Profitability Analysis

Profit test is more than a conventional test of economic efficiency. It has a direct bearing on the company’s ability to function as a successful business firm. Further, the company’s ability to tap capital markets and/or other sources of finance (for its growth and additional requirements) would depend on its commercial profitability. Given the significance of financial viability of business operations, the objective of this chapter is to assess the financial performance of the sample companies primarily in terms of profitability with a special focus on the pre- and postrecession period. In other words, financial management of resources in terms of profitability constitutes, by far, the most important element of operational efficiency and hence the significance to study this aspect. Further, to the best of the authors’ knowledge, an analysis of the impact (if any) of the recent recession on such a large sample has not been undertaken. Analysis that follows seeks to answer such basic questions with respect to the sample companies as the following: (a) Are their profits adequate? (b) What rates of return do they earn? (c) Are their returns to equity owners satisfactory? To begin with, the basic components of profits, namely, gross profit and net profit are determined for the sample companies for the entire 11-year period (2001–2011) of the study (subdivided into four phases). Then three sets of rates of return (RoR) have been computed. These are (a) return on total assets (ROTA), (b) return on capital employed (ROCE) and (c) return on ordinary shareholders’ equity (ROSE). The first two rates of return highlight how efficiently financial resources are deployed by the sample companies; the RoR on the common shareholders’ equity indicates the return provided to their equity owners. Given the positive nexus between the effective utilisation of assets and profitability, the analysis has been extended to compute major efficiency ratios, namely, total assets turnover, fixed assets turnover and current assets turnover of the sample companies. Profitability of the sample companies (measured through gross profit and net profit), prima facie, appears to be stable and attractive (as an investment choice). Though the recession in phase 4 (2009–2011) did witness some fluctuations in the profitability of certain constituent sectors like the metals sector, in contrast, select sectors like housing and power increased profits in a statistically significant manner; overall, the sample seems to have emerged unscathed from the impact of the recession, perhaps due to its strong management fundamentals. The other aspects of profitability, namely, return on total assets (ROTA), return on capital employed (ROCE) and earnings for equity owners (reflected in ROSE) appear to be equally satisfactory. All in all, not only are the sample companies deploying funds efficiently and providing adequate returns to the capital providers, they are working towards generating better returns for their shareholders. These findings are notable as well as they support the RBI’s views on the resilience of the Indian economy. In terms of efficiency, the sample companies appear to be doing a commendable job as well. However, there appears to be some scope for improvement in the TATR figures. The sample companies, being amongst the largest in the country, can afford to manage assets better with improved processes and technology.