88 CHAPTER – IV CAPITAL STRUCTURE OF STEEL INDUSTRIES IN TAMILNADU INTRODUCTION In order to run and manage a company, funds are needed. Right from the promotional stage up to end, finances plays an important role in steel industries life. If funds are inadequate, the business suffers and if the funds are not properly managed, the entire organization suffers. It is, therefore, necessary that correct estimate of the current and future need of capital be made to have an optimum capital structure which shall help the organization to run its work smoothly and without any stress. Estimation of capital requirements is necessary, but the formation of a capital structure is important. According to Maheswari.S.N., “Capital structure of a company refers to the composition or make-up of its capitalization and it includes all long- term capital resources viz: loans, reserves, shares and bonds” 1 . Capital structure, sometimes known as financial plan, refers to the components of long – term sources of funds, such as debentures, long-term debt, preference share capital and equity share capital including reserves and surpluses. In the other words of Lawrence D. Schall and Charless W. Haley, the term „capital structure means the proportion of different types of securities issued by a firm. The optimal capital structure is the set of proportion that maximizes the total value of the firm 2 . Capital structure is that part of the financial structure which represents long term funds. It is the permanent financing of the firm, represented primarily
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CHAPTER – IV
CAPITAL STRUCTURE OF STEEL INDUSTRIES IN TAMILNADU
INTRODUCTION
In order to run and manage a company, funds are needed. Right from the
promotional stage up to end, finances plays an important role in steel industries
life. If funds are inadequate, the business suffers and if the funds are not properly
managed, the entire organization suffers. It is, therefore, necessary that correct
estimate of the current and future need of capital be made to have an optimum
capital structure which shall help the organization to run its work smoothly and
without any stress.
Estimation of capital requirements is necessary, but the formation of a
capital structure is important. According to Maheswari.S.N., “Capital structure of
a company refers to the composition or make-up of its capitalization and it
includes all long-term capital resources viz: loans, reserves, shares and bonds”1.
Capital structure, sometimes known as financial plan, refers to the
components of long – term sources of funds, such as debentures, long-term
debt, preference share capital and equity share capital including reserves and
surpluses. In the other words of Lawrence D. Schall and Charless W. Haley, the
term „capital structure means the proportion of different types of securities issued
by a firm. The optimal capital structure is the set of proportion that maximizes the
total value of the firm2.
Capital structure is that part of the financial structure which represents
long term funds. It is the permanent financing of the firm, represented primarily
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by long – term debt, preference stock and common stock including reserves and
surpluses, but excluding all short – term credits. In an industrial undertaking
capital structure as decisive impact on it‟s composition. The capital structure
should be so designed as to achieve the desired managerial goals. According to
S.C. Kuchal, “ within this framework of equating the rate of return and the cost of
capital, capital structure is sought by using a proportion of debt such that the
correct degree of trading on equity leading to financial leverage will cause the
highest market value of the ordinary shares”3. Capital structure, therefore
involves a choice between size and expected returns.
Capital structure ordinarily implies the proportion of debt and equity in the
total capital of a company. Since a company may tap one or one of the different
sources of funds to meet its total financial requirement. The total capital of a
company may, thus, be composed of all such tapped sources. The term
„structure‟ has been associated with the term „capital‟. The term „capital‟ may be
defined as the long –term funds of the firm. In other words, the capital may also
be expressed as follows.
Capital = Total Assets – Current Liabilities
The capital structure of a business enterprise consists of debt and equity
shares which provide funds for a firm. “Capital structure is composed of a firm‟s
finance of its assets. It is the permanent financing of a firm represented by long
term debt plus preferred stock plus net worth”4. Apart from short term finance
from creditors and banks, companies are usually financed either by long term
loans (debentures) carrying a fixed rate of interest on capital or by ordinary
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shares carrying membership of a company and dividends at the rate which
depend upon profits”5.
The basic pattern of capital structure can be simple or complex. A simple
capital structure consists of equity shares and preference shares. But a complex
capital structure consists of multi securities such as equity shares, preference
shares, debentures, bonds, etc.,
GOALS OF EFFICIENT CAPTIAL STRUCTURE MANAGEMENT
An efficient capital structure management is aimed determining a proper
mix of debt and equity securities that maximizes the value of the common stock
on a per share basis, taking advantage of favourable financial leverage, taking
advantage of leverage offered by corporate taxes and , avoiding a perceived high
risk structure.
SOURCES OF CAPITAL
There are two categories through which a firm can raise its capital
1. External Sources and
2. Internal Sources.
External Sources:
Every undertaking in the initial stage must obtain permanent funds in the
form of share capital from its shareholders. An undertaking may raise its capital
through issuing equity shares, preference shares and debentures. Which of
these three is a better source depends upon the earning capacity of the
undertaking. If earning is uncertain, issue of debentures is not preferable,
because they involve fixed commitment of paying prescribed rate of interest on
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them. In such cases, it is desirable to go for issue of equity shares. Non-
cumulative permanent funds to the undertaking without fixed commitment.
Long term loans are raised from lending Industrial Financial Institutions
like Industrial Finance Corporation of India, Industrial Development Bank of India,
Industrial Credit and Investment Corporation of India, this method of raising funds
is becoming more popular than the issue of creditorship securities (debentures).
In addition to long term lending institutions even the commercial banks provide
term loans ranging up to five to seven years.
Internal Sources:
The internal sources of funds include earned surplus and depreciation
provision, “Depreciation is a non-cash expense, the cash goes out only when the
assets were acquired. When combined with the cash costs of operation such as
materials, labour, heat, light and administration, this non- cash charge
determines the total cost of producing the goods. When merchandise is sold, the
difference between the selling price and the total costs represents the net inflow
of cash in to expertise. The amount of net cash flow will exceed the profit by the
amount of depreciation charge. It is the sense that depreciation is some times
referred as a source of funds”6.
Capital structure is made up of debt and equity securities which comprise
a firm‟s finance of its assets. It is the permanent financing of a firm represented
by long – term debt, plus preferred stock, and plus net worth. The determination
of the degree of liquidity of a firm is not simple task.
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THE OPTIMUM CAPTIAL STRUCTURE
The capital structure differs according to different types of industries.
“There is no such thing as the model capital structure for all business
undertakings. One way of planning the capital structure is to make it fit into a
model compiled from a number of different experiences that might have been
drawn from the historical ratios of the firm”7. The optimum capital structure is the
mix of finance in which the market value of each share is maximum or the
average cost of capital is minimum. “An optimum capital structure would be
obtained at that combination of debt and equity that maximizes the total value of
the firm (value of the share plus value of debts) or minimizes the weighted
average cost of capital”8. Up to certain point, debt added to the capital structure
will cause the market value of the firm to raise and the cost of capital to decline.
However after the optimum point has reached any additional debt will cause the
market value to decrease and the cost of capital to increase”9. “Optimal capital
structure can be properly defined as that combination of debt and equity that
attains the stated managerial goals, maximization of the firms market value, and
which minimizes the firm‟s cost of capital. As the existence of an optimum capital
structure implies the simultaneous optimization of both the cost of capital and the
firm‟s market value, it occupies a central position in the theory of Financial
Management”10. “The normative objective of the firm maximizing shareholders
wealth is to reduce the cost capital to a minimum by continuing to raise long term
funds over time in the least „ expensive ways”11
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The Capital structure decision of a firm is concerned with the
determination of debt equity composition. Proper planning of the composition is
necessary for sound financial management since the debt- equity mix of financial
leverage has implications for the shareholder‟s earnings and risk, which is turn,
will affect the cost of capital and the market value of the firm. Various theories of
capital structure have been propounded in explaining the relationship between
market value of the firm and its capital structure decision. In practice, planning an
optimum capital structure is the most difficult task as the decision is influenced by
myriads of factors, which are highly psychological, conflicting, complex and
qualitative, thus adding to the woes of financing executive.
All companies should have well- defined capital structure policy, otherwise
it may face problem of raising fund and financing the projects in the long- term
funds. An appropriate capital structure decision may improve the value as well as
solvency position of the company. There would be two opposite effects its debts
exist in the capital structure. Overall cost of capital may be reduced as proportion
of debt increases in the capital structure due to low cost of debt. On the other
hand, because of fixed contractual obligation, the financial risk of the company
increases, which again increased the weighted average cost of capital. It is said
theoretically that optimum capital structure implies a ratio of debt and equity at
which weighted average cost of capital would be the least and the market value
of the share of the firm would be the highest.
A sound or appropriate capital structure should have the following
features, viz., profitability, solvency, flexibility, conservation and control. These
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features will differ from company to company. So the management of financing
decision should be made with view to achieve the target capital structure.
Wherever the fund have to be procured additionally, the Finance Manager
weighs production and consumption of various sources of finance and selects the
most advantageous sources keeping in view the target capital structure. The
capital structure decision is a continuous one and has to be taken up whenever a
firm needs additional finance.
Capital structure, the mix of long term debts and equity securities, is
generally used to finance long term assets of companies. It consists of
permanent short-term debt, preferred stock, and common equity. The financial
structure is sometimes used as synonymous with capital structure. However,
financial structure is more comprehensive than that of capital structure in the
sense that the former refers to aggregate amount of total current liabilities, long-
term debt, preferred stock, and common equity i.e., total of liability side of the
balance sheet (source of funds). Therefore, capital structure is only a part of
financial structure and refers mainly to the permanent sources of the firm‟s
obligations for a well designed capital structure policies to lessen the hurdles of
raising finance for its project.
An appropriate capital structure decision improves bottom line as well as
solvency position and rescued the firm from its impending threat of bankruptcy.
On the other hand, it brings synergy effect pertaining to boasting shareholders
value with mixing debt and equity. The overall cost of capital is reduced with
increase in significant proportion of debt in the capital structure because of fixed
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contractual obligations. At the same time financial risk of the firm is argumented
in the event of firm‟s inability to leverage its operation. Here lies the essence of
optimum capital structure concept in firm‟s financing decision relating to
determining an appropriate ratio of debt and equity at which Weighted Average
Cost of Capital (WACC) would be the least and the market value of the firm
would be the highest. Generally in the firms‟ growth trajectory it is difficult to find
an optimum capital structure as it is influenced by host of factors.
FACTORS DETERMINING CAPITAL STRUCTURE
Capital structure of different types of firms varies widely. There is no rigid
formula to explain the temperaments. There are no hard and fast rules about
what percentage of capitalization should be represented by bonds and
debentures and what part should be equity shares and preference shares.
Factors affecting capital structure revolve principally around the adequacy and
the stability of earnings. It is always better that the capital structure should be
balanced with a sufficient equity cushion to absorb the shocks of the business
cycle and to offer flexibility. The factors that affect the capital structure of a firm
are;
Cost of Capital
Market Conditions
Internal Conditions
Growth Rate
Stability of Sales
Flotation Cost
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Nature of Industry and Capital Requirements
Flexibility
Profitability
Taxes
Interest Rate Level
Control
Leverage Effect
4:1 DEBT EQUITY RATIO
The relationship between borrowed funds and owner‟s 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 reflects the relative claims of creditors and
shareholders against the assets of the firm. “The debt equity ratio is computed by
dividing long-term or total debts by the shareholder‟s fund”12. The total debt
consists of fixed deposits and long-term loan from shareholders, directors, public
and commercial banks and financial institutions. Whereas shareholder‟s fund
comprises of ordinary share capital, preference share capital and reserves and
surpluses. Change in the debt equity ratio may occur due to fluctuation in
quantities of value of any of the two variables viz., total debts or long-term debts
and shareholder‟s funds. Debt- Equity Ratio of the sample units of the steel
industries in Tamil Nadu have been shown in Table 4.1.
Total debt Debt Equity Ratio =
Shareholder‟s Fund
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TABLE 4.1
DEBT EQUITY RATIO
(Ratio in Times)
YEAR AML BSIL KSIL SIL TNECL
2000-01 0.21 4.11 0.41 2.07 1.69
2001-02 0.26 5.49 0.42 2.60 2.96
2002-03 0.23 4.91 0.42 3.27 2.52
2003-04 0.37 4.19 0.37 1.32 3.85
2004-05 0.24 3.64 0.25 4.36 3.46
2005-06 0.11 3.55 0.43 2.58 3.79
2006-07 0.32 3.30 0.58 1.71 3.65
2007-08 0.53 3.58 0.42 3.18 3.57
2008-09 0.69 4.15 0.50 3.15 3.18
2009-10 0.86 5.07 0.73 1.86 3.41
MEAN 0.38 4.19 0.45 2.61 3.20
S.D 0.24 0.73 0.13 0.90 0.66
C.V (in %) 63.15 17.42 28.88 34.48 20.62
Source: Computed from the Annual Reports.
AML Limited
It could be observed from the table 4.1 that the debt equity ratio for AML is
varied between the highest value of 0.86 during 2009-10 and the lowest value of
0.11 during 2005-06. The mean value of the debt equity ratio is 0.38. It shows
that the utilization of debt capital is less, and higher usage of equity and reserve
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and surplus. But the co-efficient of variation is high (63.15), it shows more
variability in debt equity ratio.
BSIL
It is observed from above table that the debt equity ratio of BSIL is varied
between the highest value of 5.49 during 2001-02 and lowest value of 3.30 in the
year 2006-07. The mean value of debt equity ratio is 4.19. It indicates that
utilization of debt capital is higher and lower usage of own capital. The co-
efficient of variation is less (17.42) it shows consistency in usage of debt capital.
KSIL
The table 4.1 shows that mean value of the debt equity ratio is 0.45 and of
Co-efficient variation is 28.88 percent. In the year 2009-2010 the company shows
higher value of debt-equity ratio of 0.73 and lower ratio is 0.25 in the year 2004-
05. It implies the shareholders equity should be higher than the outsider‟s funds.
The co-efficient of variation is 28.88 which show consistency of debt equity ratio.
SIL
It could be observed from the table 4.1 that the mean value of the debt-
equity ratio is 2.61 and the co-efficient variation is 34.48 percent. In the year
2004-05, the ratio shows the highest value of 4.36, and the lowest value of 1.32
during the 2003-04. This ratio shows that it is more than the ideal ratio of 1: 1. It
is inferred that loan capital utilization is higher than the owner‟s capital. The co-
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efficient of variation is high (34.48), which shows more variability in debt equity
ratio.
TNECL
The mean value of the debt equity ratio of TNECL is 3.20 and co-efficient
of variation is 20.62 percent. In the year 2003-04, the ratio shows the highest
value of 3.85, and the lowest value of 1.69 during the year 2000-01. The mean
value indicates that the higher usage of loan fund than the own funds. The
degree of co-efficient variation indicates inconsistency during the study period.
It is concluded from the table 4.1 that the consistency is found from the
BSIL and lower utilization of loan funds by AML among the five industries.
4.2 Interest Coverage Ratio
This ratio is very important from the lender‟s point of view. It indicates
whether the business would earn sufficient profits to pay periodically the interest
charge. It indicates the number of times interest is covered by the profits
available to pay the interest charges. But, a too high interest coverage ratio may
not be good for the firm because it may imply that firm does not use debt as
source of finance so as to increase the earning per share. Table 4.2 exhibits the
interest coverage ratio of the select steel industries. It is computed as follows.
Net Profit and Before Interest and Tax Interest Coverage Ratio =
Fixed Interest Charges
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TABLE 4.2
INTEREST COVERAGE RATIO
(Ratio in Times)
YEAR AML BSIL KSIL SIL TNECL
2000-01 7.24 0.64 1.21 1.42 1.38
2001-02 4.87 0.99 1.28 1.41 1.48
2002-03 4.46 1.02 1.58 1.62 1.56
2003-04 2.29 1.20 4.04 1.49 1.50
2004-05 8.87 1.35 2.96 1.76 1.63
2005-06 12.7 1.25 6.97 4.65 1.76
2006-07 6.09 1.15 4.90 3.25 1.76
2007-08 1.82 1.42 4.44 2.90 2.34
2008-09 1.09 0.30 3.49 2.42 1.73
2009-10 1.12 1.22 1.96 0.74 1.44
MEAN 5.05 1.05 3.28 2.16 1.65
S.D 3.77 0.34 1.86 1.15 0.27
C.V (in %) 74.66 32.38 56.70 53.24 16.36
Source: Computed from the Annual Reports.
AML
The company exhibits the mean value of the interest coverage ratio is
5.05 and co-efficient variation is 74.66 percent. In the year 2008-09 the company
accounts too low coverage ratio of 1.09 times which is a clear indication of
payment in large amount of interest towards borrowed funds. In the year 2005-
06, the coverage ratio shows much higher that is 12.7 times, which shows the
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long term creditors are very safe. The co-efficient of variation is high which
shows more variability in interest coverage ratio during the study period.
BSIL
The mean value of the Interest Coverage ratio is 1.05 and co-efficient of
variation is 32.38 percent. In the year 2007-08, it indicates higher interest
coverage ratio that is 1.42 times which indicates the more safe of the long term
creditors so as to increase the earnings per share and in the year 2008-09 it
shows the lowest value of 0.30.
KSIL
It is observed that the interest coverage ratio is varied between the highest
value of 6.97 during 2005-06 and lowest value of 1.21 in the year 2000-01. The
co-efficient of variation is the highest (56.70) which shows more variability in
interest coverage ratio. The firm is not using much loan capital.
SIL
The mean value of the Interest Coverage Ratio is 2.16 and co-efficient of
variation is 53.24 percent. From the year 2005-06, to 2008-09 it shows higher
ratio than mean value, this reveals the high earning and low usage of borrowed
funds. Since the amount of borrowed funds usage is the lowest the commitment
of interest payment is very low. The co-efficient of variation shows more
variability in the interest coverage ratio.
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TNECL
The mean value of the interest coverage ratio is 1.65 and co-efficient of
variation is 16.36 percent. During the period 2005-06 and 2007-08 the ratio
shows high value than the mean value, this indicates the high earning in the
periods. The degree of co-efficient of variation indicates more consistency in the
interest coverage ratio.
To sum up, the interest coverage ratio indicates the number of times
interest is covered by the profits available to pay the interest charges. In the case
of AML, its net earnings are high among the five industries. It is concluded that
the high consistency is found from TNECL among the five industries.
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4.3 PROPRIETORY RATIO
A variant to the equity ratio is the proprietary ratio, which is also known as
equity ratio or net worth to total assets ratio. This ratio establishes relationship
between the proprietors or shareholder‟s fund and the total tangible assets. It
focuses the general financial strength of the business enterprises. A high
proprietary ratio will indicate a relatively little danger to the creditors. Low
proprietary ratio indicates greater risk to the creditors. Hence the ratio should be
1:2 Assets include both the fixed assets and current assets, and shareholder‟s
funds include equity capital, reserves and surpluses. Table 4.3 shows the
proprietary ratio of the select Steel Industries in Tamil Nadu for the study period.
It is calculated as follows.
Shareholders Funds Proprietary Ratio =
Total Assets
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TABLE 4.3
PROPRIETORY RATIO
(Ratio in Times)
YEAR AML BSIL KSIL SIL TNECL
2000-01 0.83 0.18 0.50 0.52 0.57
2001-02 0.79 0.19 0.65 0.39 0.55
2002-03 0.81 0.14 0.51 0.35 0.68
2003-04 0.73 0.15 0.65 0.35 0.89
2004-05 0.80 0.16 0.33 0.24 0.73
2005-06 0.84 0.18 0.61 0.31 0.65
2006-07 0.75 0.15 0.53 0.40 0.48
2007-08 0.65 0.16 0.75 0.29 0.70
2008-09 0.63 0.16 0.63 0.27 0.63
2009-10 0.47 0.17 0.58 0.42 0.71
MEAN 0.73 0.16 0.11 0.57 0.66
S.D 0.11 1.58 0.57 0.68 0.11
C.V (in %) 15.06 9.88 19.29 119.30 16.67
Source: Computed from the Annual Reports.
AML
It could be observed from the table 4.3 the Proprietary ratio is varied
between the highest value of 0.84 during 2005-06 and lowest value of 0.47 in the
year 2009-10. The co-efficient of variation is 15.06, which shows good position of
the long term solvency of the firm and indicates greater risk to the company
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creditors. The degree of co-efficient of variation indicates less consistency in its
value during the study period.
BSIL
In the case of BSIL , the mean value of the ratio is 0.16 and co-efficient of
variation is 9.88 percent. In the period from 2000-01, 2001-02, 2005-06 to 2009-
10 greater than the mean value, it indicates the good financial strength of the
firm. In the year 2001-02 the ratio is 0.14 which indicates more risk to the
creditors of the company.
KSIL
In this company, the mean value of the ratio is 0.11 and co-efficient of
variation is 19.29 percent. The company attained higher ratio in the period 2007-
08, which indicates the long term solvency is very good. The degree of co-
efficient of variation shows fluctuation of proprietors fund and extent of utilisation
of the total assets.
SIL
The mean value of the ratio is 0.57 and co-efficient of variation is 119.30
percent. From the year 2000-01 and 2002-03 to 2008-09, the proprietary ratio
value is lower than the mean value which indicates the risk of the creditors. The
co-efficient of variation is the highest which shows more variability in the
proprietary ratio.
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TNECL
The mean value of the ratio is 0.66 and co-efficient of variation is 16.67
percent. From the years, 2002-03 to 2004-05 and 2007-08, show the high
proprietary ratio against the mean value. In this period the risk of the creditors
has reduced and they were on the safer side. This shows favourable sign to the
organization. The ratio is very low in the year 2005-06 which indicates that the
long term solvency is not stable.
It is conclude that, the proprietory ratio shows effective utilisation of share
capital of select steel industries. Among five steel industries, AML mean value is
higher than that of other industries, which leads to good financial position.
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4.4 CAPITAL EMPLOYED TURNOVER RATIO
The term capital employed refers to long- term fund supplied by the
creditors and owners of the firm. Generally the non-current assets should be
financed from the long-term sources. Capital employed turnover ratio of the
select steel industries are shown in the Table 4.4. To examine the effectiveness
in utilizing such long-term funds for generating sales, capital employed turnover
ratio is calculated as follows.
Sales Capital Employed Turnover Ratio = Capital Employed
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TABLE 4.4
CAPITAL EMPLOYED TURNOVER RATIO
(Ratio in Times)
YEAR AML BSIL KSIL SIL TNECL
2000-01 2.66 1.98 2.54 2.23 2.88
2001-02 3.02 2.49 2.54 1.89 2.73
2002-03 1.56 2.54 3.10 1.94 3.16
2003-04 1.61 3.54 3.01 2.58 2.35
2004-05 2.83 4.56 3.53 3.15 2.84
2005-06 4.62 4.97 4.12 2.18 2.40
2006-07 2.16 4.17 3.66 2.03 2.73
2007-08 0.67 3.90 4.32 1.02 2.51
2008-09 0.97 3.60 3.18 0.88 2.73
2009-10 0.98 3.68 3.20 0.90 2.75
MEAN 2.10 3.54 3.32 1.88 2.70
S.D 1.20 0.95 0.59 0.74 0.24
C.V (in %) 57.14 26.83 17.77 39.36 8.89
Source: Computed from the Annual Reports.
AML
The mean value of the capital employed turnover ratio is 2.10 and co-
efficient of variation is 57.14 percent. The capital employed turnover ratio is
varied between the highest value of 4.62 in the year 2005-06 and the lowest of
0.67during the year 2007-08. The mean value indicates that no consistency in
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the capital employed turnover ratio. The co-efficient of variation is the highest, it
shows more variability in the capital employed turnover ratio.
BSIL
In the case of BSIL, the mean value of the ratio is 3.54 and the co-efficient
of variation is 26.83 per cent. The ratio is varied between the highest of 4.97 in
the year 2005-06 and the lowest value of 1.98 in the year 2000-01. The ratio
shows the effective use of captial employed.
KSIL
The above table shows that, the mean value of ratio is 3.32., and the co-
efficient of variation is 17.77. The capital employed turnover ratio is varied
between the highest ratios of 4.32 in the year 2007-08 and the lowest of 2.54 in
the year 2001-02.The mean value discloses that the turnover to capital employed
ratio is consistent. The co- efficient of variation of KSIL does not show more
variability.
SIL
The mean value of the ratio is 1.88 and co-efficient of variation is 39.36
percent. During the study period the ratio of the company is 0.88 in 2008-09
which is low and in the year 2004-05, the ratio is 3.15 which is higher than the
other periods that indicate the effective turnover and proper use of capital
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employed. The co-efficient of variation of SIL is the highest which shows more
variability in turnover to capital employed ratio.
TNECL
The mean value of the ratio is 2.70. The capital employed turnover ratio is
varied between the highest value of 3.16 in 2002-03 and the lowest value of 2.40
in 2005-06. The co-efficient of variation is 8.89. Which is the least in TNECL,
which shows more consistency in capital employed turnover ratio.
It is concluded that the consistency in capital employed turnover ratio is
found from TNECL among the five industries.
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4.5 CAPITAL GEARING RATIO
This ratio is also known as capitalization or leverage ratio. It is also one of
the long-term solvency ratios. It is used to analyse the capital structure of the
company. The ratio establishes relationship between fixed interest and dividend
bearing funds and equity shareholders funds. Capital gearing ratio shows the
proportion of various items of long-term finance employed in the business. Its
main emphasis is on indication of the proportion between owner‟s funds and non
owner‟s funds. This proportion is called leverage. If the ratio is high, the capital
gearing is said to be high and if the ratio is low the capital gearing is said to be
low. The implication is that high gearing is trading on thin equity and low gearing
is on thick equity. The table 4.5 shows the capital gearing ratio.
Long-term loans + Debentures + Preference share capital Capital Gearing Ratio = Equity shareholders Fund
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TABLE 4.5
CAPITAL GEARING RATIO
(Ratio in Times)
YEAR AML BSIL KSIL SIL TNECL
2000-01 3.00 2.10 2.91 3.10 3.01
2001-02 3.10 3.07 2.91 2.50 3.10
2002-03 2.00 3.15 3.75 2.75 3.75
2003-04 2.10 3.75 3.60 2.60 2.85
2004-05 3.00 5.60 3.75 3.70 3.00
2005-06 5.00 5.55 4.90 2.65 3.10
2006-07 2.87 5.00 4.10 2.70 3.75
2007-08 1.47 4.10 4.60 1.90 3.10
2008-09 1.58 4.50 4.55 1.70 3.25
2009-10 2.00 4.77 4.69 2.00 3.50
Mean 2.61 4.15 3.97 2.56 3.24
SD 1.03 1.14 0.71 0.59 0.32
CV (in %) 39.46 27.47 17.88 23.01 9.87
Source: Computed from the Annual reports.
4.5 AML
It could be observed from the table 4.5 that, the mean value of the capital
gearing ratio is 2.61 and co-efficient of variation is 39.46 percent. By observing
mean value, in the year 2005-06 the ratio shows high gearing that implies trading
on thin equity and in the year 2007-08, the ratio shows low gearing that implies
trading on thick equity. The highly geared capital structure is indication of under
capitalization with high return. A low gearing indicates over capitalization with low
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return. The co-efficient of variation is the highest and shows more variability in
capital gearing ratio.
BSIL
The mean value of the capital gearing ratio is 4.15 and co-efficient
variation is 27.47 percent. It is observed from mean value in the year 2006-07 the
ratio shows high gearing which implies trading on thin equity and in the year
2000-01, the ratio shows low gearing that implies trading on thick equity. The
highly geared capital structure is the indication of under capitalization with high
return and lower gearing indicates over capitalization with low return. The co-
efficient of variation shows less variability in the capital gearing ratio.
KSIL
The mean value of the capital gearing ratio is 3.97 and co-efficient of
variation is 17.88 percent. It is observed that capital gearing ratio is higher (4.90),
in the year 2005-06 and lowest value of 2.91 during 2000-01 and 2001- 02 that
indicates trading on thin equity. A low gearing ratio indicates over capitalization
with low return. The co-efficient of variation is lower it shows consistency in the
capital gearing ratio.
114
SIL
The mean value of the capital gearing ratio is 2.56 and co-efficient of
variation is 23.01 percent. In the year 2004-05 the ratio shows high gearing,
which implies trading on thin equity and in the year 2008-09 the ratio shows low
gearing which represents trading on thick equity. It is observed from mean value,
in the year 2007-08 and 2008-09, the ratio shows low gearing that implies trading
on thick equity and leads to less profit. The co-efficient of variation shows
variability in the capital gearing ratio.
TNECL
The mean value of the capital gearing ratio is 3.24 and co-efficient of
variation is 9.87 per cent. It is observed from mean value in the year 2002-03 the
ratio shows high gearing which represents trading on thin equity and in the year
2003-04, the ratio shows low gearing trading on thick equity. The co-efficient of
variation is the lowest, it shows more consistency in the capital gearing ratio.
To sum up, among the five steel industries the mean value is low and co-
efficient of variation is very high in AML. When compared with other companies
the co-efficient of variation is the lowest in TNECL and it shows consistency in
the capital gearing ratio. It represents thick equity with high return.
115
4.6 RETURN ON CAPITL EMPLOYED RATIO
Return on capital employed establishes the relationship between profits
and the capital employed. It is the primary ratio and is most widely used to
measure the overall profitability and efficiency of a business. This ratio would
provide sufficient insight into how efficiently the long-term funds of owners and
creditors are being used. Higher the ratio, more efficient is the use of capital
employed. The formula for calculating return on capital employed is
Operating Profit ROCE =
Capital Employed
The term operating profit means „Earnings before interest and Tax‟
(EBIT). The term „gross capital employed‟ usually comprises of the total assets,
fixed assets as well as current assets used in a business.
The amount of employed is computed by using the formula
Capital Employed = Net Fixed Assets + Working Capital
The table 4.6 shows the return on capital employed among the select steel
industries in Tamil Nadu.
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TABLE 4.6
RETURN ON CAPTIAL EMPLOYED RATIO
(Ratio in Times)
YEAR AML BSIL KSIL SIL TNECL
2000-01 0.27 0.11 0.06 0.14 0.17
2001-02 0.15 0.17 0.07 0.13 0.14
2002-03 0.06 0.16 0.08 0.12 0.14
2003-04 0.09 0.19 0.11 0.19 1.09
2004-05 0.27 0.19 0.10 0.14 0.13
2005-06 0.51 0.16 0.17 0.24 0.13
2006-07 0.24 0.19 0.24 0.24 0.16
2007-08 0.10 0.17 0.24 0.14 0.19
2008-09 0.04 0.05 0.18 0.12 0.23
2009-10 0.06 0.19 0.19 0.19 0.17
MEAN 0.18 0.16 0.14 0.16 0.25
S.D 0.15 0.45 0.68 0.46 0.29
C.V (in %) 83.33 28.75 47.56 28.75 116
Source: Computed from the Annual Reports.
AML
It is be observed from the table 4.6 that, the mean value is 0.18 and Co-
efficient of variation is 83.33 per cent. The ratio is higher value of 0.51 during the
year 2005-06 because of heavy turnover, and the lower value of 0.06, in the year
2002-03, which lead to the highest variation. The co-efficient of variation is higher
which shows more variability in the return on capital employed ratio.
117
BSIL
The above shows that mean value is 0.16 and Co-efficient of variation is
28.75 per cent. It is observed that the return on capital employed ratio shows
lower fluctuations during the study period. In the year 2002-03,2003-04 and
2009-10 it shows the higher ratio as 0.19 because of heavy turnover, whereas in
the year 2008-09 is very low ratio as 0.05 the low profit is due to occurrence of
high operating expenses than that of other periods.
KSIL
The mean value is 0.14 and co-efficient of variation is 47.56 per cent. It is
observed that the return on capital employed ratio shows normal difference
during the study period. In the year 2006-07and 2007-08 it shows the higher ratio
as 0.24 because of heavy turnover, whereas, in the year 2000-01 is very low
ratio that is 0.06, the reason for the low profit due to occurrence of high operating
expenses than that of other periods. The co-efficient of variation shows less
variation in the return on capital employed.
SIL
It is observed that the return on capital employed, varied between the
highest value of 0.24 during 2005-06 and the lowest value of 0.13 in the year
2002-03 and 2008-09. The Co-efficient of variation is 28.75 percent, which shows
normal disparity similar to BSIL.
118
TNECL
It is evident from above table that the return on capital employed ratio
mean value is 0.25 and co-efficient of variation is 116 percent. It is observed that
the return on capital employed ratio is lower than the mean value in the entire
period of the study except in the year 2003-04.The co-efficient of variation shows
more variability.
It is concluded that the consistency is found from BSIL and SIL among
the five industries followed by KSIL. The mean value of TNECL is the highest
among the industries. Similarly the co-efficient of variation of TNECL also the
highest.
ENDNOTES
1. Maheshwari, S.N, (1997), Financial Management, Sultan Chand and Sons,
New Delhi, p.27.
2. Lawrence D. Schall and Charles W. Haley (1983), Introduction to Financial
Management ( 3rd Edition) Tata Mc Graw Hill, New Delhi, p.339.
3. Kuchal, S.C. (1977), Financial Management, An Analytical and Conceptual
