Financial Analysis of Hindustan Unilever Ltd.

2011-12

Introduction:

An attempt has been made to analyze Hindustan Unilever Ltd.’s overall performance and
assess its current financial standing. The purpose of this analysis is to assess company’s
financial health and performance. Effective decision making requires evaluation of the
past performance of the companies and assessment of the future prospects. The starting
point in analysis is to look at the past record. Information about past performance is
useful in judging future performance. An assessment of the current status will show
where the company stands at present. To a large extent, the expectations of investors and
creditors about future performance are shaped by their evaluation of past performance
and current position. Investors and creditors use information about past to assess the
prospects of a company. Investors expect an adequate return from the company in the
form of the dividends and market price appreciation. Creditors expect the company to pay
interest and repay the principal in accordance with the terms of lending. Therefore they
are interested in predicting the earning power and debt paying ability of the company.
Investors and creditors try to balance expected risks and return.

Needless to mention comparisons are essentially intended to throw light on how well a
company is achieving its objectives. In order to decide the types of comparisons that are
useful, we need first to consider what a business is all about? What its objectives are. A
generalization that the overall objective of a business is to create value for its
shareholders while maintaining a sound financial position; implicit to this statement is the
assumption is that value creation can be measured. Our approach to financial analysis
followed a comprehensive framework of looking at various parameters of company
performance and use different ratio’s to substantiate the analysis.

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The framework of the analysis will be as under:
 Topline Growth
 Profit and Profitability
 Liquidity Analysis
 Assets Growth
 Capital Structure Analysis
 Assets Utilization Ratio’
 Fund Flow Statements
 Market Perception
 Any other distinguishing Feature.

Here ratios and other qualitative aspects have been considered in a sequence intended to
facilitate an understanding of the total business. First as an analysis one has to look at the
firm’s performance in the broadest terms and then worked down through various levels of
detail in order to identify the significant factors that accounted for the overall results. If
the values of the ratios used in this analysis are compared with their values for other time
periods, the comparison is called a longitudinal, or trend analysis.

Dozens of ratios can be computed from a single set of financial statements. Each analyst
tend to have a set of favorite ratios selected from those described below and probably
from some which has not been described. Although here many frequently used ratios
have been described, the best analytical procedure is not to compare all of them
mechanically but rather to describe first which ratios might be relevant in the particular
type of investigation to expertise the trend and its significance.

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 1. Topline Growth

From the Profit and Loss Account we observe that HUL has registered a topline growth
of 12.06 per cent in 2011-2 compared to 2010-11. In absolute terms it has achieved a
topline of Rs 21329.96 crores in 2011-12 compared to Rs 19103.96 crores in the previous
period. Top line of HUL comprises of Sales and Other Operating Income and Other
Income. Both the components have grown at different rates as could be seen from the
Table below.

Table -1 Topline Growth of HUL (Rs in Crores)

2010-11 2011-12 %
growth
A. Income (D+E) 19103.96 21329.96 12.06

B. Sales and Other Operating Income 19735.51 22116.37

C. Excise Duty 904.43 1064.72
D. Sales and Other Operating Income net of Excise 18831.08 21051.65 1.98
Duty
E. Other Income 272.88 278.31 11.65

Sales and Other Operating Income comprise of Sale of Soaps , Synthetic detergents,
personal products tea, and other various products and Other operating income. Table -2
below shows how all these components of sales and other operating income has increased
or decreased compared to last year.

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 Table -2 Break up sales (Rs in Crores)

2010- 2011- Amount %

Items 11 12 changed change
Soaps 3939.71 4303.39 363.68 9.23
Synthetic detergents 4160.1 5373.72 1213.62 29.17
Personal Products 5926.17 6509.82 583.65 9.85
Tea 2097.5 1982.35 -115.15 -5.49
Frozen desserts and ice-creams 271.95 354.32 82.37 30.29
Processed items 15.13 19.23 4.1 27.10
Canned and processed fruits and
veg 575.71 647.91 72.2 12.54
Branded staple food 338.89 377.59 38.7 11.42
Specialty chemicals 1.04 0 -1.04 -100.00
Others 2054.81 2167.27 112.46 5.47

Table -2 reveals that the sales revenue of almost all the items have increased in 2011-12
compared to 2010-2011except Tea and Specialty chemicals. The sales revenue from Tea
has dropped down by 5.49% in 2011-12 compared to 2010-2011. Care should be taken in
this regard. Soaps, detergents, personal products, desserts and ice creams, processed
items, processed fruits, branded staples and others have reported a sales growth of 9.23,
29.17, 9.85, 30.29, 27.10, 12.54 and 5.47 percent respectively in the year 2011-12 in
comparison to its previous year.

2. Profit and Profitability

The ability to generate profit on capital invested is a key determinant of a com-
pany's overall value and the value of the securities it issues. Consequently, many
equity analysts would consider profitability to be a key focus of their analytical
efforts. Profitability ref1ects a company's competitive position to the market, and
by extension, the quality of its management. The income statement reveals the
sources of earnings and the components of revenue and expenses. Earnings can
be distributed to shareholders or reinvested in the company. Reinvested earnings'
enhance solvency and provide a cushion against short-term problems.

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 Table 3: Profitability Ratios

2010-
11 2011-12
A Profit Before Taxes(PBT) 2937.03 3469.03
B Net Finance Charges 0.24 1.24
C Depreciation 220.83 218.25
D EBDITA (A+B+C) 3158.1 3688.52
E Less Depreciation 220.83 218.25
F EBIT (D-E) 2937.27 3470.27
G Interest 0.24 1.24
H PBT (F-G) 2937.03 3469.03
I Tax 631.04 777.63
J PAT(H-I) 2305.99 2691.4

Calculation of Profitability Ratios

Profitability ratios measure the return earned by the company during a period.
Exhibit 12 provides the definitions of a selection of commonly used profitability
ratios.

Definitions of Commonly used Profitability Ratios

Profitability Ratios Numerator Denominator

Return on Sales
EBDITA margin EBDITA Income

EBIT Margin EBIT Income

Pretax margin PBT (Profit before tax Income
but after interest)
Net profit margin Profit After Tax Income

Return on Investment
ROA EBIT Average total assets
Return on capital Employed EBIT Short and long-term
(ROCE) debt and equity
ROE PAT Average total equity

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Return-on-sales profitability ratios express various subtotals on the income
statement (e.g., EBITA, EBIT,PBT,PAT) as a percentage of Income/(Revenue).
Return on investment profitability ratios measure income relative to assets, equity,
or total capital employed by the company. For ROE, return is measured as PAT
(net income i.e., after deducting interest paid on debt capital as also tax ).

Interpretation of Profitability Ratios

In the following, we discuss the interpretation of the profitability ratios presented in
Table - 5. For each of the profitability ratios, a higher ratio indicates greater
profitability.

EBDITA Margin

EBDITA margin indicates the percentage of revenue available to cover operating

and policy related expenditures. Higher EBDITA margin indicates some
combination of higher product pricing and lower product costs. The ability to
charge a higher price is constrained by competition, so EBDITA profit are affected
by (and usually inversely related to) competition. If a product has a competitive
advantage (e.g., superior branding, better quality, or exclusive technology), the
company is better able to charge more for it. On the cost side, higher gross profit
margin can also indicate that a company has a competitive advantage in product
costs.

EBIT Margin
This is calculated EBDITA minus operating costs in this case is only depreciation. So,
EBIT margin increasing faster than the EBDITA margin can indicate improvements in
controlling operating costs. In contrast, a declining/ EBIT margin could be an indicator of
deteriorating control over operating costs.

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Profit Before Tax Margin
Profit Before Tax (also called "earnings before tax") is calculated as EBIT minus interest,
so this ratio reflects the effects on profitability of leverage and other (non-operating)
income and expenses. If a company's pretax margin is rising primarily as a result of
increasing non-operating income, then we should evaluate whether this increase
reflects a deliberate change in a company's business focus and, therefore, the
likelihood that the increase will continue.

PAT Margin
Net profit, or net income, is calculated as revenue minus all expenses. Net profit includes
both recurring and nonrecurring components. Generally, the net profit margin adjusted for
nonrecurring items offers a better view of a company's potential future profitability.

Return on Assets (ROA)

ROA measures the return earned by a company on its assets. The higher the ratio, the
more income is generated by a given level of assets. Most databases compute this ratio as:

Net income
Average total assets

The problem with this computation is net income is the return to equity-holders,
whereas assets are financed by both equity-holders and creditors. Interest expense
(the return to creditors) has already been subtracted in the numerator. Some ana-
lysts, therefore, prefer to add back interest expense in the numerator.' In such cases,
interest must be adjusted for income taxes because net income is determined after
taxes. With this adjustment, the ratio would be computed as:

Net income + Interest expense (I - Tax rate)

Average total assets

Alternatively, some analysts elect to compute ROA on a pre-interest and pretax

basis as:

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Operating income or EBIT
Average total assets

As noted, returns are measured prior to deducting interest on debt capital (i.e., as
operating income or EBlT). This measure reflects the return on all assets invested
in the company, whether financed with liabilities, debt, or equity. Whichever form
of ROA that is chosen, the analyst must use it consistently in comparisons to other
companies or time periods.

Return on Total Capital

Return on total capital measures the profits a company earns on all of the capital that it
employs (short-term debt, long-term debt, and equity). As with ROA, returns are
measured prior to deducting interest on debt capital (i.e., as operating income or EBIT).

ROE
ROE measures the return earned by a company on its equity capital, including minority
shares, preference shares, and ordinary shares. As noted, return is measured as PAT or net
profit (i.e., interest on debt capital is not included in the return on equity capital). A
variation of ROE is return on ordinary shares, which measures, the return earned by a
company only on its common equity.

Both ROA and ROE are important measures of profitability and will be explored in
more detail below. As with other ratios, profitability ratios should be evaluated
individually and as a group to gain an understanding of what is driving profitability
(operating versus non-operating activities).

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 Table 4: Profitability and DuPont Analysis

2010-11 2011-12
ROE (%) 22.63 24.49

ROA (%) 28.90 31.67

Leverage 0.9972 0.9971

Profit Margin (%) 11.37 11.80

Asset Turnover 2.00 2.08

Tax Burden(PAT/PBT) 0.785 0.776

Interest Burden(PBT/EBIT) 0.9999 0.9996

EBIT Margin(EBIT/Income) 13.116 17.344

The return on assets (ROA) of HUL has increased to 31.67% in 2011-12 compared to
28.90% in 2010-11. The ROE of the company has also enhanced from 22.63% in 22.63 to
24.49% in 2011-12. These indicate an improvement of profitability of the company from
the angle of investment of total assets as well as from equity shareholders’ perspective.

DuPont Analysis: The Decomposition of ROE

As noted earlier, ROE measures the return a company generates on its equity capital.
To understand what drives a company's ROE, a useful technique is to decompose
ROE into its component parts. (Decomposition of ROE is sometimes referred to as
DuPont analysis because it was developed originally at that company.) Decomposing
ROE involves expressing the basic ratio (i.e., net income divided by average
shareholders' equity) as the product of component ratios. Because each of these
component ratios is an indicator of a distinct aspect of a company's performance that
affects ROE, the decomposition allows us to evaluate how these different aspects of
performance affected the company's profitability as measured by ROE.
Decomposing ROE is useful in determining the reasons for changes in ROE over

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time for a given company and for differences in ROE for different companies in a
given time period. The information gained can also be used by management to
determine which areas they should focus on to improve ROE. This decomposition
will also show why a company's overall profitability, measured by ROE, is a function
of its efficiency, operating profitability, taxes, and use of financial leverage. DuPont
analysis shows the relationship between the various categories of ratios discussed in
this reading and how they all influence the return to the investment of the owners.

Analysts have developed several methods of decomposing ROE. The decomposition

presented here is one of the most commonly used and the one found in popular
research databases, such as Bloomberg. Return on equity is calculated as:

ROE = PAT(i.e. net income)/Average shareholders’ equity

The decomposition of ROE makes use of simple algebra and illustrates the
relationship between ROE and ROA. Expressing ROE as a product of only two of
its components, we can write:

Net income
ROE 
Average shareholde rs ' equity

Net income Average total assets

 X
Average total assets Average shareholders' equity

Which can be interpreted as:

ROE = ROA x Leverage

In other words, ROE is a function of a company's ROA and its use of financial
leverage ("leverage" for short, in this discussion). A company can improve its ROE
by improving ROA or making more effective use of leverage. Consistent with the
definition given earlier, leverage is measured as average total assets divided by

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 average shareholders' equity. If a company had no leverage (no liabilities), its
leverage ratio would equal 1.0 and ROE would exactly equal ROA. As a company
takes on liabilities, its leverage increases. As long as a company is able to borrow at
a rate lower than the marginal rate it can earn investing the borrowed money in its
business, the company is making an effective use of leverage and ROE would
increase as leverage increases. If a company's borrowing cost exceeds the marginal
rate it can earn on investing, ROE would decline as leverage increased because the
effect of borrowing would be to depress ROA.

Just as ROE can be decomposed, the individual components such as ROA can be
decomposed. Further decomposing ROA, we can express ROE as a product of three
component ratios:

Net income Net income Re venue Average total assets

 x x
Average shareholders' equity Re venue Average total assets Average shareholders ' equity

Which can be interpreted as:

ROE = Net profit margin x Asset turnover x Leverage

The first term on the right-hand side of this equation is the net profit margin, an
indicator of profitability: how much income a company derives per one money unit
(e.g., euro or dollar) of sales. The second term on the right is the asset turnover ratio,
an indicator of efficiency: how much revenue a company generates per one money
unit of assets. 'Note that ROA is decomposed into these two components: net profit
margin and asset turnover. A company's ROA is a function of profitability (net profit
margin) and efficiency (asset turnover). The third term on the right-hand side of is a
measure of financial leverage, an indicator of solvency: the total amount of a
company's assets relative to its equity capital. This decomposition illustrates that a
company's ROE is a function of its net profit margin, its efficiency, and its leverage.
Again, using the data from Example 12 for Anson Industries, the analyst can evaluate
in more detail the reasons behind the trend in ROE:

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To separate the effects of taxes and interest, we can further decompose the net profit
margin and write:

Net income Net income EBT EBIT

 x x
Average shareholde rs ' equity EBT EBIT Re venue

Re venue Average total assets

x x
Average total assets Average shareholde rs ' equity

Which can be interpreted as:

ROE  Taxburden x Interestburden x EBIT m arg in x Asset turnover x Leverage

This five-way decomposition is the one found in financial databases such as

Bloomberg. The first term on the right-hand side of this equation measures the effect
of taxes on ROE. Essentially, it reflects one minus the average tax rate, or how much
of a company's pretax profits it gets to keep. This can be expressed in decimal or
percentage form. So, a 30 percent tax rate would yield a factor of 0. 70 or 70 percent
A higher value for the tax burden implies that the company can keep a higher
percentage of its pretax profits, indicating a lower tax rate. A decrease in the tax
burden ratio implies the opposite (i.e., a higher tax rate leaving the company with
less of its pretax profits).

The second term on the right-hand side captures the effect of interest on ROE.
Higher borrowing costs reduce ROE. Some analysts prefer to use operating income
instead of EBIT for this factor and the following one (consistency is required), In
such a case, the second factor would measure both the effect of interest expense and
non-operating income.

The third term on the right-hand side captures the effect of operating margin (if

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operating income is used in the numerator) or EBIT margin (if EBIT is used) on
ROE. In either case, this factor primarily measures the effect of operating
profitability on ROE.

The fourth term on the right-hand side is again the asset turnover ratio, an indicator
of the overall efficiency of the company (i.e., how much revenue it generates per
unit of assets), The fifth term on the right-hand side is the financial leverage ratio
described above-the total amount of a company's assets relative to its equity capital.

This decomposition expresses a company's ROE as a function of its tax rate, interest
burden, operating profitability, efficiency, and leverage. An analyst can use this
framework to determine what factors are driving a company's ROE. The
decomposition of ROE can also be useful in forecasting ROE based upon expected
efficiency, profitability, financing activities, and tax rates. The relationship of the
individual factors, such as ROA to the overall ROE, can also be expressed in the
form of an ROE tree to study the contribution of each of the five factors, as shown in
below for HUL .

DuPont Analysis of HUL for 2011-12

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 Returnon
Return onEquity:
Equity:
PAT
PAT
Averageshareholders’
Average shareholders’
equity
equity
==24.49%
24.49%

Returnon
Return onAssets:
Assets: Leverage:
Leverage:
PAT
PAT Averagetotal
Average totalassets
assets
Averagetotal
Average totalassets
assets Averageshareholder’s
Average shareholder’sequity
equity
= 31.67%
= 31.67% = 0.9971
= 0.9971

TotalAsset
Total AssetTurnover
Turnover
NetProfit
Net ProfitMargin
Margin
Revenues/
Revenues/
PAT
PAT Averagetotal
Average totalassets
assets
Revenues
Revenues =2.08
=2.08
=11.80%
=11.80%

TaxBurden:
Tax Burden:
InterestBurden:
Interest Burden: EBITMargin:
EBIT Margin:
PAT
PAT PBT
PBT EBIT
EBIT
PBT
PBT EBIT
EBIT Income
Income
=0.776
=0.776 =0.9996
=0. 9996 =17.344%
=17.344%

The most detailed decomposition of ROE that we have presented is a five way
decomposition. Nevertheless, an analyst could further decompose individual
components of a five-way analysis. For example, EBIT margin (EBIT /Revenue)
could be further decomposed into a non-operating component (EBIT/Operating
income) and an operating component (Operating income/Revenues). The analyst can
also examine which other factors contributed to these five components. For
example, an improvement in efficiency (total asset turnover) may have resulted from
better management of inventory or better collection of receivables .

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These relationships suggest the two fundamental ways that the ROI can be improved.
First it can be improved by increasing the profit margin-by earning more profit per rupee
of income sales. Second, it can be improved by increasing the asset turnover. In turn the
asset turnover can be increased in either of the two ways: (1) by generating more sales
volume with the same amount of investment or (2) by reducing the amount of investment
in assets required for a given level of sales volume.

These two factors can be further decomposed into elements that can be looked at
individually. The point of this decomposition is that no one manager can significantly
influence the overall ROI measure, simply because an overall measure reflects the
combined effects of a number of factors. For example the manager who is responsible for
the firm’s credit policies and procedures influences the level of accounts receivable.
Thus, the outside analyst, as well as the firm’s management can use the ROI chart to
identify the potential problem areas in the business.

ROE is obtained as: ROA ×Leverage. For HUL the leverage position has remained
almost unaltered in 2011-12 compared to 2010-11. Hence the increase in ROE is mainly
attributable to increase in ROA. Further ROA is given by Profit margin × Assets
Turnover. The profit margin of HUL has increased from 11.37% in 2010-11 to 11.80% in
2011-12. Moreover, the Assets Turnover of the company has gone up from 2 times in
2010-11 to 2.08 times in2011-12 and both have positively contributed towards the
improvement in ROA. In addition to these, it has also been observed that the interest
burden of the company has remained low consistently in both the financial years.
However, the EBIT margin of HUL as significantly increased from 13.116 2010-11 to
17.344% in 2011-12 implying thereby that the earning ability of the company has gone
up in 2011-12 compared to 2010-11.

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 3. Liquidity

Liquidity refers to the company’s ability to meet its current obligations. Thus liquidity
tests focus on the size of, and relationships between current liabilities and current assets.
(Current assets presumably will be converted into cash in order to pay the current
liabilities.) The importance of adequate liquidity in the sense of the ability of a firm to
meet current/short-term obligations when they become due for payment can hardly be
overstressed. In fact, liquidity is a prerequisite for the very survival of a firm. The short-
term creditors of the firm are interested in the short-term solvency or liquidity of a firm.
But illiquidity implies, from the viewpoint of utilization of the funds of the firm, that
funds are idle or they earn very little. A proper balance between the two contradictory
requirements, that is, liquidity and profitability is required for efficient financial
management. The liquidity ratios measure the ability of a firm to meet its short-term
obligations and reflect the short-term financial strength/solvency of a firm. The ratios
which indicate the liquidity of a firm are: (i) Net working capital, (i) Current ratios, (iii)
Acid test/quick ratios, (iv) Turnover ratios.

Let’s look at operating cycle of a firm which indicates the pattern of liquidity and its
management which gets extended from working capital management. Working capital is
an operational necessity. A firm needs to invest in short term current asset such as
inventory (raw materials, work in progress and finished product) and also needs debtors
to allow it to perform its day to day operations. This investment in current assets is for the
short term, as raw materials will be bought, converted into finished product and sold to
customers who ultimately will pay. For many businesses this cycle will be completed
within a short time frame and will be repeated many times over during the year; for some
other this cycle may become considerably extended. Liquidity, or solvency, means being
able to satisfy financial obligations, without difficulty, as and when they become due.
A firm is considered technically insolvent if it is unable to settle its debts when they
become due for payment. Liquidity is a measure of how easily or speedily an asset can be
converted into cash without any significant loss of value. In liquidity management the

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concern is how the business manages its short-term funds. These are the funds which are
continuously circulating through the business and of which it needs to have a constant
flow to keep it running smoothly on a day-to-day basis. By comparison, gearing or
capital structure management, is to do with managing the firm’s long-term funding and
solvency.

Profitability measures focus on assessing the firm’s return, actual or potential, in contrast
liquidity measures focus more on risk assessment. Profitability ratios tell us something
about a firm’s financial performance, what it has actually achieved. Liquidity ratios are
indicative of a firm’s financial condition, the financial state it is in. Like an athlete,
performance and condition are closely related: an athlete in poor physical condition is
unlikely to achieve an outstanding performance. Effective liquidity management is of
paramount importance for the survival and future development of any organization,
profit-making or not-for-profit. While profitability is clearly extremely important for a
commercial enterprise, it is more often a lack of liquidity rather than a lack of
profitability which causes a business to fail.

For example, even though a company may be generating profitable sales, it can run into
liquidity problems if credit control is weak and the cash is not being collected from
customers and/or if too much money is tied up in stocks (raw materials, work-in-progress
and finished goods.).

In contrast, it is possible for a company to survive – at least in the short-term-and weather

periodic economic storms, even if it is not making profits, by exercising good liquidity
management. This can be done, for example, by managing stocks and debtors efficiency
and keeping the levels of both under tight control. Clearly, survival and growth in the
longer term require a combination of good profitability and sound liquidity.

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Working capital
A firm’s total capital is found from its balance sheet by subtracting its total liabilities
from its total assets. This is represented by the balance sheet equation:

Assets(A) – Liabilities(L) = Capital (C)

Working capital can similarly be found by subtracting current liabilities from current
assets:

Current assets – Current liabilities = Working capital

CA – CL = WC

Technically the difference between the current assets and current liabilities is a firm’s net
working capital, or net current assets, assuming current assets exceed current
liabilities. However, in practice, the difference between current assets and current
liabilities is often simply referred to as working capital.

Working capital, also known as circulating capital, is the amount of money which a
business needs to survive on a day-to-day basis. It should be sufficient to cover:

1. Paying creditors (without difficulty);

2. Allowing trade credit to debtors;
3. Carrying adequate stocks.

The key questions are: is the level of working capital positive? Is it sufficient in relation
to current liabilities? Sufficient working capital is needed, not only to be able to pay bills
on time (e.g. wages and suppliers) but also to be able to carry sufficient stocks and also to
allow debtors a period of credit to pay what they owe. Working capital is the kind of
short-term capital required to finance a firm on a day-to-day basis. It is a key measure of
business liquidity. The more working capital a firm has, the less risk there is of the firm
not being able to pay its creditors when the bills become due. Conversely the less
working capital a firm has, the greater the risk of the firm not being able to pay its
creditors when the bills are due.

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Current ratio
The ratio, also called the working capital ratio, measures the relationship between current
assets and current liabilities. As current liabilities should technically be paid from current
assets, this ratio highlights the firm’s ability to meet its short-term liabilities from its
short-term assets. In other words the firm should not have to sell fixed assets to pay

suppliers for raw materials: if it does then it is clearly in trouble.

Table 5: Current Ratio and Quick Ratio of HUL

2010-11 2011-12
1.Current Assets 6974.25 7798.62

2.Inventories 2810.77 2516.65

3.Quick Assets (1-2) 4163.48 5281.97

4.Current Liabilities 6620.07 6448.7

5. Current Ratio(1/4) Times 1.05 1.21

6.Quick Ratio (3 / 4) Times 0.63 0.82

7. Net Working Capital (1-4) 354.18 1349.92

For HUL the Current Ratio has increased to 1.21:1 in 2011-12 compared to 1.05:1 in
2010-11. It is difficult to say what the ‘ideal’ current ratio should be. Current ratios tend
to be sector-specific, that is, different business sectors are likely to have different ‘typical’
current ratios. For example, what is considered a normal or typical current ratio for a steel
company is likely to be different from a FMCG Company. Therefore care needs to be
taken to ensure that like is being compared with like and that individual ratios are not
being considered in isolation.

It is also possible that an apparently healthy current ratio could actually indicate
inefficient management of stocks and debtors as these may have been allowed to

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accumulate. Conversely an apparently low current ratio may be the result of efficient
stock and debtor management, as these current assets are being turned over quickly and
stock management systems, such as Just in Time (JIT), may be in operation.

A more stringent test of liquidity than the current ratio is ‘the acid test ratio or quick
ratio’. In this case, by subtracting the stock figures from CAs, it is suggested that this
ratio gives a more immediate indication of the firm’s ability to settle its current debts.
This is because stock is less liquid compared to other liquid assets like cash or
receivables. Usually a quick ratio of 1:1 is considered satisfactory. However, here also it
may vary industry wise. For HUL the quick ratio has increased to 0.82:1 in 2011-12
compared to 0.63:1 in 2010-11. This is an indication of the improvement in short term
liquidity of the company in 2011-12 compared to its previous year but still the level of
this ratio is not very high.

However, the quality of current asset also needs to be examined while commenting on the
current assets. Sometimes in the companies’ balance sheet one observes huge amount of
loans and advances. These loans advances in a shorter time span cannot be converted to
liquidity. This point has to be kept in mind while assessing the liquidity of any company.
For HUL it has been observed that the net working capital of the company has increased
to 1349.92crores in 2011-12 from 354.18 crores in 2010-11. This increase is mainly due
to the increase in current investments in 2011-12 (2251.90 crores) compared to its
previous year 2010-11(1140.09 crores). Within these current investments the company
has invested in Mutual Fund units an amount of Rs. 1400 crores in 2011-12 compared to
Rs.750 crores in 2010-11.

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 4. Capital Structure Analysis

Table 6: D/E Ratio and Interest Coverage Ratio of HUL

2010-11 2011-12
Debt Equity Ratio (Debt 0.95% 4.67%
capital /Eq. sh. Cap)
Interest Coverage Ratio 12238.625 times 2798.60 times
(EBIT/Interest)

The analysis of capital structure of HUL reveals that the company has used very
insignificant amount of borrowed capital in comparison to equity capital in both the
financial years 2010-11 and 2011-12. This simply indicates that the company has
financed its capital structure mainly with equity capital. Hence the financial risk of the
company is very negligible. However, the debt equity ratio of the company has increased
to 4.67% in 2011-12 from just 0.95% in the previous year. In fact, debt equity ratios vary
from industry to industry. Firms that have relatively stable demand for their products
(e.g., electricity) tend to have high leverage. In contrast firms that face wide fluctuation in
demand (e.g., consumer goods) prefer to maintain low debt equity ratio. Needless to
mention that HUL falls under the second category.

Interest Coverage Ratio (ICR) is a measure of protection available to creditors for

payment of interest charges by the company. A high ratio implies adequate safety for
payment of interest even if there were a reduction in earnings of the company. The ICR of
HUL has reduced to 2798.60 times in 2011-12 from 12238.625 times in 2010-11.
However, this reduction in ICR is not at all a matter of concern for the creditors of the
company as HUL is still maintaining a very very high ICR in 2011-12 too. The reason
behind such a high ICR is the insignificant amount of interest burden as the company has
not taken much loan capital in its capital structure.

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 5. Assets Growth
Growth in the asset indicates that the companies are making a planned effort to ensure
future revenue earning capacity as well as targeting higher profitability. Expansion or
addition of fixed assets indicates future production capacity there by indicates sustainable
top line growth. In case of addition of balancing equipment it will indicate the company
is trying to achieve competitiveness by managing its cost structure and there by enhance
its bottom line. Addition to the current asset indicates inventory and debtors build up in a
systematic manner to strengthen cash to cash cycle and making the operating cycle move
faster thereby trying to ensure top line growth for the current period. However, there are
cases in companies where current asset is growing by default that is the company is not
able to push it inventory in the market neither it is able to realize its debtors at a faster
rate. For HUL the assets growth is presented below:

Table 7: Assets Growth of HUL

2010- 2011- Amount %
Items 11 12 changed change
Fixed Assets 2457.86 2362.92 -94.94 -3.86
Non current Investments 120.58 186.31 65.73 54.51
Current Assets 6974.25 7798.62 824.37 11.82
Current Liabilities 6620.07 6448.7 -171.37 -2.59
Net Working Capital 354.18 1349.92 995.74 281.14

The above table reveals that the investment in fixed assets has been reduced by 3.86% in
2011-12 compared to its previous period. This reduction is mainly due to reduction in
intangible assets under development. The investment in tangible fixed assets has
remained almost unchanged. Non-current Investments of the company has significantly
increased (54.51%) in 2011-12 compared to 2010-11. Due to increase in current assets
and reduction in current liabilities, the net working capital of HUL has reported a major
enhancement in 2011-12 compared to 2010-11. This aspect has already been discussed
under the liquidity analysis.

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 6. Asset Utilization or Turn over Ratios

Asset utilization ratios indicate how efficiently assets have been used to generate
revenues and thereby profits and is concerned with measuring the efficiency in asset
management. These ratios are also called efficiency ratios or turnover ratios. The
efficiency or productivity measures outputs of a system in relation to inputs; the greater
the volume outputs produced from a given level of inputs the more efficient the system
and the company. This also reflects the speed with which the assets are used to convert
into sales. The greater is the rate of turnover or conversion, the more efficient is the
utilization/management, other things being equal. For this reason, such ratios are also
designated as turnover ratios. Turnover is the primary mode for measuring the extent of
efficient employment of assets by relating the assets to sales. An activity ratio may,
therefore, be defined as a test of the relationship between sales (more appropriately with
cost of sales) and the various assets of a firm. Depending upon the various types of assets,
there are various types of activity ratios.

Inventory Turnover Ratio

This ratio indicates the number of times inventory is replaced during the year. It
measures the relationship between the sales and the inventory level in any period. The
merit of this approach is that it is free from practical problems of computation. The
inventory turnover ratio measures how quickly inventory is sold. It is a test of efficient
inventory management. To judge whether the ratio of a firm is satisfactory or not, it
should be compared over a period of time on the basis of trend analysis. It can also be
compared with the level of other firms in that line of business as also with industry
average as a whole. In general, a high inventory turnover ratio is better than a low ratio. A
high ratio implies good inventory management. Yet a very high ratio calls for a careful
analysis. It may be indicative of under investment in or very low level of inventory. A
very low level of inventory has serious implications. It will adversely affect the ability to
meet customers demand as it may not cope with its requirements, that is, there is a danger
of the firm being out of stock and incurring high “stock out cost”. It is also likely that the
firm may be following a policy of replenishing its stock in too many small sizes. Apart

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from being costly, this policy may retard the production process as sufficient stock of
materials may not be available.

Similarly, a very low inventory turnover ratio is dangerous. It signifies excessive

inventory or over investment in inventory. Carrying excessive inventory involves cost in
terms of interest on funds locked up, rental of space, possible deterioration, and so on. A
low ratio may be the result of inferior quality goods, over-valuation of closing inventory,
stock of unsalable/obsolete goods, and deliberate excessive purchases in anticipation of
future increase in their prices, and so on. Thus, a firm should have neither too high nor
too low inventory turnover. To avoid both “stock out costs” associated with a high ratio
and the costs of carrying excessive inventory with a low ratio, what is suggested is a
reasonable level of this ratio. A company would be well advised to maintain a close
watch on the trend of the ratio and significant deviations on either side should be
thoroughly investigated to locate the factors responsible for it.

The utilization ratios of HUL are presented below:

Table 8: Utilization ratios of HUL

Items 2010-11 2011-12

1. Net Sales 19735.51 22116.37
2. Inventory 2810.77 2516.65
3. Trade Receivables 943.21 678.99
4. Working Capital 354.18 1349.92
5. Inventory T.O.(1/2) times 7.02 8.79
6. Receivables T.O(1/3) times 20.92 32.57
7. Working Capital T.O (1/4) 55.72 16.38
8. Inventory holding period(360 days /
5) days 51.27 40.96
9. Debt Collection period(360 days /
6)days 17.21 11.05

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The inventory turnover ratio for HUL has gone up from 7.02 times in 2010-11 to 8.79
times in 2011-12 indicating higher turnover in 2011-12 with lesser inventory holding.
How many days sales equivalent is blocked in the inventory can be calculated by dividing
360 days in a year by inventory turnover ratio. We can see from the above table that last
year 51.27 days equivalent of sales were blocked in inventory which has gone down to
40.96 days in 2011-12 which shows better utilization of inventory.

Receivable (Debtors) Turnover Ratio and Average Collection Period. The second
major activity ratio is the receivables or debtors turnover ratio. Allied and closely related
to this is the average collection period. It shows how quickly receivables or debtors are
converted into cash. In other words, the debtors’ turnover ratio is a test of the liquidity of
the debtors of a firm. The liquidity of a firm’s receivables can be examined in two ways:
(i) Debtors or receivables turnover; (ii) Average collection period. The debtors’ turnover
shows the relationship between the sales and debtors of a firm. Average Collection
period for HUL were 17.21 days in 2010-11 and in 2011-12 it has reduced to 11.05 days.
This ratio also measures the liquidity of a firm’s debtors and here this HUL has reported a
major improvement over the last year.

7. Market Perception

How a company’s performance is viewed by investors is reflected in its (actual and

potential) market price of share. How a company has done is reflected in its earnings per
share.

Earning per Share

The earnings per share figure is one of the most important ratios used by investment
analysis, yet it is one of the most deceptive. If no dilutive securities are present in the
capital structure, then earnings per share is simply computed by dividing PAT by number
of ordinary shares. IF, however, convertible securities, stock options, warrants, or other
dilutive securities are included in the capital structure, (1) earnings per equity and equity

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equivalent shares and (2) fully diluted earnings per share figures may have to be used.
For HUL basic earnings per share in 2010-11 were Rs.10.58 for 1 rupee fully paid up
share which has increased to Rs. 12.46 in 2011-12. The diluted EPS of HUL has not
changed to a large extent from its basic EPS in both the periods.

Certain problems exist when the earnings per share ratio is computed. Often earnings per
share can be increased simply by reducing the number of shares outstanding through buy
back of share by the company. In addition, the earnings per share figure fail to recognize
the probable increasing base of the stockholders’ investment. That is, earnings per share,
all other factors being equal, will probably increase year after year if the corporation
reinvests earnings in the business because a larger earnings figure is generated without a
corresponding increase in the number of shares outstanding. Because even-well informed
investors attach such importance to earnings per share, caution must be exercised, and it
should not be given more emphasis than it deserves. The common problem is that the per-
share figure draws the investor’s attention away from the enterprise as a whole – which
involves differing magnitudes of sales, costs volumes, and invested capital and
concentrates too much attention on the single share of stock.

P/E Ratio
The price earnings (P/E) ratio is an off-quoted statistic used by analysts in discussing the
investment possibility of a given enterprise. It is computed by dividing the market price
of the stock by its earnings per share. A steady drop in a company’s price earnings
ratio indicates that investors are wary of the firm’s growth potential. Some companies
have high P/E multiples, while others have low multiples. This measure involves an
estimation not directly controlled by the company: the market price of its ordinary
shares. Thus the P/E ratio is the best indicator of how investors judge the future
performance (We say future performance because, conceptually the market price
indicates shareholders’ expectations about future returns dividend and share price
increases-discounted to a present value at a rate reflecting the riskiness of these returns.)
Management is of course interested in this market appraisal, and a decline in the
company’s P/E ratio, if not explainable by a general decline in stock market prices is a

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cause for concern. Also, management compares its P/E ratio with those of similar
companies to determine the market place’s relative rankings of the firms.

P/E ratios of industries vary, reflecting differing expectations about the relative rate of
growth in earnings in those industries. At times, the P/E ratios for virtually all companies
decline, predictions of general economic conditions suggest that corporate profits will
decrease and/or interest rates will rise.

Cash Flow Statement: Interpretation from the Cash Flow statement of the company.

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