A

SUMMER TRAINING REPORT

ON
INDIAN OIL CORPORATION LIMITED

SUBMITTED IN PARTIAL FULFILLMENT OF THE REQUIREMENT OF

BACHELOR OF BUSINESS ADMINISTRATION (BBA)
Maharaja Agrasen Institute of Management Studies
ON
CASH MANAGEMENT

Training Supervisor Submitted By

Ms. KAKOLI BOSE VIPUL
ASST.MANAGER (F) ENROLLMENT NO.

SESSION

MAHARAJA AGRASEN INSTITUTE OF

MANAGEMENT STUDIES

PREFACE
1
This is to certify that Mr.VIPUL Doing BBA at Maharaja Agrasen Institute
Of Management Studies, ROHINI has done a project entitled CASH
MANAGEMENT at INDIAN OIL CORPORATION LTD.

Ms.Kakoli Bose
Asst.Manager (F)

Acknowledgement

People must have guidance in doing their work and know where
to turn for help & guidance.
- Anonymous

2
It is said no learning is possible without any proper guidance and no research endeavor
is a solo exercise, some contribution is performed by various individuals.

This project work, which is a step in the field of professionalism, has been successfully
accomplished only because of the timely support of well-wishers. We would like to pay
our sincere regards and thanks to those, who directed us at every step in this project work.

We would like to thanks Ms Kakoli Bose , who allowed us to undertake this project and
provided his valuable guidance in doing it and supporting throughout the term of the
project. It was a learning experience to work under her guidance.

VIPUL

3
 LIST OF TABLES/FIGURES

TABLES PAGE NO.

World largest corporation 12

Petroleum refining 13
Data of Green Park 60
Final Outcome 61
DBASE Format 62
DATA State Offices 66

FIGURES

Marketing design 25
Refineary 37
Pipelines 38
Marketing 39
Marketing Network 40

TABLE OF CONTENTS
Sl.NO. Page No.

CHAPTER-1 INTRODUCTION

4
 1.1 Overvie of industry as a whole 6
1.2 Profile of the organization 8
1.3 Competition information 13
1.4 S.W.O.T Analysis 14

CHAPTER-2 OBJECTIVE & METHODOLOGY

2.1 Significance 19
2.2 Mangerial usefulness of study 20
2.3 Objective 26
2.4 Scope of study 30
2.5 Methodology 31

CHAPTER-3 CONCEPTUAL DISCUSSION 33

CHAPTER-4 DATA ANALYSIS 81

CHAPTER-5 ANNEXURES 86

CHAPTER-6 CONCLUSION 90

CHAPTER-7 LIMITATIONS 91

CHAPTER-8 RECCOMENDATION 92

CHAPTER-9 BIBLOGRAPHY 93

CHAPTER-10 GLOSSARY 94

INTRODUCTION

1.1 OVERVIEW OF INDUSTRY AS A WHOLE

The Beginning

5
 Oil is one of the most important factors contributing to the economic
development of a country. The production and consumption of oil in a country has
become a barometer of the countrys economic growth and prosperity.
When India became independent, it had just one refinery at Digboi. This refinery,
owned by the Assam Oil Company, processed the entire production of less than 0.3
million tones. The countrys annual oil consumption was less than 3 million tones. For
over 90% of its needs, it was dependent on imports. But the thrust of Indias rapid
economic growth and quick pace of industrialization demanded more and more
petroleum products.
With the advent of economic planning three refineries were set up, to process
crude oil, by international oil companies; two at Bombay in 1954 and 1955 and the third
at Vishakhapatnam in 1957. But, this wasnt enough. India had to build up her own
resources to minimize her dependence on foreign imports.
Prime Minister, Pundit Jawaharlal Nehru declared in Indias Parliament on May
26,1956 Oil is of vast importance in the world today. A country that does not produce its
own oil today is in a weak position. From the point of view of defence, the absence of oil
is a fatal weakness.
So, in order to protect national interest, the Government of India decided to
establish a nationally owned and controlled oil industry in India under the Ministry of
Petroleum and Chemicals. The Oil and Natural Gas Commission and Oil India Limited
were formed to search for oil in 1956 and 1959 respectively. To refine crude oil, Indian

Refineries Limited was set up in August 1958. To market it, government set up
the Indian Oil Company in July 1959 as state owned oil-marketing company.

6
 1.2 PROFILE OF THE ORGANISATION

Vision

A major diversified, transnational, integrated energy company, with national leadership and a
strong

environment conscience, playing a national role in oil security & public distribution.

Distinctions

7
Indian Oil Corporation Ltd. (IndianOil) is India's largest commercial enterprise, with a sales

turnover of Rs. 2,47,479 crore (US $ 61.70 billion) and profits of Rs. 6,963 crore

(US $ 1.74 billion) for the year 2007-08. IndianOil is also the highest ranked Indian company
in

the prestigious Fortune 'Global 500' listing, having moved up 19 places to the 116th position
in

2008. It is also the 18th largest petroleum company in the world.

8
Indias Downstream Major

Beginning in 1959 as Indian Oil Company Ltd., Indian Oil

Corporation Ltd. was formed in 1964 with

the merger of Indian Refineries Ltd. (established 1958).

IndianOil and its subsidiaries account for 49%

petroleum products market share, 40.4% refining capacity and

69% downstream sector pipelines

capacity in India.

For the year 2007-08, the IndianOil group sold 59.29 million tonnes of petroleum products,
including

1.74 million tonnes of natural gas, and exported 3.33 million tonnes of petroleum products.
The IndianOil Group of companies owns and operates 10 of India's 19 refineries with a

combined refining capacity of 60.2 million metric tonnes per annum (MMTPA, .i.e. 1.2
million barrels

per day). These include two refineries of subsidiary Chennai Petroleum Corporation Ltd.
(CPCL) and

one of Bongaigaon Refinery and Petrochemicals Limited (BRPL).

The Corporation's cross-country network of crude oil and product pipelines, spanning about
9,300 km

and the largest in the country, meets the vital energy needs of the consumers in an efficient,

9
economical

and environment-friendly manner.

IndianOil is investing Rs. 43,393 crore (US $10.8 billion) during the period 2007-12 in
augmentation

of refining and pipeline capacities, expansion of marketing infrastructure and product quality

upgradation as well as in integration and diversification projects.

Network Beyond Compare

As the flagship national oil company in the downstream sector,

IndianOil reaches precious petroleum
products to millions of people everyday through a countrywide
network of about 34,000 sales points.
They are backed for supplies by 166 bulk storage terminals and
depots, 101 aviation fuel stations and
89 Indane (LPGas) bottling plants. About 7,100 bulk consumer pumps are also in operation
for the
convenience of large consumers, ensuring products and inventory at their doorstep.

IndianOil operates the largest and the widest network of petrol & diesel stations in the
country,
numbering over 17,600. It reaches Indane cooking gas to the doorsteps of over 50 million
households
in nearly 2,700 markets through a network of about 5,000 Indane distributors.

IndianOil's ISO-9002 certified Aviation Service commands over 62% market share in aviation
fuel
business, meeting the fuel needs of domestic and international flag carriers, private airlines

10
and the
Indian Defence Services. The Corporation also enjoys a dominant share of the bulk consumer
business,
including that of railways, state transport undertakings, and industrial, agricultural and
marine sectors.

Customer First

At IndianOil, customers always get the first priority. New initiatives are launched round-the-
yearfor the
convenience of the various customer segments.
Exclusive XTRACARE petrol & diesel stations unveiled in select urban and semi-urban
markets offer
a range of value-added services to enhance customer delight and loyalty. Large format
Swagat brand
outlets cater to highway motorists, with multiple facilities such as food courts, first aid, rest
rooms and
dormitories, spare parts shops, etc. Specially formatted Kisan Seva Kendra outlets meet the
diverse
needs of the rural populace, offering a variety of products and services such as seeds,
fertilisers,
pesticides, farm equipment, medicines, spare parts for trucks and tractors, tractor engine oils
and
pump set oils, besides auto fuels and kerosene. SERVOXpress has been launched recently as a
one-stop shop for auto care services.

To safeguard the interest of the valuable customers, interventions like retail automation,
vehicle
tracking and marker systems have been introduced to ensure quality and quantity of
petroleum products.

11
Table 1.1

12
 Table 1.2

1.3 Competition Information

13
 The major competitors of IOC are HPCL & BPCL. To overcome the increasing
competition and to become the markets no.1 holder, IOC is spending a lot on
advertisement also. It improves the image of the organization and also gives
information about the company to the common man.

1.4 SWOT ANALYSIS

For a long time the company had monopoly in the downstream sector but with the
changing time, more and more private and multinational companies are entering the

14
sector, IOC is facing competition. But with the vast distribution and pipeline network, it
will have an edge over them. The following analysis throws light on the various facets of
the present position of IndianOil.

STRENGTHS

Most powerful player- IOC being the only Indian Company to be listed and
ranked 191 in the fortune global 500 companies holds a strong brand image. It is
the most powerful petroleum corporate in the downstream sector. It owns 7 out of
the 17 refineries of the country in public sector contributing to 55% of the nations
requirements.

Experience- IndianOil has been in the petroleum sector for the past 41 years.
During these years it has gathered a lot of valuable expertise and learned the trick
of trade, the tougher way. It has enjoyed unlimited protection and nurturing from
the government, which helped it grow and gain a substantial hold of the market.

This experience will be valued more as and when it will face competition with the
upcoming firms in the sector.

Pipeline network- IndianOil has a pipeline network of 6268 kms throughout the
country running right from Guwahati in the East to Kanda in the West. It also
reaches the Northern Region to Jallandar and plans to extend till Udhampur. This
decreases the transportation

cost to a great extent for the company. This is a major advantage as the other
private refineries coming up will have very little or no

15
 transporting both crude oil as well as finished products. So IndianOil has a
natural edge over these companies.

Distribution infrastructure- The Company operates the largest marketing network

of 19000 sale points in the country. It has 5026 captive consumer outlets and 52
jubilee retail outlets. It has over 3000 LPG distributorships bottled in 50 bottling
plants throughout the country. It also owns 92 Aviation Fuel Stations and 1294
SERVO shops across the nation. It also handles 853 tankers. This facilitates
uninterrupted supply of products throughout the year. Such extensive distribution
network is nothing but the muscles of the organization making it stronger and
tougher to compete with others. The wide distribution network of the corporation
takes care of the imports and exports.

Rural reach- in rural areas it has 231 multipurpose distribution centers. IndianOil
has over 100 Indane LPG distributorship commissioned in rural and semi-rural
areas. This helps to cater to the need of population of rural, remote and far flung
areas constituting about 75% of the countrys population.

WEAKNESSES

Governments control- The functioning of IOC is greatly influenced by the

governments policy and regulations. The government has 82% stake in the
company, thus, gaining the control of the company. There is always a risk of its
proposal being rejected as there is uncertain political environment prevailing in
the country.

Large size- IndianOil is a huge organization having its head office at Mumbai, 4
regional offices, 15 state offices, 44 divisional offices and 33 area offices. It
employs 30162 employees in various levels of organizational hierarchy. This
leads to slowing down of processes and inefficient performance due to numerous

16
 departmental layers. Handling such large pool of human resource and
channelizing their skills in a direction same as that of the organization is not an
easy task. This hinders the fast growth required by the organization.

Peoples perception- In our country, the perception of the corporate and

consumers towards government organizations and offices is not favorable,
hence though IOC is the only Fortune 500 company and has grown by leaps and
bounds, it is still viewed as an inefficient company, not getting the due
importance.

Retail market share- Even though IOC controls most of the retail outlets it has
market share of only 33.8% in petrol and 39.6% in diesel registering an increase
of 0.5% and 0.3% respectively over the last year. This is comparatively very small
as compared to its size, reach and production. This is because of the fact that its
retail outlets are concentrated more in semi-urban areas and rural areas

OPPORTUNITIES

More revenue- with the dismantling of APM by 2002, IOC will be able to fix the
prices of its products without government intervention resulting in an upsurge in
the revenue earned. Firstly, the new players will use the infrastructure facilities
provided by IOC and pay for the services rendered; for example, IOCL has signed
the marketing rights agreement for 10 years with RPL. Secondly, by reducing the
existing prices to the permissible extent and providing better facilities. This will
help them capture more market share making it harder for the new players to grab
the market.

Modernization- The liberation of the economy has attracted many foreign players
to invest in our country. Again, with the liberalization of the oil economy, more
and more MNCs are entering the sector. They will bring with them the latest

17
 technology available. IOCL can utilize their services by means of joint ventures,
collaborations and tie-ups, for modernization and capacity augmentation of its
plants and refineries increasing the quality as well as the quantity of its product

Intensifying infrastructure- the competitors entering the sector are still not fully
operational. While they are building up there infrastructure IOC should grab the
opportunity to extend and strengthen it in deficient areas. It can modernize its
plants and augment its capacity, extend pipelines to central and southern regions
facilitating cheaper transport in those areas. Also more jubilee retail outlets, which
are state-of-the-art, should be commissioned in different parts of the country for
greater customer satisfaction.

THREATS

Tastes of competition- as we are closing in on the dismantling of APM we already

see a lot of private participation in the sector. With the government opening the
upstream sector and taking away the sole right of distribution from PSUs, private
players see a lot of scope for business. As a result Reliance has already entered the
field and has started production and ESSAR refineries is following suite. If these
companies are able to do profitable business in this sector then other national and
multinational companies will also be lured into this field. IOCs shift from a
monopoly in the protected environment to a free market will not be easy.

Price wars- In this free market operation, where all the firms have the full liberty
to control the prices of their products, a price war is certain to happen in the near
future, since this will be a major factor in determining their market share. If
MNCs with deep pockets decide to enter this sector then they may be able to
make this war tougher by cutting down prices even below the permissible level,
initially to capture market share.

18
 Better-equipped competitors- The new players will give tough competition, as
they will have latest technology and more advanced research and development
resources, skills and expertise. They will have better and more efficient machines
capable of producing more and better. They will have easy access to foreign
markets due to their global presence and standards

OBJECTIVE AND METHODOLOGY

2.1 SIGNIFICANCE

Towards customers and dealers:- To provide prompt, courteous and efficient

service and quality products at competitive prices.

Towards suppliers:- To ensure prompt dealings with integrity, impartiality and

courtesy and help promote ancillary industries.
Towards employees:- To develop their capabilities and facilitate their
advancement through appropriate training and career planning. To have fair
dealings with recognised representatives of employees in pursuance of healthy
industrial relations practices and sound personnel policies.
Towards community:- To develop techno-economically viable and environment-
friendly products. To maintain the highest standards in respect of safety,
environment protection and occupational health at all production units.
Towards Defence Services:- To maintain adequate supplies to Defence and other
para-military services during normal as well as emergency situations.

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2.2 MANAGERIAL USEFULLNESS OF STUDY

ANALYSIS ON THE BASIS OF 4 S MODEL OF Mc KINSEY

MODEL FOLLOWED:

1. Strategy

2. Style

3. Skills

4. Structure of the marketing division

1. STRATEGY:

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Strategies can be defined as the policies or the guidelines, which are being used in any
organization. Strategies of any company can be changed with the change in business
atmosphere or the increase in the competition. But there can be some strategies in the
organization, which will remain the same over a period of time because of their nature.

Internal Strategies:

To provide the quality products.

To provide various schemes to the customers as already launched like IOC Extra
and Credit Card etc.
To provide the products with best satisfaction to the retailers (Industries, Aviation)
as well as to the customers.
To concentrate more on customer orientation than profit maximization.
To provide better working environment to the employees to attract the potential
employees as well as satisfy the present employees.

Broad Area:

IOCL has been developed all over the country. There is no area left in
the country where Indian Oil doesnt have its retail outlets. It has its retail outlets
not only in urban area but also in rural areas .It has its retail outlets in under

developed areas like J&K, Himachal Pradesh, Leh etc. where the means of
transportation is very costly as well as rare. In J&K in spite of terrorism and
Kargil war, Indian Oil has provided the required oil without fear. So it has helped
in nations security and integration also.

21
 Indian Oil is providing its services to Airlines also. Aviation is one of the major
customers of the company and it is providing the best quality product to Airlines.
It is providing the facility inside the Airport only so that the requirements can be
met at any time.

EXPORTS:

IndianOil exports its products mainly to Kenya, Bangladesh, and Dubai etc. Most
of the times the NAPHTA is being exported to these countries. But the company
has to face losses on these exports. Though it has a big domestic market, at times

in case of excess the products are exported.It also exports Lubricants to Dubai,
Kenya etc. with profits because of regular dealings with these countries.

2. STYLE:

Since with the increase in the competition and new inventions, training has become the
necessity of any organization. IndianOils employees are being trained from time to time
as per requirement. The various measures of training adopted in IOC are:

Off the job training.

Lecture system.
Group discussion.
Seminars etc.

22
Since all these measures of training are indirect and less motivating because the
employees are not actually put into work. So the company should try to adopt the system
of On the Job Training where the employees are actually given hands on work for what
they are being trained. This system is more effective and motivating than any other
system

3. SKILLS:

The term Recruitment means to attract the potential employees to apply in the
organization. It is also one of the most important systems in any organization. The
success of any company depends on its employees. In IOC people are being recruited on
the basis of the qualification required for the particular job.

The written examinations are conducted as per the requirements and the selected
candidates are called for an interview. There are no direct placements in the company.

First division professional degree holders and Post Graduates from relevant disciplines
are recruited as management/engineering trainees, officers, accountants, medical officers,
lab officers, system officers, communication officers, scientists etc.

4 . STRUCTURE FOR THE MARKETING DIVISION

It can be broadly divided into 3 categories as represented by the following ways

MARKETING
23
 AVIATION L.P.G PETROL

AIRLINES AIRFORCE

Fig 1.1

There are only 2 major customers for aviation products namely airlines and air force.
After the deregulations of aviation products in 1992, maintaining high market share has
been a challenging task for the company.

For marketing of L.P.G , the company has divided the total market into various areas
headed by respected area officers .

24
2.3 OBJECTIVES

FINANCIAL OBJECTIVES

To ensure adequate return on capital employed and maintain a reasonable annual

dividend on its equity capital.

To ensure maximum economy in expenditure.

To generate sufficient internal resources for partly/wholly financing expenditure

on new capital projects.

To develop long term corporate plans to provide adequate growth of the activities
of the corporation.

25
 To continue to make an effort in bringing reduction in the cost of production of
petroleum products by means of systematic cost control.

FINANCIAL GOALS

To inculcate cost consciousness in user departments.

Proper implementation of budgetary control and submission of MIS in time.
To keep the level of inventories below the level fixed by the Board of Outstanding
Debts, loans & advances and claims at bare minimum.
Ensure payment on due date to various agencies.
Monitor capital expenditure to ensure completion within stipulated time and cost.

26
 ]

SPECIFIC OBJECTIVE

Study is conducted to understand and analyze the working of Banking Section

in IOCL.

To understand the various Accounts prepared in the Banking

To understand the various Reconciliations prepared in the Banking Section.

To find out the various causes of the unmatching of the Reconciliation.

To identify the open items and unmatched items.

To analyze and clear the open items.

To interpret the results thereof and to reach at some conclusion.

To understand the practical difficulties faced in the Banking Section.

To study the overall Objectives and Obligations of the company.

27
 GENERAL OBJECTIVES

Employees recommendation regarding future strategies, ideas and various skills

required for the various fields.
To study the structure of the organization.

To study the S.W.O.T ANALYSIS

2.4 SCOPE OF THE STUDY

28
The study has been conducted in the Indian oil corporation (marketing division), New
Delhi. It covers the preparation of the reconciliation in the I.O.C.L and the problems
encountered ion the preparation of the same. The study is mainly done to found out
various causes of the unmatching of the reconciliation. It covers the perception of various
respondents (mostly officers), through interview on the system of reconciliation and
various other activities included in it. The study is limited to the Northern Region of IOC
only.

2.5 METHODOLOGY

The study requires majority of primary data for the completion of the project. Viewing
the work done by the various staff and the executives of the organization has collected

29
primary data. Executives were chosen on the basis of their in depth knowledge and work
experience in the company and in the Banking section.

The second source of data collection is the secondary data, which is collected from the
past-recorded files, annual reports of the company and also from some other financial
statements. The monthly magazines published by the company Indian Oil News and
Parivar is also one of the most important sources of data collection.

RESEARCH DESIGN

This study has been conducted in New Delhi (IOCL) Northern Region. I
had taken the required information from the officers related to the
banking section.

Capital Structure: Theory and

Analysis
Capital Structure

Financing decisions involve raising funds for the firm. It is

concerned with formulation and designing of capital structure or
30
leverage. The most crucial decision of any company is involved in
the formulation of its appropriate capital structure. The best design
or structure of the capital of a company helps the management to
achieve its ultimate objectives of minimising overall cost of
capital, maximising profitability and also maximising the value of
the firm.
The capital structure decision of a firm is concerned with the
determination of debt equity composition. Capital structure
ordinarily implies the proportion of debt and equity in the total
capital of a company. The term capital may be defined as the long
term funds of the firm. Capital is the aggregation of the items
appearing on the left hand side of the balance sheet minus current
liabilities.
In other words capital may be expressed as follows:
Capital = Total Assets Current Liabilities.
Further, capital of a company may broadly be categorised into
equity and debt. The total capital structure of a firm is represented
in the following figure:

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 TOTAL CAPITAL

EQUITY CAPITAL DEBT CAPITAL

EQUITY SHARE CAPITAL TERM LOANS

PREFERENCE SHARE DEBENTURES
CAPITAL DEFERRED PAYMENTS
SHARE PREMIUM LIABILITIES
RETAINED EARNINGS OTHER LONG TERM DEBT

Established companies generally have track record of their profit

earning capacity, which helps them to create their creditworthiness.
The lenders feel safe to invest their funds in such companies. Thus,
there is ample scope for this type of companies to collect debt. But
a company cannot freely i.e. without having any limit. The
company must have to chalk out a plan to collect a debt in such a
way that the acceptance of debt becomes beneficial for the
company in terms of increase in EPS, profitability and value of the
firm.
If the cost of capital is greater than the return, it will have an
adverse effect on companys profitability, value of the firm and its
EPS. Similarly, if company is unable to repay the debt within the
scheduled period it will affect the goodwill of the company in the
credit market and consequently may create problems in future for
collecting further debt. Other factors remaining constant, the
32
company should select its appropriate capital structure with due
consideration.

Capital structure involves a choice between risk and expected

return. The optimal capital structure strikes the balance between
these risks and returns and thus examines the price of the stock.

Significant variations with regard to capital structure can easily be

noticed among industries and firms within the same industry. So it
is difficult to generate the model capital structure for all business
undertakings. The following is an attempt to consolidate the
literature on various methods to suggested by researchers in
arriving at optimal capital structure.
Notations used:

V = value of firm

FCF = free cash flow

WACC = weighted average cost of capital

rs and rd are costs of stock and debt

re and wd are percentages of the firm that are financed

with stock and debt.

Operating and Financial Leverages

The term leverage refers to the ability of a firm in employing long
term funds having a fixed cost, to enhance returns to the owners.
In other words leverage is the employment of fixed assets or funds
for which a firm has to meet fixed costs or fixed rate of interest
obligation irrespective of the level of activities attained or the level
of operating profit earned.

33
Higher the leverage, higher the profits and vice versa. But a
higher leverage obviously implies higher outside borrowings and
hence riskier if the business activity of the firm suddenly takes a
dip. But a low leverage does not necessarily indicate prudent
financial management, as the firm might be incurring an
opportunity cost for not having borrowed funds at a fixed cost to
earn higher profits.

Operating Leverage
Operating leverage is concerned with the operation of any firm.
The cost structure of any firm gives rise to operating leverage
because of the existence of fixed nature of costs. This leverage
relates to the sales and profit variations.

Operating Contribution
Leverage = EBIT

Contribution = Sales Variable Costs

EBIT = Earnings Before Interest and Taxes.

Disadvantages of Operating Leverages

The reliability of operating ratios rests to a large extent on the
correctness of the fixed costs identified with a product.
Faulty apportionment would distort the usefulness of the
ratio.
The published accounts does not give details of the fixed cost
incurred and the contribution from each product and for an
outsider it is difficult to calculate the firms operating
leverage.

34
 Firms cost structure and nature of the firms business affects
operating leverage. A degree change in sales volume results in
more than proportionate change (+/-) in operating (or loss) can
be observed by use of operating leverage.

Financial Leverage

This ratio indicates the effects on earnings by rise of fixed cost

funds. It refers to use the use of debt in the capital structure.
Financial leverage arises when a firm deploys debt funds with
fixed charge. The ratio is calculated with the following:
Earnings before interest and tax / Earnings after interest
The higher the ratio, the lower the cushion for paying
interest on borrowings. A low ratio indicates a low interest
outflow and consequently lower borrowings. A high ratio is
risky and constitutes a strain on profits. This ratio is
considered along with the operating ratio, gives a fairly and
accurate idea about the firms earnings, its fixed costs and the
interest expenses on long term borrowings.
Earnings per Share Higher financial leverage leads to
higher EBIT resulting in higher EPS, if other things remain
constant. Financial leverage affects the variability and
expected level of EPS. The more debt the firm employs the
higher its financial leverage. Financial leverage generally
raises expected EPS, but it also increases the riskiness of
securities as the debt / asset ratio rises.

Financial EBIT
Leverage = EBT

EBIT Earnings Before Interest and Tax

EBT Earnings Before Taxes.
Consider Two Hypothetical Firms

35
Firm U Firm L

No debt 10,000 of 12% debt

20,000 in assets 20,000 in assets

40% tax rate 40% tax rate

Both firms have same operating leverage, business risk, and EBIT
of 3,000. They differ only with respect to use of debt.

Impact of Leverage on Returns

Firm U Firm L
(Fig. in Rs000)
EBIT 3,000 3,000
Interest 0 1,200
EBT 3,000 1,800
Taxes (40%) 1, 200
720
NI 1,800 1,080
ROE 9.0% 10.8%

More EBIT goes to investors in Firm L.

Total dollars paid to investors:

U: NI = Rs.1,800.

L: NI + Int = Rs.1,080 + Rs.1,200 = Rs.2,280.

Taxes paid:

U: Rs.1,200; L: Rs.720.

36
Now consider the fact that EBIT is not known with certainty.
Determining the impact of uncertainty on stockholder
profitability and risk for Firm U and Firm L
Firm U: Unleveraged

Economy
(Fig. in Rs000)

Bad Avg. Good

Prob. 0.25 0.50 0.25

EBIT 2,000 3,000 4,000

Interest 0 0 0
EBT 2,000 3,000 4,000
Taxes (40%) 800 1,200 1,600
NI 1,200 1,800 2,400

Firm L: Leveraged

Economy
(Fig. in Rs000)

Bad Avg. Good

37
Prob.* 0.25 0.50 0.25
EBIT* 2,000 3,000 4,000
Interest 1,200 1,200 1,200
EBT 800 1,800 2,800
Taxes (40%) 320 720 1,120
NI 480 1,080 1,680
*Same as for Firm U.

Firm U Bad Avg. Good

BEP 10.0% 15.0% 20.0%
ROIC 6.0% 9.0% 12.0%
ROE 6.0% 9.0% 12.0%
TIE n.a. n.a. n.a.

Firm L Bad Avg. Good

BEP 10.0% 15.0%
20.0%
ROIC 6.0% 9.0% 12.0%
ROE 4.8% 10.8%
16.8%
TIE 1.7x 2.5x 3.3x

U L

Profitability Measures:
E(BEP) 15.0% 15.0%
E(ROIC) 9.0% 9.0%
E(ROE) 9.0% 10.8%

Risk Measures:

38
 sROIC 2.12%
2.12%
sROE 2.12%
4.24%

Conclusions
Basic earning power (EBIT/TA) and ROIC
(NOPAT/Capital = EBIT(1-T)/TA) are unaffected by
financial leverage.

L has higher expected ROE: tax savings and smaller

equity base.

L has much wider ROE swings because of fixed interest

charges. Higher expected return is accompanied by higher
risk.

In a stand-alone risk sense, Firm Ls stockholders see much more

risk than Firm Us.

U and L: sROIC = 2.12%.

U: sROE = 2.12%.

L: sROE = 4.24%.

Ls financial risk is sROE - sROIC = 4.24% - 2.12% =

2.12%. (Us is zero.)

39
 For leverage to be positive (increase expected ROE), BEP
must be > rd.

If rd > BEP, the cost of leveraging will be higher than the

inherent profitability of the assets, so the use of financial
leverage will depress net income and ROE.

In the example, E(BEP) = 15% while interest rate = 12%, so

leveraging works.

Choosing the Optimal Capital Structure for Ranbaxy

Laboratories Ltd.
Based on the ratio analysis done above it can be concluded that
Ranbaxy is an unleveared firm with very less debt component in its
capital structure. The company is in a position to increase its debt
component by resorting to external debt financing. However it
should be kept in mind that, there could be two opposite effects if
debt is increased in the capita structure. The first effect may be an
overall reduction in the cost of capital as the proportion of debt
increases in the capital structure due to low cost of debt. On the
other hand, because of fixed contractual obligation the financial
risk of the company increases. Thus, it is said that the optimum
capital structure implies a ratio of debt and equity at which
weighted average cost of capital would be least and the market
value of the firm would be highest.
Keeping the above thought in mind I have tried to compute what
would be the optimal capital structure for Ranbaxy
Laboratories Ltd., based on the following information as per the
Annual Report 2005:

40
EBIT being 37,273,800;
Assuming that the firms expects zero growth
225,557,810 shares outstanding; rs = 12%;
T = 35%; b = 1.0; rRF = 6%;
RPM = 6%.

Estimates of Cost of Debt

Percent financed
with debt, wd rd

0% -
20% 8.0%
30% 8.5%
40% 10.0%
50% 12.0%

If company recapitalizes, debt would be issued to repurchase stock.

The Cost of Equity at Different Levels of Debt: Hamadas

Equation
MM theory implies that beta changes with leverage.
bU is the beta of a firm when it has no debt (the unlevered
beta)

41
 bL = bU [1 + (1 - T)(D/S)]

The Cost of Equity for wd = 20%

Use Hamadas equation to find beta:

bL = bU [1 + (1 - T)(D/S)]
= 1.0 [1 + (1-0.35) (20% / 80%) ]
= 1.16
Use CAPM to find the cost of equity:
rs = rRF + bL (RPM)
= 6% + 1.16 (6%) = 12.98%

Cost of Equity vs. Leverage

wd D/S bL rs
0% 0.00 1.00 12.00%
20% 0.25 1.16 12.98%
30% 0.43 1.28 13.67%
40% 0.67 1.43 14.60%
50% 1.00 1.65 15.90%

The WACC for wd = 20%

WACC = wd (1-T) rd + we rs
WACC = 0.2 (1 0.35) (8%) + 0.8 (12.98%)

42
WACC = 11.42%
Repeat this for all capital structures under consideration.

WACC vs. Leverage

wd rd rs WACC

0% 0.0% 12.00% 12.00%

20% 8.0% 12.98% 11.42%
30% 8.5% 13.67% 11.23%
40% 10.0% 14.60% 11.36%
50% 12.0% 15.90% 11.85%
Corporate Value for wd = 20%
V = FCF / (WACC-g)
g=0, so investment in capital is zero; so FCF = NOPAT = EBIT (1-
T).
NOPAT = (Rs.37,273,800)(1-0.35) = Rs.24,227,970

V = Rs.24,227,970/ 0.1142 = Rs.212,153,852.89

Corporate Value vs. Leverage

wd WACC Corp. Value
0% 12.00% Rs.201,899,750.00
20% 11.42% Rs.212,153,852.89
30% 11.23% Rs.215,791,315.97
40% 11.36% Rs.213,274,383.80

43
 50% 11.85% Rs.204,455,443.04

Debt and Equity for wd = 20%

The value of debt is:
= wd V = 0.2 (Rs.212,153,852.89) = Rs.42,430,770.58.
S=VD
S = Rs.212,153,852.89 Rs.42,430,770.58 = Rs.169,723,082.31

Debt and Stock Value vs. Leverage

wd Debt, D Stock Value, S

0% 0
Rs.201,899,750.00
20% Rs.42, 430,770.58
Rs.169,723,082.31
30% Rs.64, 737,394.79
Rs.151,053,921.18
40% Rs.85, 309,753.52
Rs.127,964,630.28
50% Rs.102, 227,721.52
Rs.102,227,721.52

44
Wealth of Shareholders

Value of the equity declines as more debt is issued, because debt is

used to repurchase stock.
But total wealth of shareholders is value of stock after the recap
plus the cash received in repurchase, and this total goes up (It is
equal to Corporate Value on earlier slide).

Stock Price for wd = 20%

The firm issues debt, which changes its WACC, which changes
value.
The firm then uses debt proceeds to repurchase stock.
Stock price changes after debt is issued, but does not change
during actual repurchase (or arbitrage is possible).

The stock price after debt is issued but before stock is

repurchased reflects shareholder wealth:
S, value of stock

Cash paid in repurchase.

D0 and n0 are debt and outstanding shares before recap.
D - D0 is equal to cash that will be used to repurchase stock.
S + (D - D0) is wealth of shareholders after the debt is issued but
immediately before the repurchase.
45
 P = S + (D D0)
n0
P = Rs.169,723,082.31+ (Rs. 42,430,770.58 0)
225,557,810
P = Rs.94.06 per share.

# Repurchased = (D - D0) / P
# Rep. = (Rs.42,430,770.58 0) / Rs.94.06
= 45,116.
# Remaining = n = S / P
n = Rs.169,723,082.31 / Rs.94.06
= 1,804,462.

Price per Share vs. Leverage

# shares # shares
wd P Repurch.
Remaining

0% Rs.89.51 0 2,255,578
20% Rs.94.06 451,116 1,804,462
30% Rs.95.67 676,673 1,578,905
40% Rs.94.55 902,231 1,353,347
50% Rs.90.64 1,127,789 1,127,789

46
Optimal Capital Structure
wd = 30% gives:
Highest corporate value
Lowest WACC
Highest stock price per share
But wd = 40% is close. Optimal range is pretty flat.

Modigliani and Miller Theory (Modern View)

The traditional view of capital structure explained in weighted
average cost of capital is rejected by the proponents Modigliani
and Miller (MM) (1958). According to them, under competitive
conditions and perfect markets, the choice between equity
financing and borrowing does not affects a firms market value
because the individual investor can alter investment to any mix of
debt and equity the investor desires.

Assumptions of MM Theory
The MM Theory is based on the following assumptions:
Perfect capital markets exist where individuals and
companies can borrow unlimited amounts at the same rate of
interest.
There are no taxes or transaction costs.

47
 The firms investment schedule and cash flows are assumed
constant and perpetual.
Firms exist with the same business or systematic risk at
different levels of gearing.
The stock markets are perfectly competitive.
Investors are rational and except other investors to behave
rationally.

MM Theory: No Taxation
The debt is less expensive than equity. An increase in debt
will increase the required rate of return on equity. With the increase
in the levels of debt, there will be higher level of interest payments
affecting the cash flow of the company. Then equity shareholders
will demand for more returns. The increase in cost of equity is just
enough to offset the benefit of low cost debt, and consequently
average cost of capital is constant for all levels of leverage as
shown in Figure 1.

Cost of

Cost of Capital r Equity

Average cost of Capital

Cost of
Debt

Level of leverage

Figure 1: MM view of Capital Structure

In MM theory the following notations will be used:

48
 Vu = Market value of ungeared company i.e. company
with 100% equity financing.
Vg = Market value of a geared company i.e. capital
structure of the company includes both debt and
equity capital.
D = Market value of debt in a geared company.
Ve = Market value of equity in a geared company.
Vg = Ve + D
Ku = Cost of equity in an ungeared company.
Kg = Cost of equity in a geared company.
Kd = Cost of Debt.

M M Theory: Proposition I
The market value of any firm is independent of its capital
structure, changing the gearing ratio cannot have any effect on
the companys annual cash flow. The assets in which the
company has invested and not how those assets are financed
determine the market value. Thus, the market value of a firm is
unaffected by its financing decisions, its capital structure, or its
debt-equity ratio.
In simple words, M & M theory views the value of the company
as a whole pie. The size of the pie does not depend on how it is
sliced i.e. the firms capital structure but rather the size of the
pie pan i.e. the firms present value based on its future cash
flows and its asset base.
The value of the geared company is as follows:
Vg = Vu
Vg = Profit before interest
WACC
Vg = Vu = Earnings in ungeared company
Ku

49
WACC is independent of the debt / equity ratio and equal to the
cost of capital which the firm would have with no gearing in its
capital structure.
Proof by example -
Consider holding 1% of stock in an all-equity
firm with value VU.
Then your wealth is 0.01VU.
Also, you receive a cash flow of 0.01CFt every
period.
Alternatively, consider holding 1% equity and 1%
debt in levered version of the same firm with
value Vg=E+D.
Your wealth then is [0.01E+0.01D] = 0.01Vg.
Cash Flows each period? [0.01(Int)+0.01(CF t-
Int)]=0.01CFt.
As the inherent risk of the firm is the same, then
the discounted value of the cash flows must be the
same, i.e., Vg= VU.
WACC Prop. I

M&M

Traditional

B
E

50
 MM Theory: Proposition I
M M Theory: Proposition II
The rate of return required by shareholders increases linearly as
the debt / equity ratio is increased i.e. the cost of equity rises
exactly in line with any increase in gearing to precisely offset
any benefits conferred by the use of apparently cheap debt.
MM went on arguing that the expected return on the equity of a
geared company is equal to the return on a pure equity stream plus
a risk premium dependent on the level of capital structure.
The premium for financial risk can be calculated as debt / equity
ratio multiplied by the difference between the cost of equity for
ungeared company and risk free cost of debt.

The cost of equity depends on the following three variables:

1. The required rate of return on the firm (Ku).
2. The required rate of return on the firms debt (K d).
3. The firms debt/equity ratio (D/E)

D
Kg Ku K Kd
Vg u

MM proposition II can be summed up in following points:

Equity holders require a premium over what everyone is paid
if the firm has debt.
The premium DOES depend upon the firms financing mix.
The wealth of equity holders, however, is unaffected.
Any increase in leverage raises both the risk of equity and its
required return.
51
 Stockholders are indifferent to capital structure and to change
in leverage.

RE Prop. II
M&M
Slope = RA RD

Traditional
RA
B
E

MM Theory: Proposition II
M M Theory: Proposition III
MM theorys third proposition asserts that the cut-off rate for new
investment will in all cases be average cost of capital and will be
un affected by the type of security used to finance the investments.

M M Theory: Arbitrage
The cost of equity will rise by an amount just sufficient to offset
any possible saving or loss. The lenders determine the supply of
debt. The optimal level is simply the maximum amount of debt
which lenders are prepared to subscribe in any given circumstances
e.g. level of inflation, rate of economic growth, level of profits etc.
the investors will exercise their own leverage by mixing their own
portfolio with debt and equity. The investors call this the arbitrage
process. Under these conditions of investment the average cost of
capital is constant.

52
If two different firms with same level of business risk but different
levels of gearing sold for different values, then shareholders would
move from over valued firm to the under value firm and adjust
their level of borrowing through the market to maintain financial
risk at the same level. The shareholders would increase their
income through this method while maintaining their net investment
and risk at the same level. This process of arbitrage would drive
the price of the two firms to a common equilibrium total value.
The word arbitrage is a technical term referring to a situation
where two identical commodities are selling in the same market for
different prices, then the market will reach equilibrium by the
dealers start at the lower price and sell at the higher price, thereby
making profit. The increase in demand will force up the price of
the lower priced goods and increase in supply will force down the
price of the high priced commodities.
The arbitrage in MM theory shows that the investors will move
quickly to take advantage and will make profit in an equilibrium
capital market, then this would represent an arbitrage opportunity.

MM Theory: Corporate Taxation

In above discussion, MM theory has ignored the tax relief on debt
interest. MM has further modified their theory by considering tax
relief available to a geared company when the debt component
exists in the capital structure. The tax burden on the company will
lessen to the extent of relief available on interest payable on the
debt, which makes the cost of debt cheaper, which reduces the
weighted average capital of the lower where capital structure of a
company has debt component.
Consider a firm with no debt (i.e. all equity or unlevered) with a
value of Vu.
Suppose firm changes capital structure by issuing debt and retiring
some equity. The firm will realize gain since interest payments on
debt are tax-deductible, so tax liability will decline!
For perpetual debt:
53
 Yearly Tax Savings (Tax Shield)
= Interest TC = r D TC
= RD B TC
Tax shield will be realized each year forever. Since it goes to
bondholders, it should be discounted at RD, thus
PV of tax shield = (RD B TC)/ RD
= B TC
Value of firm with debt VL (i.e. levered firm) will be : VL = Vu
+ B TC
Value increases by PV of tax shield.
Tax advantage of debt increases as TC increases.
In M&M world (TC = 0), VL = V

Slope = TC
VL

PV of Tax Shield

VU M&M Value

B
MM Theory: Corporate Taxation

Under the assumption of tax relief being available on debt interest,

the total market value of the company is increasing function of the
level of gearing.
MM theory cost of equity formula for a geared company:

54
 Kg = Ku + (1 T) (Ku Kd)

MM theory assumes that the value of the geared company will

always be greater than an ungeared company with similar business
risk but only by the amount of debt associated tax saving of the
geared company. Value of geared company:
Vg = Vu + DT
When corporation taxation is introduced, the tax deductibility of
debt interest creates value for shareholders via the tax shield, but
this is a wealth transfer from taxpayers. The value of a geared
company equals the value of an equivalent ungeared companys
shareholders is less than that in the all equity company, reflecting
the tax benefits. A further effect of corporate taxation is to lower
WACC, which falls continuously as gearing increases.

MM Theory: Personal Taxation

MM theory considered only corporate taxes. It was left to a
subsequent analysis by Miller (1977) to include the effects of
personal as well as corporate taxes. He argued that the existence of
tax relief on debt interest but not on equity dividends would make
debt capital more attractive than equity capital to companies. The
market for debt capital under the laws of supply and demand,
companies would have to offer a higher return on debt in order to
attract greater supply of debt. When the company offers after
personal tax return on debt at least as equal to the after personal tax
return on equity, the equity supply will switch over to supply debt
to the company. It is assumed that, from the angle of the company,
it will be indifferent between raising debt or equity as the effective
cost of each will be the same and there is no advantage to gearing.

Financial Distress and Capital Structure

55
The assumption is that when firm has very high level of borrowing
they are more likely to run into the cost of final distress and cost of
bankruptcy. When the leverage of the firm is extremely high then it
is very likely that at some stage it will not be able to make annual
interest payments and loan repayments. Dividends for shareholders
can be bypassed but failure to pay interest on loans often gives the
lender the right to claim on the firms operating assets thereby
preventing the firms continuity of activity.
The following illustrative list of activities which may cause
increase in cost of the firm.
Successive borrowings beyond the companys target debt
equity ratio.
Borrowing higher levels of interest
Skip off or cut in dividend which may cause the fall of
market rate of shares.
Loss of trade credit from suppliers
Distress sale of highly profitable instruments.
Abandonment of promising new projects.
Reduced credit period resulting in loss of business.
Corporate image may be tarnished.
Demand for withdrawal of loans made to the firm previously.
Reduction in stock levels result in reduction in sales etc.

Bankruptcy Costs

The cost of bankruptcy may be of two types:

Direct costs
Those directly associated with bankruptcy, both legal
and administrative.
Indirect costs

56
 Costs associated with a firm experiencing financial
distress (creditors, bankers, customers, employers, etc.)
Bankruptcy costs = direct costs + indirect costs

An increase in debt is associated with increased tax savings but

also an increased probability of running into cost of financial
distress and bankruptcy. The value of the leveraged firm is its
capitalised after tax operational cash flow plus the present value of
the tax savings incorporating the anticipated cost of financial
distress and bankruptcy.

V = X + DT BC
R
Where,
V = Value of leverage firm
X = Anticipated net operational cash flows
R = Capitalisation Rate
D = Market Value of Debt
T = Corporate tax rate
BC = Anticipated costs of bankrupting

Cost of Debt
V PV of Bankruptcy Cost

PV of Tax Shield

VU

Cost of Equity

Optimum Capital
Structure
57 B
Figure: Optimum Capital Structure and Costs of Financial
Distress

The existence of tax benefit for modest amounts of debt, and the
need to avoid the costs of financial distress, suggest that there is an
optimal capital structure as illustrated in figure which shows that
there is an optimal capital structure at the point where the market
value of the firm is maximized, that is where (DT BC) is
maximized.

Debt Financing and Agency Costs

Agency theory models a situation in which a principal (a superior)
delegates decision making authority to an agent (the subordinate)
who receives reward in return for performing some activity on
behalf of the principal. The outcome of the agents effects the
principals welfare in some way, for example sales revenue, output
or contribution margin. The principal attempts to combine a reward
system with an information system, in order to motivate the agent
to choose the action, which maximizes the principals welfare.
In respect of debt finance, the suppliers of debt are much
concerned, about their investment in the company, about their
investment in the company, about the risk involved in financing
debt to the company. In order to minimize the risks in debt finance,
the suppliers of loan will impose restrictive conditions in loan
agreements that constraint managements freedom of action and it
is known as agency costs. The more money the suppliers of debt
lend to the company then the more constraints they are likely to
impose on the managements in order to secure their investments.
Therefore, agency costs are more in highly geared firms.
58
Difficult to identify and estimate, but exist
V = VU + BTC PVBC PV of agency costs
PVBC + PVAC eventually dominate over PV of tax shield.
PV of agency costs , as B generally.

PVBC + PVAC
V

PV of Tax Shield

VU

Debt Financing and Agency Cost

Signaling Theory

In a pioneering study published in 1961, Gordon Donaldson

examined how companies actually establish their capital structure.
The findings of his study are summarised below:
1. Firms prefer to rely on internal accruals, i.e. on retained
earnings and depreciated cash flow.
2. Expected future investments oppurtunities and expected
future cash flow influence target dividend payout ratio. Firms
set the target pay out ratio at such a level that capital

59
 expenditures, under normal circumstances, are covered by
internal accruals.
3. Dividends tend to be sticky in the short run. Dividends are
raised only when the firm is confident that the higher
dividend can be maintained; dividends are not lowered unless
things are very bad.
4. If a firms internal accruals exceed its capital expenditure
requirements, it will invest in marketable securities, retire
debt, raise dividends, resort to acquisitions, or buyback its
shares.
5. If a firms internal accruals are less than its non-postponable
capital expenditure, it will first draw down its marketable
securities portfolio and then seek external finance.
Noting the inconsistencies in the trade off theory, Myers
proposed a new theory, called the signalling, or asymmetric
information, theory of capital structure. The main points of the
theory are:
Managers often have better information.
Sell stock if stock is overvalued.
Sell bonds if stock is undervalued.
Investors understand this, so view new stock sales as a
negative signal.

Corporate Finance Practices

The capital structure decision is a difficult decision that involves a

complex trade off among several considerations like income,
risk, flexibility, etc. given the over riding objective of
maximising the market value of a firm, the following guidelines
should be kept in mind while hammering out the capital structure
of the firm.

Avail of the Tax Advantage of Debt.

60
 Interest on debt finance is a tax deductible expense. Hence
finance scholars and practitioners agree that debt financing
gives rise to tax shelter which enhances the value of the firm.
Preserve Flexibility
Flexibility implies that the firm maintains reserve borrowing
power to enable it to raise debt capital to respond to
unforeseen changes in business and political environment.
Hence the firm must maintain some unused debt capacity as
an insurance against adverse future developments.

Ensure that the Total Risk Exposure is Reasonable

The affairs of the firm should be managed in such a way that
the total risk borne by the equity shareholders is not unduly
high.

Subordinate Financial Policy to Corporate Strategy

Financial policy and corporate strategy are often not
integrated well. This may be because financial

Mitigate Potential Agency Costs.

Due to separate ownership and control in modern
corporations, agency problems arise. Shareholders scattered
and dispersed as they are not able to organise themselves
effectively. Hence, very little monitoring takes place in the
security markets.
Since agency costs are borne buy shareholders and the
management, the financing strategy of a firm should seek to
minimise these cost by employing external agents who
specialise in low cost monitoring.

61
 Issue innovative Securities
Thanks to SEBI guidelines introduced in 1992, issues have
considerable freedom in designing financial instruments.
There is greater scope for employing innovative securities to
the advantage of the firm. The important securities
innovations have been as follows: floating rate bonds (or
notes), collateralised mortgage obligations, dual currency
bonds, extendible notes, medium term notes.
Widen the Range of Financing Sources
In as dynamically evolving financial environment, traditional
sources of financing may diminish in importance. They may
not be adequate or optimal. Hence, it behoves on a firm to
employ new modes of finance like commercial paper,
factoring, Euro issues, and securitisation.

62
Capital expenditure: an
overview

Factors Of Capex

Organizations engaged in manufacturing and marketing of

goods or services require assets in their operations. An asset
can be thought of as any expenditure, which creates or aids
in creation of a revenue-generating base. Companies incur
various expenditure to carry on standard flow of work,
expenditure intended to yield returns over a period of time,
and usually exceeding one year is regarded as capital
expenditure. Various factors are considered before Board of
Directors approves any expenditure. All that factors can
further be divided into:

Operational Factors
I. To meet future requirements based on market
forecast.
II. To maintain coordination with the vision of the
company as Ranbaxy vision Garuda states to be top
five generic players in the world by 2012 and
achieve sales of 5 billion. To achieve this target
company has to incur heavy expenditure on
acquisition of fixed assets.
III. To increase market penetration.
IV. To maintain, renew, expand, upgrade existing
physical assets that helps to facilitate and enhance
revenue-generating capacity.
V. To create, acquire and develop revenue generating
activities/ capacities that is imperative for an
organizations healthy growth and existence.

63
Financial Factors
In deciding which assets to create, acquire or develop, the
benefits to be gained from the expenditure have to be
weighed against the costs that will be incurred. While costs
can always be expressed in financial terms, the benefits may
or may not be similarly quantifiable. Nevertheless, an
attempt must be made to express the benefits expected, in a
manner that facilitates comparison with costs and helps
formulate a rational basis for the decision making process.
Following are the financial tools that are taken into account
for approving capital expenditure.

Discounted Cash Flow (DCF)

This is one of the techniques for financial evaluation of
Capexs. DCF techniques are based on the concept of time
value of money and provide a methodology of taking into
account the timing of cash proceeds and outlays over the life
of the investment. The procedure underscores the need to
state cash flow streams arising in different time periods thus
differing in value and, hence comparable only in terms of a
common denominator viz. present values.

I. Discounted Payback Period (DPP)

DPP is the number of years it takes for the present value of
inflows to equal the initial investment. Apart from giving
due importance to time value of money it serves as a
reasonable tool of risk approximation. It favors projects,
which generate substantial cash inflows in initial years, and
discriminates against those that bring in substantial inflows
in later years (risk tending to increase with tenure). Thereby
implying that an early resolution of uncertainty enables the
decision maker to take prompt corrective action by
modifying/ changing other investment decisions.

64
 However, by the same logic it cannot be used as a principal
tool for analysis because it ignores any substantial cash
flows arising after the pay back period.

II. Internal Rate of Return (IRR)

IRR is the discount rate that equates the present value of the
expected future cash inflows to the present value of the
expected future cash outflows. It is the post tax return from
investment and hence the excess of IRR over the cost of
capital indicates a surplus after paying for the capital
employed. IRR presupposes an equivalent rate of return on
the cash flows generated during the life of the asset i.e., it
assumes re-investment of intermediate cash flows at the rate
of return equal to the project's IRR.
Internal rates of return are most often used as useful
additions to NPV computations. This has in turn justified the
use of IRR as a good substitute to NPV. IRRs have the merit
of indicating whether a project is worthwhile, in
st of capital represents a positive NPV project, an IRR equal to the cost of capital is a zero NPV p
apital is associated with a negative NPV project.
Inspite of its merits, it needs to be understood that IRRs
helps only to identify projects that maximizes the ratio of
rupee-value to rupee-capital in percentage terms. What NPV
will help in determining is the projects that maximizes the
rupee-spread between value and capital.

III. Net Present Value (NPV)

NPV is equal to the present value of cash inflows minus the
present values of cash outflows. A positive NPV is a
prerequisite for the 'acceptance' of the project.
The primary tool of appraisal would be the NPV method. Its
superiority over other methods arises out of its principal
merit of incorporating all benefits and costs occurring over
the life of the asset

65
IV. Profitability Index (PI)
The Profitability Index essentially measures the Present
value of benefits times the initial investment. Under
unconstrained conditions, the profitability index will accept
and reject the same projects as the NPV criterion.
It is possible that a project may have no critical risks. Or the
financial are extremely favorable (high NPV, high IRR, high
PI, low DPP etc.) and the occurrence of consequent risks
may not compromise the success of the project. It is also
possible that there is a conscious corporate decision to
accept certain risks. In such cases, no measures are required.
These risks, in any case, must be explicitly stated in the
Quantitative assessment of Risk Capital investments are
essentially committed in expectation rather than in certainty,
which implies that investments are subject to risk contribute
to removing the shortcomings of an unstructured workings.

INTRODUCTION
The term 'Capital expenditure' refers to expenditure
intended to yield returns over a period of time, usually
exceeding one year. This basically implies that any
expenditure, which results in the creation of a new asset or
substantially increases the capacity/benefits of an existing
asset and is of a "long term" nature, should be classified as
Capital expenditure.

Since, the expression 'Capital expenditure' is not

exhaustively defined, the facts of a particular case would
decide whether expenditure is capital or revenue. Generally
speaking, the expenditure should be tested on the following
criteria to facilitate classification between capital and
revenue.

66
 Expenditure would be deemed to be capital, if incurred
for

Initiation of business

Extension of business: Entry into new markets &

products (including R&D and regulatory
expenses).

Modification of asset/ equipment resulting in

increased benefits from the existing asset

Bringing into existence a new asset.

Conversely, expenditure would be deemed to be

revenue, if incurred for

Routine repairs and maintenance of existing

plant.

Replacement of any part of the existing plant

with capacities remaining unchanged

Shifting of plants

Making alterations or renovations on rented

premises

Assets having life of less than one year

Classification Of Capital Investments

67
 Since the analysis for appraisal of the proposed capital
expenditure will largely depend upon the kind of
investment, it is necessary to classify capital investments
into the following categories:

1) Cost Reduction, Modernisation and Rationalisation.

Expenditure to replace serviceable, but obsolete
equipment. This may become necessary because of the
expiry of normal life or change in technology. The purpose
of this expenditure is to improve productivity, increase
efficiency or reduce cost of labour, material or other items
such as power.

2) Expansion of Existing Products/ Capacity

Expenditures to increase plant capacity for existing
products/equipment or enhance multi-purpose flexibility.

3) Expansion into New Products/New Product Packs

Expenditure necessary to produce new products/new
product pack. This also includes expenditure on existing
facilities to handle new products which may result in
incremental realizations / value additions.

4) New market development and Market Entry

This would include expenditure made for entering and
developing new markets. Such proposals would require the
business case to be accompanied with detailed financial
analysis.

5) Replacement: Maintenance of Business

Expenditure necessary to replace worn-out or damaged
equipment. They are not likely to increase capacity or alter
production significantly. Capital spares are included here.

68
6) Quality, Good Manufacturing Practices, Safety, Health
and Environment.
Expenditures necessary to upgrade quality, compliance of
GMPs, government regulations, labour agreements,
insurance policy terms, and environmental safety
requirements. Financial evaluation/benefits from such
expenditure may to the extent quantifiable, be provided.

7) Research & Development

Expenditure on R&D projects/ equipment/ facilities.
Financial evaluation/benefits from such expenditure may to
the extent quantifiable, be provided.

8) Information Technology
Expenditure on procurement of IT infrastructure (Hardware)
and/or application software. Financial evaluation/benefits
from such expenditure may to the extent quantifiable, be
provided.

9) Others
This includes office buildings, vehicles, furniture, office
equipment, InfoTech related equipment and utilities, and all
such assets, which provide infrastructures support. This also
includes any capital expenditure not explicitly covered in
the above classifications.

Capital Expenditure proposals are not applicable

for

1] Employee entitlements
Capital expenditure necessary to meet the commitments in
respect of provision of assets to the employees in terms of
personnel policies. Financial evaluation of such expenditure
is not required. Assets purchased by employees against their
hard/soft furnishing entitlements do not fall within the scope
69
 of this manual and hence, will not be included here as they
are per policy.

2] Amounts less than Rs.10, 000/ $1,000

Segregation of Capex and Revenue Expenditure

Broadly, the following shall be considered as Revenue:

All repairs to equipment in the normal course of business.
All annual maintenance contracts (AMC) to keep the said
equipment/assets in working condition.
All expenditures, which do not result in an
enduring/permanent benefit to the assets.
Modification to the existing assets, which does not result
in enduring benefit, are to be treated as Revenue after
taking ratification of Technical Head of Plant.
Piping and insulation of the nature of minor repair or
replacement.
Re-arrangement of assets or minor structural changes for
regulatory batches.
All accessories / dies & punches which are procured
subsequent to purchase of assets
In case of certain expenditure the treatment of which is in
doubt, the decision in this respect shall be exercised by the
Plant Account Manager in consultation with the
User/Technical Head.

Date Of Capitalisation
Date of Capitalisation would be the date when the assets is
certified by the concerned Engineering / E&F Department
as ready to use or GRN date in case of assets which do not
need commissioning (that is computers, furniture, fixtures
etc.). Authority for fixing date of capitalisation would be
with E&F department.

70
 Lead-time between certification and Commencement of
commercial production will not normally exceeds 30 days
In case of lead-time exceeding 30 days to take specific
approvals from the Plant Head.

Capitalization of Expenditure other than basic cost of assets

All expenditure directly related to the assets capitalized
including freight, Entry tax, Octroi, custom duty, and any
such amount, which does not form part of the original
invoice, is to be capitalized along with the relevant assets.
All installation cost, service charges and labour cost, trial
run cost (net of realizable value of the product), technician
fee and any other expenditure directly attributable to the
installation.
Cenvat /CVD credits will be netted off from the cost of
assets. As per accounting standard we have to capitalise the
assets net of Modvat.
E&F department operational cost will be directly identified
with the projects or allocated to the projects on equitable
basis.
For all this expenditure it is important to book at the stage of
initiation at SAP locations through the same capital internal
order number, which has been uniquely given to the Capex
proposal at the time of initiation of the particular asset.
Regarding Cenvat/ CVD credits netting off, special care is
required to be taken towards year ends to ensure meeting
technical requirements as per the Accounting Standards and
ensure maximum depreciation (including higher
depreciation allowed is accounted for on capitalization, as
applicable & there is no Cenvat (cash flow) loss.

Capex Numbering
71
The numbering scheme is as under
Entity/Division/Cost Center No./ Year/ Serial No. of
CEP raised by that RCC/ Running Serial No. of Capex of
the Division/ Plant, to be given by the Accounts department.
In case of Head Office, H.O will appear against division's
name.

At the beginning of the year capital budget prepared by every

cost center (RCC) for the particular year in every business area.
This budget prepared every department and submitted to the
division. Then division decided and finalized the budget and
given to the management committee for the final approval.
Capital budget is three type prepared by the company.
Divisional
Info tech
Employee entitlement
The whole process works in a very systematic manner where
firstly engineers working at operational level locate the
requirement of any new machinery. After identifying need at
operational level process of capital budgeting commence.
Currently whole Capex system is followed manually. The
whole organization is divided plant wise.
Plants located at Mohali 1 &2, Toansa, Dewas are handled
division wise. Division consists of head from each department
and they control API Manufacturing plants from one division.
API manufacturing acts as a coordinator between above 4
plants. They are responsible for communicating reports
generated by each plant head that comes under API
manufacturing to higher authorities. For each Plant responsible
cost center head are assigned who looks after operational need.
Different RCCs are prepared depending upon the functions.

72
 These head can be divided into following categories
Production
Engineering
Personnel/security
Safety/ETP
QA/QC
Stores

For above different functions RCCs head prepared their

requirement chart specifying
RCCs number
Description (whether production, engineering,
QA/QC)
Classification (Replacement, Upgradation)
Kind of expenditure (capital or revenue)
Justification
VED
Quantity

RCCs number is unique for each function. Description

about the function whether it falls in production,
engineering, personnel etc.

Revenue or capital expenditure can be further divided as per

RCCs requirements:

CAPITAL EXPENDITURE
73
 Regulation
GMP (Goods Manufacturing Practices)
EHS (Environment Health Safety)
Replacement
Capacity
Upgradation
Additional

REVENUE EXPENDITURE
Operating Expenses
Stores
Repairs Building
Repairs and Maintenance
Staff Welfare
VED is a management science tool, which is used by
various department depicting vitality of particular need
raised at operational level where
V stands for VITAL
E stands for ESSENTIAL
D stands for DESIRABLE

The above requirement chart prepared by RCC head then

consolidated by Divisional Finance Accounts Department
and budgets are prepared. For each plant this chart is
prepared where requirement of various functions are shown
and also respective RCC head gives justification. Finance
74
 department review the expenditure type whether capital or
revenue again as it could be classified wrong by RCC head.
Finance department then modifies this chart into budget
based on
Plant wise requirement
Kind of function

In plant wise requirement various excel files are prepared

which is as follows
Summery statement
Revenue expenditure
Capital expenditure
RCC wise
Similarly depending upon the functions various budgets is
prepared. Basically here for production and engineering
requirements send by RCC head is provided in plant wise
description chart but for others such as
Personnel/security
Safety/ETP
QA/QC
Stores

In above functions division wise budgets are also made for

example

QA/QC -> Division -> PDL

QA
Contract Manufacturing

75
 Personnel/security -> Division ->
Personnel/security
Division Management
Division Accounts

Separate budgets are prepared and then sanctioned by

respective head.
Now the budgets prepared by finance department is further
send to respective departmental head. Then plant heads,
followed by Vice President & onwards as per the Capex
amount, approves these capexs.

As explained earlier Finance manager maintain the budget

information, following manufacturing locations of API are
catered at Mohali Division
MOHALI
TOANSA
DEWAS

After preparation of Budgets, BOD approves Capital

Expenditure by initiating CAPEX form by Plant head that is
appropriately signed by requisite authorities. In CAPEX
Form itself amount is classified into various categories
A. Replacement/Cost Reduction
B. Expansion into New Product/New Product Packs
C. Quality, Safety, Environmental
D. Expansion of Existing Products Packs
E. Replacement: Maintenance of Business
76
 F. Others
All kinds of expenditure are classified into above head for
API Manufacturing for approval of Capital Expenditure

Accounting Route for API Manufacturing

Capital Expenditure
When top authorities approve the Capex requirement then
an internal order number is created by Plant department.
After the creation of internal order number finance
department inform respective accounts department about the
same. On receipt of the IO, indenter will create the purchase
requisition that subsequently go to purchase department.
Purchase department will float enquires and prepare
comparative charts for at least 3 vendors. After selecting the
vendor, purchase department will place a purchase order
(PO) on the vendor for supply of the asset. In case, as per
the terms of the PO, any advance is to be given to vendor,
the same is released by accounts department, after passing
the necessary entries in the vendor account under respective
business area (BA). The purchase department while
preparing the PO would ensure to mention complete name
as RANBAXY LABORATORIES LIMITED, API
MANUFACTURING and address/ location of delivery of
the asset. On receipt of the goods, the
Stores department will arrange to prepare the GRN and get
the same approved by the user department. On approval of
the GRN, the stores department will send the bill to
accounts for invoice verification. The accounts department
will verify the invoice with PO and release the balance
payment to vendor.

77
Material Cost
The purchase requisition (PR) for domestic materials i.e.
Solvents, Chemicals and other Consumables required for
project completion will be raised by scientists after obtaining
approval from the respective head, the purchase requisition
(PR) will be send to purchase department for procurement of
the material. Purchase department will float enquires and
prepare comparative charts for at least 3 vendors. The purchase
department will place the PO on the vendor for supply of the
materials. In case, as per the terms of the PO, any advance is to
be given to vendor, the same will be released by accounts
department after passing the necessary entries in the vendor
account under Business Area (BA). The purchase department
while preparing the PO would ensure to mention complete
name as RANBAXY LABORATORIES LIMITED, API
MANUFACTURING and address/ location of delivery of the
asset. On receipt of the goods, the stores department will
arrange to prepare the GRN and do the respective head approve
the same. On approval of the GRN, the stores department will
send the bill to accounts department for invoice verification.
The accounts department verifies the invoice with PO and
releases the balance payment to vendor. The cost of material
will be booked in the API MANUFACTURING cost center
under Business Area 1000.
In case of imported material on receipt of approved PR from
the API MANUFACTURING, purchase department, Mohali
will send the PR to international purchasing department (ID
Purchase) at Devika Tower, Delhi. The ID Purchase, while
preparing the PO would ensure to mention the complete as
RANBAXY LABORATORIES LIMITED, API
MANUFACTURING and address/ location of delivery of the
asset.

78
On receipt of the material, the purchase department will arrange
to prepare the GRN and do the respective head approve the
same. On approval
Of the GRN, the ID Purchase department will send the bill to
accounts department will only verify for invoice verification.
The accounts department will verify the invoice with PO .the
verification of Custom duty; Overseas fright etc. will be done
by ID accounts and will arrange to release the payment to
vendor. The cost of material will be booked in the API
MANUFACTURING cost center under Business Area 1000.
In the SAP system, a separate storage location (Storage
Location 1075 plant 1030) for material required by API
MANUFACTURING should be created so that at any given
point the material purchased & consumed may be identified.
Physically, the capital assets as well as the materials purchased
for API MANUFACTURING should be stored in a separate
storage preferably within API MANUFACTURING storage
location.

Revenue Expenditure
Apart from material, to carry on the API MANUFACTURING,
certain expenses will be incurred under various accounting
heads. These expenses either may be incurred directly by API
MANUFACTURING, or may be incurred by other locations.
The accounting of these expenses would be made as under:
The manpower i.e. lab technician and other supporting staff
working for the API MANUFACTURING should be identified.
All direct & indirect expenses incurred in connection with
recruitment, salaries, allowances and other benefits related the
said manpower be charged to the cost center for API
MANUFACTURING e.g. Repairs & maintenance of building,
AMCs housekeeping, Horticulture, Books & Periodicals,
Conference & Meeting, training, traveling lab assistant, Gifts &
79
presents etc, should be charged to the cost center of API
MANUFACTURING.
Utilities cost such as Electricity, Water, Power, and Stream etc,
incurred for API MANUFACTURING, based upon the actual
bills received from the supplier. In case the utilities are
provided by any of the existing manufacturing facilities, the
supply should be monitored by separate meter/sub meter etc,
and charges for the same based upon the actual units consumed
should be debited to the cost center of API
MANUFACTURING.
The other supplies/facilities such as Telephone, Fax, Telex etc.,
should be directly in the name of API MANUFACTURING. In
case, any common facility is used, charges on reasonable basis
should be debited to the cost center of API
MANUFACTURING, Mohali. The supplies from common
canteen should also be charged on a reasonable basis i.e. linked
to the number of employees working in API
MANUFACTURING. The charges for Tea, coffee, snakes etc,
consumed by API MANUFACTURING. Guest would be
charged on reasonable basis to the Cost Center of API
MANUFACTURING.
In case any materials/consumables are provided by any of the
manufacturing location to the API MANUFACTURING. A
stock transfer note will be raised on API MANUFACTURING.
Similarly if any services are provided by marketing facility to
API MANUFACTURING, cost there of at arms length basis
will be debited to the API MANUFACTURING.
Statutory Compliances (For Duties & Taxes):
[a] Excise:
1. The CENVAT credit shall not be available in respect
of the Inputs received from the vendors.

80
 2. Transfer of any excisable inputs as such or
intermediate from manufacturing locations the same
should be on payment/reversal of appropriate duty,
on which CENVAT is not applicable
[b] Sales Tax:
1. The premises stand already declared for the purpose
of sales tax registration.
2. As no direct sale activity is involved from the
premises, hence no payment on account of sales
taxes.
[c] Other taxes:
As applicable on the items procured for the purpose
(Octroi, etc.)

SAP Programming Route For Approval Of Capex

SAP stands for System Application Products in Data

Processing. Before giving the route of SAP for Capex an
introduction about what actually is SAP
Ranbaxy is an ERP organization that uses the SAP software
system in their organization. Ranbaxy has adopted SAP R/3
version. System Application Product (SAP) is a product of
GERMANY that helps in data processing.
In this SAP software there are various modules, which deal
with different business activities.
Configuration of inventory under SAP system
In the SAP system various materials master codes are
maintained to identify the materials whether it is raw material,
work in progress, finished goods or semi finished goods. For
this purpose a 7-digit code is maintained.

81
 RAW MATERIAL 3******
PACKING MATERIAL 5******
WORK IN PROGRESS 8******
FINISHED GOODS 1******
STORE AND SPARES 4******

Material module under SAP consist of the following

Organization structure
Master data
Procurement process
Inventory management

Organization structure
Client
Company code
Business Area
Plant
Controlling area
Operating concern
Cost center

Client & Company Code

Client - Application-independent unit: Top level Physical
structure
82
Client is a self-contained unit in SAP R/3 System with Separate
Master Records and its own set of tables
Company Code Represents an independent legal accounting
unit, wherein a Balance sheet, and P&L statement can be
prepared. Several company codes can be set up for each client,
thus enabling accounting data to be managed simultaneously
for several independent organizations.
Example: a subsidiary company, member of a corporate group
RANBAXY organization has different client and company
codes for its companies. Such as

Ranbaxy laboratories LTD

Ranbaxy fine chemical LTD
Ranbaxy UK LTD

83
Business Area
Line of Business: e.g. API Manufacturing, Pharmaceuticals.

An organizational entity that is not independent from a Legal

standpoint. Internal balance sheets and income Statements can
be created at Business Area level.
Business Area configured in RLL
API MANUFACTURING
API MARKETING
FORMULATION MANUFACTURING
FORMULATION MARKETING
TRADING
ALLIED BUSINESS
PHARMA BUSINESS SUPPORT
REASEARCH & DEVELOPMENT

Plant
A plant is an organizational unit within a company. A plant
produces goods; render services, or makes goods available for
distribution. A plant can be one of the following types of
locations

Manufacturing facility e.g. MFG (Mohali)

Warehouse distribution center
Branch office

84
Controlling Area
This is organizational controlling unit. Transactions within
Controlling area is possible

Operating Concern
Top-level logical unit in SAP. It is superset of all Cost Center,
Business Area and Controlling Area etc

Cost Center
Cost center is the smallest unit in Phase I. In SAP for handling
various costs, there are different types of cost centers.
Examples, Personal Cost Center, Amoxy Cost Center, Utility
Cost Center. For Financial purposes Cost Center are classified
into various heads such as administrative cost center, works
cost center, Utility / Production cost center.

SAP Route
SAP functioning in the system begins by creating internal order.
Internal order number is created by finance department by
using SAP command is

Accounting -> Investment Management -> internal order ->

Master data -> special functions -> KO02

The above path command is KO02 that creates an internal order

for which following information need to be filled

85
General data, Applicant, Person Responsible, Processing group,
Estimated costs, Application data, Department, Control data,
System status, User status, Assignments, Company code,
Business area, Plant, Object class

To make certain changes in internal order the command is

Accounting -> Investment Management -> internal order ->

Budgeting -> Original Budget -> KO22

In above command is used to verify the amount and text of

internal order.

The report created by finance department can be viewed by

using command S_ALR_8701301.

It is not mandatory to fill up certain fields in the internal order

at the time of its creation with the result that the cost over-runs
are not reflected automatically by SAP systems. For example,
the system provides that where the expenditure under any
internal order exceeds 2.5% of the budgeted amount, the same
is reflected in the reports.
After creating the internal order the finance manager will mail
the CAPEX amount sanctioned by higher authorities and also
the internal order number to respective Plant Head. Indenter
will indent the required material. Indenter is the person who at
operational level requires the material In SAP next step is
creation of Purchase Requisition that can further be prepared in
2 ways
Cost Center

86
CAPEX-IO

For the purpose of capitalization we have to focus on CAPEX

route. Here, after getting mail from finance department Plant
Head will authorizes the indenter to raise indent that is the
indenter will create Purchase Requisition. From the department
the SAP route comes to Purchase Department that in Mohali
handles the Purchase Requisition for Mohali and Toansa. In
purchase department three documents are prepared in order to
raise final PURCHASE ORDER that is initiate to supplier.

1 REQUEST FOR QUOTATION (RFQ) Purchase

Department after receiving the Purchase Requisition will place
order depending upon requirements. In system, for different
items different staff person receives particular Purchase
requisition that is differentiated by unique purchasing group.
For Example 505 is the purchasing group that handled Purchase
Requisition for items related to Electrical and instruments.
For each item Purchase Department is required to send RFQ to
3 vendors. Three is the minimum limit for every item but in
case where Purchase Requisition (PR) specify the brand of
particular need to be acquired, in that case only one RFQ need
to send. For example if PR specifies one LG T.V then only one
RFQ need to send to dealers dealing in LG commodities. For
CAPEX PR starts from 3000001987. RFQ is the 10-digit
number. In SAP for creating a RFQ ME41 is the command used
by purchase department. Then a applet window comes where
information regarding

RFQ type
Language key
RFQ date
87
Quotation deadline
RFQ
Organizational data
Purchase organization
Purchasing group
Default data for items
Item category
Delivery date
Plant
Material Group
Storage location.

88
Balance sheet
Dec ' 08 Dec ' 07 Dec ' 06 Dec ' 05 Dec ' 04
Sources of funds
Owner's fund
Equity share capital 210.19 186.54 186.34 186.22 185.89
Share application money 175.66 1.18 0.88 0.28 2.83
Preference share capital - - - - -
Reserves & surplus 3,330.92 2,350.68 2,162.79 2,190.80 2,320.79
Loan funds
Secured loans 162.07 365.07 224.29 353.49 133.37
Unsecured loans 3,563.30 3,137.96 2,954.31 676.31 2.49
Total 7,442.14 6,041.42 5,528.61 3,407.10 2,645.38
Uses of funds
Fixed assets
Gross block 2,386.75 2,261.48 2,133.57 1,799.32 1,402.79
Less : revaluation reserve - - - - -
Less : accumulated depreciation 930.07 791.96 699.54 599.35 525.21
Net block 1,456.68 1,469.52 1,434.03 1,199.97 877.58
Capital work-in-progress 428.77 327.42 301.88 432.84 264.16
Investments 3,618.03 3,237.55 2,679.95 762.78 679.07
Net current assets
Current assets, loans & advances 6,509.97 2,922.42 2,620.99 2,409.08 2,366.89
Less : current liabilities & provisions 4,571.31 1,915.49 1,508.24 1,397.56 1,542.33
Total net current assets 1,938.67 1,006.93 1,112.76 1,011.52 824.57
Miscellaneous expenses not written - - - - -
Total 7,442.14 6,041.42 5,528.61 3,407.10 2,645.38
Notes:
Book value of unquoted investments 3,372.60 3,106.69 2,659.94 762.77 679.07
Market value of quoted investments - 280.46 14.27 0.01 0.01
Contingent liabilities 252.85 201.00 159.40 202.40 307.95
Number of equity sharesoutstanding (Lacs) 4203.70 3730.71 3726.87 3724.42 1858.91

89
Capital structure
Paid Up
From To Class Of Authorized Issued Paid Up Paid Up
Face
Year Year Share Capital Capital Shares (Nos) Capital
Value
Equity
2008 2008 299.00 210.18 420369753 5 210.18
Share
Equity
2007 2007 299.00 186.54 373070829 5 186.54
Share
Equity
2006 2006 299.00 186.34 372686964 5 186.34
Share
Equity
2005 2005 299.00 186.22 372442190 5 186.22
Share
Equity
2004 2004 199.00 185.89 185890742 10 185.89
Share
Equity
2003 2003 199.00 185.54 185543625 10 185.54
Share
Equity
2002 2002 199.00 185.45 185452098 10 185.45
Share
Equity
2001 2001 150.00 115.90 115895478 10 115.90
Share
Equity
2000 2000 150.00 115.90 115895478 10 115.90
Share
Equity
1999 1999 150.00 115.90 115895250 10 115.90
Share
Equity
1997 1998 69.00 53.73 53726252 10 53.73
Share
Equity
1996 1997 69.00 49.41 49414717 10 49.41
Share
Equity
1995 1996 69.00 48.13 43132253 10 43.13
Share
Equity
1995 1996 69.00 48.13 5000000 3 1.25
Share
Equity
1994 1995 69.00 43.13 43132253 10 43.13
Share
Equity
1993 1994 69.00 35.33 35330269 10 35.33
Share
Equity
1992 1993 49.00 21.79 21793050 10 21.79
Share

Flagships Brands

90
Servo
IndianOil's SERVO is the largest selling
lubricant brand in India, with one of the largest ranges
of automotive and industrial lubricants. Developed
exclusively at IndianOil's world-class R&D Centre at Faridabad, there is a SERVO
lubricant for virtually every single application. With over 42% market share and 450
grades, the country's leading SERVO brand lubricants from IndianOil are sold through
over 8,100 IndianOil petrol/diesel stations, over 1,300 SERVO Shops and a countrywide
network of bazaar traders.

Indane
Indian Oil reaches Indane brand cooking gas to
the doorsteps of over 35 million households in over
2,000 markets through the country's largest network of
over 4,000 distributors. The Corporations 82 LPG
plants bottle about 3,380 thousand tonnes of LPG per annum. Compact 5 kg Indane
cylinders were launched in 75 rural and hilly markets of 11 states, i.e. J & K, Himachal
Pradesh, Punjab, Uttar Pradesh, Arunachal Pradesh, Meghalaya, Assam, Orissa, West
Bengal, Madhya Pradesh and Tamil Nadu, with plans to introduce them in 500 markets in
rural areas.

Premium Fuel
The launch of premium fuels - XtraPremium and
XtraMile (originally IOC Premium and Diesel Super

91
 respectively), marks a new beginning for IndianOil and its customers.
XtraPremium is, in fact, the only petrol in India with 91 Octane and doped with
Multifunctional Additives. The maiden launch of these branded fuels took place in Delhi
on Sept. 24, 2002. Subsequently, XtraPremium sales have been extended to 200 cities and
750 petrol & diesel stations, and XtraMile to 850 cities and 1750 petrol and diesel
stations by the end of the financial year 2003 2004.

Aviation Service
Indian Oils ISO-9002 certified Aviation Service,
with 68% market share, meets the fuel and lubricants needs
of domestic and international flag carriers, Defence
Services and private aircraft operators through 93 aviation
fuelling stations. Between one sunrise and the next, IndianOil refuels over 900 aircrafts.
In fact, the refuelling never stops and neither does our customer service, which is round
the clock. The wings foreign exchange earnings during the year 2002-03 touched Rs. 898
crore.

Auto Gas

Auto gas (LPG) has been introduced in

Hyderabad, Bangalore and Mumbai markets. This
alternative fuel is a good business proposition in the
long term, and IndianOil intends to further expand its
marketing in a big way.

92
 DATA ANALYSIS

INDIANOIL MAJOR PRODUCTS

IndianOil continues to lay emphasis on infrastructure development. Towards this end, a

number of schemes have been initiated with increasing emphasis on project execution in
compressed schedules as per world benchmarking standards. Schemes for improvement and
increased profitability through debottlenecking / modifications / introduction of value added
products are being taken up in addition to grassroots facilities. Project systems have been
streamlined in line with ISO standards.

GRASSROOTS REFINERY-CUM-PETROCHEMICALS PROJECT AT PARADIP

Project Cost: Rs. 25,646 crore
Expected Commissioning: By end of 2011-12
Benefit: The project will help in partly meeting deficit of distillates viz. LPG, Naphtha, MS,
Jet/Kero, Diesel and other products, in the eastern part of the country. The complex will
generate intermediate petrochemicals feedstock.
Brief Description: A 15 MMTPA grassroots refinery-cum-petrochemicals complex (along
with a product pipeline to Ranchi) is planned to be constructed at Paradip in the state of
Orissa. The Refinery will have, apart from a Crude and Vacuum Distillation Unit, a
Hydrocracking Unit, a Delayed Coker Unit and other secondary processing facilities. It will
also have an integrated gasification combined cycle plant for production of steam, power and
hydrogen from petroleum coke for captive use in the refinery. This will be the most modern
refinery in India with nil residue production and the products would meet stringent
specifications. 3344 acre of land has been taken over by IndianOil and necessary
infrastructure development jobs prior to setting up of the

main refinery are progressing.This complex envisages production of integrated

petrochemicals like Paraxylene, Polypropylene, and Styrene.

RESIDUE UPGRADATION AND MS/HSD QUALITY IMPROVEMENT PROJECT

AT GUJARAT REFINERY

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Project Cost: Rs. 5,693 crore
Expected Commissioning: January 2010
Benefit: The project envisages setting up of a number of units like VGO-HDT, ATF-Merox,
FCC-Merox, LPG-Merox, ISOM, Coker, DHDT, HGU (PDS) and SRU.
Brief Description: The objectives of the project are multifold. It shall ensure meeting
product quality requirement of MS/HSD to EURO-III/IV levels, processing increased
quantity of high sulphur crude and improvement in distillate yield.
Last Updated: August 09, 2007

NAPHTHA CRACKER AND POLYMER COMPLEX AT PANIPAT (HARYANA)

Project Cost: Rs. 14,439 crore
Expected Commissioning: November 2009
Benefit: This project is a cornerstone for IndianOil's entry into petrochemicals and a new
business line for growth. For the State of Haryana, this project shall lay the foundation for
creation of a world-class petrochemicals hub, which will engender significant industrial
activity in the coming years.

Brief Description: The project envisages setting up of a Naphtha Cracker based on captive
utilisation of naphtha from Panipat, Mathura and Koyali refineries of IndianOil. With a
capacity of 800,000 MT/year of ethylene production, the Cracker complex will have
associated units viz. hydrogenation, butadiene extraction, benzene extraction etc. besides
downstream polymer units like swing unit (LLDPE/HDPE), a dedicated HDPE unit,
Polypropylene unit and MEG unit.

CHENNAI-BANGLORE PRODUCT PIPELINE

Project Cost: Rs. 232.11 crore
Expected Commissioning: July 2009(or 24 months from Forest & Environment Clearance)
Benefit: The project consists of laying 14"/12" diameter 290 km long product pipeline from
CPCL Refinery (Manali, Chennai) in Tamil Nadu to Banglore in Karnataka
Brief Description: The pipeline would ensure uninterrupted, regular and economical

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transportation of petroleum products to Bangalore-fed areas in a cost-effective manner.

DADRI-PANIPAT R-LNG SPUR PIPELINE

Project Cost: Rs. 250.66 crore

Expected Commissioning: January 2009
Benefit: The 132 km long 30 inch diameter spurline carrying regassified LNG (R-LNG) will
stretch from GAIL Indias Dadri terminal in UP to Panipat.

Brief Description: The proposed R-LNG pipeline would provide for an economical means
of feeding natural gas to Panipat refinery.

AUGMENTATION OF MUNDRA PANIPAT CRUDE OIL PIPELINE

Project Cost: Rs. 204.74 crore
Expected Commissioning: December 2008
Brief Description: Project consists of laying a 22" diameter 20 KM long loopline in Kot-
Beawar section and conversion of Radhanpur scraper station to pumping station while
adding pumping units at Mundra, Kot, Sanganer and Rewari.
Benefit: This is a low cost expansion scheme of Mundra-Panipat crude oil pipeline system
for meeting the additional crude oil requirement of Panipat refinery to the tune of 3
MMTPA.

PANIPAT-JALANDHAR LPG PIPELINE

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 Project Cost: Rs.186.72 crore
Expected Commissioning: August 2008
Benefit: The pipeline with feed IndianOil's LPG bottling Plants at Nabha and Jalandhar in a
cost-effective manner.
Brief Description: Project consists of laying a 10" diameter 275 KM long LPG pipeline
from Kohand (near Panipat refinery) in Haryana to Jalandhar via Nabha in Punjab.

66

STATEMENT OF PURPOSE

Indian oil is a public sector company and has a broad area of working .it has a
continuosly increasing turnover. The debtors and inventories are increasing at a higher
rate due to increase in sales. The study will cover the preparation of reconciliation of
I.O.C.L. A single mistake in the preparation of the reconciliation can cause a big problem
in the future.

The study is conducted to understand the various reconciliations prepared in

I.O.C.L. for its proper functioning, the problems encountered in the preparation of the
same and to provide effective solutions

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DATA ANALYSIS & INTERPRETATION :

Business Industrial Network

Don't be laymen by the low bars for the "Paper" industry. The survey participants
did not supply monthly T&M cost. This could be a result of participants not being aware
of cost, or not trusting that they remain anonymous in this survey.

Lost Production Cost

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 Industry

Analysis:

This graph shows us just how unaware each industry is, of the "True Cost" of
downtime. For example it has been calculated in some paper facilities, that a corrugator
down cost $10K per hour. One might construed the bar for paper industry indicates the
corrugator has not been down for more than an hour the entire year! The graph indicates
the Automotive, Food and Metal industries are most aware of "True Cost" of downtime.

98
 Once the tools and articles at bin95.com are used to calculate, track, and
benchmark the "True Cost" of downtime, this information should be used in daily
management decisions. (Such as repair or replace.)

This database and documentation is the confidential and proprietary information

of Business Industrial Network ("Confidential Information"). You shall not disclose such
Confidential Information and shall use it only in accordance with the terms of the license
agreement you entered into with Business Industrial Network.

No portion of these proceedings or exhibits may be copied, duplicated, used or

referenced without written permission from Business Industrial Network.
bin95@bin95.com

OEM Response Time

lndustry

99
_ = Highest Maximum time reported by any one facility, waiting on OEM to respond.

_ = Average maximum time for industry that OEM took to respond.

Analysis:
100
 Note: These are averages among industry of maximum respond time. Not average
respond time of OEM. This graph is just to show extreme cases, to bring attention to cost
involved.

For example if you calculated your true cost of down time as $1,000 per hour,
some instances cost as much as $50,000. If that breakdown was a bottle neck, the hourly
cost could escalate to over a half a million!

This is yet another example of why you should take out insurance against costly
downtime, and subscribe to Business Industrial Network's technical resources.
(If you only shave 10% off one instance, with our services, you could see a ROI of more
than 500%.)

101
 Annual OEM Cost

Analysis:

With an increase in outsourcing, industry wide, $100K a year is not bad. If you dig deeper,
you'll find these figures to be actual dollars paid out. Not actual cost of downtime related to OEM
service.

You will find that service is not the only OEM related cause for downtime cost. Most
facilities do not track downtime cost related to OEM warranty work, and OEM new
installations/upgrades.
The first step is to accurately track cost related OEM service, warranty, and installations. Then
you will see the "True Cost", and potential for savings. (Lack of standards for dealing with OEMs is
the primary reason for cost ten times the scale in the graph above. BIN95 is working on a set of tools
and standards you can use to save thousands.)

102
 .

_ = Average number of PLC techs per industry

_ = Average number of PLCs per industry

Analysis:

Its amazing to find out how many don't know exactly how many PLCs are in their
facility. Injection Molding was the lowest in our survey. But with just about every
Molding machine and extruder having some flavor of PLC in it, I suspect the numbers are
a lot higher than surveyed.

TIPS:
1. Take an inventory of all machines.
2. Insure you have manuals and preferably software on hand, for each brand

Business Industrial Network has personnel who will inventory for you, and make
back up copies of all programs.

103
 .

_ = Average monthly downtime for industry

_ = Average total annual downtime for industry

Analysis:

The Automotive, metal and paper industries reported monthly averages where off
by an average of 30% of what they reported for an annual downtime. One of 2 conclusion
can be drawn from this fact.

1. They are not aware of the true monthly average downtime.

2. They had one or more major break downs that where not calculated in monthly
averages

104
 CONCLUSION

After undergoing an in-depth study of the report, one can easily recognize that
Indian Oil ensures proper accounting for each and every rupee transacted through
bank.

Utmost care is taken while implementing all the control measures and there is no
deviation from the laid down procedures. Various checklists of control have
been made as exhaustive as possible in dealing with the banking transactions.

The functions, activities, roles and responsibilities of the concerned work groups
are also being performed very smoothly.

Further, in view of the large number of accounts being operated by IOCL,

spread over 500 places across the country, a grievances settlement procedures
has been very efficiently worked out by IOCL and SBI, which would lead to
early redressal of any problems or unresolved issues with IOCL location against
SBI branches.

Undoubtedly, it is because of this incredible expertise an synchronize

functioning that Indian Oil has a monopoly in the down stream sector, but still
certain improvements are yet to take place.

105
 LIMITATIONS

Time limitation as the duration of the project is only 8 weeks.

The report is limited to the Indian Oil Bhavan (Northern Region).
It is based on consultation, discussion with all concerned officials.
Responses, which come, are very slow.
The respondents were not interested in revealing all the data, as it
was confidential to the organization

106
 RECOMMENDATIONS

The CMP facility has been administered at nearly about 85% of the total number
of branches of IOCL. This is because rest of the 15% of the branches is yet to be
computerized. The facility should be extended to all of its branches because that
would results in saving interest on bank borrowings.

Since cost of financing is an important and major component of the over all
expenditure, there is a need to exercise due control and take suitable measures to
reduce the burden of financing cost which comprises of interest on bank
borrowings and bank charges.

It should be ensured that there is no withholding of credit balances beyond Rs.

1000 in collection account under any circumstances.

In case of holidays for IOCL but working day for bank, it should be ensured that
the DCR is deposited in the bank even on such day.

Immediate arrangements should be made to recover overdue interest form the

customers where the same is debited to bank.

The interest rate on bank borrowings should be reduced to certain extent.

BIBLIOGRAPHY

107
 Banking manual of IOCL

Capital budget manual of IOCL

Closing manual of IOCL

Material provided at IOCL

IOCL NEWS

www.indianoilcorp.com

www.iocl.com

www.google.com

www.indianoilcorporation.com

Annual Report 2007-2008

GLOSSARY

108
IOC- Indian Oil Corporation

NR- Northern Region

DSO-Delhi State Office
PSO-PunjabStateOffice
RSO-RajasthanStateOffice
UPSO-Uttar Pradesh State Office
RCC-Regional Cash Credit
CMP-Cash Management Product
DCR-Daily Credit Report

109