concern. In other words, it is an indicator of the company s ability to meet its short-term obligations. It matches the total current assets of the company against its current liabilities. The analyst with the help of this ratio can review the extent to which the company can cover such liabilities with current assets. It also enlightens the adequacy of the working capital of a company and of the 96

3 company s ability to meet its day-to-day payment obligations. It, further, measures the margin of safety provided for paying current debts in the event of a reduction in the value of current asset.5 It is calculated on the basis of the following formula: Current assets Current ratio = Current liabilities A relatively high current ratio is an indication that the firm is liquid and has the ability to pay its current obligations in time as and when they become due. On the other hand, a relatively low current ratio represents that the liquidity position of the firm is not good and the firm shall not be able to pay its current liabilities in time without facing difficulties. An increase in the current ratio represents improvement in the liquidity position of a firm while a decrease in the current ratio indicates that there has been deterioration in the liquidity position of the firm. As a convention the minimum of two to one ratio is referred to as a banker s rule of thumb or arbitrary standard of liquidity for a firm. In other words of Walker and Boughn, A good current ratio may mean a good umbrella for creditors against rainy day, but to the management it reflects bad financial planning or presence of ideal assets or over-capitalization.6 A ratio equal or near to the rule of thumb of 2:1 i.e., current assets double the current liabilities is to provide for delays and losses in the realization of current assets. However, the rule of 2:1 should not be blindly followed while making interpretation of the ratio. Because firms having less than 2:1 ratio may be having better liquidity than even firms having more than 2:1 ratio. This is so because the current ratio measures only the quantity of current assets and not quality of current assets. Table 1 provides the data related to current ratios calculated for the sample NBFCs taken for the study. These ratios are calculated for ten consecutive years from to The following are the inferences derived from the analysis and interpretation of the data provided in the table-1. TABLE 1 CURRENT RATIO (In Times) Year SFL SRFL CFL DFL MEAN SD CV (%) Source: Compiled from annual reports of the NBFCs TABLE 1A ANOVA of Current Ratio Source of Variation Sum of Squares Degrees of Freedom Mean Square F 97

4 Between Groups Within Groups Total The current ratio of SFL in higher than that of SRFL throughout the decade. The growth rate of current assets in SFL in nominal, whereas that of SRFL is at a faster rate. Both SFL and SRFL have higher level of current ratio during 9 out of 10 years and have shown their respective lowest ratio in These two NBFCs can maintain the current ratios of in future to exhibit an optimum level of liquidity. In case of DFL, the performance both in current assets and current liabilities have shown neither increase nor decrease throughout the decade. Both current assets and current liabilities of DFL show frequent ups and downs. But the current ratios of both CFL and DFL have shown a sharp increase in and Both CFL and DFL have optimum level of current ratio during the 8 out of 10 years and it has gone up in and Both these NBFCs can reduce their current ratio around 2.00 to have an optimum level of liquidity position. ANOVA Hypothesis: There is not any significant difference in Current Ratios of NBFCs under study. Alternative Hypothesis: There is a significant difference in Current Ratios of NBFCs under study The table value of F for degree of freedom 39 at 5 per cent level of significance is Since the calculated value of F (9.80) is greater than table value, the null hypothesis is rejected and alternative hypothesis is accepted. It is concluded that there is a significant difference in the current ratio of NBFCs under study. Liquid ratio Liquid ratio is known as quick or acid test ratio. It is a more rigorous test of liquidity than the current ratio. The two determinants of current ratio, as a measure of liquidity, are current assets and current liabilities. Current assets include inventories and prepaid expenses which are not easily convertible into cash within a short period. Quick ratio may be defined as the relationship between quick/liquid assets and current liabilities. An asset is said to be liquid if it can be converted into cash within a short period without loss of value. In that sense, cash in hand and cash at bank are the most liquid assets. The other assets which can be included in the liquid assets are bills receivable, sundry debtors, marketable securities and short-term or temporary investments. Inventories cannot be termed to be liquid asset because they cannot be converted into cash immediately without a sufficient loss of value. This ratio expressed in formula is: Liquid assets Liquid ratio = Current liabilities Usually, a high quick ratio is an indication that the firm is liquid and has the ability to meet its current or liquid liabilities in time and on the other hand a low quick ratio represents that the firm s liquidity position is not good. As a rule of thumb or as a convention quick ratio of 1:1 is considered satisfactory. It is generally thought that if quick assets are equal to current liabilities then the concern may be able to meet its short-term obligations. Although quick ratio is a more rigorous test of liquidity than the current ratio, yet it should be used cautiously and 1:1 rule should not be used blindly. A quick ratio of 1:1 does not necessarily mean satisfactory. In the same manner, a low quick ratio does not necessarily mean a bad liquidity position as inventories are not absolutely non-liquid. Hence, a firm having a high quick ratio may not have a satisfactory liquidity position if it has slow-paying debtors. On the other hand, a firm having a low quick ratio may have a good liquidity position if it has fast moving inventories. Table 2 gives the arranged data regarding the annual liquid ratios duly calculated for the four NBFCs taken as samples for the study. The following are the interpretation results derived from the data provided in the table 2. TABLE 2 LIQUID RATIO (In Times) Year SFL SRFL CFL DFL

5 MEAN SD CV (%) Source: Compiled from annual reports of the NBFCs TABLE 2A ANOVA of Liquid Ratio Source of Variation Sum of Squares Degrees of Freedom Mean Square F Between Groups Within Groups Total The liquid ratio of SRFL is better as it could have the ratio at more than 1.00 in the second half of the decade, except But in case of SFL, the liquid ratio is less than 1.00 throughout the decade. Both SFL and SRFL have the decade s lowest level of liquid ratio in , which causes concern and it infers that these two NBFCs have not been doing a planned business operations. Therefore SFL and SRFL must make appropriate adjustments in the maintenance of liquid assets and current liabilities so as to ensure the liquid ratio around DFL, being small in size and operations, cannot be compared to CFL, a fairly big NBFC in its business and operations. The business of DFL is very limited and easily manageable. Therefore the liquid ratio of DFL is above 1.00 in five out of 10 years of the decade. In case of CFL, the liquid ratio is dismal in many years of the decade, i.e., the liquid ratio of CFL is less than the mean of 0.27 in 7 out of 10 years of the decade. CFL must make improvement in the liquid ratio making appropriate adjustments in its assets and liabilities. A proper management of assets and liabilities, in order to maintain optimum level of operating results, is essential for CFL and DFL. ANOVA Hypothesis: There is not any significant difference in Liquid Ratio of NBFCs under study. Alternative Hypothesis: There is significant difference in Liquid Ratio of NBFCs under study. The table value of F for degree of freedom 39 at 5 per cent level of significance is Since the calculated value of F (8.05) is less than table value, the null hypothesis is accepted. It is concluded that the liquid ratio does not differ significantly for the NBFCs under study. Long-term Solvency The long-term indebtedness of a firm includes debenture holders, financial institutions providing medium and long-term loans and other creditors selling goods on installment basis. The long-term creditors of a firm are primarily interested in knowing the firm s ability to pay regularly interest on long-term borrowings, repayment of the principal amount at the maturity and the 99

6 security of their loans. Accordingly, long-term solvency ratios indicate a firm s ability to meet the future interest and costs and repayment schedules associated with its long-term borrowings. The following ratios serve the purpose of determining the long-term solvency of the concern: 1. Debt-equity ratio, Debt-equity ratio 2. Proprietary ratio The financing of total assets of a business concern is done by owner s equity (also known as internal equity) as well as outside debts (known as external equity). How much fund has been provided by outsiders in the acquisition of total assets is a very significant factor that affect the long-term solvency position of a concern. This ratio is calculated in various ways. One view is to calculate the debt-equity ratio as long-term debts (non-current liabilities) divided by the shareholders equity. 7 In other words, the relationship between borrowed funds and owners capital is a popular measure of the long-term financial solvency of a firm. This relationship is shown by the debt-equity ratio. This ratio indicates the relative proportions of debts and equity in financing the assets of a firm. It may be calculated as follows: Debt or Outsiders funds Debt-equity ratio = Equity or Proprietor s funds or Net worth The debt-equity ratio is calculated to measure the extent to which debt financing has been used in a business. The ratio indicates the proportionate claims of owners and the outsiders against the firm s assets. The purpose is to get an idea of the cushion available to outsiders on the liquidation of the firm. As a general rule, there should be an appropriate mix of owners funds and outsiders funds in financing the firms assets. However, the owners want to do the business with the maximum of outsider s funds in order to take lesser risk of their investment and to increase their earnings (per share) by paying a lower rate of interest to outsiders. The outsiders (creditors), on the other hand, want that shareholders (owners) should invest and risk their share of proportionate investments. An ideal norm of the ratio is 100 per cent, i.e., 1:1. However, this ratio differs from industry to industry. According to the guidelines issued by the finance ministry to financial institutions. The debt equity ratio in the case of projects entailing an investment of less than Rs.5 crores will be in the range of 1:1 and 1.5:1. In the case of project whose investment ranges between Rs.5 crores and 10 crores, the ratio will be in the range of 1.5:1 to 2:1. Similarly where the investment on the project exceeds Rs.10 crores which is considered capital intensive, the debt-equity ratio will be 2:1 or more. 8 Table 3 provides the data regarding the debt-equity ratio duly calculated year wise for the four NBFCs. The following are the inferences derived from the analysis of the data provided in the table 3. TABLE 3 DEBT EQUITY RATIO (In Times) Year SFL SRFL CFL DFL

7 MEAN SD CV (%) Source: Compiled from annual reports of the NBFCs TABLE 3A ANVOA of Debt Equity Ratio Source of Variation Sum of Squares Degrees of Freedom Mean Square F Between Groups Within Groups Total SFL and SRFL do good business throughout the decade of study. In case of SFL, both debt and equity have shown proportionate growth throughout the decade and hence the debt equity ratios of the decade do not vary widely, i.e., the annual debt equity ratios are around the mean only. In case of SRFL, the growth rate of equity exceeds that of debt during the period of 10 years. As a result the debt equity ratios of SRFL have shown wide variations from the mean ratio. Both SFL and SRFL raise their debt level on an average of around 5 times that of their respective equity. Another inference derived is that the growth of SFL is steady with a moderate annual increase, while the growth of SRFL is at a faster rate both in case of debt and equity during the decade. In case of debt equity ratio, CFL and DFL cannot be compared. DFL, being a small size NBFC, its debt is not more than one or two percent of its equity and mostly it does not raise debt at all. On the contrary, CFL, being a well-established NBFC, its debt level is around 6 times of its equity. As a growing NBFC, CFL is very vibrant in which both debt and equity register continuous growth throughout the years of the decade. DFL maintains its equity almost at a constant level throughout the period of study. As the debt is negligent in DFL, its solvency position is highly sound. In case of CFL, the growth trend both in debt and equity with a moderate debt equity ratio exhibit an acceptable solvency position. ANOVA Hypothesis: There is not any significant difference in Debt Equity Ratio of NBFCs under study. Alternative Hypothesis: There is significant difference in Debt Equity Ratio of NBFCs under study. The table value of F for degree of freedom 39 at 5 per cent level of significance is Since the calculated value of F (64.03) is greater than table value, the null hypothesis is rejected and alternative hypothesis is accepted. It is concluded that there is a significant difference in the Debt equity ratio of NBFCs under study. Proprietary ratio This ratio compares the shareholders funds or owner s funds and total tangible assets. In other words, this ratio expresses the relationship between the proprietor s funds and the total tangible assets. Choudhary observes this ratio brings out the extent of shareholders funds in relation to the total funds employed.9 This ratio expressed in formula is, Proprietor s Funds Proprietary ratio = Total Tangible Assets This ratio is very useful to determine the long-term solvency of the company. It is of particular importance to the creditors who can ascertain the proportion of shareholders funds in the total assets employed in the company. A high ratio shows that there is safety for creditors of all types. A ratio below 50% may be alarming for the creditors since they may have to lose heavily in the event of company s liquidation as it indicates more of creditors funds and less of shareholder funds in the total assets of the company. Table 4 contains the data related to the Proprietary ratio duly calculated for the 4 NBFCs. The ratios so calculated for 10 years have been arranged in the table to facilitate an effective analysis. The following are the inferences derived from the analysis of the ratio figures given in the table 4. TABLE 4 101

8 PROPRIETARY RATIO (In Times) Year SFL SRFL CFL DFL MEAN SD CV (%) Source: Compiled from annual reports of the NBFCs TABLE 4A ANVOA of Proprietary Ratio Source of Variation Sum of Squares Degrees of Freedom Mean Square F Between Groups Within Groups Total The mean of the proprietor s funds to assets ratio of SFL and SRFL are almost same as they are 0.14 and 0.13 respectively. This shows clearly that SFL and SRFL do good business improvement utilizing the borrowed funds including the deposits which is around 86 per cent and 87 per cent of their respective total assets. From the analysis of the data, the growth of both total assets and proprietor s funds is faster in SRFL than that of SFL during the decade of study. Both these NBFCs have similar solvency position. Both these NBFCs are expected to have an effective ALM as they mainly do their business with borrowed funds. CFL s management is similar to that of SFL and SRFL, though it is not taking deposits from the public. Therefore CFL must also have an effective ALM to safeguard its solvency position. In case of DFL, solvency ratio is high as it is doing its business mainly with its own funds. ANOVA Hypothesis: There is not any significant difference in Proprietary Ratio of NBFCs under study. Alternative Hypothesis: There is significant difference in Proprietary Ratio of NBFCs under study. The table value of F for degree of freedom 39 at 5 per cent level of significance is Since the calculated value of F (103) is greater than table value, the null hypothesis is rejected and alternative hypothesis is accepted. It is concluded that there is a significant difference in the Proprietary ratio of NBFCs under study. 102

9 5. CONCLUSION The analysis of solvency reveal a fact that the sample NBFCs do their business taking high risk, namely, (a) holding very low percentage of total assets as their owned funds, (b) high debt-equity ratio, i.e., more dependence on borrowed funds and (c) holding more current assets with low percentage of liquid assets with reference to current liabilities. Profit making is in direct proportion to risk taking. Thus, these NBFCs take more risk to earn more profits. However, the performance of these NBFCs proves that they have comfortable solvency, as they manage the risks applying their expertise in Asset-Liability Management. Analysis of the cash flow statements of the sample NBFCs reveals that these NBFCs have enough cash generation capacity. However, these NBFCs need to improve their cash management, as they have wide fluctuations in maintaining cash balances. The overall inference derived from this chapter is that the selected NBFCs are capable of ensuring their solvency position both in short and long run. References: [1]. Anil B. Roy Choudhary (1970), Analysis and Interpretation of Financial Statements through Financial Ratios, Orient Longmans, New Delhi, pp [2]. Gaist, Paul A (2009), Igniting the Power of Community: The Role of CBOs and NGOs in Global Public Health, Springer, p. 34. [3]. Herbert Mayo (1968), Basic Finance- An Introduction to Money and Financial Management, McGraw Hill, New York, p [4]. H.G. Guthmann (1976), Analysis of Financial Management, Prentice Hall of India, New Delhi, p.63. [5]. I.M. Pandey (1984), Financial Management, Vani Educational Books, New Delhi, p.508. [6]. Walker and Boughn (1974), Financial Planning Policy, Harper International, p [7]. R.P. Sharma (1988), Corporate Financial Structure, Printwell Publishers, Jaipur, p.130. [8]. Zietlow, John T; Seidner, Alan G (2007), Cash & investment management for nonprofit organizations. John Wiley and Sons, p