Capital Structure of a Company refers to the composition or make up of its Capitalization and it includes all long term Capital resources i.e. loans, reserves, shares and bond. It shows the mix of a company's long-term debt, specific short-term debt, common equity and preferred equity. The capital structure is how a firm finances its overall operations and growth by using different sources of funds.In finance, capital structure refers to the way a corporation finances its assets through some combination of equity, debt, or hybrid securities. A firm's capital structure is then the composition or 'structure' of its liabilities. For example, a firm that sells $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 tens of sources. Gearing Ratio is the proportion of the capital employed of the firm which come from outside of the business finance, e.g. by taking a short term loan etc.Debt comes in the form of bond issues or long-term notes payable, while equity is classified as common stock, preferred stock or retained earnings. Short-term debt such as working capital requirements is also considered to be part of the capital structure structure. A company's proportion of short and long-term debt is considered when analyzing capital Structure. When people refer to capital structure they are most likely referring to a firm's debt-to-equity ratio, which provides insight into how risky a company is. Usually a company more heavily financed by debt poses greater risk, as this firm is relatively highly levered. The long term creditors would judge the soundness of the firm on the basis of the long term financial strength measured in terms of ability to pay the interest regularly as well as repay the installment of the principal on due dates or in one lump sum at the time of maturity. Accordingly, there are two different, but mutually dependent and interrelated, types of leverage ratio First Ratio which are based on the relationship between borrowed funds and owner's capital. In this Paper, researcher explain the different leverage ratio as also how they can be used to draw inferences regarding the financial soundness of the firm.
ABOUT THE COMPANY
Indian Oil Corporation is a public sector petroleum company. It is India's largest commercial enterprise, ranking 116th on the Fortune Global 500 listing (2008). It began operation in1959 as Indian oil company ltd. The Indian Oil Corporation was formed in 1964, with the merger Indian refineries ltd. Indian oil group of Companies owns and operates 10 of India's 19 refineries with combined refining capacity of 60.2 million metric tones per day.
India, being a vast country, a wide network of pipelines becomes the paramount requirement of transporting petroleum products to interiors from refineries and crude oil to the land lock refineries For the year 2008-09, Indian oil's eight refineries achieved the highest ever throughput of 51.4 million tones and 103.4% capacity utilization registering 8.4% growth in crude oil processing over the previous year.
Company owns and operates country's largest pipeline network of 10000 km. Commissioning of Indian new projects worth about 2300 crore including LPG and R-LNG pipelines will reach the capacity to 75 million metric tones per annum. For transporting crude oil and petroleum products, registered the highest ever-operational throughput of 59.5 million tones in 2008-09 as compared to the previous year. The crude oil pipelines registered a 6.7% growth at 38.2 million tones in 2008-09. Over the last four decades the pipeline network of Indian Oil has grown to 9273 km with a capacity of about 62 million metric tones per year. Indian Oil plans to take the group refining capacity 80 million tones per annum by the year 2011-12.
Indian Oil Corporation Ltd has registered a profit of after Tax of Rs. 284 crore for the second quarter of the current financial year ended September 30, 2009 as compared to a loss of Rs. 7047 crore for the same quarter of the previous year. The unaudited financial results of the corporation were taken on record at the meeting of the Board of directors. The corporation sold 16.726 million tones of products, including exports, during the second quarter of 2009-10. Its eight refineries registered a combined throughput of 12.412 million tones, with a capacity utilization of 99.9 Percent.The Corporation's pipeline network to registered 83.0 percent capacity utilization with a throughput of 15.536 million tones for the same period. Indian oil plays a key role in the Petrochemical industries currently building its petrochemicals business as a major driver of growth. The Corporation is envisaging an investment of Rs. 30,000 crore in the petrochemicals business in the next few years.
Objective of the Study
This research study fulfills the following objectives:-
To examine the Capital Structure policy and pattern of IOCL.
To examine the relationship between Profitability and Capital Structure of the company.
To give suggestions for improvement of the Capital Structure composition of Indian Oil corporation Ltd.
Limitations of the Study
This Capital Structure Analysis of IOCL is based on analysis of the financial Statement For Last three years i.e. 2006-07 to 2008-09. Only secondary data has been used in this study which is derived from annual reports of IOCL.
Data and Research Methodology
For an analysis of the Capital Structure of Indian Oil Corporation Ltd. (IOCL), Secondary data, complied from the annual reports of IOCL, from the year 2006-07 to 2008-09 were used along with other Published material of IOCL. In this Study ratio of Capital Structure, common size Statement and trend analysis techniques are used.
Finding and detailed discussion
The Capital Structure of a corporation consists of debt and equity securities, which finance for a firm. An optimum Capital Structure is one that market valuation of the company's securities in order to minimize the cost of capital structure ratios or leverages to draw inferences regarding the financial soundness of IOCL, The following ratios related to Capital Structure are used:-
Total Debt to Equity Ratio
Debt-to-Equity ratio indicates the relationship between the external equities or outsiders funds and the internal equities or shareholders funds. It is also known as external internal equity ratio. It is determined to ascertain soundness of the long term financial policies of the company. A high ratio shows a long share of financing by the creditors of the firm; low ratio implies a smaller claim of the creditors. Debt to equity ratio indicates the proportionate claims of owners and the outsiders against the firm's assets. The purpose is to get an idea of the cushion available to outsiders on the liquidation of the firm. However, the interpretation of the ratio depends upon the financial and business policy of the company. The owners want to do the business with maximum of outsider's funds in order to take lesser risk of their investment and to increase their earnings (per share) by paying a lower fixed rate of interest to outsiders. The outsider's creditors) on the other hand, want that shareholders (owners) should invest and risk their share of proportionate investments. A ratio of 1:1 is usually considered to be satisfactory ratio although there cannot be rule of thumb or standard norm for all types of businesses. Theoretically if the owner's interests are greater than that of creditors, the financial position is highly solvent. In analysis of the long-term financial position it enjoys the same importance as the current ratio in the analysis of the short-term financial position.
Table: 1- Total Debt to equity ratio
Year
Debt (Rs.)
Equity (Rs.)
Ratio
2006-07
27183
34857
0.78:1
2007-08
35523
41086
0.86:1
2008-09
44972
43998
1.02:1
Average
35834.33
39980.33
0.90:1
As per Table: 1 Total debt to equity ratio for the year 2006-07 is 0.78:1 and it has continuously increased with 0.8 and 0.16 in the subsequent years i.e.,2007-08 and 2008-09.it is clear that the total debt and equity both are continuously increase and the average Debt equity ratio is 0.90:1. It shows that company maintains a balance between their debt and equity.
Long term Debt to Equity Ratio
It is also known as solvency ratio. It is a ratio between long term debt and total long term funds (i.e., Capital employed). This ratio measures the long-term financial position of long term funds which is raised by way of debt. A higher proportion is not considered good. It is also one of the important ratios that explain the Capital Structure position of the company.
Table: 2- Long term Debt to Equity Ratio
Year
Long term debt
Equity
Ratio
2006-07
13594.23
34857
0.39:1
2007-08
14380.1
41086
0.35:1
2008-09
18919.14
43998
0.43:1
Average
15631.16
39980.33
0.39:1
As per Table:-2 Long term debt to equity ratio is 0.39:1 in the year 2006-07 but after that it has been decreased with 0.04 in the year 2007-08, it means company repaid some long term borrowings in the year 2007-08.it has again increase with 0.8 in the next year 2008-09 with the overall average of 0.39:1.it shows that the company continuously efforts to pay their long term borrowings.
Proprietary Ratio
This is a variant of the debt-to-equity ratio. It is also known as equity ratio or net worth to total assets ratio. This ratio relates the shareholder's funds to total assets. Proprietary / Equity ratio indicates the long-term or future solvency position of the business. Shareholder's funds include equity share capital plus all reserves and surpluses items. Total assets include all assets, including Goodwill. Some authors exclude goodwill from total assets. In that case the total shareholder's funds are to be divided by total tangible assets. This ratio throws light on the general financial strength of the company. It is also regarded as a test of the soundness of the capital structure. Higher the ratio or the share of shareholders in the total capital of the company better is the long-term solvency position of the company. A low proprietary ratio will include greater risk to the creditors.
Table: 3- Proprietary Ratio
Year
Proprietary fund
Equity
Ratio
2006-07
34857
69382.52
0.50:1
2007-08
41086.25
85703.3
0.48:1
2008-09
43998.18
67715.06
0.65:1
Average
39980.33
74266.96
0.54:1
As per the Table: 3 Proprietary ratio of the IOCL is in fluctuate trend during the study period. In the year 2006-07 it has 0.50:1 and in the year 2007-08, 0.48:1.it means it has decreased with 0.02 in the year 2007-08.after that tit has again increase with 0.17 and the overall average is 0.54:1. it shows the that the position of IOCL is medium.
Fixed Asset Ratio
The Relationship between fixed assets and Shareholders fund is called fixed asset ratio. If the ratio is less then 100%, it implies those owners' funds are not sufficient. The ratio of fixed assets to networth indicates the extent to shareholders fund is in to fixed assets.
Table: 4 Fixed Asset Ratio
Year
Net Fixed Asset
Net worth
Ratio
2006-07
33370
34857
0.95:1
2007-08
32772
41086
0.79:1
2008-09
34778
43998
0.79:1
Average
33640
39980.33
0.84:1
As per table: 4, fixed asset ratio of IOCL is 0.95:1 in the year 2006-07and after that it stayed at 0.79:1 in the subsequent years 2007-08 and 2008-09 with overall average growth rate of 0.84:1. when we analyzing ,we find that company's net worth is continuously increase while fixed assets is in up and down trend. it means company improves net worth as compare to fixed assets.
Return on Equity
It is the ratio of net profit to share holder's investment. It is the relationship between net profit (after interest and tax) and share holder's/proprietor's fund. This ratio establishes the profitability from the share holders' point of view. The ratio is generally calculated in percentage. The two basic components of this ratio are net profits and shareholder's funds. Shareholder's funds include equity share capital, (preference share capital) and all reserves and surplus belonging to shareholders. Net profit means net income after payment of interest and income tax because those will be the only pr This ratio is one of the most important ratios used for measuring the overall efficiency of a firm. As the primary objective of business is to maximize its earnings, this ratio indicates the extent to which this primary objective of businesses being achieved. This ratio is of great importance to the present and prospective shareholders as well as the management of the company. As the ratio reveals how well the resources of the firm are being used, higher the ratio, better are the results. The firm comparison of this ratio determines whether the investments in the firm are attractive or not as the investors would like to invest only where the return is higher.
Table: 5- Return on Equity
Year
Net Profit After Tax
Net Worth
%
2006-07
7499
34857
21.51%
2007-08
6963
41086
16.94%
2008-09
2950
43998
6.71%
Average
5804
39980.33
0.14%
As per table: 5, the percentage of Return on Equity is constantly decreasing from the year of 2006-07 to 2008-09. it is 21.51% in the year of 2006-07 and 16.94% in 2007-08 and after that it was quite down in 2008-09,i.e, 6.71%.it means investor's situation is not satisfactory.
Return on Capital Employed
Capital employed and operating profits are the main items. Capital employed may be defined in a number of ways. However, two widely accepted definitions are "gross capital employed" and "net capital employed". Gross capital employed usually means the total assets, fixed as well as current, used in business, while net capital employed refers to total assets minus liabilities. On the other hand, it refers to total of capital, capital reserves, revenue reserves (including profit and loss account balance), debentures and long term loans. The prime objective of making investments in any business is to obtain satisfactory return on capital invested. Hence, the return on capital employed is used as a measure of success of a business in realizing this objective. Return on capital employed ratio is considered to be the best measure of profitability in order to assess the overall performance of the business. It indicates how well the management has used the investment made by owners and creditors into the business. It is commonly used as a basis for various managerial decisions. As the primary objective of business is to earn profit, higher the return on capital employed, the more efficient the firm is in using its funds. The ratio can be found for a number of years so as to find a trend as to whether the profitability of the company is improving or otherwise.
Table: 6- Return on Capital Employed
Year
PBIT
Capital Employed
%
2006-07
11990
41477.82
28.90%
2007-08
11626
47501.78
24.47%
2008-09
8281
61563.13
13.45%
Average
10632
50180.91
21.18%
As per Table:6 the ROCE is 28.90% in 2006-07 but after that it is continuously decreased with 4.43% and 11.02% in the year 2007-08 and 2008-09.it means company's profitability is not in satisfactory position and it is quite alarming for the company.
Earning Per Share
Earnings per share ratio (EPS Ratio) are a small variation of return on equity capital ratio and are calculated by dividing the net profit after taxes and preference dividend by the total number of equity shares. The EPS is an important ratio for the stock market. In the market, any ordinary investor looks to the Earning per share and also the P/E ratio which reflects the current market value as the number of times of the earning per share are considered. During the boom period in the share markets, especially when the issues were able to command a premium, the lead managers and the corporate justified the premium in terms of comparable P/Es of similarly placed firms. It is a different matter altogether that the markets today having taken a beating, do not present the sentiments that were expected. This also brought out a fact or a realization that two firms in the industry need not have the market capitalization set on same P/E levels.
Table: 7 - Earning Per Share
Year
PBIT
No. of Equity Share
Rs.
2006-07
7499
1168.01
64.20
2007-08
6963
1192.37
58.39
2008-09
2950
1192.37
24.74
Average
5804
1184.25
16.30
As per Table: 7 earning per share is in decreasing trend from the year 2006-07 to 2008-09. EPS has decreased Rs. 5.81 in 2007-08 as compared to 2006-07 and Rs. 33.65 in 2008-09 as compared to 2007-08 with the overall average of Rs.16.30. this is quit alarming for the company.
Financial Leverage Ratio
Financial leverage ratio is the relationship between earning before interest and tax (EBIT) and earning before tax (EBT). This ratio shows the earning available for equity shareholders before paying tax. The term financial leverage return to the use of fixed charge; such as a debenture and the use of variable charge on securities: whereas the return available to the equity shareholders, which is residual balance, is affected by the charge in EBIT.
Table: 8- Financial Leverage
Year
EBIT
EBT
Ratio
2006-07
11990
10485
1.14
2007-08
11626
10080
1.15
2008-09
8281
4329
1.91
Average
10632
8298
1.28
As per table :8 financial leverage of the company regularly increased during the study Period. It increased with 0.01 in the year 2007-08 as compared to 2006-07 and again grown up to 0.76 in 2008-09 as compared to the previous year.
Interest Coverage Ratio
Interest coverage ratio is also known as debt service ratio or debt service coverage ratio. This ratio relates the fixed interest charges to the income earned by the business. It indicates whether the business has earned sufficient profits to pay periodically the interest charges. This Ratio is measure the debt servicing capacity of a firm in so far as fixed interest on long term loan is concerned. It is determined by dividing the operational profits or earning before interest and tax by fixed interest charges on loans. it measures the margin of safety for lenders and debenture holders. A high interest coverage ratio means that the firm can easily meet its interest burden even if earning before interest and tax suffer a considerable.
Table: 9- Interest Coverage Ratio
Year
EBIT
Fixed Interest
Ratio
2006-07
11990
1505
7.96:1
2007-08
11626
1546
7.52:1
2008-09
8281
3952
2.09:1
Average
10632
2334.33
4.55:1
As per table: 9 the interest coverage ratio is regularly decrease during the study period. It shows that the company easily paid their interest burden in the year of 2006-07 and 2007-08 but after that the ratio is quite down in 2008-09.Means Company is not paying easily their interests as compared to the previous year i.e., 2006-07 and 2007-08.
Findings and Conclusions-
Indian oil Corporation Ltd. plays a key role in the Petrochemical industries currently building its petrochemicals business as a major driver of growth. The Corporation is envisaging an investment of Rs. 30,000 crore in the petrochemicals business in the next few years. Indian Oil creates customer delight and to stay ahead of the competitors with demand for petroleum products and services in India, projected to grow 368 million metric tons by 2025. At the time when the petroleum industry is moving towards new horizons, exploring new technologies, collaborating and developing symbiotic relationships to ensure secure, environment - friendly and affordable energy supplies, Indian oil too is seeking quantum leaps in its core business, adding on new and emerging segments on the way.
After the analysis of Capital structure of the company which is the India's largest petroleum company in Public sector, it is clear that the capital structure Pattern of IOCL includes equity Share capital and borrowing capital. Both are constantly Shows tremendous increasing trend. In the year 2006-07, Equity is 34857 crore, after that it reached in 43998 crore, while borrowing capital is also in increasing trend, it was 27188 crore in the year 2006-07,which is grown up to 44972 crore in the year 2008-09. Debt is a cheaper source of financing and IOCL is continuously using full use of this source. It is clear that company maintains a optimum balance between debt and equity. Interest Coverage Ratio also discloses a secret of the concern regarding EBIT and fixed interest charges. In the year 2006-07 EBIT are Rs.11990 crore on Equity reserve of Rs.34857 crore and it is decrease in the year 2008-09,i.e. Rs. 8281 crore in comparison of equity reserve of Rs. 43998 crore, it shows decreasing trend in EBIT while Equity Reserves shows a rapid growth. Fixed interest Charges stayed with nominal difference in the year 2006-07 and 2007-08 but it is quite down in 2008-09, it shows a lower earning and lower inters paid in 2008-09. The growth rate of net fixed assets is down than basis of100% but we can say that is near about 100% so that it shows the sufficient level of working capital in concern. In this study it is also concluded that IOCL should try to run the business as per its maximum capacity in the market. It also suggested that company must improve their EBIT in favors of investors as comparison of their investments because company's EPS is continuously down in the market and it is not the good symbol for the company. Finally, after analyzing the above study we wish and believe that Indian oil is well positioned for future growth and prosperity.
