C h a p te r: 7. M e a s u re m e n t a n d analysis o f p r o fita b ility o f N T P C L td.

Transcription

1 C h a p te r: 7 M e a s u re m e n t a n d analysis o f p r o fita b ility o f N T P C L td.

2 7.1 P ro fit a n d p r o fita b ility Profit is the main and ultimate aim of every business. In accounting, profit is the difference between total revenue and total expenses over a period of time. It is the barometer of the success of the business. Lord Keynes remarked Profit is the engine that drives the business enterprise. If it is used in general sense then it is responsible for all economic activities in the society. The survival of a business depends upon its earning capacity. Thus, if an enterprise fails to make profit, capital invested is eroded and if this situation prolongs, the enterprise ultimately ceases to exist. In fact, profits are the soul of the business without which it is lifeless. In short, profit is the legitimate object of an enterprise in any society. It attracts funds for the enterprise from the investors. Profit is a yardstick forjudging managerial efficiency. In the present time, though profits are the legitimate object, but it would be wrong to assume that every action initiated by management of a company should be aimed at maximizing profits, irrespective of social consequences. The philosophy of the socialistic pattern of society has shifted the importance from the economic and accounting profit to the social profit or the national profit. Thus, profit becomes the essential means for reaching wider economic and social objectives. Profitability means the profit earning capability of the enterprise. It is the overall measure of efficiency. Profitability is distinguished from profit. Profit represents the absolute quantum of earning whereas the profitability refers to the ability to earn profit. According to W.M. Harper, Profitability is a relafive measure - it indicates the most profitable alternative. Profit on the other hand, is an absolute measure - it indicates the overall amount of profit earned by a transaction. Profitability is analysed through the computation of various profit ratios. In computing profit ratios, two issues are to be considered: 187

3 (i) What shall be the basis of profitability? (ii) How profitability is to be measured? The profitability can be measured on the basis of either operating profits or net profits. While computing operating profit, all non-operating incomes and expenses are excluded. On the other hand, all operating and non-operating items are taken into account at the time of measuring net profit. However, the figure of net profit may assume any of the following forms: (a) N e t p r o f i t b e f o r e i n t e r e s t a n d t a x : Interest is a share of creditors and tax is a compulsory levy on income of the concern out of the visible pool of profits. Hence, net profit before interest and tax is an index of the efficiency of management (b) N e t p r o f i t b e f o r e t a x : The taxation policy of the Government has nothing to do with the management s efficiency and so this figure, too, can form the base of profitability. (c) N e t p r o f i t a f t e r t a x : Profitability from the shareholders point of view can be analysed on this basis, because, the net profit after tax is the amount of earnings available to the shareholders. The basis of working out profitability would depend on the objective of the analyst. The measurement of profitability requires the calculations of several interconnected ratios varying according to the purpose of the analysis. Profitability can be measured and analysed from the viewpoint of any of the following three interested parties. Management Shareholders Creditors 188

4 The management should always strive to evaluate the efficiency of the concern in terms of profit. On the other hand, creditors want to get interest as well as principal on maturity on regular basis and owners desire reasonable return on their investment. There are two factors upon which the profitability of a concern depends: (a) the rapidity of turnover of assets or capital employed and (b) the operating profit margin. Profitability is the product of these two factors. In other words, these are the two basic forces which determine the ultimate results. 7.2 A n a ly s is o f P r o fita b ility o f N T P C L td. In this chapter, the profitability of NTPC Ltd, has been analysed. Profitability can be measured in terms of different components of profit and loss account and balance sheet. At the outset, common size statement and common base year statement have been prepared in order to evaluate changes over the study period and then different profitability ratios have been computed for assessing the earning capability of the company during the study period C o m m o n size s ta te m e n t o f N T P C L td. For meaningful comparison, standardization of financial statements is required. A simple way to do this is to work with percentages, rather than rupees. A useful and convenient way of standardizing financial statements is to express each item on the profit & loss account as a percentage of sales and each item on the balance sheet as a percentage of total assets. The resulting statements are called common size statement. Table 7.1 exhibits the comparative common-size statement of NTPC Ltd. for eighth and ninth five-year plan periods. Sale of electricity including own consumption contributed lion share of the total income of the company. It ranged fi*om 93.61per cent to per cent. The fluctuation was 189

5 occurred due to variation of other income in the composition of total assets. Income from consultancy and project management contributed a scanty amount of 0.10 per cent to 0.69 per cent of the total income. Manufacturing and distribution cost varied from per cent to per cent of the total income. Depreciation cost fluctuated from 6.77 per cent in the year to per cent of the total income in the year Due to enactment of new mandatory tariff regulation notified by CERC the provision for depreciation came down abruptly to 6.77 per cent of the total income in the ultimate year of the study period. A further investigation reveals the fact that the fuel charges consisted of near about 50 per cent of the sales revenue throughout the study period except in the last two years. Table 7.2 exhibits the trend in operating expenses during the study period. Employees remuneration & benefits increased steadily except for the years and It stepped up from 2.47 per cent of the sale of energy in to 4.52 per cent in Repair & maintenance cost decreased in the first four years of the ninth five -year plan period. It reached as high as 4.79 per cent of the sales revenue in the year It was because of pay revision, which gave a handsome pay hike of the employees. The administrative and other overhead expenses showed a fluctuating trend throughout the study period. On an average it was 2.54 per cent. Interest and finance charges came down abruptly during the ninth plan period. The management of NTPC Ltd. had been able to curtail interest cost from per cent of the total income in to a mere 4.67 per cent of the total income in the year However, in the eighth plan period the percentage of interest cost had been fluctuating. The average profit before tax was per cent of the total income. PBT reached per cent of the total income in the year

6 7.2.2 C o m m o n Base S ta te m e n t o f N T P C L td. In financial analysis the direction of changes over a period of years is of crucial importance. Time series or trend analysis indicates the direction of changes. An useful way to trend out revenues, profits, net worth, debt and so on is to select a base year and then express each item relative to the base year. The resulting statements are called common-base statement. This statement will throw ample light to the situation if the figures taken are suitably adjusted by general price index. Another way of comparing of time series data is the physical volume though it is not possible for all items. Table 7.3 showed the common base statement of NTPC Ltd. during the study period. While the generation has doubled in the study period, income from sale of energy quadruplicated in the same time period. So, it can be inferred that unit price of electricity doubled during a span of ten years. The company is a growth-oriented company indeed. Cost of goods sold increased at a faster rate than that of sale of energy during the study period. Profit after tax (PAT) also quadruplicated during the period. But the growth rate of PAT was not consistent with the firm growth of sale revenue. 7.3 P ro fita b ility fro m th e v ie w p o in t o f F in a n c ia l M a n a g e m e n t The financial management of a company is very much interested to locate and pinpoint the causes which are responsible for low or high profitability. The financial manager should continuously evaluate the efficiency of its company in terms of profit. The profit margin can be increased by marking up prices or by reduction in costs or by both. However, neither the price mark-up nor does the cost reduction depends on the sole discretion of those who manage a business enterprise. The forces of free competition in an open economy and public interest in a controlled economy put restrictions on the managerial discretion to hike price at will. On the other hand, inflationary pressure makes it impossible to avoid cost 191

7 escalation. These constraints restrict efforts towards widening of profit margins. However, better management, effective organizational structure, technical supremacy are some of the ways, which can help in improving profit margins within limits. In India, there has been a state control over the price of electricity. As the electric power generating companies in the country are bound to sale electricity at a regulated price, it is necessary for them to enhance the operational efficiency in order to increase profitability. Generally, there are two major types of profitability ratios. Profitability in relation to sales revenue Profitability in relation to investment. In analyzing the profitability of NTPC Ltd, the following ratios have been computed: A) Profitability in relation to sales revenue: (i) Gross Profit Ratio (ii) Operating Profit Ratio (iii) Net Profit Ratio B) Profitability in relation to investment: (i) Return on capital employed (ii) Return on net worth (iii) Earning per share Analysis of profitability in relation to sales revenue: (i) Gross Profit Ratio; This ratio expresses the relationship of gross profit to net sales, in terms of percentage. So, the determinants of this ratio are the gross profit and sales. Net sales revenue is obtained after deducting the value of goods returned by the customers from total sales. In electricity industry there is no scope 192

8 of sales return. Hence, gross profit ratio is obtained from the difference between sale of energy and cost of energy. The higher the gross profit ratio, the higher is the gross earning capacity of the company. It is calculated as follows: Gross Profit Gross Profit ratio = X 100 Net Sales This ratio shows the operating efficiency of the company. A higher gross profit ratio as compared to the industry average implies that the company is able to produce its goods and services at a relatively lower cost. Gross profit ratio is of vital importance for gauging business results. A low gross profit ratio may occur due to insufficient sales revenue, higher cost of production with the existing or reduced selling price or inefficient utilization of current assets or fixed assets, and over investment in plant & machinery etc. It may be on account of a fall in prices in the market, lack of demand and inferior quality of product etc. On the other hand, a high gross profit margin also indicates either higher sales price without corresponding increase in the cost of goods sold or decrease in cost of sales without a corresponding decline in sales price. Tables 7.4 exhibits the gross profit ratio of NTPC Ltd. during eighth and ninth plan periods. It registered a declining trend during second and third years of the eighth plan period. However, the situation improved in the last two years of the eighth plan period. The gross profit ratio of the company which was per cent in stepped up to per cent in The mean gross profit ratio was per cent during the eighth plan period with the coefficient of variation of 4.55 per cent. In the ninth plan period the gross profit ratio of the company further declined steadily except in the year In the last year of the ninth plan period ( ) it was only per cent. In spite of achieving operational efficiency the margin fell due to mandatory follow up of new tariff regulation and 193

9 depreciation policy notified by the Central Electricity Regulatory Commission. The mean gross profit ratio of the company declined significantly during the ninth plan period. It was only per cent with the C.V. of per cent. The mean value of the ratio during the entire study period was per cent and its C.V. was 9.67 per cent. (ii) Operating profit Ratio: For capital-intensive industry like electricity, depreciation is a major element o f total cost. Operating profit may be defined as the earnings left after meeting all operating expenses including depreciation. It excludes all non- operating income and expenses. This ratio measures the operating efficiency of the company. The ratio expresses the relationship between operating profit and net sales. It is calculated as: Operating Profit Operating Profit Ratio = X 100 Net Sales Table 7.5 exhibits the operating profit ratio of NTPC Ltd during the period under study. During the eighth five-year plan period the ratio showed a fluctuating trend with a C.V. of 6.28 per cent. During the ninth five-year plan it witnessed a downward trend except in the year During the entire study period the mean operating profit was per cent with a C.V. of 8.66 per cent. (iii) Net P rofit Margin Ratio: This ratio shows the earning left for both equity and preference shareholders as a percentage of net sales. It is defined as: Net Profit after Taxes Net Profit Ratio = X 100 Net sales 194

10 This ratio measures the overall efficiency of production, administration, selling and distribution, financing, pricing, tax management etc. A high net profit ratio is desirable as it usually ensures a higher return to the owners. It also implies that the company w ill be capable of withstanding any unfavourable condition which may take place in future. A low net profit ratio, on the other hand, is definitely a red signal for the company. However, a company with a low net profit margin can earn a high rate of return on investment if it has a higher inventory turnover. The net profit margin should be evaluated with reference to turnover ratio. It is also advisable to interpret gross profit margin and net profit margin jointly. If the gross profit margin increases over years but the net profit margin remains constant or declines or is not in accordance with the gross profit margin, it indicates that the operating expenses to net sales increases. Table 7.6 shows the net profit ratio of NTPC Ltd. during the eighth and ninth plan periods. In the eighth five-year plan period the net profit ratio, which was per cent in came down to per cent in registering a sharp continuous decrease. In the last year of the eighth plan period the net profit increased slightly which reached per cent. The mean ratio and its C.V. were per cent and 8.15 per cent respectively during the eighth plan period. In the ninth plan period the net profit ratio stepped up from per cent in to per cent in In the ratio again declined to per cent. In the ultimate year of the study period the net profit ratio was per cent. The average net profit ratio and the C.V. during the ninth plan period were per cent and 6.39 per cent respectively. The mean net profit ratio and its C.V. for the entire study period were per cent and 8.10 per cent respectively. 195

11 7.3.2 Analysis of profitability in relation to investment The commonly used measure of profitability is to relate the profit output with the capital input. The return on investment is equal to the profit margin on sales multiplied by the investment turnover. This is the end product of different interconnected and interrelated factors of business operations. It can be measured in different ways as under; (i) Return on capital em ployed (ROCE) It measures the overall performance of management and profitability of the business. This is the most comprehensive ratio which covers every aspects of operative management such as selling prices, profit margins, sales volume, manufacturing costs and capital equipment. It thus integrates the major functional sub-systems to the overall objectives of the enterprise. The conventional approach of calculating ROCE is to divide profit after tax (PAT) by capital employed. The fund employed in net assets is known as capital employed. Net assets equal to net fixed assets plus current assets minus current liabilities excluding bank loan. Alternatively, capital employed is equal to net worth plus total debt. PAT represents residue income available for shareholders. As long-term liabilities are included in capital employed, interest on such liabilities should be added back to the net profit. Again, for the sake of consistency, any abnormal or non recurring losses or gains, income from investment outside the business are excluded from the net profit. Since taxes are not controllable by management, it is more prudent to take before-tax measure of ROCE. In table 7.7 depicts ROCE of NTPC Ltd. during the study period. It registered a continuous upward trend during the eighth five-year plan period except in the year , The mean ROCE and the C.V. were per cent and 3.42 per cent respectively. The upward trend continued till the yearl in the 196

12 ninth plan period. ROCE declined slightly in the year But due to mandatory follow up of new tariff policy declared by CERC, return fell almost by two per cent. The mean ROCE and C.V. were and 6.44 per cent during ninth five- year plan. As the company has been operating in a regulated environment and the industry has been categorized as utility, the grov^h in respect of ROCE was commendable The mean ratio may be a normative ratio for power generating companies in Indian context. (ii) Return on net worth (RONW ) The RONW is calculated to find out the profitability of the owners investment. The ratio shows the degree to which the company is able to convert operating profit into an after tax profit that eventually can be claimed by the owners. The term shareholders equity includes: (i) Equity share Capital (ii) Reserves and surplus less accumulated loss While calculating this ratio, revaluation reserve is not taken into account as a component of net worth because it is not a part of the savings of the shareholders. Though it may be the reward for a waiting, the shareholders do not really have any claim on the revaluation reserve, as it is not distributable to them in any form, including issue of bonus share. The argument that inclusion of revaluation reserve brings the net worth closer to market value that holds good only for inter-firm comparison provided all firms have revalued their assets. Profit after tax (PAT) is the actual return that a company can give to its shareholders, part of which is given in the form of cash dividends and the remaining part is retained in the business as savings; which is virtually the cash contribution by the shareholders. If there are any preference shareholders, dividend payable to them are deducted from PAT 197

13 before calculating this ratio. The ratio is calculated by applying the following formula: Profit after tax RONW = Net worth Table 7.8 exhibits RONW for the study period. In the eighth plan period, the RONW increased marginally from per cent to per cent in the eighth plan period. The mean RONW was per cent with the C.V. of 2.15 per cent. In the ninth plan period, the ratio also showed a upward trend for the first three years. The ratio reached as high as per cent in Subsequently, the ratio fell marginally to per cent in the year L it came down to 12,91 per cent in the year The average RONW during the entire study period was per cent with the C.V. of 9.8 per cent As the price of electricity has been regulated in India, higher rate of RONW was achieved due to efficiency in operational and financial management. (iii) Earnings Per Share (EPS) The profitability from the viewpoint of the ordinary shareholders may be calculated by the way of earnings per share. It measures the profit available to the equity shareholders. This is calculated by dividing the net profit after tax less preference dividend by the total number of equity shares. Thus, Net profit after tax - Preference divid.end Earning per share Number of Equity Shares EPS should be used cautiously as it does not recognize the effect of increase in equity capital as a result of retention of earnings. Rate of growth of EPS does not suggest proportionate growth of profitability. Because, increased EPS is due to enlarged equity capital base due to retention, though the number of equity 198

14 shares outstanding remains constant. Table 7.9 exhibits EPS and PAT to equity capital ratio of NTPC Ltd. for the study period. It increased four fold during a span of ten years. A high degree of retention of earnings of the previous years helped the company to achieve such target. EPS has jumped from Rs in to Rs in The peak earning was Rs in the year The average EPS during the eighth plan period was Rs with a C.V. of per cent. The average increased by two and half times in the ninth plan period compared to the previous plan. It was Rs in the ninth plan period with C.V. of per cent. The overall mean was Rs during the study period with C.V. of per cent. A prudent retention policy was the cause of such higher growth rate in EPS. 199

15 References Bernstein, L A and Wild, J J (2004), Analysis o f fin a n c ia l Statements, New Delhi, Tata Mcgraw H ill Publishing Co. Ltd., pp Bhattacharya, H (1995), Total management by ratio s: an integrated approach, New Delhi,Sage Publication India Pvt. Ltd., pp Bhattacharya, H (2004), W orking C apital Management- strategic and techniques, New Delhi, Prentice Hall of India Pvt. Ltd. pp Chandra, P (2004) F inancial Management- theory and practice. New Delhi, Tata Mcgraw H ill Publishing Co. Ltd., pp Foster G (2002) F inancial Statement Analysis, New Delhi, Pearson Education (Singapore) Pvt. Ltd. pp Gqel, S (2001), Management o f Finance in P ub lic Enterprises, New Delhi, Deep & Deep Publication Pvt. Ltd. pp Gupta, R.K. (1990), P rofitab ility, F in a n c ia l Structure and Liq uid ity, Jaipur, Prinwell Publishers, ppl-84. ibid pp Khan, M Y and Jain, P K (2005), F ina ncial Management- Text, Problems and Cases, New Delhi, Tata Mcgraw H ill Publishing Co. Ltd., pp Kumar, P (1990), Analysis o f fin a n c ia l statement o f Indian industries, Delhi, Kanishka Publishing House, pp Pandey, I M (2004), Financial Management, New Delhi, Vikas Publishing House Pvt. Ltd. pp

16 TABLE 7.1 COMPARATIVE COMMON -SIZE PROFIT & LOSS ACCOUNT OF NPTC LTD. Eight five-year plan Ninth five year plan Particulars Sale of Electricity Consultancy etc Other income Total income Generation, administrationsc other expenses Depreciation Interest charges Profit before tax Total Source: Compiled and computed from published Annual Reports of NTPC Ltd. for the years to

17 TABLE 7.2 TREND OF OPERATING EXPENSES AS A PERCENTAGE OF SALE OF ENERGY IN NPTC LTD. DURING EIGHTH & NINTH FIVE YEAR PLAN PERIODS. Eighth Five Year Plan Ninth Five Year Plan Particulars Fuel Employees Remuneration & benefits Repair & Maintenance Administrative & other ovehead expenses Source: Compiled and computed from publishec Annua Reports of NTPC Ltd. for the years to 202

18 TABLE 7.3 COMMON -BASE YEAR PROFIT & LOSS ACCOUNT OF NPTC LTD. DURING EIGHTH & NINTH FIVE YEAR PLAN PERIODS ( IN Particulars Generation (In MUs) Sale of Electricity Consultancy etc. Other income Total income Cost of good sold PBIT Interest charges PAT Source: Compiled and computed from published Annual Reports of NTPC Ltd. for the years to

19 TABLE 7.4 GROSS MARGIN RATIO BEFORE DEPRECIATION OF NTPC LTD. DURING EIGHTH & NINTH FIVE YEAR PLAN PERIODS Year (Eighth plan) Gross margin ratio (In %) Year (Ninth plan) Gross margin ratio (In %) Average Average C.V. 4.55% C.V 12.70% Average of the period C.V. of the entire period 9.67% Source; Compiled and computed from published Annual Reports of NTPC Ltd. for the years to

20 TABLE7.5 OPERATING PROFIT RATIO OF NTPC LTD. DURING EIGHTH & NINTH FIVE YEAR PLAN PERIODS Year (Eighth plan) Operating Profit Ratio (In% ) Year (Ninth plan) Operating Profit Ratio (In% ) Average Average C.V. 6.28% C.V 2.30% Average of the period C.V. of the entire period 8.66 % Source: Compiled and computed from published Annual Reports of NTPC Ltd. for the years to

21 TABLE 7.6 NET PROFIT RATIO OF NTPC LTD. DURING EIGHTH & NINTH FIVE YEAR PLAN PERIODS Year (Eighth plan) Net Profit Ratio (In %) Year (Ninth plan) Net Profit Ratio (In% ) Average Average C.V. 8.15% C.V 6.39% Average of the period C.V. of the entire period 8.10% Source; Compiled and computed from published Annual Reports of NTPC Ltd. for the years to

22 TABLE 7.7 RETURN ON CAPITAL EMPLOYED RATIO OF NTPC LTD. DURING EIGHTH & NINTH FIVE YEAR PLAN PERIODS Year ROCE (in %) Year ROCE (in% ) (Eighth plan) (Ninth plan) Average Average C.V. 3.42% C.V 6.44% Average of the period C.V. of the entire period 8.27% Source: Compiled and computed from published Annual Reports of NTPC Ltd. for the years to

23 a> 35 O) n*- 30 c 0> a 25 0) a 20 ~ Gross margin, operating margin & Net profit margin of NTPC LTD. during 8th & 9th five year plan penody Gross margin ratio (in %) operating profit margin (in %) Net Profit ratio (In %) Unear operating profit margin (in %)) Linear (operating profit margin (in %)) Linear Gross margin ratio (In %)) y = x y = x ' Year Figure

24 TABLE 7.8 RETURN ON NET WORTH OF NTPC LTD. DURING EIGHTH & NINTH FIVE YEAR PLAN PERIODS Year Return on net Year Return on net (eighth plan) worth (in %) (ninth plan) worth (in %) Average Average C.V. 2.15% C.V 7.24% Average of the period C.V. of the entire period 9.8% Source: Compiled and computed from published Annual Reports of NTPC Ltd. for the years to

25 TABLE 7.9 EPS & PAT TO EQUITY CAPITAL RATIO OF NTPC LTD. DURING EIGHTH & NINTH FIVE YEAR PLAN PERIODS Year EPS (In Rupees) PAT equity capital ratio (%) to Year EPS (In Rupees PAT to equity capital ratio (%) Average Average C.V 27.94% C.V 19.42% Average of the period C.V. of the entire period 50.28% Source: Compiled and computed from published Annual Reports of NTPC Ltd. for the years to