International Journal of of Financial Management Research Research and Development and (IJFMRD), ISSN

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1 IJFMRD International Journal of of Financial Management Research Research and Development and (IJFMRD), ISSN Development (Print) ISSN 2248 (IJFMRD), 9339 (Online), ISSN 2248 Volume , Number (Print) 1, January - April (2011) ISSN (Online), Volume 1, Number 1 January - April (2011), pp PRJ PUBLICATION PRJ Publication, CORPORATE SHORT TERM SOLVENCY ANALYSIS: A CASE STUDY ON NEYVELI LIGNITE CORPORATION LIMITED, NEYVELI A. Govindarajan, Research Scholar, Sathyabama University, Chennai-119 Dr. R. Thamilselvan, Research Supervisor, Sathyabama University, Chennai-119 ABSTRACT The current paper aims to study and assess the Short term solvency position of Neyveli Lignite Corporation Ltd.(NLC). Considering NLC as a sample among public sector under taking giving maximum contribution of power generation to Tamil Nadu and other southern states. NLC is a PSU which generates power from lignite and it was graded as mini rathana then and now attained the status as one of the navarathans of India. The study was made by extracting data for a period of 10 Years from 31 st March 2001 to 2010 from the published financial statements of the company. Various Short term solvency ratios and statistical tools were applied to test the Short term solvency position of NLC. From the analysis the PSU under study has been maintaining the short term solvency position so as to have a favorable impact on banckruptcy. Key Words: Short term solvency, solvency, stability, financial crunch, saturation. INTRODUCTION Solvency ratio measured in short term is known as liquidity and in the long term is known as stability Short term solvency is maintaining the current asset and current Liability and it is an important task to every company. For the analysis, a known public sector under taking Neyveli Lignite Corporation Ltd (NLC Ltd) was taken for study.. NLC Ltd among other public sector under taking gives maximum contribution of Power generated to Tamil Nadu and other southern states. It is referred as Nava Rathana under Government of India. The Short term solvency position of NLC Ltd is analysed as under. OBJECTIVES OF THE STUDY The study has been carried out to fulfill the following objectives. i) To analyse over all Short term solvency position of NLC Ltd using appropriate ratios. 61

2 ii) iii) iv) METHODOLOGY To compare and analyse the percentage spread of various constituents of current assets. To test statistically the degree of association between various constituents of current assets and Short term solvency percentage. To examine the level of Bankruptcy condition of the company under study. The present study is carried out on the basis of the objectives under three categories as 1. Short term solvency Ratios 2. Measurement of relationship between current asset and Short term solvency. 3. Measure on level of Bankruptcy. Short term solvency ratios that are carried out are Current ratio, Quick ratio, Cash ratio and advance ratio. The ratios gives precise measurement on NLC ltd s ability to meet its current obligations. The second Part deals with the measurement of relationship between the selected variables. If it is said that the level of current assets play a dominant role in maintaining sound Short term solvency policy, then there is a strong bond that exists between each and every constituents of current assets and Short term solvency. Hence this part has been constituted to measure the degree of association between various components of current assets and Short term solvency position of NLC and the influence of the former on the later. For the purpose, some of the current asset components taken into consideration are given as follow : Inventories = Inventories / TCA X 100 Debtors = Debtors / TCA X 100 Cash and Bank Balance(CBB) = CBB/ TCA X 100 Other current asset(oca) = OCA/ TCA X 100 Loans and Advances (L&A) = L & A / TCA X 100 TCA = Total Current assets as per Balance sheet The Short term solvency position of the NLC has been computed by appropriating Total Current Assets (TCA) with Total assets(ta) of the NLC. Short term solvency(%) = TCA/ TA X 100 Statistical tools like spearman s rank correlation and students t test have been employed to test the degree of association and influence of various current assets on Short term solvency with the following hypothesis Ho: There is no significant correlation between current assets constituents and Short term solvency. H1 : There is significant correlation between current assets constituents and Short term solvency. In this respect the Short term solvency position of NLC is measured by the ratio between Current Assets and Total Assets expressed in percentage whereas Bankruptcy condition is measured by Altman Z Score. The period of study related to NLC Ltd is from 31 st March 2001 to 31 st March DISCUSSION AND RESULTS Short term solvency Ratios that measure the ability of NLC to meet its current obligation is shown in Table 1 62

3 Table : 1 Short term solvency Ratios Ratio analysis CR QR CASR AR Sources: annual reports from 2001 to 2010 As a conventional rule, a current ratio of 2 to1 or more is considered satisfactory. The NLC is maintaining the ratio so it is interpreted as having enough Short term solvency. Generally a quick ratio of 1 to 1 is considered satisfactory in this respect also NLC is performing better by marinating better Short term solvency. The cash and bank balance ratio and Loans & Advances ratio also plays a good role. But considering overall performance current ratio, quick ratio and cash& bank balance ratio show a decreasing trend and Advances ratio tends to be fluctuating over the years. Measurement of Relationship between constituents of Current assets and Short term solvency: If Short term solvency management deals with maintaining optimum level of current assets of a firm to meet its current obligation, then it is implied that the level of current assets affects the firms Short term solvency. Table 2 shows the statement of ranking of various constituents of current assets and Short term solvency of NLC Table: 2 Ranking of liquid assets of NLCLtd. I/CA Rank DB/CA Rank CBB/CA Rank OCA/CA Rank L &A/CA Rank CA/TA Rank To measure the degree of association between various constituents of current asset and Short term solvency of NLC ltd. Spearmans correlation co-efficient has been employed and to examine whether the computed value of such correlation coefficient is significant or not students t test has been applied as shown in table. 3 63

4 Table 3. Rank correlation analysis between various constituents of current asset and Short term solvency and student t test of NLC ltd RANK DIFFERENCE YEAR SHORT TERM SOLVENCY (1) INVENTORY (2) DEBTORS (3) CBB (4) OCA (5) L&A (6) 2-1 (a) 3-1 (b) (d) 6-1 (e) D 2 a 2 b 2 c 2 d 2 e TOTAL Applying Edward Spearmans formula the rank correlation(r) between various constituents of current asset and Short term solvency is presented in Table 4 Table 4: Edward Spearman s Formula SL.NO CONSTITUENTS OF CURRENT ASSETS RANK CORRELATION 1 Inventories 2 Debtors 3 Cash 4 OCA 5 L & A

5 s Short term solvency inventory Debtors CBB OCA L & A Spearman's rho Short term solvency * Sig. (2-tailed) inventory * * Sig. (2-tailed) Debtors ** Sig. (2-tailed) CBB * ** Sig. (2-tailed) OCA Sig. (2-tailed) L & A Sig. (2-tailed) *. is significant at the 0.05 level (2-tailed). **. is significant at the 0.01 level (2-tailed). Observed value of t which is calculated by Mod of r n (n-2) (1-r n ) for various constituents are given 65

6 S.LO Factors t value 1 Inventory Debtors Cash and Bank Balances Other current Assets Loans and Advances Critical value of t at 5% Level of significance with (n-2) i.e.. 3 degree of freedom = The result shows that the rank correlation co-efficient of the NLC was statistically significant at 5% level of significance because the observed level of t is more than the critical value of t (3.182) leading to rejection of null hypothesis. It indicates that although with a degree of association between selected variables of NLC ltd, factors like inventory, Debtors, OCA and L&A are negatively correlated whereas Cash and bank balance is Positively correlated. There is a strong association with respect to short term solvency between inventory, cash and bank balance at the same time Debtors,other current asset, Loans and Advances shows a low level of association with Short term solvency. Prediction of Bankruptcy: There are multiple number of ratios. The Altman Z Score takes into account few required ratios of balance sheet and trading and profit and loss account, and combined them into a unique formula. Z score has different formula to judge Public manufacturer, Private manufacturer and Private general firm. Now we will consider z-score for a Public Sector Manufacturer the frame work of Z score for such companies is Z = 1.2 Ratio A +1.4 Ratio B Ratio C Ratio D + Ratio E Evaluation on the ratios: To cover the justification Whether the Z score is applicable to the appraisal of companies. Here are the valid points Ratio A - Working capital / total assets - Which measures a Short term solvency. Ratio B- Retained earnings/ Total Assets - Which a measures reinvested earnings. Ratio C- EBIT / Total Assets - Which measures the Profitability the profitability of the Company. Ratio D- Market value of Equity/ Book Value of total liability- Which measures the firms leverage. Ratio E- Sales /Total assets Which measures the sales generating ability of the firms Assets. The above formula is applicable only for public manufacturing companies. Its prediction is, when the Z Score is 3.00 and above, it indicates that bankruptcy is not likely, but a score of 1.8 or below is a strong indicator that bankruptcy is likely. Probability of bankruptcy in the above range is 95% for first one year and 70% within two years. Obviously a high score is desirable 66

7 Application of Altman Z Score on NLC Ltd Year/ Items Working capital Total Asset EBIT Market Value of Equities Total liability Retained Earning Sales Sources: annual reports from 2001 to 2010 YEAR Z.SCORE According to Altman Zscore Year 2001 and 2006 are unsafe because of huge fall in the market price of the share. All the other years they are in the gray area of bankruptcy. The variations that occur in the z score is due to increase in salary to the employees in the year 2006, limited supply of raw material to Mine II during 2006 and 2007, and due to heavy rain fall that made the government to use more of hydel power instead of thermal power. Similarly during the year due to reduction in power generation pay revision there was a considerable decrease in EBIT. YEAR CA/TA RANK Z SCORE RANK

8 s VAR00002 VAR00003 Spearman's rho VAR Sig. (2-tailed)..947 N VAR Sig. (2-tailed).947. N The co efficient of correlation between Z Score and Liquidity shows that there is no significant correlation between these two. This shows that Liquidity alone cannot plays a greater roles in making a company bankrupt. CONCLUSION From the above analysis it is very clear that the corporate under study is maintaing the solvency position. The fluctuation is mainly due to the policies of the government related to payment of dues, subsidies, pay revision aging of thermal plant which leads to reducing in power generation. The Altman z score reflects that the corporation under study is away form bankruptcy. REFERENCE 1. Hampton J.J 1979.Finacial decision making 2 nd ed. P12 2. Krishnamurthy,K., and Sastry. D.U Investment Accelerator and financial factors : an analysis of the corporate sector in India, Institute of Economics Growth, University of Delhi. 3. Krishnamurthy,K., and Sastry D.U. Dividends, external finance and investment ; an analysis of the corporate sector in India, Institute of Economics Growth, University of Delhi. 4. Neuman,A.M The Doctrine of Short term solvency, The review of Economics Studies, Vol. 111, No.2, 1936, p Peter Drucker Managing in turbulent times, p Slater, S.D The strategy of cash : A Short term solvency approach to maximizing the company s profits, Wiley. 7. C. R. Kothari Research methodology New age publication. 2 nd ed. 8. Murillo Campello, Evasmo Giambona, 2010 Management and Corporate Investment During a Financial Crisis, University of Amsterdam. 68