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CHAPTER 1
INTRODUCTION
1. Introduction
Financial statements on their own are of limited use. For example: if you were to identify that
a business has made profits of $1 million what does that tell you about the business? Does it
suggest the business is a success? It might, but not if in the previous year they made profits of
$50 million and their closest rival earned profits of $60 million.
It is important that users of financial statements can interpret the financial statements to be
able to draw out valid conclusions. Typically this involves the use of comparisons to prior
years, forecasts and competitors. Users can compare sales and expense figures, asset and
liability balances and cash flows to perform this analysis.
Ratio analysis is widely used to support this process of comparison. Don't forget though that
ratios are calculated using the figures already present in the financial statements. The raw
data is equally useful when performing analysis. Ratios are simply a tool to try and assist
understanding and comparison.
Suppliers and lenders concerned with the security of their debt or loan
Management concerned with the trend and level of profits, since this is the main
measure of their success.
Financial institutions
Employees
3. Ratio analysis
Ratios use simple calculations based upon the interactions in sets of data. For example;
changes in costs of sale are directly linked to changes in sales activity. Changes in sales
activity also have an effect upon wages and salaries, receivables, inventory levels etc. Ratios
allow us to see those interactions in a simple, concise format.
Ratios are of limited use on their own, thus, the following points should serve as a useful
checklist if you need to analyzed data and comment on it:
4. Focus of analysis
Traditionally financial statements analysis focuses on four key areas:
Profitability,
Liquidity,
Efficiency, and
Financial position.
2
CHAPTER 2
INTERPRETATION OF FINANCIAL STATEMENTS
1. Introduction
An important component of most introductory financial accounting programmers is the
analysis and interpretation of financial statements. This is usually dealt with towards the end
of the programmer and may be seen and used as a test of the students comprehension of much
of the material covered. It requires knowledge of the users of financial statements and the
particular requirements of each category of user. It requires the skill to select and measure
various indicators of performance and offer possible explanations for trends over a period or
variances from norms. A review of all recent Accounting Framework papers shows that the
topic is popular. At an introductory level questions usually take the form of analyzing income
statements and balance sheets. In effect students are expected to appraise the performance of
a reporting entity over different reporting periods, the performances of different entities over
the same period or compare the performance of an entity with the industry norm (which will
be given if required to answer a question). Students will normally calculate ratios and
comment on them. The particular ratios may be specified or it may be left to the student to
select. This article sets out to give students guidance as to what is expected from a good
answer and how to approach such questions. The normal approach to the interpretation of
financial statements is to select suitable accounting ratios and to comment on them. These
questions often guide the student on the ratios to be selected by specifying aspects of
performance or financial position to be analyzed. Sometimes the ratios themselves are
specified; sometimes the student is asked to select the ratios without any indication as to
which category is required. In this latter case there may be significant marks allocated for the
correct selection. The following are some of the ratios most likely to be useful to the student
at Formation 2 level.
1.3. Profit after interest, preference dividends and tax X100 / Total equity
shareholders funds
This ratio may be important for examination candidates as the difference between ROCE and
ROE has significant implications for how a business might raise additional capital. However,
it may not be so significant for equity shareholders in large plcs as other measures such as
price earnings (P/E) ratio give a better indication of return. One of the reasons for this is that
the balance sheet numbers (especially for non-current assets) may not reflect correct current
values.
The profitability of sales is clearly important for the financial health of any business. It is
normally analysed under the following: Gross profit margin This ratio is calculated as
follows:
Gross profit X 100 / Sales revenue
Gross profit is the difference between sales revenue and the cost of sales. Changes in the
margin are caused by changes in selling prices, changes in purchasing price or a combination
of both. It is important for students to remember what does not affect the ratio. For a nonmanufacturing business increases in wages, interest, depreciation or other such expenses have
no effect on this ratio.
1.7. Debt to Equity ratio Total long-term debt Equity and Gearing ratio:
Total long-term debt Equity + long term debt
In the past the treatment of preferred share capital presented problems as it was considered
neither debt nor equity. Sometimes the term prior charge capital was used and preference
shares were included with loans. Now, however, all capital must be classified as either debt or
equity. At this level if preferred capital is stated to be redeemable it may be classified as debt.
The ideal capital structure (ratio between debt and equity) is a matter that will be dealt with
later in your programme of studies. At this level we consider the risks inherent in having too
much debt on the one hand and the advantages of the probable lower cost of debt on the
other. Also the composition of the assets of the business may indicate the preferred capital
structure. Perhaps non-current assets need to be financed mainly by equity whereas other
assets could be financed by debt. Interest cover should also be considered.
Dividend cover: EPS Dividend per share Dividend yield is the return a shareholder receives
on investment measured at current price. If the selection of ratios is left to the student then it
is important to select wisely. A common complaint of markers is that when candidates are
left to decide which ratios to calculate, they calculate far too many, thus spending very little
time on their interpretation. On the other hand ratios should be selected from the various
categories such as return on investment, profitability of sales, solvency (preferably both short
term and long term), use of assets and shareholder investment ratios where these are relevant.
However, no more than two from each category should be necessary. In recent examinations
some candidates failed to calculate profit. This meant that it was very difficult for them to
achieve a pass mark. Candidates should ensure that they are capable of using the information
given to reconcile opening and closing balances in retained earnings so deriving the profit.
1.10. Interpretation
Having calculated the appropriate ratios most questions will request the student to comment
on them. A review of the examiners reports will show that the most common shortcoming
has been the lack of analysis. In particular candidates do not offer possible reasons for
movement or differences in the ratios. A typical comment may be that the stock turnover has
improved from 3.4 times to 5.8 times. This adds little value to the users understanding of the
entitys performance earns no marks. Candidates are expected to show some commercial
understanding. The possible reasons as to why the ratio has changed must be offered. While
the student cannot be sure of the reasons plausible explanations are expected. Even if they are
not the actual cause, marks will be awarded.
Examples of comments expected might be as follows
ROCE has improved from 15% to 17%. The gross margin improved slightly from 12% to
12.5% but this was more than offset by a significant increase in expenses which left the net
profit down from 6% to 5%. Despite this, greater utilization of assets resulted in the overall
increase to 17%. This greater utilization arose from tighter control of working capital with
stock turnover increasing from 3 times to 5.5 times, days debtors being reduced from 46 to 28
and creditors being slightly extended from 26 to 30. The increase in gross margin is probably
due to new purchasing controls introduced early in the year. The increase in expenses is due
to a significant increase in rent payable and wages.
2. Examination approach
7
As always read the question carefully. If you are asked for a report, give it, perhaps
appending the ratios. Allocate your time between calculation of ratios and the report
appropriately i.e. roughly in proportion to the marks available. Limit ratios to important areas
bearing in mind the scenario. Avoid duplication in your ratios. If you are analyzing a single
entity over time establish if there are changes to the capital structure. The introduction of
fresh capital may impact many of the ratios and so explain changes.
3. Structure
It may be useful to have a standard structure to your answer even though questions may vary
slightly. In the case of a single entity question one may start with the change in the level of
activity (sales). Compare this change with the change in profitability (absolute) and in
percentage profitability of sales, distinguishing between gross, operating and net profit if
relevant. If there is a significant change in the gross profit percentage try and offer plausible
explanations. Were selling prices reduced to stimulate increased sales? Was the sales mix
altered? If the change was at operating profit level what gave rise to it. If change was between
operating and net profit then this may be explained by changes in the capital structure of the
entity. Having dealt with profitability of sales examines use of assets. Were new assets
purchased? If the sales to non-current assets ratio have deteriorated might this be due to
acquiring new assets late in the period? Comment on the ROCE and its composition. Was use
of assets a factor in the change or was it entirely due to changes in the profitability of sales.
Changes in working capital should then be commented on. If considering making
comparisons between two entities establish that it is fair to compare them. For example are
they are in the same or similar business? Are accounting policies similar? One might then
address profitability, asset utilization, capital structure and liquidity using the same approach
as mentioned for the single entity question above. Candidates should be aware that there may
be justifiable reasons for what appears to be a deterioration in a ratio. An offer of longer
credit terms in order to increase sales will result in an increase in trade receivables. Increase
in stock levels may be to avoid stock outs or earn quantity discounts from suppliers.
Overtrading arising from fast expansion may cause liquidity problems.
CHAPTER 3
RELIANCE INDUSTRIES
1. Introduction
Reliance Industries Limited (RIL) is an Indian conglomerate holding company headquartered
in Mumbai, Maharashtra, India. Reliance owns businesses across India engaged in energy,
petrochemicals, textiles, natural resources, retail and telecommunications. Reliance is the
second most profitable company in India, the second-largest publicly traded company in India
by market capitalization and the second largest company in India as measured by revenue
after the government-controlled Indian Oil Corporation. The company is ranked 215th on the
Fortune Global 500 list of the world's biggest corporations as of 2016. RIL contributes
approximately 20% of India's total exports. It is ranked 8th among the Top 250 Global
Energy Companies by Platts as of 2016.
2. History
a) 1960 1980
The company was co-founded by Dhirubhai Ambani and his brother Champaklal Damani in
1960s as Reliance Commercial Corporation. In 1965, the partnership ended and Dhirubhai
continued the polyester business of the firm. In 1966, Reliance Textiles Industries Pvt Ltd
was incorporated in Maharashtra. It established a synthetic fabrics mill in the same year at
Naroda in Gujarat. In 1975, the company expanded its business into textiles, with "Vimal"
becoming its major brand in later years. The company held its Initial public offering (IPO) in
1977. The issue was over-subscribed by seven times. In 1979, a textiles company Sidhpur
Mills was amalgamated with the company. In 1980, the company expanded its polyester yarn
business by setting up a Polyester Filament Yarn Plant in Raigad, Maharashtra with financial
and technical collaboration with E. I. du Pont de Nemours & Co., U.S.
b) 1981 2000
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In 1985, the name of the company was changed from Reliance Textiles Industries Ltd. to
Reliance Industries Ltd. During the years 1985 to 1992, the company expanded its installed
capacity for producing polyester yarn by over 145,000 tonnes per annum.
c) 2001 Present
In 2001, Reliance Industries Ltd. and Reliance Petroleum Ltd. became India's two largest
companies in terms of all major financial parameters. In 201102, Reliance Petroleum was
merged with Reliance Industries. In 2002, Reliance announced India's biggest gas discovery
(at the Krishna Godavari basin) in nearly three decades and one of the largest gas discoveries
in the world during 2002. The in-place volume of natural gas was in excess of 7 trillion cubic
feet, equivalent to about 1.2 billion barrels of crude oil. This was the first ever discovery by
an Indian private sector company. In 200203, RIL purchased a majority stake in Indian
Petrochemicals Corporation Ltd. (IPCL), India's second largest petrochemicals company,
from Government of India. IPCL was later merged with RIL in 2008. In the years 2005 and
2006, the company reorganized its business by demerging its investments in power
generation and distribution, financial services and telecommunication services into four
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separate entities. In 2006, Reliance entered the organised retail market in India with the
launch of its retail store format under the brand name of 'Reliance Fresh'. By the end of 2008,
Reliance retail had close to 600 stores across 57 cities in India.[10] In November 2009,
Reliance Industries issued 1:1 bonus shares to its shareholders. In 2010, Reliance entered
Broadband services market with acquisition of Infotel Broadband Services Limited, which
was the only successful bidder for pan-India fourth-generation (4G) spectrum auction held by
Government of India. In the same year, Reliance and BP announced a partnership in the oil
and gas business. BP took a 30 per cent stake in 23 oil and gas production sharing contracts
that Reliance operates in India, including the KG-D6 block for $7.2 billion. Reliance also
formed a 50:50 joint venture with BP for sourcing and marketing of gas in India. In 2012,
RIL set up a joint venture with Russian Company Sibur for setting up a Butyl rubber plant in
Jamnagar, Gujarat. The plant is scheduled to be operational in 2015 Presently, Tejpal Singh
Bisht is the President and CEO of New Ventures in the Chairmans Office at Reliance
Industries Limited.
3. Shareholding
Chairman and MD: Mukesh Ambani
The number of shareholders in RIL is approx. 3 million. The promoter group, Ambani family,
holds approx. 45.34% of the total shares whereas the remaining 54.66% shares are held by
public shareholders, including FII and corporate bodies. Life Insurance Corporation of India
is the largest non-promoter investor in the company with 7.98% shareholding.
Buyback: In January 2012, the company announced a buyback programme to buy a
maximum of 120 million shares for 104 billion (US$1.5 billion). By the end of January 2013,
the company bought back 46.2 million shares for 33.66 billion (US$500 million).
4. Listing
The company's equity shares are listed on the National Stock Exchange of India Limited
(NSE) and the BSE Limited. The Global Depository Receipts (GDRs) issued by the
Company are listed on Luxembourg Stock Exchange. It has issued approx. 56 million GDRs
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wherein each GDR is equivalent to 2 equity shares of the company. Approx. 3.46% of its total
shares are listed on Luxembourg Stock Exchange.
Its debt securities are listed at the Wholesale Debt Market (WDM) Segment of the National
Stock Exchange of India Limited (NSE).
Credit Ratings: It has received domestic credit ratings of AAA from CRISIL (S&P
subsidiary) and Fitch. Moodys and S&P have provided investment grade ratings for
international debt of the Company, as Baa2 positive outlook (local currency issuer rating) and
BBB+ outlook respectively.
5. Operations
The company's petrochemicals, refining, and oil and gas-related operations form the core of
its
business;
other
divisions
of
the
company
include
cloth,
retail
business,
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Retail brand. Its annual revenue for the financial year 201213 was $108 billion (US$1.6
billion) with an EBITDA of $780 million (US$12 million).
Reliance Life Sciences works around medical, plant and industrial biotechnology
opportunities. It specializes in manufacturing, branding, and marketing Reliance Industries'
products in bio-pharmaceuticals, pharmaceuticals, clinical research services, regenerative
medicine, molecular medicine, novel therapeutics, biofuels, plant biotechnology, and
industrial biotechnology sectors of the medical business industry.
Reliance Institute of Life Sciences (RILS), established by Dhirubhai Ambani Foundation, is
an institution offering higher education in various fields of life sciences and related
technologies.
Reliance Logistics is a single-window company selling transportation, distribution,
warehousing, logistics, and supply chain-related products, supported by in-house telematics
and telemetry solutions. Reliance Logistics is an asset based company with its own fleet and
infrastructure. It provides logistics services to Reliance group companies and outsiders.
Reliance Clinical Research Services (RCRS), a contract research organisation (CRO) and
wholly owned subsidiary of Reliance Life Sciences, specialises in the clinical research
services industry. Its clients are primarily pharmaceutical, biotechnology and medical device
companies.
Reliance Solar, the solar energy subsidiary of Reliance, was established to produce and retail
solar energy systems primarily to remote and rural areas. It offers a range of products based
on solar energy: solar lanterns, home lighting systems, street lighting systems, water
purification systems, refrigeration systems and solar air conditioners.
Relicord is a cord blood banking service owned by Reliance Life Sciences. It was established
in 2002. It has been inspected and accredited by AABB, and also has been accorded a license
by Food and Drug Administration (FDA), Government of India.
Reliance Jio Infocomm Limited (RJIL) previously known as Infotel Broadband, is a
broadband service provider which gained 4G licences for operating across India. Sandip Das,
former CEO of Maxis Malaysia, is the current group president of Reliance Jio Infocomm.
Reliance Industrial Infrastructure Limited (RIIL) is an associate company of RIL. RIL holds
45.43% of total shares of RIIL. It was incorporated in September 1988 as Chembur
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Patalganga Pipelines Limited, with the main objective being to build and operate crosscountry pipelines for transporting petroleum products. The company's name was
subsequently changed to CPPL Limited in September 1992, and thereafter to its present
name, Reliance Industrial Infrastructure Limited, in March 1994. RIIL is mainly engaged in
the business of setting up and operating industrial infrastructure. The company is also
engaged in related activities involving leasing and providing services connected with
computer software and data processing. The company set up a 200-millimetre diameter twin
pipeline system that connects the Bharat Petroleum refinery at Mahul, Maharashtra, to
Reliance's petrochemical complex at Patalganga, Maharashtra. The pipeline carries petroleum
products including naphtha and kerosene. It has commissioned facilities like the supervisory
control and data acquisition system and the cathodic protection system, a jackwell at River
Tapi, and a raw water pipeline system at Hazira. The infrastructure company constructed a
71,000 kilo-litre petrochemical product storage and distribution terminal at the Jawaharlal
Nehru Port Trust (JNPT) Area in Maharashtra.
LYF, a 4G-enabled VoLTE device brand from Reliance Retail.
Network 18, a major mass media company owned by RIL. It has interests in Television,
Digital Platforms, Publication, Mobile Apps, Films, et cetera. It also operates two JVs namely
Viacom 18(50% ownership) and History TV18 (50% ownership) with Viacom and A+E
Networks. It also has acquired ETV Networks and since renamed the channels under Colours
TV brand.
7. Employees
As on 31 March 2013, the company had 23,519 employees of which 1,159 were women and
83 were employees with disabilities. It also had 29,462 temporary employees on the same
date. As per its Sustainability Report for 201112, the attrition rate was 7.5%. But currently,
the same attrition rate has gone up to 23.4% in 2015 as per latest report released within the
organisation.
In its 39th Annual General Meeting, its Chairman informed the shareholders of the
investment plans of the company of about $1,500 billion (US$22 billion) in next three years.
This would be accompanied by increasing the staff strength in Retail division from existing
strength of 35,000 to 120,000 in next 3 years and increasing employees in Telecom division
from existing 3,000 to 10,000 in 12 months.
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15
9. Controversies
9.1 De-merger of RIL in 200506
The Ambani family holds around 45% of the shares in RIL. Since its inception, the company
was managed by its founder and chairman Dhirubhai Ambani. After suffering a heart attack in
1986, he handed over the daily operations of the company to his sons Mukesh Ambani and
Anil Ambani. After the death of Dhirubhai Ambani in 2002, the management of the company
was taken up by both the brothers. In November 2004, Mukesh Ambani, in an interview,
admitted to having differences with his brother Anil over 'ownership issues'. He also said that
the differences "are in the private domain". The share prices of RIL were impacted by some
margin when this news broke out. In 2005, after a bitter public feud between the brothers
over the control of the Reliance empire, mother Kokilaben intervened to broker a deal
splitting the RIL group business into the two parts. In October 2005, the split of Reliance
Group was formalized. Mukesh Ambani got Reliance Industries and IPCL. Younger brother
Anil Ambani received telecom, power, entertainment and financial services business of the
group. The Anil Dhirubhai Ambani Group includes Reliance Communications, Reliance
Infrastructure, Reliance Capital, Reliance Natural Resources and Reliance Power.
The division of Reliance group business between the two brothers also resulted in de-merger
of 4 businesses from RIL. These businesses immediately became part of Anil Dhirubhai
Ambani Group. The existing shareholders in RIL, both the promoter group and nonpromoters, received shares in the de-merged companies.
16
Subsequently, the two companies agreed to form an independent expert panel to probe any
pilferage.
Mar '15
Sources Of Funds
Total Share Capital
Equity Share Capital
Share Application Money
Reserves
Net worth
Secured Loans
Unsecured Loans
Total Debt
Total Liabilities
3,240.00
3,240.00
8.00
236,936.00
240,184.00
4,524.00
87,832.00
92,356.00
332,540.00
3,236.00
3,236.00
17.00
212,923.00
216,176.00
2,036.00
87,105.00
89,141.00
305,317.00
Application Of Funds
Gross Block
Less: Revaluation Reserves
Less: Accum. Depreciation
Net Block
Capital Work in Progress
Investments
Inventories
Sundry Debtors
Cash and Bank Balance
Total Current Assets
Loans and Advances
Total CA, Loans & Advances
Current Liabilities
Provisions
Total CL & Provisions
Net Current Assets
Total Assets
229,250.00
0.00
97,840.00
131,410.00
106,879.00
152,059.00
28,034.00
3,495.00
6,892.00
38,421.00
28,951.00
67,372.00
122,521.00
2,659.00
125,180.00
-57,808.00
332,540.00
205,638.00
0.00
91,075.00
114,563.00
75,753.00
112,573.00
36,551.00
4,661.00
11,571.00
52,783.00
42,113.00
94,896.00
86,210.00
6,258.00
92,468.00
2,428.00
305,317.00
Contingent Liabilities
Book Value (Rs)
78,906.00
741.20
80,641.00
668.05
17
(Rs. in crores)
Mar 16
Mar 15
251,241.00
340,814.00
18,083.00
11,738.00
233,158.00
329,076.00
233,158.00
7,582.00
240,740.00
329,076.00
8,721.00
337,797.00
152,769.00
4,241.00
255,998.00
7,134.00
17,328.00
19,693.00
4,171.00
1,943.00
4,260.00
2,454.00
3,686.00
2,367.00
9,566.00
8,488.00
12,757.00
10,593.00
2,507.00
1,573.00
205,039.00
308,329.00
35,701.00
29,468.00
Income
Revenue From Operations
[Gross]
Less: Excise/Service
Tax/Other Levies
Revenue From Operations
[Net]
Total Operating Revenues
Other Income
Total Revenue
Expenses
Cost Of Materials Consumed
Purchase Of Stock-In Trade
Operating And Direct
Expenses
Changes In Inventories Of
FG,WIP And Stock-In Trade
Employee Benefit Expenses
Finance Costs
Depreciation And
Amortisation Expenses
Other Expenses
Less: Transfer to / From
Investment / Fixed Assets /
Others
Total Expenses
Profit/Loss Before
Exceptional, Extraordinary
Items And Tax
18
35,701.00
29,468.00
7,802.00
482.00
8,284.00
6,124.00
625.00
6,749.00
27,417.00
22,719.00
27,417.00
22,719.00
27,417.00
22,719.00
84.66
84.66
70.25
70.25
3,095.00
605.00
105.00
2,944.00
615.00
100.00
Other Additional
Information
Earnings Per Share
Basic EPS (Rs.)
Diluted EPS (Rs.)
Dividend And Dividend
Percentage
Equity Share Dividend
Tax On Dividend
Equity Dividend Rate (%)
Particulars
Mar' 16
Mar' 15
84.61
70.21
114.13
96.45
84.61
70.21
114.13
96.45
10.50
10.00
123.87
97.67
741.20
668.05
741.20
668.05
719.54
1,017.02
19
0.00
0.00
17.21
9.60
13.11
7.02
11.75
6.90
15.36
9.23
11.41
10.51
11.41
10.51
11.99
10.88
0.32
0.35
Total Debt/Equity
0.38
0.41
72.22
70.80
0.73
1.12
Current Ratio
0.53
1.03
0.47
0.89
Quick Ratio
0.31
0.63
8.96
9.32
11.28
12.95
8.36
9.43
88.72
87.05
91.64
90.57
2.50
2.86
PROFITABILITY RATIOS
LEVERAGE RATIOS
LIQUIDITY RATIOS
PAYOUT RATIOS
COVERAGE RATIOS
Adjusted Cash Flow Time Total Debt
20
19.45
17.04
16.07
14.18
69.38
81.38
0.00
0.00
59.11
63.63
91.71
90.96
0.83
0.73
65.07
65.15
COMPONENT RATIOS
21
CHAPTER 4
CAPITAL STRUCTURE
1. Introduction
A firm's capital structure is the composition or 'structure' of its liabilities. For example, a firm
that has $20 billion in equity and $80 billion in debt is said to be 20% equity-financed and
80% debt-financed. The firm's ratio of debt to total financing, 80% in this example, is
referred to as the firm's leverage. In reality, capital structure may be highly complex and
include dozens of sources of capital. Leverage (or gearing) ratios represent the proportion of
a firm's capital that is obtained through debt which may be either bank loans or bonds.
The Modigliani-Miller theorem, proposed by Franco Modigliani and Merton Miller in 1958,
forms the basis for modern thinking on capital structure, though it is generally viewed as a
purely theoretical result since it disregards many important factors in the capital structure
process factors like fluctuations and uncertain situations that may occur in the course of
financing a firm. The theorem states that, in a perfect market, how a firm is financed is
irrelevant to its value. This result provides the base with which to examine real world reasons
why capital structure is relevant, that is, a company's value is affected by the capital structure
it
employs.
Some
other
reasons
include bankruptcy
costs, agency
costs, taxes,
and information asymmetry. This analysis can then be extended to look at whether there is in
fact an optimal capital structure: the one which maximizes the value of the firm.
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Analysts use the D/E ratio to compare capital structure. It is calculated by dividing debt by
equity. Savvy companies have learned to incorporate both debt and equity into their corporate
strategies. At times, however, companies may rely too heavily on external funding, and debt
in particular. Investors can monitor a firm's capital structure by tracking the D/E ratio and
comparing it against the company's peers.
The relative proportion of various sources of funds used in a business is termed as financial
structure. Capital structure is a part of the financial structure and refers to the proportion of
the various long-term sources of financing. It is concerned with making the array of the
sources of the funds in a proper manner, which is in relative magnitude and proportion. The
capital structure of a company is made up of debt and equity securities that comprise a firms
financing of its assets. It is the permanent financing of a firm represented by long-term debt,
preferred stock and net worth. So it relates to the arrangement of capital and excludes shortterm borrowings. It denotes some degree of permanency as it excludes short-term sources of
financing. Again, each component of capital structure has a different cost to the firm. In case
of companies, it is financed from various sources. In proprietary concerns, usually, the capital
employed, is wholly contributed by its owners. In this context, capital refers to the total of
funds supplied by bothowners and long-term creditors. The question arises: What should
be the appropriate proportion between owned and debt capital? It depends on the financial
policy of individual firms. In one company debt capital may be nil while in another such
capital may even be greater than the owned capital. The proportion between the two, usually
expressed in terms of a ratio, denotes the capital structure of a company.
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Capital structure minimizes the firms cost of capital or cost of financing. By determining a
proper mix of fund sources, a firm can keep the overall cost of capital to the lowest.
4.1.3 Increase in Share Price:
Capital structure maximizes the companys market price of share by increasing earnings per
share of the ordinary shareholders. It also increases dividend receipt of the shareholders.
4.1.4 Investment Opportunity:
Capital structure increases the ability of the company to find new wealth- creating investment
opportunities. With proper capital gearing it also increases the confidence of suppliers of
debt.
4.1.5 Growth of the Country:
Capital structure increases the countrys rate of investment and growth by increasing the
firms opportunity to engage in future wealth-creating investments.
4.1.6 Patterns of Capital Structure:
There are usually two sources of funds used by a firm: Debt and equity. A new company
cannot collect sufficient funds as per their requirements as it has yet to establish its
creditworthiness in the market; consequently they have to depend only on equity shares,
which is the simple type of capital structure. After establishing its creditworthiness in the
market, its capital structure gradually becomes complex.
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8. Stability of sales- An established business which has a growing market and high sales
turnover, the company is in position to meet fixed commitments. Interest on
debentures has to be paid regardless of profit. Therefore, when sales are high, thereby
the profits are high and company is in better position to meet such fixed commitments
like interest on debentures and dividends on preference shares. If company is having
unstable sales, then the company is not in position to meet fixed obligations. So,
equity capital proves to be safe in such cases.
9. Sizes of a company- Small size business firms capital structure generally consists of
loans from banks and retained profits. While on the other hand, big companies having
goodwill, stability and an established profit can easily go for issuance of shares and
debentures as well as loans and borrowings from financial institutions. The bigger the
size, the wider is total capitalization.
A complex capital structure pattern may be of following forms:
i. Equity Shares and Debentures (i.e. long term debt including Bonds etc.),
ii. Equity Shares and Preference Shares,
iii. Equity Shares, Preference Shares and Debentures (i.e. long term debt including Bonds
etc.).
However, irrespective of the pattern of the capital structure, a firm must try to maximize the
earnings per share for the equity shareholders and also the value of the firm.
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REFERANCE
1. Baker, Malcolm P.; Wurgler, Jeffrey (2002). "Market Timing and Capital
Structure". Journal of Finance.
2. Fernandes, pN.. Finance for Executives: A Practical Guide for Managers. 2014;
chapter 5
3. Lyandres, Evgeny and Zhdanov, Alexei,Investment Opportunities and Bankruptcy
Prediction(February 2007)
4. Myers, Stewart C.; Majluf, Nicholas S. (1984). "Corporate financing and investment
decisions when firms have information that investors do not have". Journal of
Financial Economics.
5.
6.
"Reliance
Industries
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leads
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highest
profit
earner".http://timesofindia.indiatimes.com.
7. "Reliance Industries Overtakes ONGC to Become India's Most Profitable
Firm".http://profit.ndtv.com. Retrieved 31 May 2015. External link in |publisher
8. Timmer, Jan (2011). "Understanding the Fed Model, Capital Structure, and then
Some".
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9. Vuong, Quan Hoang (July 2014). "Operational scales, sources of finance, and firms'
performance: Evidence from Vietnamese longitudinal data". CEB Working Paper
Series (N 14/017). Retrieved July 23, 2014
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