Project for Fin-I Asset Management

8/9/2019 Project for Fin-I Asset Management

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INDEX

1.0 INTRODUCTION 3

2.0 OBJECTIVES OF THE STUDY 4

3.0 METHODOLOGY 4

4.0 FINDINGS OF THE STUDY 7

5.0 CONCLUSION 12

6.0 BIBLIOGRAPHY 13

7.0 APPENDICES I,II &III


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ABSTRACT

Every enterprise needs efficient Asset Management as overall corporate strategy to

create shareholder value. Asset Management is a business process and a decision

making frame work, it is the way in which assets are managed can have a significant

impact on both the liquidity and profitability of the company.

Asset turnover is the main tool to measure the degree of efficiency with which the

assets are being used. This is done by relating the asset turn over to the sales. The

conventional approach says that a low asset turnover is an indication of decreasing

profitability of a company. In our paper, we have tried to study relation between

asset turnover and profitability of a company and establish, if possible, a linkage

between the two parameters. The study is based on 10 selected companies in the

Indian industry for the period 2005 to 2007.

I. INTRODUCTION

Efficient asset management is supposed to be the most important ingredient of the overall

corporate strategy to create shareholder value. The speed with which assets are converted

into sales denotes the efficiency with which the assets are being used. The greater is the

rate of conversion, the more efficient is the utilization of assets. Assets management can

have a significant impact on both the liquidity and profitability of the company.

In this paper, we test the relationship between Return on Asset, Receivable Turn Over

Ratio, Inventory Turn Over Ratio and Asset Turn.

We examine whether considering the relative contributions of asset turnover and profitmargin to total operating profitability improves forecasts of changes in profitability,

defined as return on assets, one year ahead. We also test whether the year-to-year changes

in asset turnover and profit margin provide incremental information over the change in

total return on assets for forecasts of the change in return on assets one year ahead.


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Asset turnover measures the firms ability to generate revenues from its assets while

profit margin measures the firms ability to control the costs incurred to generate the

revenues. The level of asset turnover, reflecting the firms asset utilization, and the profit

margin, reflecting the firms operating efficiency, are in part products of the firms

strategy.

Assets turnover is the primary mode for measuring the extent of efficient employment of

the assets by relating the assets to sales. It is an empirical question whether a high value

of asset turnover is beneficial for the companys profitability. A firm can have larger

sales with a very liberal credit policy, which extends the age of debtors.

In this case, the longer age of debtors may result in higher profitability. However, thetraditional view of the relationship between asset turnover and corporate profitability is

that a low value of asset turnover hurts the profitability of a firm. In this paper, an attempt

has been made to investigate empirically the relationship between the firms efficiency in

asset management and its profitability.

The remainder of this paper is structured as follows. Section II presents the objectives of

the study. Section III deals with the methodology adopted in this study. In Section IV, the

findings of the study are discussed. Section V gives a brief conclusion about the study

II. OBJECTIVES OF THE STUDY

i To assess the effect of efficiency in asset management on profitability in the Indian

industry by computing Karl Pearsons simple correlation coefficient between the selected

profitability measure and each of the selected ratios relating to measurement of efficiency

in asset management. The assessment is done for each of the companies selected in this

study and also taking all the selected companies as a whole.

ii To evaluate the joint influence of the selected efficiency ratios on the profitability

taking all the selected companies in a consolidated.


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III. METHODOLOGY OF THE STUDY

The study is based on 10 selected companies in the Indian industry. These companies

selected for the study are :

i) Dabur

ii) BHEL

iii) GAIL

iv) Aditya Nuvo Birla

v) Cipla

vi) Tata Chem

vii)Essar Steel

viii) Mahindra & Mahindra

ix) Hero Honda

x) Hindustan Lever Ltd

The data of the above selected companies for the period 2005 to 2007 used in the study

has been collected from the websites of the respective companies. The data has been

analyzed by using statistical techniques like Karl Pearson Correlation analysis and

multiple regression analysis. The ratios used in this study for measuring asset

management efficiency are :

(a) Receivable Turnover Ratio (RTR)

(b) Inventory Turnover Ratio (ITR) and

(c) Asset Turnover ratio (ATR).

In this study the Return on Assets (ROA) has been taken as the profitability

The description of the above parameters are described as below:

Return on Assets (ROA)

Return on assets is an indicator of how profitable a company is before leverage, and is

compared with companies in the same industry. Since the figure for total assets of the

company depends on the carrying value of the assets, some caution is required for

companies whose carrying value may not correspond to the actual market value. Return
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on assets is a common figure used for comparing performance of financial institutions

(such as banks), because the majority of their assets will have a carrying value that is

close to their actual market value. Return on assets is not useful for comparisons between

industries because of factors of scale and peculiar capital requirements (such as reserve

requirements in the insurance and banking industries).

ROA can be computed as:

ROA = Net income + Interest Expense / Total Assets

This number tells you "what the company can do with what it's got", i.e. how many

dollars of earnings they derive from each dollar of assets they control. It's a useful

number for comparing competing companies in the same industry. The number will vary

widely across different industries. Return on assets gives an indication of the capital

intensity of the company, which will depend on the industry; companies that require large

initial investments will generally have lower return on assets.

Receivable Turnover Ratio(RTR)

Receivable Turnover Ratio is one of the Accounting Liquidity ratios, a financial ratio.

This ratio measures the number of times, on average, receivables are collected during the

period. A popular variant of the receivables turnover ratio is to convert it into an Average

Collection Period in terms of days. Remember that the Receivable turnover ratio is

figured as "turnover times" and the Average collection period is in "days".

An accounting measure used to quantify a firm's effectiveness in extending credit as well

as collecting debts. The receivables turnover ratio is an activity ratio, measuring how

efficiently a firm uses its assets.

Formula:

Net Credit Sales

Receivable Turn over = --------------------------------------

Average account Receivable
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Some companies' reports will only show sales - this can affect the ratio depending on the

size of cash sales. By maintaining accounts receivable, firms are indirectly extending

interest-free loans to their clients. A high ratio implies either that a company operates on

a cash basis or that its extension of credit and collection of accounts receivable is

efficient.

A low ratio implies the company should re-assess its credit policies in order to ensure the

timely collection of imparted credit that is not earning interest for the firm.

Inventory turnover ratio (ITR)

Inventory turnover reflects how frequently a company flushes inventory from its system

within a given financial reporting period. The measure can be computed for any type of

inventorymaterials and supplies used in manufacturing or service delivery, work in progress (WIP), finished products, or all inventory combined. With the exception of

finished product inventory, the measure applies to service and manufacturing businesses.

The guidance below addresses whatever type of inventory you choose to measure

however, the benchmarks for good performance will vary by type of inventory and

industry.

Inventory turnover ratio is one of the Accounting Liquidity ratios, a financial ratio.

This ratio measures the number of times, on average, the inventory is sold during the

period. Its purpose is to measure the liquidity of the inventory. A popular variant of the

Inventory turnover ratio is to convert it into an average days to sell the inventory in

terms of days. Remember that the Inventory turnover ratio is figured as "turnover times"

and the average days to sell the inventory is in "days".

Inventory turnover ratio = Cost of goods sold / Average inventory

Average days to sell the inventory = 365 / Inventory Turnover Ratio

Asset Turn Over Ratio (ATR)

Formula:

Revenue

Asset Turn over = --------------------------------------
http://en.wikipedia.org/wiki/Financial_ratiohttp://en.wikipedia.org/wiki/Financial_ratio


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Total Asset

Companies with low profit margins tend to have high asset turnover, those with high

profit margins have low asset turnover - it indicates pricing strategy.

This ratio is more useful for growth companies to check if in fact they are growing

revenue in proportion to sales

III. FINDINGS OF THE STUDY

The efficient asset management is linked with profitability or not is being examined in

Exhibit 1 and Exhibit 2. The 10 Indian companies are studied for 3 consecutive years

from 2005 to 2008. The Karl Pearsons simple correlation coefficient has been calculated

between OROA and each of the selected ratios (ITR, RTR and AT). The significance test

is done by calculating t value and significance level is tested with p value with

confidence limit of 95%. As we know that receivable management plays role in firms

profitability so it is expected that a positive relationship should exist between RTR and

OROA. Table 1 shows that in 5 out of 10 companies under study, RTR was positively

associated with OROA. However in none of the companies the relationship is found

statistically significant. Both positive and negative relationships are observed. All the

companies are taken as a whole and statistically significant positive association is

observed. At the same time simple regression analysis is done for the relationship of RTR

and OROA (Exhibit) and it is observed that r2 is 0.407 which means that 40.7%

variability of OROA is linked with RTR. The relationship observed is

OROA = 0.218+ .0075 RTR

This means that for every 1 unit increase in RTR the OROA increase by .0075 units.

Table -1: Karl Pearsons Simple Correlation Analysis between the selected

Profitability Measure and Ratios Indicating Efficiency in Asset Management of the

selected Companies in Indian Industry


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Company

Correlation

Coefficient

Between

RTR and

OROA(r1)

t

Value

of r1

Correlation

Coefficient

Between ITR

and

OROA(r2)

t

Valu

e of

r2

Correlation

Coefficient

Between

OLTR and

OROA(r3)

t Value

of r3


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DABUR -0.28 -0.29 -0.96 -3.46 -0.20 -0.20

BHEL 0.69 0.94 0.94 2.78 0.9999 80.50

GAIL -0.31 -0.33 0.90 2.12 -0.62 -0.80

Aditya Birla

Nuvo -0.62 -0.80 0.34 0.36 -0.96 -3.28

Cipla 0.21 0.21 -0.94 -2.67 0.78 1.27

Tata Chem. -0.99 -6.21 0.87 1.75 0.97 4.15

Essar Steel -0.34 -0.37 0.996 11.11 0.79 1.27

M & M 0.33 0.35 0.87 1.73 -0.69 -0.96

Hero Honda 0.96 3.39* -0.23 -0.23 0.88 1.90

HLL 0.95 3.13* -0.999

-

20.20 0.84 1.56

* Significant at 5% level.

Table -2: Karl Pearsons Simple Correlation Analysis Between The Selected

Profitability Measure and Ratios Indicating Efficiency in Asset Management of the

Selected Companies in The Indian Industry

(Taking All The Selected Companies in a Consolidated Manner)

Company Avg. ITR Avg.RTR Avg. AT Avg.OROA

Aditya Birla Nuvo 3.00 9.41 0.79 0.06BHEL 1.98 1.90 1.84 0.36

Cipla 1.57 3.61 1.16 0.30

DABUR 3.94 22.34 3.18 0.51

Essar Steel 2.73 14.33 0.78 0.20

GAIL 17.11 18.18 1.10 0.25

Hero Honda 26.12 64.66 4.44 0.65

HLL 4.20 26.13 6.12 0.76

M & M 6.96 14.90 2.25 0.29

Tata Chem 2.44 6.57 0.98 0.16

Table no 3: Multiple Correlation Analysis and Multiple Regression Analysis of the

Selected Companies in The Indian Industry

(Taking All The Selected Companies in a Consolidated Manner)

Multiple Correlation of Regression Equation of OROA on RTR, ITR and AT:

OROA on RTR, ITR and AT : OROA = b0+b1 RTR+b2 ITR+b3 OLTR


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Mode

l

Sum of

Squares Df

Mean

Square F Sig.

1 Regressio

n.408 3 .136 23.331 .001(a)

Residual .035 6 .006Total .442 9

a Predictors: (Constant), AT, RTR, ITR

b Dependent Variable: OROA

Model Summary

Mode

l R R Square

Adjusted

R Square

Std. Error

of the

Estimate

1 .960(a) .921 .882 .07630

a Predictors: (Constant), AT, RTR, ITR

Coefficients(a)

Mode

l

Unstandardized

Coefficients

Standardized

Coefficients t Sig.

B

Std.

Error Beta B

Std.

Error1 (Constant

).079 .043 1.831 .117

RTR .003 .007 .102 .394 .707

ITR -.001 .004 -.050 -.153 .883

AT .118 .023 .957 5.198 .002

OROA = .079+.003 RTR-.001 ITR+.118 AT

It is believed that more the ITR better is the profitability so positive relationship isexpected between ITR and OROA. Exhibit 1 shows that in 6 out of 10 companies under

study, ITR is positively associated with OROA. However one positive association and

one negative association depict statistically significant relationship. Both positive and

negative relationships are observed. All the companies are taken as a whole and

statistically insignificant positive association is observed between ITR and OROA. At the


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same time simple regression analysis is done for the relationship of ITR and OROA

(Exhibit) and it is observed that r2 is 0.117 which means that 11.7% variability of

OROA is linked with ITR. The relationship observed is

OROA = 0.286+ .0099 ITR

This means that for every 1 unit increase in ITR the OROA increase by .0099 units.

It is generally accepted that a higher Asset Turnover (AT) indicate efficient long-term

asset management and this in turn increases profitability. Exhibit 1 shows that in 6 out of

10 companies under study, AT is positively associated with OROA. However only one

positive association shows statistically significant relationship. Both positive and

negative relationships are observed. All the companies are taken as a whole and

statistically insignificant positive association is observed between AT and OROA. At the

same time simple regression analysis is done for the relationship of AT and OROA

(Exhibit) and it is observed that r2 is 0.865 which means that 86.5% variability of

OROA is linked with AT. The relationship observed is

OROA = 0.097+ .114 AT

This means that for every 1 unit increase in AT the OROA increase by .114 units.

Multiple regression analysis is done and shown in Exhibit .. By this analysis joint

influence of all the efficiency ratios (ITR,RTR, AT) on the profitability is studied. The

mean of the ratios used in this analysis have been taken. Thet test with significance

value (p) is taken to check the statistically significance of the model.

The regression equation derived from the analysis is: OROA = X0+X1 RTR+X2 ITR+X3

AT

where X0 is the intercept, X1, X2 and X3 are the partial regression coefficients. It is

observed from exhibit.. that the relationship is OROA = .079+.003 RTR-.001 ITR+.118

AT

Table 3 shows that for one unit increase in ITR, the OROA decreased by 0.001 units.

For the one unit increase in RTR and AT the OROA increases by .003 and .118 units


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respectively. Both ITR and RTR partial regression coefficients were found to be

statistically insignificant. The r2 value is 0.921 which shows that 92.1% variation in

OROA is influenced by receivable turnover, inventory turnover and asset turnover ratios.

V. CONCLUSION

As far as relationship between RTR and OROA is observed, no significant pattern was

found because both positive and negative relationship exists. But when examined as

whole there is significant positive relationship found between RTR and OROA. 40.7%

variability of OROA is linked with RTR. The relationship observed is

OROA = 0.218+ .0075 RTR

This means higher the RTR, the better is the profitability.

For the relationship of ITR with OROA there is no significant relationship is observed. In

simple and multiple regression analysis the association between ITR and OROA is found

to be insignificant. The combined position as observed in multiple regression shows

negative value which leads us to conclude that weak evidence exist for an inverse

relationship between inventory turnover and profitability.

Both positive and negative association/correlation exist between asset turnover and

profitability with different companies. But when examined as whole for all the 10

companies under study the AT shows strong positive correlation with OROA. Moreover

simple as well as multiple regression analysis shows significant positive association of

OROA with AT and as AT increases the OROA also increases. So widely accepted rule

of positive linkage of larger asset turnover with profitability is proved in this study.

Findings of multiple regression analysis gives the equation of

OROA = .079+.003 RTR-.001 ITR+.118 AT

This shows asset management shows positive and significant contribution in

profitability. RTR is although positive but value in combine analysis is

insignificant and ITR is having insignificant inverse relationship. So AT is the


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only parameter in combined analysis by which profitability can be confidently

predicted.

The multiple regression analysis shows that the r2 value is 0.921 which shows that

92.1% variation in OROA is influenced by efficient management of receivable

turnover, inventory turnover and asset turnover. So proper management of above

parameter is important and asset turnover is the most important parameter to

influence the profitability.

References:

1. Chandra Prasanna (2001) : Financial Management : Theory & Practice,

Tata McGraw Hill publishing Co Ltd, Delhi

2. Ross, Westerfield, Jaffe (2004) : Corporate Finance, Tata McGraw Hill

publishing Co Ltd, Delhi3. Pandey IM (2005) ; Financial Management : Vikas Publishing House Pvt

Ltd, New Delhi

Websites:

http://en.wikipedia.org/

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