A CASE STUDY

ON ANALYSIS ON CAPITAL STRUCTURE

Submitted by CA. Poonam Mehndiratta M.No. 094388 For Master in Business Financ Certificate Course Institute of Chartered Accountants of India

Executive summary The case study was assigned to me to make analysis of any corporate sector. I decided to choose the largest company Reliance Industries that has rapidly grown over last few years. Through this report I try to analyze the factors affecting the capital structure and its impact on the financial statement. The financial statement of last five years have taken, studied and interpreted the companys capital structure and thereby impact on the profitability and on the cost of capital of the company.

Index 1. Meaning of the capital structure 2. Factors affecting capital structure 3. Trend in Capital structure 4. Analysis 5. Balance Sheet of last five years 6. Profit & Loss for last five years 7. Ratios for the last five years

Meaning of Capital Structure Capital Structure is referred to as the ratio of different kinds of securities raised by a firm as long-term finance. The capital structure involves two decisionsa. Type of securities to be issued are equity shares, preference shares and long term borrowings( Debentures). b. Relative ratio of securities can be determined by process of capital gearing. On this basis, the companies are divided into twoa. Highly geared companies- Those companies whose proportion of equity capitalization is small. b. Low geared companies- Those companies whose equity capital dominates total capitalization. For instance - There are two companies A and B. Total capitalization amounts to be Rs. 20 lakh in each case. The ratio of equity capital to total capitalization in company A is Rs. 5 lakh, while in company B, ratio of equity capital is Rs. 15 lakh to total capitalization, i.e, in Company A, proportion is 25% and in company B, proportion is 75%. In such cases, company A is considered to be a highly geared company and company B is low geared company.

Factors Determining Capital Structure 1. Trading on EquityTrading on equity means taking advantage of equity share capital to borrowed funds on reasonable basis. It refers to additional profits that equity shareholders earn because of issuance of debentures and preference shares. It is based on the thought that if the rate of dividend on preference capital and the rate of interest on borrowed capital is lower than the general rate of companys earnings, equity shareholders are at advantage which means a company should go for a judicious blend of preference shares, equity shares as well as debentures. Trading on equity becomes more important when expectations of shareholders are high. 2. Degree of controlThere is great affect of control situation on capital structure decisions, because in such a situation management has 50% voting control between the debt and equity. If the management is not in a position to buy or purchase more stock, the other option for it is to use debt for new financing. But in a situation when the firms financial position is so week that the use of debt may cause serious risk of default then the control considerations could lead to use either debt or equity.

3. Flexibility of financial planIn an enterprise, the capital structure should be such that there is both contractions as well as relaxation in plans. Debentures and loans can be refunded back as the time requires. While equity capital cannot be refunded at any point which provides rigidity to plans. Therefore, in order to make the capital structure possible, the company should go for issue of debentures and other loans. 4. Period of financingWhen company wants to raise finance for short period, it goes for loans from banks and other institutions; while for long period it goes for issue of shares and debentures. 5. Cost of financingIn a capital structure, the company has to look to the factor of cost when securities are raised. It is seen that debentures at the time of profit earning of company prove to be a cheaper source of finance as compared to equity shares where equity shareholders demand an extra share in profits. 6. Stability of salesAn 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. 7. Sizes of a companySmall 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. 8. Operating Structure: This is another factor which is involved in making capital structure decisions. A firm having less operating leverage can imply financial leverage in better way as it will have less business risk. 9. Assets Structure: This factor may affect the capital structure decisions; there are two types of assets which are: general purpose assets and special purpose assets. The real state companies usually

use general purpose assets as it makes good collateral. While the companies which are involved in technological research use special purpose assets because they are not highly leveraged. 10. Profitability: The factor of profitability also plays an important role in capital structure decisions. The firms which get high rates of return on investment do not use high debt but they use relatively little debt. High rates of return on investment make them able to do financing with internally generated funds. 11. Growth Rate: This factor plays an important role in capital structure decision making. It has been observed that faster growing firms mostly rely on external capital as the flotation costs exceeds. It is also possible that the firms relying on external capital may often face greater uncertainty due to which they may reduce their willingness to use debt. 12. Taxes: As far as interest is concerned it is no doubt a deductible expense which is much valuable to firms with high tax rates. This is the reason that many firms use much debt because if firms tax rate is higher the advantage is also greater. 13. Management Attitudes: Different management attitudes may bring different changes in capital structure decisions. Management may be conservatives or aggressive depending upon the attitude towards risk taking. Both managerial styles exercise according to their own judgments and analytical approaches about the proper capital structure. If the management attitude is conservative it uses less debt, where if the management is having aggressive approach then it uses more debt to get higher profits. 14. Lender and Rating Agency Attitudes: Lenders and rating agencies also plays an important role in financial structure decisions. The corporations give much importance to the lenders and rating agencies. They make discussions about the capital structure and mostly act accordingly to their advice. 15. Market Conditions: Capital structure also depends on market conditions; a firms optimal capital structure or favorable capital structure depends on long-term and short-term changes. Low rated companies which are in need of capital either go for the stock market or the short-term debt market without taking consideration of target capital structure.

16. Financial Flexibility: financial flexibility has also impact on capital structure decision. A firm or company makes the decision according to its financial flexibility. If a company is financially good it can raise capital with either stock or bond. But when its financial position is week the suppliers of capital make funds available if the company gives them a secure position in shape of debt. Seeking all above thoughts in mind it can be said that the companies should maintain the financial flexibility or adequate reserve borrowing capacity because it depends on the factors which are necessary in making capital structure decisions.

BRIEF ABOUT THE COMPANY Through the company annual report we could see that the company is investing in new technologies. The Company has entered into various joint ventures, partnerships and contracts in the area of oil and gas, refining and petrochemicals businesses. While benefits from such contracts will accrue in future years, their progress is periodically monitored. In line with its aspirations of ongoing growth, Reliance is investing its resources in core business across the integrated energy chain. While doing so, the Company is also taking the initiative of investing in new technologies and businesses that help meet changing aspirations of millions of Indian consumers. These strategies and initiatives are aimed at ensuring that Reliance delivers long- term sustainable growth and creates unprecedented value for all its stakeholders.

Capital Structure (Reliance Industries)

YEAR PAID UP CAPITAL INCREASE IN EQUITY DEBT INCREASE IN DEBT IMPACT ON EBT

IMPACT ON DIFF. RATIOS

Long Term Debt Equity Ratio 0.38 0.44 0.59 0.35 0.32

Equity Share 2011 2010 2009 2008 2007 2006 3273.37 3270.37 1573.8 1453.65 1393.51 1393.51 3.00 1696.57 120.15 60.14 0 67,396.68 62,494.69 73,904.48 36,479.68 27,825.73 4901.99 -11409.79 37424.8 8653.95 0 20,286.30 16,235.67 15,309.32 19,458.29 11,943.40

Current Ratio 1.22 1.11 1.08 1.01 0.77

Quick Ratio 1.01 0.76 0.9 0.94 0.69

Debt Equity Ratio 0.46 0.49 0.65 0.46 0.45

Impact on the capital structure y The company is having debt equity ratio is minimum 0.45 from last five years. The company has borrowed funds Rs. 8653 Crore and Rs.37424.80 Crore in 2008 and 2009 respectively.The company has also raise funds Rs.1696 Crore through equity. The company has invested the funds in fixed capital for expansion in 2008 and 2010. Company has borrow the funds in 2008 and 2009 resulting in reduction of profit during the year 2008-2009 and 2009-2010. The Profit before Interest and tax ratio also has been impacted due to more interest and reduced from 13.06 to 10.02. Since the company is earning good profits, the it s financial coverage ratio is 14 times. The net profit ratio has been also reduced to 8.35 in 2010 from 14.45 in 2008. The return on capital ratio has been also reduced from 15.68 (year 2008) to 10.96 (year 2009) The Impact on Earning per share and equity dividend is as follows:

y y

y y

Mar '11 Earning Per Share (Rs) Equity Dividend (%) 61.97 80

Mar '10 49.64 70

Mar '09 97.28 130

Mar '08 133.86 130

Mar '07 85.71 110

When company has made reduction in debt profit has been increased which can be seen from below trend:
37,832.71 41,191.32 2,328.30 29,969.07 33,057.12 1,999.95 24,152.39 25,416.42 1,774.47 22,432.52 29,028.18 1,162.90 20,405.91 20,642.80 1,298.90

Operating Profit PBDIT Interest

Balance Sheet of Reliance Industries

------------------in Rs. Cr. -----------------Mar '11 12 mths Mar '10 12 mths Mar '09 12 mths Mar '08 12 mths Mar '07 12 mths

Sources Of Funds Total Share Capital Equity Share Capital Share Application Money Preference Share Capital Reserves Revaluation Reserves Networth Secured Loans Unsecured Loans Total Debt Total Liabilities 3,273.37 3,273.37 0 0 142,799.95 5,467.00 151,540.32 10,571.21 56,825.47 67,396.68 218,937.00 Mar '11 12 mths 3,270.37 3,270.37 0 0 125,095.97 8,804.27 137,170.61 11,670.50 50,824.19 62,494.69 199,665.30 Mar '10 12 mths 1,573.53 1,573.53 69.25 0 112,945.44 11,784.75 126,372.97 10,697.92 63,206.56 73,904.48 200,277.45 Mar '09 12 mths 1,453.39 1,453.39 1,682.40 0 77,441.55 871.26 81,448.60 6,600.17 29,879.51 36,479.68 117,928.28 Mar '08 12 mths 1,393.21 1,393.21 60.14 0 59,861.81 2,651.97 63,967.13 9,569.12 18,256.61 27,825.73 91,792.86 Mar '07 12 mths

Application Of Funds Gross Block Less: Accum. Depreciation Net Block Capital Work in Progress Investments Inventories Sundry Debtors Cash and Bank Balance Total Current Assets Loans and Advances Fixed Deposits Total CA, Loans & Advances Deffered Credit Current Liabilities Provisions Total CL & Provisions Net Current Assets Miscellaneous Expenses Total Assets Contingent Liabilities Book Value (Rs) 221,251.97 78,545.50 142,706.47 12,819.56 33,019.27 29,825.38 17,441.94 604.57 47,871.89 17,320.60 31,162.56 96,355.05 0 61,399.87 4,563.48 65,963.35 30,391.70 0 218,937.00 41,825.13 446.25 215,864.71 62,604.82 153,259.89 12,138.82 19,255.35 26,981.62 11,660.21 362.36 39,004.19 10,517.57 17,073.56 66,595.32 0 48,018.65 3,565.43 51,584.08 15,011.24 0 199,665.30 25,531.21 392.51 149,628.70 49,285.64 100,343.06 69,043.83 20,268.18 14,836.72 4,571.38 500.13 19,908.23 13,375.15 23,014.71 56,298.09 0 42,664.81 3,010.90 45,675.71 10,622.38 0 200,277.45 36,432.69 727.66 104,229.10 42,345.47 61,883.63 23,005.84 20,516.11 14,247.54 6,227.58 217.79 20,692.91 18,441.20 5,609.75 44,743.86 0 29,228.54 2,992.62 32,221.16 12,522.70 0 117,928.28 37,157.61 542.74 99,532.77 35,872.31 63,660.46 7,528.13 16,251.34 12,136.51 3,732.42 308.35 16,177.28 12,506.71 1,527.00 30,210.99 0 24,145.19 1,712.87 25,858.06 4,352.93 0 91,792.86

46,767.18 439.57

Profit & Loss account of Reliance Industries

------------------in Rs. Cr. -----------------Mar '11 12 mths Mar '10 12 mths Mar '09 12 mths Mar '08 12 mths Mar '07 12 mths

Income Sales Turnover Net Sales Other Income 258,651.15 248,136.06 3,358.61 200,399.79 192,091.87 3,088.05 146,328.07 141,959.00 1,264.03 139,269.46 133,805.78 6,595.66 118,353.71 111,699.03 236.89

Stock Adjustments Total Income Expenditure Total Expenses

3,243.05 254,737.72 213,546.40 Mar '11 12 mths

3,947.89 199,127.81 166,070.69 Mar '10 12 mths

427.56 143,650.59 118,234.17 Mar '09 12 mths

-1,867.16 138,534.28 109,506.10 Mar '08 12 mths

654.6 112,590.52 91,947.72 Mar '07 12 mths

Operating Profit PBDIT Interest PBDT Depreciation Other Written Off Profit Before Tax Extra-ordinary items PBT (Post Extra-ord Items) Tax Reported Net Profit Total Value Addition Preference Dividend Equity Dividend Corporate Dividend Tax Per share data (annualised) Shares in issue (lakhs) Earning Per Share (Rs) Equity Dividend (%) Book Value (Rs)

37,832.71 41,191.32 2,328.30 38,863.02 13,607.58 0 25,255.44 0 25,255.44 4,969.14 20,286.30 15,470.19 0 2,384.99 386.9

29,969.07 33,057.12 1,999.95 31,057.17 10,496.53 0 20,560.64 0 20,560.64 4,324.97 16,235.67 12,381.68 0 2,084.67 346.24

24,152.39 25,416.42 1,774.47 23,641.95 5,195.29 0 18,446.66 0 18,446.66 3,137.34 15,309.32 8,949.83 0 1,897.05 322.4

22,432.52 29,028.18 1,162.90 27,865.28 4,847.14 0 23,018.14 48.1 23,066.24 3,559.85 19,458.29 10,673.96 0 1,631.24 277.23

20,405.91 20,642.80 1,298.90 19,343.90 4,815.15 0 14,528.75 0.51 14,529.26 2,585.35 11,943.40 11,156.07 0 1,440.44 202.02

32,733.74 61.97 80 446.25

32,703.74 49.64 70 392.51

15,737.98 97.28 130 727.66

14,536.49 133.86 130 542.74

13,935.08 85.71 110 439.57

Key Financial Ratios of Reliance Industries

------------------in Rs. Cr. ------------------

Mar '11

Mar '10

Mar '09

Mar '08

Mar '07

Investment Valuation Ratios Face Value Dividend Per Share Operating Profit Per Share (Rs) Net Operating Profit Per Share (Rs) Free Reserves Per Share (Rs) Bonus in Equity Capital Debt Coverage Ratios Interest Cover Total Debt to Owners Fund Financial Charges Coverage Ratio Financial Charges Coverage Ratio Post Tax Liquidity And Solvency Ratios Current Ratio Quick Ratio Debt Equity Ratio Long Term Debt Equity Ratio Profitability Ratios Operating Profit Margin(%) Profit Before Interest And Tax Margin(%) Gross Profit Margin(%) Cash Profit Margin(%) Adjusted Cash Margin(%) Net Profit Margin(%) Adjusted Net Profit Margin(%) Return On Capital Employed(%) Return On Net Worth(%) Adjusted Return on Net Worth(%) Return on Assets Excluding Revaluations Return on Assets Including Revaluations Return on Long Term Funds(%)

10 8 115.58 758.04 431.95 64.41

10 7 91.64 587.37 378.21 64.47

10 13 153.47 902.02 704.28 30.61

10 13 154.32 920.48 520.59 33.14

10 11 146.44 801.57 416.9 34.57

11.66 0.46 17.4 15.56

10.97 0.49 16.08 14.37

11.85 0.65 14.58 12.56

17.05 0.46 19.95 21.9

13.51 0.45 16.06 13.9

1.22 1.01 0.46 0.38

1.11 0.76 0.49 0.44

1.08 0.9 0.65 0.59

1.01 0.94 0.46 0.35

0.77 0.69 0.45 0.32

15.24 9.65 9.76 13.24 13.24 8.08 8.08 12.6 13.88 13.42 446.25 462.95

15.6 10.02 10.13 13.29 13.29 8.35 8.35 11.35 12.64 11.95 392.51 419.43

17.01 13.19 13.35 14.58 14.58 10.65 10.65 10.96 13.36 13.76 727.66 802.54

16.76 13.06 13.14 13.73 13.73 14.45 14.45 15.68 24.66 17.28 542.74 548.73

18.26 13.9 13.95 15.13 15.13 10.64 10.64 18 19.49 19.85 439.57 458.61

13.37 Mar '11 61.97

11.71 Mar '10 49.64

11.34 Mar '09 97.28

17.18 Mar '08 133.86

19.83 Mar '07 85.71

Earnings Per Share

Book Value

446.25

392.51

727.66

542.74

439.57