CHAPTER-I

INTRODUCTION

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INTRODUCTION:
“Capital structure is essentially concerned with how the firm decides to divide its cash flows
into two broad components, a fixed component that is earmarked to meet the obligations
toward debt capital and a residual component that belongs to equity shareholders”

-P. Chandra.

The capital structure is how a firm finances its overall operations and growth by using
different sources of funds. Debt comes in the form of bond issues or long-term notes payable,
while equity is classified as common stock, preferred stock or retained earnings. Short-term
debt such as working capital requirements is also considered to be part of the capital structure.

Capital structure is the mix of the long-term sources of funds used by a firm. It is made up of
debt and equity securities and refers to permanent financing of a firm. It is composed of long-
term debt, prefer-ence share capital and shareholders’ funds.

The capital structure decision can affect the value of the firm either by changing the expected
earnings or the cost of capital or both.

The objective of the firm should be directed towards the maximization of the value of the firm
the capital structure, or average, decision should be examined from the point of view of its
impact on the value of the firm.

If the value of the firm can be affected by capital structure or financing decision a firm would
like to have a capital structure which maximizes the market value of the firm. The capital
structure decision can affect the value of the firm either by changing the expected earnings or
the cost of capital or both.

A mix of a company's long-term debt, specific short-term debt, common equity and preferred
equity. The capital structure is how a firm finances its overall operations and growth by using
different sources of funds.

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Debt comes in the form of bond issues or long-term notes payable, while equity is classified as
common stock, preferred stock or retained earnings. Short-term debt such as working capital
requirements is also considered to be part of the capital structure.

The phrase “capital structure” can mean different things to different people. At its simplest,
capital structure reflects the equity and debt of the company. A privately held company that
plans to share equity with employees and rise outside capital generally has at least two classes
of stock: common for founders and employees, and preferred for investors. A company has a
finite amount of equity to exchange for the financial and talent resources necessary to execute
your plan successfully. Great care should be taken when planning the allocation of equity. The
experienced team at top level management can help you navigate the many elements of
creating your capital structure. Often we begin by creating a forward-looking financial
forecast to assist in determining the required capital (financial and human) to support your
business plans. We offer several specialized advisory services, including tools, templates and
data to assist in the process. Experienced financial consulting services will likely include

 Determining the appropriate capital structure

 Supporting the capital raise process, including financial pro forma development,
managing due diligence and negotiating terms
 Developing and implementing short- and long-term cash flow forecasting processes
 Optimizing working capital investments in accounts receivable and inventory
 Negotiating appropriate debt facilities to leverage an equity raise

The assets of a company can be financed either by increasing the owners claim or the creditors
claim. The owners claims increase when the form raises funds by issuing ordinary shares or
by retaining the earnings, the creditors’ claims increase by borrowing .The various means of
financing represents the “financial structure” of an enterprise .The financial structure of an
enterprise is shown by the left hand side (liabilities plus equity) of the balance sheet.
Traditionally, short-term borrowings are excluded from the list of methods of financing the
firm’s capital expenditure, and therefore, the long term claims are said to form the capital
structure of the enterprise .The capital structure is used to represent the proportionate
relationship between debt and equity .Equity includes paid-up share capital, share premium

3
and reserves and surplus. The financing or capital structure decision is a significant
managerial decision .It influences the shareholders returns and risk consequently; the market
value of share may be affected by the capital structure decision. The company will have to
plan its capital structure initially at the time of its promotion.

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NEED OF THE STUDY:
The value of the firm depends upon its expected earnings stream and the rate used to discount
this stream. The rate used to discount earnings stream it’s the firm’s required rate of return or
the cost of capital.

 The capital structure decision can affect the value of the firm either by changing the
expected earnings of the firm, but it can affect the reside earnings of the shareholders.

 The effect of leverage on the cost of capital is not very clear. Conflicting opinions have
been expressed on this issue. In fact, this issue is one of the most continuous areas in the
theory of finance, and perhaps more theoretical and empirical work has been done on
this subject than any other.

 If leverage affects the cost of capital and the value of the firm, an optimum capital
structure would be obtained at that combination of debt and equity that maximizes the
total value of the firm or minimizes the weighted average cost of capital.

 A firm has certain structure of assets, which offers net operating earnings of given size
and quality, and given a certain structure of rates in the capital markets, is there some
specific degree of financial leverage at which the market value of the firm’s securities
will be higher than at other degrees of leverage?

 The existence of an optimum capital structure is not accepted by all. These exist two
extreme views and middle position.

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SCOPE OF THE STUDY:
 A study of the capital structure involves an examination of long term as well as short
term sources that a company taps in order to meet its requirements of finance.
 The scope of the study is confined to the sources that Heritage Foods Ltd tapped over
the years under study i.e. 2013-14 to 2017-18.

OBJECTIVES OF CAPITAL STRUCTURE :

Decision of capital structure aims at the following two important
objectives:
 Maximize the value of the firm.
 Minimize the overall cost of capital.

RESEARCH DESIGN :
A research design is a systematic plan to study a scientific problem. The design
of a study defines the study type (descriptive, correlational, semi-experimental,
experimental, review, meta-analytic) and sub-type (e.g., descriptive-longitudinal
case study), research question, hypotheses, independent and dependent variables,
experimental design, and, if applicable, data collection methods and a statistical
analysis plan. Research design is the framework that has been created to seek
answers to research questions. Design types and sub-types There are many ways
to classify research designs, but sometimes the distinction is artificial and other
times different designs are combined. Nonetheless, the list below offers a
number of useful distinctions between possible research designs. • Descriptive
(e.g., case-study, naturalistic observation, Survey) • Correlational (e.g., case-
control study, observational study) • Semi-experimental (e.g., field experiment,
quasi-experiment) • Experimental (Experiment with random assignment) •
Review (Literature review, Systematic review) • Meta-analytic (Meta-analysis,

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i.e., using statistical methods for contrasting and combining results from
different studies to identify patterns among study results, sources of
disagreement among those results, or other interesting relationships that may
come to light in the context of multiple studies)

RESEARCH METHODOLOGY:
SOURCES OF DATA:
Data relating to Heritage Foods Ltd. Has been collected through

SECONDARY SOURCES:
 Published annual reports of the company for the year 2013-14 to 2017-18

PRIMARY SOURCES:
 Detailed discussions with Asst. Finance Manager
 Discussions with the Finance manager and other members of the Finance department
(plant location).

TECHNIQUES:

 The collected data has been processed using the tools of

 Ratio analysis
 Graphical analysis
 Year-year analysis

These tools access in the interpretation and understanding of the Existing scenario of the
Capital Structure.

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LIMITATIONS OF STUDY:

CHAPTER-II
REVIEW OF LITERATURE
ARTICLES ON CAPITAL STRUCTURE ANALYSIS:
By Prof. (Dr). T. Velnampy & J. Aloy Niresh-2012- Capital structure decision is the vital
one since the profitability of an enterprise is directly affected by such decision. The successful
selection and use of capital is one of the key elements of the firms’ financial strategy. Hence,
proper care and attention need to be given while determining capital structure decision. The
purpose of this study is to investigate the relationship between capital structure and
profitability of ten listed Srilankan banks over the past 8 year period from 2002 to 2009.The
data has been analyzed by using descriptive statistics and correlation analysis to find out the
association between the variables. Results of the analysis show that there is a negative
association between capital structure and profitability except the association between debt to
equity and return on equity. Further the results suggest that 89% of total assets in the banking
sector of Sri Lanka are represented by debt, confirming the fact that banks are highly geared
institutions. The outcomes of the study may guide banks, loan-creditors and policy planners to
formulate better policy decisions as far as the capital structure is concerned.

Achmad Faizal Azmi (2018) - The purpose of this thesis is to investigate the association
between revaluation of fixed assets and future firm performance in Indonesia. This thesis aims

8
to find the answer whether Indonesia’s government decision to issue temporary tax cut policy
is effective, to the extent it enhances future performance of Indonesian firm. To observe the
effect of the fixed assets revaluation on the future firm performance, a multiple regression
analysis is employed. Future firm performance operationalized by using the changes in
operating income and the changes in operating cash flow for one and two subsequent years.
This thesis utilized revaluation of fixed assets data in the year 2015 since the temporary tax
cut for fixed assets revaluation was started at that year. The result shows that revaluation of
fixed assets by Indonesian firms are significantly positively associated with changes in
operating income on one subsequent year after revaluation. This result implied that the
benefits of fixed asset revaluations are realized in the subsequent year and motivation of
revaluation is mainly related with the effort to disclose the fair value of the fixed assets to the
user of financial statements. Meanwhile, revaluation of fixed assets by Indonesian firms
having a statistically insignificance negative association to the future operating cash flow after
two subsequent years of revaluation. These findingslead to the conclusion that temporary tax
cut policy is effective enough to foster the future operating income of the Indonesian firms.

Rakesh H M-2013- Capital structure is most significant discipline of company’s operations.

This study constitutes an attempt to identify the impact between Capital Structure and
Companies Performance, taking into consideration the level of Companies Financial
Performance. The analysis has been made on the capital structure and its impact on Financial
Performance capacity during 2009 to 2012 (03 years) financial year of Business companies in
India. The results show the relationship between the capital structure and financial
performance is having a negative association. It reflects the insignificant level of the Business
Companies in India. Hence Business companies mostly depend on the debt capital. Therefore,
they have to pay interest expenses much.

Dr. M Sekara -2014- This study examines the influence of capital structure on the
performance of the company. It is measured using EBIT-EPS analysis. In this paper an
attempt is made to analyze the capital structure of Tata Motors Limited during the period
2003-04 to 2012-2013, so as to understand the factors that influenced the capital structure
decisions of the company and to know the impact of capital structure decisions on profitability
and performance of the company. The company’s performance is measured through EBIT-

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EPS analysis. Increase in the level of debt and net worth increases the debt equity ratio.
Capital structure is the crucial decision to be taken by every business, the positives and
negatives of these decisions plays a important role in determining the future of every business.

JIANJUN MIAO-2005- This paper provides a competitive equilibrium model of capital

structure and industry dynamics. In the model, firms make financing, investment, entry, and
exit decisions subject to idiosyncratic technology shocks. The capital structure choice reflects
the tradeoff between the tax benefits of debt and the associated bankruptcy and agency costs.
The interaction between financing and production decisions influences the stationary
distribution of firms and their survival probabilities. The analysis demonstrates that the
equilibrium output price has an important feedback effect. This effect has a number of testable
implications. For example, high growth industries have relatively lower leverage and turnover
rates.

Dharmendra Singh-2016- The aim of this research paper is to examine the firm-specific
determinants of the capital structure for non-financing companies of Oman. Based on the
existing literature and theories of capital structure, the probable determinants of capital
structure are identified. The analysis is performed using panel data techniques; fixed and
random effects, for a sample of 61 companies listed on the Muscat Securities Market during
2011-2015. The results suggest that tangibility, profitability and liquidity are having negative
relationship with the leverage, whereas firm size and growth opportunity are positively related
to the leverage. Non-debt tax shields do not appear to be significantly related to leverage of
Omani firms. Pecking order theory is most successful in explaining the determinants of capital
structure of the Omani companies. The results of this paper suggest that findings are
consistent with the capital structure studies on other developed and developing countries. The
study has important policy implications for the finance managers of the firms in Oman.

By Rashid Naim Nasimi-2016- This paper develops a study on identifying the most
significant determinants of capital structure of 15 firms listed on the S&P 500 index, New
York Stock Exchange using panel data over 5 years period from 2010 to 2014. Multiple
regression analysis has been employed for testing the impact of six independent variables on
three dependent variables. The results show that among all the six independent variables that

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represent profitability, size, growth, tangibility, cost of financial distress and non-debt tax
shield effects; tangibility has a significant impact on the three of dependent variables which
are total debt ratio, long term debt ratio and short term debt ratio. Thus, profitability, size,
growth, tangibility, cost of financial distress and non-debt tax shield effects are the
determinants of capital structure for the IT firms in the United States. The study concludes
that debt is preferred in the capital structure of firms in the IT sector of the United States.

Lyubomira Koeva-Dimitrova,-2016- The capital structure analysis of medical institutions is

related to the assessment of their financial sustainability. The degree of their financial
sustainability indicates the extent to which the medical institution is exposed to financial risk.
This financial risk is related to the use of foreign capital (debts, loans, etc.) and it is defined as
the probability of insolvency and possible bankruptcy due to the existence of debts which
could not be repaid at some point in the foreseeable future. Objective: To analyze the capital
structure of the medical diagnostic-consultative centers in Varna city and on this basis to
assess their long-term solvency and existence of financial risk.

Dr.J.TAMILSELVI,-2018- Capital structure is the imperative area of financial decision

making due to the interrelationship with other financial decision variables. In finance, capital
structure is the controversial subject and endures to retain scholars contemplative. The
proportion of debt funding is measured by long term debt ratios. There are numerous factors
that affect a firm‘s capital structure, and a firm should try to decide the optimum mix of
financing. Therefore, an effort is made in this study to ascertain the impact of various
determinants of capital structure so that appropriate capital structure could be premeditated by
the companies and create them competitive and cost effective. Structural equation model is
used to test the hypothesised model. The study of the model advocates that the measured
variables are prejudiced to determine the capital structure of select companies in software
industry except liquidity.

Hans Lööf-2003- This paper incorporates the cost of adjustment between observed and
optimal leverage in explaining the variation in firm’s equity or bank-debt financing
investments. Using a dynamic adjustment approach identifies the determinants to capital
structure between different financial systems. In relation to firm sales U.K and U.S firms have

11
50-100 percent more equity financing than Swedish firms depending on which measure used,
while the ratio of debt to sales is highest in Sweden. The major findings are that observed
leverage often deviates from the target leverage in both equity and debt dominated systems.
There are large and also unexpected cross country differences in determinants to optimal
capital structure. Swedish and U.K. firms deviate more from the optimal level than U.S firms.
A faster speed towards the target is observed in the equity based systems.

Kennedy Prince Modugu- 2013- Capital structure decision poses a lot of challenges to firms.
Determining an appropriate mix of equity and debt is one of the most strategic decisions
public interest entities are confronted with. A wrong financing decision has the tendency of
stalling the fortunes of any business. Therefore, if managers are to achieve the goal of wealth
maximization, conscious steps must be taken in the right direction and at the right time to
identify those factors that must be taken into cognizance in determining appropriate financing
mix. It is upon this premise that this conceptual piece is designed to guide the top echelons of
corporate managers in capital structure decisions. The paper explores a vast body of literature
in articulating critical issues in capital structure decision.

THEORETICAL FRAMEWORK

INTRODUCTION:
The capital structure decision can affect the value of the firm either by changing the expected
earnings or the cost of capital or both. The objective of the firm should be directed towards the
maximization of the value of the firm the capital structure, or average, decision should be
examined from the point of view.

The combination of a company's long-term debt, specific short-term debt, common equity,
and preferred equity; the capital structure is the firm's various sources of funds used to finance
its overall operations and growth. Debt comes in the form of bond issues or long-term notes
payable, whereas equity is classified as common stock, preferred stock, or retained earnings.
Short-term debt such as working capital requirements also is considered part of the capital
structure

12
The assets of a company can be financed either by increasing the owners claim or the creditors
claim. The owners claims increase when the form raises funds by issuing ordinary shares or
by retaining the earnings, the creditors claims increase by borrowing .The various means of
financing represents the “financial structure” of an enterprise .The financial structure of an
enterprise is shown by the left hand side (liabilities plus equity) of the balance sheet.
Traditionally, short-term borrowings are excluded from the list of methods of financing the
firm’s capital expenditure, and therefore, the long term claims are said to form the capital
structure of the enterprise .The capital structure is used to represent the proportionate
relationship between debt and equity .Equity includes paid-up share capital, share premium
and reserves and surplus.

The financing or capital structure decision is a significant managerial decision .It influences
the shareholders returns and risk consequently; the market value of share may be affected by
the capital structure decision. The company will have to plan its capital structure initially at
the time of its promotion.

FACTORS AFFECTING THE CAPITAL STRUCTURE:

 LEVERAGE: The use of fixed charges of funds such as preference shares, debentures and
term-loans along with equity capital structure is described as financial leverage or trading
on. Equity. The term trading on equity is used because for raising debt.

 DEBT /EQUITY RATIO-Financial institutions while sanctioning long-term loans insists that
companies should generally have a debt –equity ratio of 2:1 for medium and large scale
industries and 3:1 indicates that for every unit of equity the company has, it can raise 2
units of debt. The debt-equity ratio indicates the relative proportions of capital
contribution by creditors and shareholders.

 EBIT-EPS ANALYSIS-In our research for an appropriate capital structure we need to

understand how sensitive is EPS (earnings per share) to change in EBIT (earnings before
interest and taxes) under different financing alternatives.

The other factors that should be considered whenever a capital structure decision is taken are
 Cost of capital

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  Cash flow projections of the company
 Size of the company
 Dilution of control
 Floatation costs

FEATURES OF AN OPTIMAL CAPITAL STRUCTURE:

An optimal capital structure should have the following features,
1. PROFITABILITY: - The Company should make maximum use of leverages at a
minimum cost.

2. FLEXIBILITY: - The capital structure should be flexible to be able to meet the changing
conditions .The company should be able to raise funds whenever the need arises and costly to
continue with particular sources.

3. CONTROL: - The capital structure should involve minimum dilution of control of the
company.

4. SOLVENCY: - The use of excessive debt threatens the solvency of the company. In a high
interest rate environment, Indian companies are beginning to realize the advantage of low
debt.

CAPITAL STRUCTURE AND FIRM VALUE:

Since the objective of financial management is to maximize shareholders wealth, the key issue
is: what is the relationship between capital structure and firm value? Alternatively, what is the
relationship between capital structure and cost of capital? Remember that valuation and cost
of capital are inversely related. Given a certain level of earnings, the value of the firm is
maximized when the cost of capital is minimized and vice versa.

There are different views on how capital structure influences value. Some argue that there is
no relationship what so ever between capital structure and firm value; other believe that
financial leverage (i.e., the use of debt capital) has a positive effect on firm value up to a point
and negative effect thereafter; still others contend that, other things being equal, greater the
leverage, greater the value of the firm.

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CAPITAL STRUCTURE DIAGRAM
The Capital Structure Decision Process

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CAPITAL STRUCTURE AND PLANNING:
Capital structure refers to the mix of long-term sources of funds. Such as debentures, long-
term debt, preference share capital including reserves and surplus (i.e., retained earnings) The
board of directors or the chief financial officer (CEO) of a company should develop an
appropriate capital structure, which are most factors to the company. This can be done only
when all those factors which are relevant to the company’s capital structure decision are
properly analyzed and balanced. The capital structure should be planned generally keeping in
view the interests of the equity shareholders, being the owners of the company and the
providers of risk capital (equity) would be concerned about the ways of financing a
company’s operations. However, the interests of other groups, such as employees, customers,
creditors, society and government, should also be given reasonable consideration. When the
company lays down its objective in terms of the shareholder’s wealth maximization (SWM), it
is generally compatible with the interests of other groups. Thus while developing an
appropriate capital structure for its company, the financial manager should inter alia aim at
maximizing the long-term market price per share. Theoretically, there may be a precise point
or range within an industry there may be a range of an appropriate capital structure with in

16
which there would not be great differences in the market value per share. One way to get an
idea of this range is to observe the capital structure patterns of companies’ vis-à-vis their
market prices of shares. It may be found empirically that there are not significant differences
in the share values within a given range. The management of a company may fix its capital
structure near the top of this range in order to make maximum use of favorable leverage,
subject to other requirements such as flexibility, solvency, control and norms set by the
financial institutions, the security exchange Board of India (SEBI) and stock exchanges.

FEATURES OF AN APPROPRIATE CAPITAL STRUCTURE: -

The board of Director or the chief financial officer (CEO) of a company should develop an
appropriate capital structure, which is most advantageous to the company. This can be done
only when all those factors, which are relevant to the company’s capital structure decision, are
properly analyzed and balanced. The capital structure should be planned generally keeping in
view the interest of the equity shareholders and financial requirements of the company. The
equity shareholders being the shareholders of the company and the providers of the risk
capital (equity) would be concerned about the ways of financing a company’s operation.
However, the interests of the other groups, such as employees, customer, creditors, and
government, should also be given reasonable consideration. When the company lay down its
objectives in terms of the shareholders wealth maximizing (SWM), it is generally compatible
with the interest of the other groups. Thus, while developing an appropriate capital structure
for it company, the financial manager should inter alia aim at maximizing the long-term
market price per share. Theoretically there may be a precise point of range with in which the
market value per share is maximum. In practice for most companies with in an industry there
may be a range of appropriate capital structure with in which there would not be great
differences in the market value per share. One way to get an idea of this range is to observe
the capital structure patterns of companies’ Vis-a Vis their market prices of shares. It may be
found empirically that there is no significance in the differences in the share value with in a
given range. The management of the company may fit its capital structure near the top of its
range in order to make of maximum use of favorable leverage, subject to other requirement
(SEBI) and stock exchanges.

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A SOUND OR APPROPRIATE CAPITAL STRUCTURE SHOULD HAVE THE
FOLLOWING FEATURES

1) RETURN: the capital structure of the company should be most advantageous, subject to
the other considerations; it should generate maximum returns to the shareholders without
adding additional cost to them.

2) RISK: the use of excessive debt threatens the solvency of the company. To the point debt
does not add significant risk it should be used other wise it uses should be avoided.

3) FLEXIBILITY: the capital structure should be flexibility. It should be possible to the

company adopt its capital structure and cost and delay, if warranted by a changed
situation. It should also be possible for a company to provide funds whenever needed to
finance its profitable activities.

4) CAPACITY: - The capital structure should be determined within the debt capacity of the
company and this capacity should not be exceeded. The debt capacity of the company
depends on its ability to generate future cash flows. It should have enough cash flows to
pay creditors, fixed charges and principal sum.

5) CONTROL: The capital structure should involve minimum risk of loss of control of the
company. The owner of the closely held company’s of particularly concerned about
dilution of the control.

APPROACHES TO ESTABLISH APPROPRIATE CAPITAL STRUCTURE:

The capital structure will be planned initially when a company is incorporated .The initial
capital structure should be designed very carefully. The management of the company should set
a target capital structure and the subsequent financing decision should be made with the a view
to achieve the target capital structure .The financial manager has also to deal with an existing
capital structure .The company needs funds to finance its activities continuously. Every time
when fund shave to be procured, the financial manager weighs the pros and cons of various
sources of finance and selects the most advantageous sources keeping in the view the target
capital structure. Thus, the capital structure decision is a continues one and has to be taken
whenever a firm needs additional Finances.

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The following are the three most important approaches to decide about a firm’s capital structure.
 EBIT-EPS approach for analyzing the impact of debt on EPS.

 Valuation approach for determining the impact of debt on the shareholder’s value.

 Cash flow approached for analyzing the firm’s ability to service debt.

In addition to these approaches governing the capital structure decisions, many other factors
such as control, flexibility, or marketability are also considered in practice.

EBIT-EPS APPROACH:
We shall emphasize some of the main conclusions here .The use of fixed cost sources of
finance, such as debt and preference share capital to finance the assets of the company, is know
as financial leverage or trading on equity. If the assets financed with the use of debt yield a
return greater than the cost of debt, the earnings per share also increases without an increase in
the owner’s investment.

The earnings per share also increase when the preference share capital is used to acquire the
assets. But the leverage impact is more pronounced in case of debt because

 The cost of debt is usually lower than the cost of performance share capital and

 The interest paired on debt is tax deductible.

Because of its effect on the earnings per share, financial leverage is an important consideration
in planning the capital structure of a company. The companies with high level of the earnings
before interest and taxes (EBIT) can make profitable use of the high degree of leverage to
increase return on the shareholder’s equity. One common method of examining the impact of
leverage is to analyze the relationship between EPS and various possible levels of EBIT under
alternative methods of financing.

The EBIT-EPS analysis is an important tool in the hands of financial manager to get an insight
into the firm’s capital structure management .He can considered the possible fluctuations in
EBIT and examine their impact on EPS under different financial plans of the probability of
earning a rate of return on the firm’s assets less than the cost of debt is insignificant, a large
amount of debt can be used by the firm to increase the earning for share. This may have a

19
favorable effect on the market value per share. On the other hand, if the probability of earning a
rate of return on the firm’s assets less than the cost of debt is very high, the firm should refrain
from employing debt capital .it may, thus, be concluded that the greater the level of EBIT and
lower the probability of down word fluctuation, the more beneficial it is to employ debt in the
capital structure However, it should be realized that the EBIT EPS is a first step in deciding
about a firm’s capital structure .It suffers from certain limitations and doesn’t provide
unambiguous guide in determining the capital structure of a firm in practice.

RATIO ANALYSIS:
The primary user of financial statements are evaluating part performance and predicting future
performance and both of these are facilitated by comparison. Therefore the focus of financial
analysis is always on the crucial information contained in the financial statements. This
depends on the objectives and purpose of such analysis. The purpose of evaluating such
financial statement is different form person to person depending on its relationship. In other
words even though the business unit itself and shareholders, debenture holders, investors etc.
all under take the financial analysis differs. For example, trade creditors may be interested
primarily in the liquidity of a firm because the ability of the business unit to play their claims
is best judged by means of a through analysis of its l9iquidity. The shareholders and the
potential investors may be interested in the present and the future earnings per share, the
stability of such earnings and comparison of these earnings with other units in thee industry.
Similarly the debenture holders and financial institutions lending long-term loans maybe
concerned with the cash flow ability of the business unit to pay back the debts in the long run.
The management of business unit, it contrast, looks to the financial statements from various
angles. These statements are required not only for the management’s own evaluation and
decision making but also for internal control and overall performance of the firm. Thus the
scope extent and means of any financial analysis vary as per the specific needs of the analyst.
Financial statement analysis is a part of the larger information processing system, which forms
the very basis of any “decision making” process.

The financial analyst always needs certain yardsticks to evaluate the efficiency and
performance of business unit. The one of the most frequently used yardsticks is ratio analysis.

20
Ratio analysis involves the use of various methods for calculating and interpreting financial
ratios to assess the performance and status of the business unit.

It is a tool of financial analysis, which studies the numerical or quantitative relationship

between with other variable and such ratio value is compared with standard or norms in order
to highlight the deviations made from those standards/norms. In other words, ratios are
relative figures reflecting the relationship between variables and enable the analysts to draw
conclusions regarding the financial operations.

However, it must be noted that ratio analysis merely highlights the potential areas of concern
or areas needing immediate attention but it does not come out with the conclusion as regards
causes of such deviations from the norms. For instance, ABC Ltd. Introduced the concept of
ratio analysis by calculating the variety of ratios and comparing the same with norms based on
industry averages. While comparing the inventory ratio was 22.6 as compared to industry
average turnover ratio of 11.2. However on closer sell tiny due to large variation from the
norms, it was found that the business unit’s inventory level during the year was kept at
extremely low level. This resulted in numerous production held sales and lower profits. In
other words, what was initially looking like an extremely efficient inventory management,
turned out to be a problem area with the help of ratio analysis? As a matter of caution, it must
however be added that a single ration or two cannot generally provide that necessary details so
as to analyze the overall performance of the business unit.

In order to arrive at the reasonable conclusion regarding overall performance of the business
unit, an analysis of the entire group of ratio is required. However, ration analysis should not be
considered as ultimate objective test but it may be carried further based on the out come and
revelations about the causes of variations. Some times large variations are due to unreliability
of financial data or inaccuracies contained there in therefore before taking any decision the
basis of ration analysis, their reliability must be ensured.

Similarly, while doing the inter-firm comparison, the variations may be due to different
technologies or degree of risk in those units or items to be examined are in fact the
comparable only. It must be mentioned here that if ratios are used to evaluate operating

21
performance, these should exclude extra ordinary items because there are regarded as non-
recurring items that do not reflect normal performance.

Ratio analysis is the systematic process of determining and interpreting the numerical
relationship various pairs of items derived form the financial statements of a business.
Absolute figures do not convey much tangible meaning and is not meaningful while
comparing the performance of one business with the other.

It is very important that the base (or denominator) selected for each ratio is relevant with the
numerator. The two must be such that one is closely connected and is influenced by the other

CAPITAL STRUCTURE RATIOS:

Capital structure or leverage ratios are used to analyse the long-term solvency or stability of a
particular business unit. The short-term creditors are interested in current financial position
and use liquidity ratios. The long-term creditors world judge the soundness of a business on
the basis of the long-term financial strength measured in terms of its ability to pay the interest
regularly as well as repay the installment on due dates. This long-term solvency can be judged
by using leverage or structural ratios.

There are two aspects of the long-term solvency of a firm:-

1. Ability to repay the principal when due, and
2. Regular payment of interest, there are thus two different but mutually dependent and
interrelated types of leverage ratio such as:
3. Ratios based on the relationship between borrowed funds and owner’s capital,
computed form balance sheet eg: debt-equity ratio, dividend coverage ratio, debt
service coverage ratio etc.,

THE CAPITAL STRUCTURE CONTROVERSY:

The value of the firm depends upon its expected earnings stream and the rate used to discount
this stream. The rate used to discount earnings stream it’s the firm’s required rate of return or
the cost of capital. Thus, the capital structure decision can affect the value of the firm either by
changing the expected earnings of the firm, but it can affect the reside earnings of the
shareholders. The effect of leverage on the cost of capital is not very clear. Conflicting

22
opinions have been expressed on this issue. In fact, this issue is one of the most continuous
areas in the theory of finance, and perhaps more theoretical and empirical work has been done
on this subject than any other.

If leverage affects the cost of capital and the value of the firm, an optimum capital structure
would be obtained at that combination of debt and equity that maximizes the total value of the
firm or minimizes the weighted average cost of capital. The question of the existence of
optimum use of leverage has been put very succinctly by Ezra Solomon in the following
words.

Given that a firm has certain structure of assets, which offers net operating earnings of given
size and quality, and given a certain structure of rates in the capital markets, is there some
specific degree of financial leverage at which the market value of the firm’s securities will be
higher than at other degrees of leverage?

The existence of an optimum capital structure is not accepted by all. These exist two extreme
views and middle position. David Durand identified the two extreme views the net income and
net operating approaches.

1. Net Income Approach:

Under the net income approach (NI), the cost of debt and cost of equity are assumed to be
independent to the capital structure. The weighted average cost of capital declines and the
total value of the firm rise with increased use of leverage.

2. Net Operating Income Approach:

Under the net operating income (NOI) approach, the cost of equity is assumed to increase
linearly with average. As a result, the weighted average cost of capital remains constant and
the total value of the firm also remains constant as leverage is changed.

3. Traditional Approach:
According to this approach, the cost of capital declines and the value of the firm increases
with leverage up to a prudent debt level and after reaching the optimum point, coverage cause
the cost of capital to increase and the value of the firm to decline.

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Thus, if NI approach is valid, leverage is significant variable and financing decisions have an
important effect on the value of the firm. On the other hand, if the NOI approach is correct
then the financing decisions should not be a great concern to the financing manager, as it does
not matter in the valuation of the firm.

Modigliani and Miller (MM) support the NOI approach by providing logically consistent
behavioral justifications in its favor. They deny the existence of an optimum capital structure
between the two extreme views; we have the middle position or intermediate version
advocated by the traditional writers.

Thus these exists an optimum capital structure at which the cost of capital is minimum. The
logic of this view is not very sound. The MM position changes when corporate taxes are
assumed. The interest tax shield resulting from the use of debt adds to the value of the firm.
This advantage reduces the when personal income taxes are considered.

Capital Structure Matters: The Net Income Approach:

The essence of the net income (NI) approach is that the firm can increase its value or lower
the overall cost of capital by increasing the proportion of debt in the capital structure. The
crucial assumptions of this approach are:
1. The use of debt does not change the risk perception of investors; as a result, the equity
capitalization rate, kc and the debt capitalization rate, kd, remain constant with changes
in leverage.
2. The debt capitalization rate is less than the equity capitalization rate (i.e. kd<ke)
3. The corporate income taxes do not exist.

The first assumption implies that, if ke and kd are constant increased use by debt by
magnifying the shareholders earnings will result in higher value of the firm via higher value of
equity consequently the overall or the weighted average cost of capital ko, will decrease. The
overall cost of capital is measured by equation: (1)

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 It is obvious from equation 1 that, with constant annual net operating income (NOI), the
overall cost of capital would decrease as the value of the firm v increases. The overall cost of
capital ko can also be measured by
KO = Ke - (Ke - Kd) D/V

As per the assumptions of the NI approach Ke and Kd are constant and Kd is less than Ke.
Therefore, Ko will decrease as D/V increases. Equation 2 also implies that the overall cost of
capital Ko will be equal to Ke if the form does not employ any debt (i.e. D/V =0), and that Ko
will approach Kd as D/V approaches one.

NET OPERATING INCOME APPROACH

According to the met operating income approach the overall capitalization rate and the cost of
debt remain constant for all degree of leverage.

rA and rD are constant for all degree of leverage. Given this, the cost of equity can be
expressed as.

The critical premise of this approach is that the market capitalizes the firm as a whole at
discount rate, which is independent of the firm’s debt-equity ratio. As a consequence, the
decision between debt and equity is irrelevant. An increase in the use of debt funds which are
‘apparently cheaper’ or offset by an increase in the equity capitalization rate. This happens
because equity investors seek higher compensation as they are exposed to greater risk arising
from increase in the degree of leverages. They raise the capitalization rate rE (lower the price
earnings ratio, as the degree of leverage increases.

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The net operating income position has been \advocated eloquently by David Durand. He
argued that the market value of a firm depends on its net operating income and business risk.
The change in the financial leverage employed by a firm cannot change these underlying
factors. It merely changes the distribution of income and risk between debt and equity,
without affecting the total income and risk which influence the market value (or equivalently
the average cost of capital) of the firm. Arguing in a similar vein, Modigliani and Miller, in a
seminal contribution made in 1958, forcefully advanced the proposition that the cost of capital
of a firm is independent of its capital structure.

COST OF CAPITAL AND VALUATION APPROACH:

The cost of a source of finance is the minimum return expected by its suppliers. The expected
return depends on the degree of risk assumed by investors. A high degree of risk is assumed
by shareholders than debt-holders. In the case of debt-holders, the rate of interest is fixed and
the company is legally bound to pay dividends even if the profits are made by the company.
The loan of debt-holders is returned within a prescribed period, while shareholders will have
to share the residue only when the company is wound up.

This leads one to conclude that debt is cheaper source of funds than equity. This is generally
the case even when taxes are not considered. The tax deductibility of interest charges further
reduces the cost of debt. The preference share capital is also cheaper than equity capital, but
not as cheap as debt. Thus, using the component, or specific, cost of capital as criterion for
financing decisions and ignoring risk, a firm would always like to employ debt since it is the
cheapest source of funds.

CASH FLOW APPROACH:

One of the features of a sound capital structure is conservatism does not mean employing no
debt or small amount of debt. Conservatism is related to the fixed charges created by the use
of debt or preference capital in the capital structure and the firm’s ability to generate cash to

26
meet these fixed charges. In practice, the question of the optimum (appropriate) debt –equity
mix boils down to the fir’s ability to service debt without any threat of insolvency and
operating inflexibility. A firm is considered prudently financed if it is able to service its fixed
charges under any reasonably predictable adverse conditions.

The fixed charges of a company include payment of interest, preference dividend and
principal, and they depend on both the amount of loan securities and the terms of payment.
The amount of fixed charges will be high if the company employs a large amount of debt or
preference capital with short-term maturity. Whenever a company thinks of raising additional
debt, it should analyse its expected future cash flows to meet the fixed charges. It is
mandatory to pay interest and return the principal amount of debt of a company not able to
generate enough cash to meet its fixed obligation, it may have to face financial insolvency.
The companies expecting larger and stable cash inflows in to employ fixed charge sources of
finance by those companies whose cash inflows are unstable and unpredictable.

It is possible for high growth, profitable company to suffer from cash shortage if the liquidity
(working capital) management is poor. We have examples of companies like BHEL, NTPC,
etc., whose debtors are very sticky and they continuously face liquidity problem in spite of
being profitability servicing debt is very burdensome for them.

One important ratio which should be examined at the time of planning the capital structure is
the ration of net cash inflows to fixed changes (debt saving ratio). It indicates the number of
times the fixed financial obligation are covered by the net cash inflows generated by the
company.

LIMITATION OF EPS AS A FINANCING-DECISION CRITERION

EPS is one of the mostly widely used measures of the company’s performance in practice. As
a result of this, in choosing between debt and equity in practice, sometimes too much attention
is paid on EPS, which however, has serious limitations as a financing-decision criterion.

The major short coming of the EPS as a financing-decision criterion is that it does not
consider risk; it ignores variability about the expected value of EPS. The belief that investors

27
would be just concerned with the expected EPS is not well founded. Investors in valuing the
shares of the company consider both expected value and variability.

EPS VARIABILITY AND FINANCIAL RISK: -

The EPS variability resulting form the use of leverage is called financial risk. Financial risk is
added with the use of debt because of

(a) The increased variability in the shareholders earnings and

(b) The threat of insolvency.

A firm can avid financial risk altogether if it does not employ any debt in its capital structure.
But then the shareholders will be deprived of the benefit of the financial risk perceived by the
shareholders, which does not exceed the benefit of increase EPS. As we have seen, if a
company increase its debt beyond a point the expected EPS will continue to increase but the
value of the company increases its debt beyond a point, the expected EPS will continue to
increase, but the value of the company will fall because of the greater exposure of
shareholders to financial risk in the form of financial distress. The EPS criterion does not
consider the long-term perspectives of financing decisions. It fails to deal with the risk return
trade-off. A long term view of the effects of the financing decisions, will lead one to a
criterion of the wealth maximization rather that EPS maximization. The EPS criterion is an
important performance measure but not a decision criterion.

Given limitations, should the EPS criterion be ignored in making financing decision?
Remember that it is an important index of the firm’s performance and that investors rely
heavily on it for their investment decisions. Investors do not have information in the projected
earnings and cash flows and base their evaluation and historical data. In choosing between
alternative financial plans, management should start with the evaluation of the impact of each
alternative on near-term EPS. But management’s ultimate decision making should be guided
by the best interests of shareholders.

Therefore, a long-term view of the effect of the alternative financial plans on the value of the
shares should be taken, o management opts for a financial plan which will maximize value in
the long run but has an adverse impact in near-term EPS, and the reasons must be

28
communicated to investors. A careful communication to market will be helpful in reducing the
misunderstanding between management and Investors.

COMPOSITION AND OBSERVATION

The sources tapped by HERITAGE FOODS LTD Industries Ltd. Can be classified into:
 Shareholders’ funds resources
 Loan fund resources

SHAREHOLDER FUND RESOURCES:

Shareholder’s fund consists of equity capital and retained earnings.

EQUITY CAPITAL BUILD-UP

RETAINED EARNINGS COMPOSITION
This includes…
 Capital Reserve
 Share Premium Account
 General Reserve
 Contingency Reserve
 Debentures Redemption Reserve
 Investment Allowance Reserve
 Profit & Loss Account

1. The profit levels, company dividend policy and growth plans determined. The amounts
transferred from P&L A/c to General Reserve. Contingency Reserve and Investment
Allowance Reserve.
2. The Investment Allowance Reserve is created for replafood of long term leased assets
and this reserve was removed from books because assets pertaining to such reserves
ceased to exist. The account was transferred to investment allowance utilized.

Capital structure describes how a corporation has organized its capital—how it obtains the
financial resources with which it operates its business. Businesses adopt various capital
structures to meet both internal needs for capital and external requirements for returns on

29
shareholders investments. As shown on its balance sheet, a company's capitalization is
constructed from three basic blocks:

1. Long-term debt. By standard accounting definition, long-term debt includes

obligations that are not due to be repaid within the next 12 months. Such debt consists
mostly of bonds or similar obligations, including a great variety of notes, capital lease
obligations, and mortgage issues.
2. Preferred stock. This represents an equity (ownership) interest in the corporation, but
one with claims ahead of the common stock, and normally with no rights to share in
the increased worth of a company if it grows.
3. Common stockholders' equity. This represents the underlying ownership. On the
corporation's books, it is made up of: (I) the nominal par or stated value assigned to the
shares of outstanding stock; (2) the capital surplus or the amount above par value paid
the company whenever it issues stock; and (3) the earned surplus (also called retained
earnings), which consists of the portion of earnings a company retains after paying out
dividends and similar distributions. Put another way, common stock equity is the net
worth after all the liabilities (including long-term debt), as well as any preferred stock,
are deducted from the total assets shown on the balance sheet. For investment analysis
purposes, security analysts may use the company's market capitalization—the current
market price times the number of common shares outstanding—as a measure of
common stock equity. They consider this market-based figure a more realistic
valuation.

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 CHAPTER-III
INDUSTRY PROFILE
&
COMPANY PROFILE

INDUSTRY PROFILE

Introduction:
The Indian food industry is poised for huge growth, increasing its contribution to world food
trade every year. In India, the food sector has emerged as a high-growth and high-profit sector
due to its immense potential for value addition, particularly within the food processing
industry.

Accounting for about 32 per cent of the country’s total food market, The Government of India
has been instrumental in the growth and development of the food processing industry.

31
Thegovernment through the Ministry of Food Processing Industries (MoFPI) is making all
efforts to encourage investments in the business. It has approved proposals for joint ventures
(JV), foreign collaborations, industrial licenses, and 100 per cent export oriented units.

Industrial Growth Pattern in India (4 Phases)

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The industrial growth pattern in India can be divided into four phases as
explained below:
1. First Phase (1951-65): Strong Industrial Base:
The first phase of industrial growth consists of the first three plan periods which had
build a strong industrial base in India. During this phase, huge investments were
made in major industries like iron and steel, heavy engineering and machine building
industries. The annual compound growth rate of industrial production during the first
three plan periods moved between 5.7 per cent to 9.0 percent.

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The capital goods industries had registered its annual average compound growth rate
between 9.8 per cent to 19.6 per cent during this period. Again the annual rate of
growth of basic industries moved between 4.7 per cent to 12.1 per cent over the same
period. Thus, a strong industrial base was laid during the first phase covering the first
three plan periods.

2. Second Phase (1965-80): Deceleration and Retrogression:

The second phase of industrial growth covers the period of three Ad-hoc Annual
Plans, Fourth Plan and Fifth Plan. The annual compound growth rate in industrial
production declined from 9.0 per cent during the Third Plan to only 4,1 per cent
covering the period of 1965 to 1976. In 1976-77, the annual rate of growth of industrial
output was 6.1 per cent. In 1979-80, a negative annual growth rate of (—) 1.6 per cent
was recorded in respect of industrial outputs as the index of industrial production in
this year (Base 1970 = 100) has declined to 148.2 as compared to 150.7 in 1978-79.

The industrial sector faced a structural retrogression during the second phase. The
capital goods industries registered its annual average growth rate of only 2.6 per cent
during the second phase Fifth Plan recorded the annual growth rate of 5.7 per cent
which was far below as compared to that of first three five year plans. For, basic

32
industries, the annual growth rate during the second phase was far below as
compared to that of Third Plan. Thus basic industries were engaged in the production
of ferrous metal groups, construction materials, mechanical engineering industries
etc.

ADVERTISEMENTS:

Causes of Deceleration and Retrogression:

The causes of deceleration and structural retrogression during the
second phase are;
(a) The wars of 1962, 1965 and 1971. During this period investment was made into
unproductive uses. Successive droughts of 1965-67 and 1971-73, and oil crisis of 1973
was also responsible for supply constraints.

(b) Considerable slackening of real investment;

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(c) Unequal distribution of income in favour of the rich followed by stagnation in

demand for consumer goods;

(d) Unsatisfactory performance of the agricultural sector;

(e) Policy constraints and bureaucratic obstacles on industrial growth;

(f) Conflicts in the dominant coalition between proprietary classes, capitalist class and
the class representing rich agricultural farmers.

ADVERTISEMENTS:

3. Third Phase: Industrial Recovery in Eighties (1981 to 1991):

The third phase of industrial growth covers the period of eighties consisting of both
Sixth and Seventh Plan. This period of eighties experienced industrial recovery.
During the period 1981-85, the average annual rate of growth of industrial production
was accelerated to 7.0 per cent which further increased to 8.6 per cent during 1985-
90. In 1990-91 also, the annual rate of industrial growth was registered at 9.0 per
cent.

33
The growth rate for consumer durable goods increased to 16.9 percent in 1985-89. In
1981-90, there was a set back as the segment recorded only 1.7 per cent growth rate
and then the same rate again shot up to 14.8 per cent in 1990-91.

The basic goods industries maintained the annual average growth rate of 8.8 and 8.9
per cent during 1980-85 and 1985-89 respectively. But gradually declined to 5.4 per
cent and 3.8 per cent in 1989-90 and 1990-91 respectively. The capital goods
industries recorded 6.3 per cent annual rate of growth during 1980-85 which
experienced increase in its growth rate of 13.0 per cent in 1985-89 and then
significantly 24.0 percent in 1989-90. The growth rate of capital goods was 17.4 per
cent in 1990-91.

ADVERTISEMENTS:

Thus during this third phase, there is a clear shift in the pattern of industrialisation in
the country. Looking at the growth of different product group in the manufacturing
sector, chemicals, petrochemicals and allied industries recorded a faster rate as
compared to others. During this period, the production of chemicals and chemical
product industries, expanded at an annual average rate of 11.19 per cent as compared
to that of only 5.47 per cent in machine building sector.

Moreover, during this period, iron and steel, basic metal and alloys and metal
products recorded only 5.15 percent 4.94 per cent and 3.95 per cent. It shows a clear
shift in the growth pattern of the industrial sector during eighties (Third Phase) as
compared to two earlier phases.

Causes of Industrial Recovery:

The main factors which were responsible for the industrial recovery
during eighties are described as under:
(a) Introduction of new industrial policy and liberal fiscal period.

(b) Higher contribution of agricultural sector in some of the regions in the country
which helped in raising the demand for industrial inputs used for agricultural
production.

(c) Revival of investment in the infrastructure sectors and its effects in raising the
degree of efficiency of the industrial sector.

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4. Fourth Phase: Industrial Retrogression followed by an Upturn and
Downturn Nineties (1991-92 to 1997-98):
The fourth phase of industrial growth covers the early part of nineties, i.e., from 1991-
92 to 1997-98. This short period experienced a sharp industrial retrogression
followed by an immediate upturn in the industrial growth of the country.

During 1991-92, the country had a bitter experience of negative growth rate of (—)
0.10 per cent as compared to that of 8.5 per cent in 1990-91. This is the clear evidence
of sharp industrial retrogression in the country.

But after that in 1995-96 the country experienced an industrial upturn trend as
annual growth rate during this year stood at 11,7 per cent, During the year 1996-97
industrial output has increased by 7.1 per cent and further 8.6 per cent in 1997-98.

The industrial growth rates by use-based industrial classification again showed

downward trend from April to Feb. 1997 to 7.2 and 10.2 per cent in April to Feb. 1998.
The growth rate of consumer non- durables decreased to 4.2 per cent and 2.4 per cent
during April-Feb. 1996-97 and 1997-98 respectively. The growth rate of capital goods
industry declined to 7.2 per cent in 1996-97 and to 1.8 per cent in 1997-98. During the
same period, the general growth rate of industrial production declined from 7.7 per
cent in 1996-97 to only 4.7 per cent in 1997-98.

Causes of Industrial Slow down:

The factors responsible for industrial slow down in the fourth phase are
summarized as below:
ADVERTISEMENTS:

(a) Decline in the growth of export to 4.6 per cent in the first eight months between
April and November 1997.

(b) The impact of the tight money policy followed in 1995-96 when the monetary
expansion was about 13.7 per cent;

(c) Significant build up industrial capacity in the first phase of liberalization;

(d) In some cases the rate of demand growth was overestimated.

35
ADVERTISEMENTS:

Signs of Sustained Industrial Recovery in 1999-2000:

The acceleration of growth rates in various sectors of the economy underline the
significance of industrial recovery in the current year and cyclical downturn.

However, following are some of the major indicators of industrial

recovery in recent years:
(a) Overall industrial output of the country i.e. 6.2 per cent in April-December 1999 as
compared to that of only 3.7 per cent in April-December 1998.

(b) The position of electricity generation remained much better in 1999-2000.

(c) Manufacturing segment of industrial sector has grown by 6.7 per cent in April to
December 1998.

(d) As per use based classification, basic goods, intermediate goods and consumer
goods, are having higher growth in 1999- 2000.

(e) Non-metallic mineral products, machinery and equipment, wool, leather, paper
and basic chemicals are some of the industries growing at more than 10 percent
during 1999-2000.

(f) Industries like electricity, crude oil, coal, steel and cement having a weight of 26.7
per cent in overall IIP, grew at 8.2 per cent in April-December 1999.

(g) Better corporate performance in 1999-2000 compared to previous year.

Industrial Slowdown since 2001:

In recent years, the country is experiencing a serious phase of industrial slowdown
during 2000-01 and in 2001- 02. The overall industrial growth during April-
December 2001-02 at 2.3 per cent, is substantially lower than the 5.8 per cent
achieved during the corresponding period of 2000- 01. In fact, the growth rate of the
industrial sector during the first nine months of 2001-02 is considered as the lowest
during the last ten years.

Industrial slowdown was recorded in all broad sectors such as manufacturing,

electricity and mining an all end use based groups such as capital goods, intermediate

36
goods, consumer goods both durables and non-durables. However, the reasons for
slowdown in industrial growth during this period is due to a number of structural and
cyclical factors.

The other reasons are explained below:

1. The adjustment process is industry in response to increased competition in the
form of Mergers and Acquisitions is taking longer time than expected.

2. Infrastructural bottlenecks and high costs.

3. Unreliable supply of services in transport, communications and power sector.

4. Low levels of productivity due to low economies of scale, out-dated technology and
restricted labour laws’.

5. Lower speculative demand for sectors like automobiles and real estate due to
expectation of lower prices and reduction of taxes and duties in the short term period.

6. High interest rates.

Market Size:
The Indian food and grocery market is the world’s sixth largest, with retail contributing 70 per
cent of the sales. Food has also been one of the largest segments in India's retail sector, which
was valued at US$ 490 billion in 2013@. The Indian food retail market is expected to reach
Rs 61 lakh crore (US$ 894.98 billion) by 2020.

The Indian food processing industry accounts for 32 per cent of the country’s total food
market, one of the largest industries in India and is ranked fifth in terms of production,
consumption, export and expected growth. It contributes around 14 per cent of manufacturing
Gross Domestic Product (GDP), 13 per cent of India’s exports and six per cent of total
industrial investment. Indian food service industry is expected to reach US$ 78 billion by
2018.The Indian gourmet food market is currently valued at US$ 1.3 billion and is growing at
a Compound Annual Growth Rate (CAGR) of 20 per cent. India's organic food market is
expected to increase by three times by 2020##.

37
The online food ordering business in India is in its nascent stage, but witnessing exponential
growth. The organised food business in India is worth US$ 48 billion, of which food delivery
is valued at US$ 15 billion. With online food delivery players like FoodPanda, Zomato,
TinyOwl and Swiggy building scale through partnerships, the organised food business has a
huge potential and a promising future.

Investments:
According to the data provided by the Department of Industrial Policies and Promotion
(DIPP), the food processing sector in India has received around US$ 7.54 billion worth of
Foreign Direct Investment (FDI) during the period April 2000-March 2017. The
Confederation of Indian Industry (CII) estimates that the food processing sectors have the
potential to attract as much as US$ 33 billion of investment over the next 10 years and also to
generate employment of nine million person-days.

Mr Tomasz Lukaszuk, the Ambassador of the Republic of Poland had also highlighted the
keen interest shown by Polish companies looking for opportunities in India to expand
collaboration and invest food processing.

Some of the major investments in this sector in the recent past are:
 Di Bella, the Australia-based coffee chain, plans to invest Rs 67 crore (US$ 10
million) for setting up around 20 new outlets in Mumbai, besides entering Delhi and
Bangalore by 2017.
 KKR & Co LP, the US-based private equity firm, plans to invest about Rs 520 crore
(US$ 77.38 million) in dairy company Kwality Ltd, which will be used to strengthen
its milk procurement infrastructure and increase processing capacity.
 Henry Ford Health Systems (HFHS), a US-based health and wellness group, plans to
enter India by signing a franchise partnership with Chandigarh-based hospitality and
food services firm KWalls Hospitality, and set up 'Culinary Wellness' branded stores
across the country.
 Mondelez International, the US-based confectionery, food, and beverage major,
inaugurated its new manufacturing plant in Andhra Pradesh set up for Rs 1,265 crore
(US$ 190 million), with an annual production capacity of 250,000 tonnes.

38
  PureCircle, a Malaysia-based natural sweetener producer, plans to invest around Rs
1,300 crore (US$ 200 million) in India to set up a manufacturing plant and make the
country its regional production and export hub in the next five years.
 Swiggy, a food delivery start-up owned by Bundl Technologies Private Limited, has
raised Rs 230.34 crore (US$ 33.80 million) in a Series C funding round, with its
existing investors SAIF Partners, Accel Partners, Norwest Venture Partners and
Apoletto Asia Ltd contributing 79 per cent of the new funds raised.
 Gujarat Cooperative Milk Marketing Federation (GCMMF), popularly known as
'Amul', plans to invest Rs 5,000 crore (US$ 733.6 million) to establish ten new
processing plants as well as expand the current capacity to touch 32 million litres per
day (MLPD) capacity by 2020.
 American doughnut chain Dunkin' Donuts has tied up with local online grocery
delivery platform Grofers for home-delivery of its packaged and freshly made
products.
 Private Equity (PE) firm India Value Fund Advisors (IVFA) plans to invest around
US$ 100-150 million in the food business in India over the next two years.
 Zomato, a restaurant search and discovery platform, has raised US$ 60 million from
Singapore government-owned investment company Temasek, along with existing
investor Vy Capital, in order to explore new business verticals.
 ITC Limited plans to invest Rs 800 crore (US$ 117.4 million) to set up a world-class
food processing facility in Medak, a district located in Telangana. The company has
also formulated plans to enter the dairy market.

Government Initiatives:
In order to promote food processing industries, increase level of processing and exploit the
potential of domestic and international market for processed food products, Vision Document-
2015 was prepared by the Ministry of Food Processing Industries. The document envisages
trebling the size of investment in the processed food sector by increasing the level of
processing of perishables from 6 per cent to 20 per cent, value addition from 20 per cent to 35
per cent and share in global food trade from 1.5 per cent to 3 per cent by 2015. According to
the Ministry, an investment of Rs 100,000 crore (US$ 14.67 billion) would be required in

39
2015 to achieve these targets. The Government of India has also relaxed foreign direct
investment (FDI) norms for the sector, allowing up to 100 per cent FDI in food product e-
commerce through foodmatic route.
Some of the major initiatives taken by the Government of India to improve the food
processing sector in India are as follows:
 The Government of India allocated Rs 1,500 crore (US$ 225.7 million) and announced
various measures under the Merchandise Exports from India Scheme (MEIS),
including setting up of agencies for aquaculture and fisheries in coastal states and
export incentives for marine products.
 Union Budget 2016-17 has proposed 100 per cent FDI through FIPB (Foreign
Investment Promotion Board) route in marketing of food products produced and
manufactured in India.
 All of the ration cards in India have been digitised and 42 per cent of the digitised
ration cards are now linked to Unique Identification (UID) or Aadhaar cards.
 Government of India plans to allow two Indian dairy companies, Parag Milk Foods
and Schreiber Dynamix Dairies, to export milk products to Russia for six months, after
these companies got approval for their products by Russian inspection authorities.
 Ms Harsimrat Kaur Badal, Union Minister for Food Processing Industries,
Government of India inaugurated the first of its kind Rs 136 crore (US$ 20 million)
mega international food park at Dabwala Kalan, Punjab. She has also expressed
confidence that the decision to allow 100 per cent Foreign Direct Investment (FDI) in
multi-brand retail with 100 per cent local sourcing condition, will act as a catalyst for
the food processing sector, thereby controlling inflation, uplifting the condition of
farmers, and creating more jobs in the country.
 The Food Safety and Standards Authority of India (FSSAI) has issued new rules for
importing products, to address concerns over the entry of sub-standard items and
simplify the process by setting shelf-life norms and relaxing labelling guidelines.
 The Ministry of Food Processing Industries announced a scheme for Human Resource
Development (HRD) in the food processing sector. The HRD scheme is being
implemented through State Governments under the National Mission on Food
Processing. The scheme has the following four components:

40
  Creation of infrastructure facilities for degree/diploma courses in food
processing sector
 Entrepreneurship Development Programme (EDP)
 Food Processing Training Centres (FPTC)
 Training at recognised institutions at State/National level
 The Food Safety and Standards Authority of India (FSSAI) under the Ministry of
Health and Family Welfare has issued the Food Safety and Standards (Food Product
Standards and Food Additives) Regulations, 2011 and the Food Safety and Standards
(Contaminants, Toxins and Residues) Regulations, 2011 which prescribe the quality
and safety standards, respectively for food products.
 The Ministry of Food Processing Industries has taken some new initiatives to develop
the food processing sector which will also help to enhance the incomes of farmers and
export of agro and processed foods among others.
 Spices Board, set up by the Ministry of Commerce to develop and promote Indian
spices worldwide, aims spice exports of US$ 3 billion by 2017.
 The Government of India has approved the setting up of five numbers of Mega Food
Parks in the states of Bihar, Maharashtra, Himachal Pradesh and Chhattisgarh. The
Government plans to set up 42 such mega food parks across the country in next three
to four years.
 In the Budget 2015-16, a corpus of Rs. 2,000 crore (US$ 293.44 million) was created
under National Bank for Agriculture and Rural Development (NABARD) to provide
cheaper credit to food processing industry. Excise duty on plant and machinery for
packaging and processing has been brought down to six per cent from 10 per cent.

Road Ahead:
Going forward, the adoption of food safety and quality assurance mechanisms such as Total
Quality Management (TQM) including ISO 9000, ISO 22000, Hazard Analysis and Critical
Control Points (HACCP), Good Manufacturing Practices (GMP) and Good Hygienic Practices
(GHP) by the food processing industry offers several benefits. It would enable adherence to
stringent quality and hygiene norms and thereby protect consumer health, prepare the industry

41
to face global competition, enhance product acceptance by overseas buyers and keep the
industry technologically abreast of international best practices.

Reports:
India is the world’s second–largest producer of fruits and vegetables. India enjoys a similar
stature in the production of marine products, and meat and poultry. India is the single largest
producer of milk in the world, with the production estimated at 137.7 MT.

India has the largest livestock population across the globe which is equal to 512 million,
including 119 million milch (in-milk and dry) animals, 135 million goats and 65 million
sheep. The segment contributes about 25 per cent to the country’s farm Gross Domestic
Product (GDP).

To reduce post-harvest losses of fruits and vegetables, Government plans to set up 500 cold
chain projects in the country. Moreover, 42 sanctioned mega food parks in the country are
likely to become operational by 2018

As on November 2016, Food Safety and Standards Authority of India (FSSAI) has
launched a major scheme worth US$ 72 million to address the urgent need to upgrade Food
Testing Laboratories in India.

Given the above context, it is easy to understand that the food processing industry is one of
the largest industries in India. The country’s food processing industry ranks fifth in terms of
production, consumption and exports.

Strategic geographic location and proximity to food importing nations benefit India in terms
of exporting processed foods. Main export destinations for food products have been the
Middle East and Southeast Asia.

Exports of processed food and related products:

42
During FY11–16, India's exports of processed food and related products (inclusive of animal
products) grew at a CAGR of 11.74 per cent, reaching US$ 16.2 billion. Main export
destinations for food products have been the Middle East and Southeast Asia.
In FY17* India’s exports stood at US$ 1.3 billion.

Fast moving consumer goods (FMCG):

Introduction:
Fast-moving consumer goods (FMCG) sector is the 4th largest sector in the Indian economy
with Household and Personal Care accounting for 50 per cent of FMCG sales in India.
Growing awareness, easier access and changing lifestyles have been the key growth drivers
for the sector. The urban segment (accounts for a revenue share of around 55 per cent) is the
largest contributor to the overall revenue generated by the FMCG sector in India However, in
the last few years, the FMCG market has grown at a faster pace in rural India compared with
urban India. Semi-urban and rural segments are growing at a rapid pace and FMCG products
account for 50 per cent of total rural spending.

Market Size:
The Retail market in India is estimated to reach US$ 1.1 trillion by 2020 from US$ 840 billion
in 2017, with modern trade expected to grow at 20 per cent - 25 per cent per annum, which is
likely to boost revenues of FMCG companies. Revenues of FMCG sector reached Rs 3.4 lakh
crore (US$ 52.75 billion) in FY18 and are estimated to reach US$ 103.7 billion in 2020. The

43
sector witnessed growth of 16.5 per cent in value terms between July-September 2018;
supported by moderate inflation, increase in private consumption and rural income. @

Investments/ Developments:
The government has allowed 100 per cent Foreign Direct Investment (FDI) in food processing
and single-brand retail and 51 per cent in multi-brand retail. This would bolster employment
and supply chains, and also provide high visibility for FMCG brands in organised retail
markets, bolstering consumer spending and encouraging more product launches. The sector
witnessed healthy FDI inflows of US$ 13.63 billion, during April 2000 to June 2018. Some of
the recent developments in the FMCG sector are as follows:
 Patanjali will spend US$743.72 million in various food parks in Maharashtra, Madhya
Pradesh, Assam, Andhra Pradesh and Uttar Pradesh.
 Dabur is planning to invest Rs 250-300 crore (US$ 38.79-46.55 million) in FY19 for
capacity expansion and is also planning to make acquisitions in the domestic market.
 In May 2018, RP-Sanjiv Goenka Group created an Rs 1 billion (US$ 14.92 million)
venture capital fund to invest in FMCG start-ups.
 In August 2018, Fonterra announced a joint venture with Future Consumer Ltd which
will produce a range of consumer and foodservice dairy products.

Government Initiatives:
Some of the major initiatives taken by the government to promote the FMCG sector in India
are as follows:
 The Government of India has approved 100 per cent Foreign Direct Investment (FDI)
in the cash and carry segment and in single-brand retail along with 51 per cent FDI in
multi-brand retail.
 The Government of India has drafted a new Consumer Protection Bill with special
emphasis on setting up an extensive mechanism to ensure simple, speedy, accessible,
affordable and timely delivery of justice to consumers.

44
  The Goods and Services Tax (GST) is beneficial for the FMCG industry as many of
the FMCG products such as Soap, Toothpaste and Hair oil now come under 18 per
cent tax bracket against the previous 23-24 per cent rate.
 The GST is expected to transform logistics in the FMCG sector into a modern and
efficient model as all major corporations are remodeling their operations into larger
logistics and warehousing.

Achievements:
Following are the achievements of the government in the past four years:
 Number of mega food parks ready increased from 2 between 2008-14 to 13 between
2014-18.
 Preservation and processing capacity increased from 308,000 during 2008-14 to 1.41
million during 2014-18.
 The number of food labs increased from 31 during 2008-14 to 42 during 2014-18.

Road Ahead:
Rural consumption has increased, led by a combination of increasing incomes and higher
aspiration levels; there is an increased demand for branded products in rural India. The rural
FMCG market in India is expected to grow to US$ 220 billion by 2025 from US$ 23.6 billion
in FY18. In FY18, FMCG’s rural segment contributed an estimated 10 per cent of the total
income and it is forecasted to contribute 15-16 per cent in FY 19. ^ FMCG sector is forecasted
to grow at 12-13 per cent between September–December 2018.

On the other hand, with the share of unorganised market in the FMCG sector falling, the
organised sector growth is expected to rise with increased level of brand consciousness, also
augmented by the growth in modern retail.

Another major factor propelling the demand for food services in India is the growing youth
population, primarily in the country’s urban regions. India has a large base of young
consumers who form the majority of the workforce and, due to time constraints, barely get
time for cooking.

45
Online portals are expected to play a key role for companies trying to enter the hinterlands.
The Internet has contributed in a big way, facilitating a cheaper and more convenient means to
increase a company’s reach. It is estimated that 40 per cent of all FMCG consumption in India
will be online by 2020. The online FMCG market is forecasted to reach US$ 45 billion in
2020 from US$ 20 billion in 2017.

It is estimated that India will gain US$ 15 billion a year by implementing the Goods and
Services Tax. GST and demonetisation are expected to drive demand, both in the rural and
urban areas, and economic growth in a structured manner in the long term and improve
performance of companies within the sector.

Reports:
Fast moving consumer goods (FMCG) are the 4th largest sector in the Indian economy. There
are three main segments in the sector – food and beverages which accounts for 19 per cent of
the sector, healthcare which accounts for 31 per cent and household and personal care which
accounts for the remaining 50 per cent.

The FMCG sector has grown from US$ 31.6 billion in 2011 to US$ 52.75 billion in 2017-18.
The sector is further expected to grow at a Compound Annual Growth Rate (CAGR) of 27.86
per cent to reach US$ 103.7 billion by 2020. The sector witnessed growth of 16.5 per cent in
value terms between June–September 2018; supported by moderate inflation, increase in
private consumption and rural income. It is forecasted to grow at 12-13 per cent between
September– December 2018.^ FMCG’s urban segment is expected to have a steady revenue
growth at 8 per cent in FY19 and the rural segment is forecasted to contribute 15-16 per cent
of total income in FY19.* Post GST and demonetisation, modern trade share grew to 10 per
cent of the overall FMCG revenue, as of August 2018.

Accounting for a revenue share of around 45 per cent, rural segment is a large contributor to
the overall revenue generated by the FMCG sector in India. Demand for quality goods and
services have been going up in rural areas of India, on the back of improved distribution
channels of manufacturing and FMCG companies. Urban segment accounted for a revenue
share of 55 per cent in the overall revenues recorded by FMCG sector in India.

46
FMCG Companies are looking to invest in energy efficient plants to benefit the society and
lower costs in the long term. Patanjali will spend US$ 743.72 million in various food parks in
Maharashtra, Madhya Pradesh, Assam, Andhra Pradesh and Uttar Pradesh. Dabur is planning
to invest Rs 250-300 crore (US$ 38.79-46.55 million) in FY19 for capacity expansion and is
also looking for acquisitions in the domestic market. Investment intentions, related to FMCG
sector, arising from paper pulp, sugar, fermentation, food processing, vegetable oils and
vanaspathi, soaps, cosmetics and toiletries industries, worth Rs 165.52 billion (US$ 2.36
billion) were implemented between January–September 2018.

Growing awareness, easier access, and changing lifestyles are the key growth drivers for the
consumer market. The focus on agriculture, MSMEs, education, healthcare, infrastructure and
employment under the Union Budget 2018-19 is expected to directly impact the FMCG
sector. These initiatives are expected to increase the disposable income in the hands of the
common people, especially in the rural area, which will be beneficial for the sector.

Dairy:
India is the highest milk producer in the entire globe. India is well known as the 'Oyster' of the
global dairy industry, with opportunities galore for the entrepreneurs globally. It might be
dream for any nation in the world to capitalize on the largest and fastest growing milk and
milk products' market. The dairy industry in India has been witnessing rapid growth with
liberalization. As the economy provides good opportunities for MNCs and foreign investors to
release the full potential of this industry. The main objective of the Indian Dairy Industry is to
manage the national resources in a manner to enhance milk production and upgrade milk
processing using innovative technologies.

The crossbred technology in the Indian Dairy Industry has further augmented with the
viability of the dairy units by increasing the milk production per animal. Then subsequently
milk production has also increased at an exponential rate while the benefits of an increase in
milk production also reached the consumers from a relatively lower increase in the price of
milk. The favorable price environment for milk producers for the Dairy Industry in India
however appeared to have weakened during the 90's, a decline in the real price of milk being
noticed after the year 1992. And then slowly regained it is glory after 1992 to till now.

47
In India dairying from very much earlier is regarded as an instrument for social and economic
development. The country's milk supply comes from millions of small producers, who are
dispersed throughout the rural areas. All these farmers maintain an average herd of one or two
milch animals, comprising cows and/or buffaloes.

Mostly ample labour and a small land base encourage farmers to practice dairying as an
occupation subsidiary to agriculture. As income from crop production is seasonal instead
dairying provides a stable which is a year-round income and also an important economic
incentive for the small farmer.

LIST OF FOOD PROCESSING COMPANIES IN INDIA:

 Aavin
 Al Nassma Chocolate
 Amira Nature Foods
 Amul
 Banas Dairy
 Balaji Wafers
 Bikanervala
 Bihar State Milk Co-operative Federation
 Bisk Farm
 Bonn Group of Industries
 Britannia Industries
 BTW
 Cafe Coffee Day
 Candico
 Creambell
 Dabur
 Dudhsagar Dairy
 Everest Spices
 Faasos
 The Grand Sweets and Snacks

48
 Haldiram's
 Heritage Foods
 Idhayam (brand)
 Indian dairy products
 ITC Limited
 Jubilant FoodWorks
 Karachi Bakery
 Karnataka Milk Federation
 Kerala Co-operative Milk Marketing Federation
 Kerala Solvent Extractions
 KS Oils
 Mahashian Di Hatti
 Marico
 Mavalli Tiffin Room
 Meat Products of India
 Milk Mantra
 Monginis
 Morarka Organic
 Mother Dairy
 MTR Foods
 Orissa State Cooperative Milk Producers' Federation
 Parle Agro
 Parle Products
 Patanjali Ayurved
 Perigreen
 Pulla Reddy Sweets
 Punjabi Chandu Halwai Karachiwala
 Rajesh Masala
 REI Agro Limited
 Ruchi Soya

49
  Shanthi Feeds
 Skylark Group
 Sri Krishna Sweets
 Suguna Foods
 Suminter India Organics
 Tasty Bite
 Vadilal

COMPANY PROFILE

The Heritage Foods, founded in the year 1992 by Mr. Nara Chandrababu Naidu, is one of the
fastest growing Public Listed Companies in India, with two-business divisions-Dairy and
Renewable Energy under its flagship Company Heritage Foods Limited (Formerly known as
Heritage Foods (India) Limited).The annual turnover of Heritage Foods crossed Rs.2344.01
crores in financial year 2017-18.

Currently Heritage's milk and milk products have a market presence in Andhra Pradesh,
Telangana, Karnataka, Kerala, Tamil Nadu, Maharastra, Odisha, NCR Delhi, Haryana,
Rajasthan, Punjab and Uttarakhand. In the year 1994, HFL went Public and was
oversubscribed 54 times. HFL shares are listed on BSE (Stock Code: 519552) and NSE (Stock
Code: HERITGFOOD).

About The Founder:

Mr. Nara Chandrababu Naidu
Heritage Foods Limited, India
Mr. Nara Chandrababu Naidu is one of the greatest dynamic, pragmatic, progressive and
visionary Leaders of the 21st Century. With an objective of "Bringing prosperity into rural
families through co-operative efforts", he along with a few like minded, friends and associates
promoted 'Heritage Foods' in the year 1992 taking opportunity from the Industrial Policy,
1991 of the Government of India to which end he has been successful.

50
At present, Heritage has a market presence in the states of Andhra Pradesh, Telangana,
Karnataka, Kerala, Tamil Nadu, Maharastra, Odisha, NCR Delhi,Haryana, Rajasthan, Punjab
and Uttarakhand. More than three thousand villages and three lakh farmers are being benefited
in these states. On the other side, Heritage is serving millions of customers needs by,
employing more than 2400 people and generating indirect employment opportunities for more
than 10000 people. Beginning with a humble annual turnover of Rs.4.38 crores in 1993-94,
the annual turnover of Heritage Foods crossed Rs 2344.01 crores in financial year 2017-18.

Mr. Chandrababu Naidu was born on April 20, 1951 in Naravaripally Village, Chittoor
District, Andhra Pradesh, India. His late father Mr. N. Kharjura Naidu was an agriculturist and
his late mother Smt. Ammanamma was a housewife. Mr. Naidu did his schooling in
Chandragiri. He went on to study at the Sri Venkateswara Arts College, Tirupati. He later also
obtained his Masters in Economics from the Sri Venkateswara University, Tirupati. Mr. Naidu
is married to Mrs. Bhuvaneswari, the daughter of Mr. N T Rama Rao, Ex-Chief Minister of
Andhra Pradesh and a famous star of Telugu Cinema. Mrs. N Bhuvaneswari is the Vice
Chairperson & Managing Director of the company.

Mr. Naidu held various positions of office in college and organised a number of social
activities. Following the 1977 cyclone, which devastated the Diviseema Taluk of Krishna
District, he actively organised donations and relief material from Chittoor district for the
cyclone victims. Mr. Naidu has always evinced keen interest in rural development activities in
general and the upliftment of the poor and downtrodden sections of society in particular.

Mr. Naidu has held various coveted and honourable positions including Chief Minister of
Andhra Pradesh, Minister for Finance & Revenue, Minister for Archives & Cinematography,
Member of the A.P. Legislative Assembly, Director of A.P. Small Scale Industries
Development Corporation, and Chairman of Karshaka Parishad.

Mr. Naidu has been honoured with numerous prestigious awards including "Member of the
World Economic Forum's Dream Cabinet" (Time Asia), "South Asian of the Year" (Time
Asia), "Business Person of the Year" (Economic Times), and "IT Indian of the Millennium"
(India Today).

51
Mr. Naidu was chosen as one of 50 leaders at the forefront of change in the year 2000 by the
Business Week magazine for being an unflinching proponent of technology and for his drive
to transform the State of Andhra Pradesh.Mr. Naidu has been re-elected as the Chief Minister
of Andhra Pradesh in the 2014 elections.

Vision:
 Delighting every home with Fresh & Healthy products and empowering the Farmer

Mission:
 To be a nationally recognized brand for Healthy and Fresh products with a revenue of
INR 6000 Crore.(USD 1 Billion) by 2022We anticipate, understand and respond to our
Customers' needs by creating high quality products and making them available through
innovative and convenient channels
 We embrace the right technology to delight our Customers
 We are a strong supporter of balancing Economic, Social and Environmental aspects to
create a better tomorrow
 We are devoted to empowering the Farmer community through our unique
'Relationship Farming' Model
 We aim to be the Employer of Choice by nurturing Entrepreneurship and Promoting
Empowerment, alongside transparency

OUR COMMITMENTS:
Milk Producers:
Change in life styles of rural families in terms of
 Regular high income through co-operative efforts
 Women participation in income generation
 Protect the farmers from price exploitation by the un-organized sector
 Provide remunerative prices for milkIncrease milk productivity through input and
extension activities
 Supplementing agriculture with dairy farming
 Financial support for purchase of cattle; insuring cattle
 Establishment of Cattle Health Care Centers

52
  Supplying high quality Cattle feed
 Organizing 'Rythu Sadasu' and video programmes for educating the farmers in dairy
farming

Customers:
 Timely supply of quality & healthy products
 Supply high quality milk and milk products at affordable prices
 Focus on nutritional foods
 More than 4 lakh happy customers
 High customer satisfaction24 hour help-lines ( <10 complaints a day)

Employees:
 Enhancing the Technical and Managerial skills of employees through continuous
training and development
 Best appraisal systems to motivate employees
 Incentive, bonus and reward systems to encourage employees
 Heritage forges ahead with the motto "add value to everything you do"

SHAREHOLDERS:
Returns:
Dividend Payment since Public Issue (January 1995)
Service:
Highest importance to investor service; no notice from any regulatory authority since 2001 in
respect of investor serviceVery transparent disclosures
Suppliers:
Doehlar: technical collaboration for milk drinks, yogurt drinks and fruit flavoured drinks
Alaval: supplier of high-end machinery and technical support focusing on Tetra pack
association for products package
Society:
 Potential Employment Generation
• more than 2400 employees are working with Heritage

53
 • more than 11,097 procurement agents have found self employment in rural
areas
• more than 6300 sales agents are associated with the company
 Employment opportunities for the youth by providing financial and animal husbandry
support for establishing MINI DAIRIESProducing healthy products for society

Awards & Recognitions:

Heritage Foods is proud to have been recognized by some of the most important and
influential publications and organizations around the world.
 Heritage Foods Limited bags “Golden Peacock Award for Excellence in Corporate
Governance” for the year 2017, by the Awards Jury under the Chairmanship of Justice
(Dr.) Arijit Pasayat, former Judge, Supreme Court of India.
 Heritage Foods Limited bags FTAPCCI Excellence Awards in Corporate Social
Responsibility
 Heritage Foods Bags "Golden Peacock Award for Excellence in Corporate
Governance' for the year 2016"
 100 Most Innovative CIO's of India
 100 Most Influential CFO's of India
 Heritage has won 4 awards in "The Great Indian Icecream Contest", New Delhi
 2nd Prize in National Energy Conservation Awards-2017
 1st Prize in National Energy Conservation Awards-2016
 1st Prize in National Energy Conservation Awards-2015
 2nd Prize in National Energy Conservation Awards-2015
 National Energy Conservation Award 2014
 National Energy Conservation Award 2012
 National Energy Conservation Award 2010
 National Energy Conservation Award 2008

CSR Activities:
Heritage Foods Limited works with a registered trust i.e. NTR Memorial Trust, Hyderabad
towards promoting education, enhancing vocational skills and supply of clean water. These
projects are in accordance with Schedule VII of the Companies Act, 2013 and the Company's

54
CSR Policy read with Companies (Corporate Social Responsibility Policy) Rules,
2014.Company has built the "Academic Block" at "NTR Junior College" for Girls, Gandipet
Campus, Hyderabad from the CSR funds of the Company and the block has been inaugurated
by Sri D Seetharamaiah, Chairperson of the Company on 19th August, 2016 in the presence of
the Directors of Heritage Foods and other officials of NTR Memorial Trust.

HFL Risk Management Policy:

1. Scope:
This Policy is a formal representation of Heritage Foods Limited(HFL)’s
commitment to Risk Management and has been approved by the HFL
Board/Committee. This Policy is applicable to all HFL businesses; all
levels within the organization, all types and consequence categories. This
Policy applies to HFL, its directors, and all its employees and contractors.
Through the remainder of this Policy, HFL’s directors, employees and
contractors are referred to collectively as “employees”. The Policy is
supported by the Risk Management & Assessment Framework which provides
guidance with regard to the processes that underpin effective and
consistent risk management.
2. Policy Statement:
HFL is committed to ensuring that risk management practices are
entrenched into all business processes and operations to drive consistent,
effective and accountable action, decision making and management practice.
HFL’s fundamental, underlying risk principles are consistent with ISO
31000(Risk Management –Principles & Guidelines); and, the COSO
Standard for Enterprise Risk Management.
3. Purpose:
The Heritage Group, founded in 1992, is one of the fastest growing
Private Sector Enterprises in India, with four-business divisions’viz.,
Dairy, Retail, Agri, and Bakery under its flagship Company Heritage Foods
Limited (HFL).Our vision is to delight every home with fresh & healthy
products and empowering the farmers. Our mission is to be a nationally
recognized brand for healthy and fresh products with a revenue of INR 6000

55
 Crores by 2020. To fuel this dream, HFL plans to increase its milk processing
capabilities, increase its retail presence, focus on value added products to
increase margins and be known for quality products. Our continued growth
and success depends on our ability to understand and respond to the
challenges of an uncertain and changing world and build capability to
respond to disruptions to our business. As a large, dispersed and
complex organisation, this uncertainty generates risk, with the potential
to be a source of both opportunities and threats. By understanding and
managing risk and being well prepared for disruption-related risks, we
provide greater certainty and confidence for all our stakeholders.

Board of Directors
 A Prabhakara Naidu
 D Seetharamaiah
 J Samba Murthy
 M Sambasiva Rao
 N Bhuvaneswari
 N Bhuvaneswari
 N Brahmani
 N Sri Vishnu Raju
 Rajesh Thakur Ahuja
 Umakanta Barik
 Umakanta Barik
 V Nagaraja Naidu
Chief Financial Officer
Ind.Non Exe.Director&Chairman
Head
President
CEO
Vice Chairperson & M.D
Executive Director
Non Exe. & Ind. Director
Non Exe. & Ind. Director
Co. Secretary & Compl. Officer
Secretary
Non Executive Director

56
 CHAPTER-IV
DATA ANALYSIS
AND
INTERPRETATION
57
RETURN ON ASSETS
In this case profits are related to assets as follows

Return on assets = Net profit after tax

Total assets
Table 4.1 Rs: Crors
Particulars 2014 2015 2016 2017 2018
2144.47 2014.73 2174.65 2627.72
2655.43
16264.27 16667.95 19697.50 21970.29 25369.51
25.41522 14.6758 13.4810 9.7607 7.9415

58
Graph 4.1

ROA
30

25

20

15

10

0
1 2 3 4 5

TOTAL ASSETS

RETURN ON CAPITAL EMPLOYED

Here return is compared to the total capital employed. A comparison of this ratio with that of
other units in the industry will indicate how efficiently the funds of the business have been
employed. The higher the ratio the more efficient is the use of capital employed.

Return on capital employed = Net profit after taxes & Interest

Total capital employed

(Total capital employed = Fixed assets + Current assets–Current liabilities)

Table 4.2

59
 particulars 2014 2015 2016 2017 2018
PAT 4133.60 2446.19 2655.63 2144.47 2014.73
Total Capital 304.80 10247.47 11986.24 14186.57 16827.08
Emp
ROC 13.56168 23.8711 22.15 15.1161 11.9731

Graph 4.2

ROC
ROC

23.8711
22.15

15.1161
13.56168
11.9731

1 2 3 4 5

YEAR 2013-2014
PERFORMANCE OF COMPANY (AMOUNT IN RS.CR’S)
Gross Revenue 13558.42 Total Expenditure 11782.74
Profit (Loss) before tax 1786.19 Profit after tax 1404.23
Earnings per share Rs. 51.24 Dividend ratio 15%

YEAR 2014-2015
PERFORMANCE OF COMPANY (AMOUNT IN RS.CR’S)
Gross Revenue 18622.23 Total Expenditure 14144.45
Profit (Loss) before tax 3351.36 Profit after tax 2446.19
Earnings per share Rs. 89.26 Dividend ratio 20%

60
 YEAR 2015-2016
PERFORMANCE OF COMPANY (AMOUNT IN RS.CR’S)
Gross Revenue 20598.13 Total Expenditure 15617.65
Profit (Loss) before tax 3825.40 Profit after tax 2655.63
Earnings per share Rs. 96.85 Dividend ratio 23.51%

YEAR 2016-2017
PERFORMANCE OF COMPANY (AMOUNT IN RS.CR’S)

Gross Revenue 20501.86 Total Expenditure 16354.92

Profit (Loss) before tax 2775.51 Profit after tax 2144.47
Earnings per share Rs. 78.20 Dividend ratio 23.24%

YEAR 2017-2018
PERFORMANCE OF COMPANY (AMOUNT IN RS.CR’S)
Gross Revenue 23418.1 Total Expenditure 18851.20
Profit (Loss) before tax 2886.25 Profit after tax 2014.73
Earnings per share Rs. 73.45 Dividend ratio 21.39%

PERFORMANCE ANALYSIS OF 2013-2014:

Company is operating in 3 segments, out of which food contributes about 55% of turnover
while the Boards and prefab segments contribute about 45%. Huge investment in the
industrial sector over the next 3 years is expected to lead to higher food off –take on the back
of strong GDP growth across the country. It is expected that the domestic food consumption
would grow at a CAGR of 8% for the next 5 years. By FY 2014 the domestic consumption is
expected to grow to 199 million Tons from 136 million Tons consumption FY2012. During
the year 2013-14 your company’s Gross sales increased.

Net sales increased by about 39% to Rs.1404.23 crs from Rs.1093.24 crs in FY 2013-14.
Improved sales from all the tree divisions particularly from prefab division contributed for
increased turnover.

61
PERFORMANCE ANALYSIS OF 2014-2015
Company is operating in 3 segments, out of which food contributes about 65% of turnover
while the Boards and prefab segments contribute about 52%. Huge investment in the
industrial sector over the next 5 years is expected to lead to higher food off –take on the back
of strong GDP growth across the country. It is expected that the domestic food consumption
would grow at a CAGR of 11% for the next 5 years. By FY 2015 the domestic consumption is
expected to grow to 232 million Tons from 152 million Tons consumption FY2014. During
the year 2014-15 your company’s Gross sales increased.

Net sales increased by about 38.57% to Rs.18270.69 crs from Rs. 13205.64 crs in FY 2014-
15. Improved sales from all the tree divisions particularly from prefab division contributed for
increased turnover.

PERFORMANCE ANALYSIS OF 2015-2016:

Company is operating in many segments, out of which food contributes about 62% of turnover
while the Boards and prefab segments contribute about 48%. Huge investment in the
industrial sector over the next 10 years is expected to lead to higher food off –take on the back
of strong GDP growth across the country. It is expected that the domestic food consumption
would grow at a CAGR of 13% for the next10 years. By FY 2016 the domestic consumption
is expected to grow to 289 million Tons from 232 million Tons consumption FY2014. During
the year 2015-16 your company’s Gross sales increased.

Net sales increased by about 42.54% to Rs.20174.94 crs from Rs. 18313.13 crs in FY 2015-
16. Improved sales from all the tree divisions particularly from prefab division contributed for
increased turnover.

PERFORMANCE ANALYSIS OF 2016-2017:

1. The production and Sales has increased by 8 %
2. Food turnover has increased by3% as against fall in Sales realization by 12% last year.
3. Food Boards Division has contributed 18% more than the previous year to the PBDIT.
4. Perform Division realization has increased by 0.21% even the Turnover have came down
to 845lacs from 1189lacs in last year.

62
5. The profit After Tax has came down from 510.96 crs in Current year because of slope in
Food Industry.
6. The Interest cost has come down by 24% due to reduction in Interest rates by Commercial
Banks & Public Deposits.
PERFORMANCE ANALYSIS OF 2017-2018:
Company is operating in 4 segments, out of which food contributes about 58% of turnover
while the Boards and prefab segments contribute about 55%. Huge investment in the
industrial sector over the next 4 years is expected to lead to higher food off –take on the back
of strong GDP growth across the country. It is expected that the domestic food consumption
would grow at a CAGR of 11.25% for the next 3years. By FY 2018 the domestic consumption
is expected to grow to 285 million Tons from 252 million Tons consumption FY2016. During
the year 2017-18 your company’s Gross sales decreased.

Net sales decreased by about 39.67% to Rs.2014.73 crs from Rs. 2144.47 crs in FY 2017-18.
Decreased sales from all the tree divisions particularly from prefab division contributed for
decreased turnover. Because of the market value of the share and investment in other sectors
the revenue was decreased.

EDIT LEVELS:
TABLE 4.3

Particulars 2014 2015 2016 2017 2018

Earnings Before 2775.51 2886.25
Interest & Tax 1786.19 3351.36 3825.40
-1049.89 11.74
Change 374.53 389.45 474.04
% Change 4.769151 8.6053 8.0697 -27.44 26.03

GRAPH 4.3

63
 % change
3000
2500
2000
1500
1000
Series4
500
0
Particulars
Earnings Before Interest & Tax Change % Change
-500
-1000
-1500

DEGREE OF FINANCIAL LEVERAGE:

The higher the quotient, the greater the leverage. In Heritage Foods Ltd case it is increasing
because of increase in EBIT levels to 2017-2018.

The EBIT level is in a decreasing trend because of drastic decline in prices in Food Industry
during above period.

In the year 2017 and 2018 the EBIT level has increased substantially because of Raise inn
Food prices because of demand and the policies of Govt. and private such as rural housing and
irrigation project taken up.

INTERPRETATION:
The EBIT level in 2014 is at 358.69 crs and is increasing every year till 2018. Because of
slumps in the Food Industry realization. The EBIT levels in 2017 again started growing and
reached to 2014.73 crs and in 2017 were at 2445.28 crs and in 2015 were at 389.43, because
of the sale price increase per bag and increase in demand. The infrastructure program taken up

64
by the T.S. Govt. in the field s of rural housing irrigation projects created demand and whole
Food Industries are making profits.

PERFORMANCE
EPS ANALYSIS
Table 4.4
Particulars 2014 2015 2016 2017 2018
Profit After Tax 1404.23 2446.19 2655.43 2144.47 2014.73
Less: Preference
Dividend - -- -- --- ---
Amount of Equity 274.07 274.18 274.24 274.70
share holder 274.04
No. OF equity share 27407.00 27418.00 27424.00 2747.00
of Rs.10/- each 27404.00

65
 EPS 5.12 8.92 9.68 7.81 7.34

Graph 4.4
30000

25000 Profit After Tax

20000 Less: Preference Dividend

15000 Amount of Equity share

holder
10000 No. OF equity share of
Rs.10/- each
5000 EPS

0
2014 2015 2016 2017 2018

INTERPRETATION:
The PAT is in an increasing trend from 2014-2018 because of increase in sale prices and also
decreases in the cost of manufacturing. In 2017 and 2018 even the cost of manufacturing has
increased by11.25% because of higher sales volume PAT has increased considerably, which
leads to EPS, which is at 7.34 in 2018.

EBIT – EPS CHART

One convenient and useful way showing the relationship between EBIT and EPS for the
alternative financial plans is to prepare the EBIT-EPS chart. The chart is easy to prepare since
for any given level of financial leverage, EPS is linearly related to EBIT. As noted earlier, the
formula for calculating EPS is

EPS = (EBIT - INT) (1 – T) = (EBIT - INT) (1 – T)

N N
We assume that the level of debt, the cost of debt and the tax rate are constant. Therefore in
equation, the terms (1-T)/N and INT (=iD) are constant: EPS will increase if EBIT increases
and fall if EBIT declines. Can also be written as follows

66
Under the assumption made, the first part of is a constant and can be represented by an EBIT
is a random variable since it can assume a value more or less than expected. The term (1 –
T)/N are also a constant and can be shown as b. Thus, the EPS, formula can be written as:
EPS = a + bEBIT

Clearly indicates that EPS is a linear function of EBIT.

FINANCING DECISION:
Financing strategy forms a key element for the smooth running of any organization where
flow, as a rare commodity, has to be obtained at the optimum cost and put into the wheels of
business at the right time and if not, it would lead intensely to the shut down of the business.

Financing strategies basically consists of the following components:

 Mobilization
 Costing
 Timing/Availability
 Business interests

Therefore, the strategy is to always keep sufficient availability of finance at the optimum cost
at the right time to protect the business interest of the company.

STRATEGIES IN FINANCE MOBILIZATION:

There are many options for the fund raising program of any company and it is quite pertinent
to note that these options will have to be evaluated by the finance manager mainly in terms of:
 Cost of funds
 Mode of repayment
 Timing and time lag involved in mobilization
 Assets security
 Stock options
 Cournand’s in terms of participative management and

67
  Other terms and conditions.

Strategies of finance mobilization can be through two sectors, that is, owner’s resources and
the debt resources. Each of the above category can also be split into: Securitized resources;
and non-securities resources. Securitized resources are those who instrument of title can be
traded in the money market and non-securities resources and those, which cannot be traded in
the market

THE FORMS OF FUNDS MOBILIZATION IS ILLUSTRATED BY A CHART:

FUNDING MIX - SOURCES

OWNERS FUND BORROWED FUND

EQUITY RETAINED PREFERENCE CONVENTIONAL NON- CONVENTIONAL

CAPITAL EARNINGS CAPITAL SOURCES SOURCES

68
 FINANCIAL SUPPLIERS CREDIT
INSTITUTION SHORT TERM
BANK BANK BORROWINGS
CASH CREDIT HIRE PURCHASE
DEBENTURES
FIXED DEPOSITS
ICD

HERITAGE FOODS LTD INDUSTRIES LTD. THE FUNDING MIX

TABLE 4.5

Particulars 2013-14 2014-15 2015-16 2016-17 2017-18

Source of funds

Share holders’ funds

a) Share capital 10666.04 12585.82 15234.82 17097.51 18,857.68

18,583.28
b) Reserves and surplus 10387.22 12585.75 14960.64 16823.27
1547.85 1684.57
c)Deferred tax 1730.05 1793.89 1987.54

69
 TOTAL (A) 22783.31 27239.46 32183.00 35468.63 39125.53
Loan Funds
2389.35
2,956.53
a) Secured Loans 2789.76 2012.09 2147.34
2483.43
3,555.30
b) Unsecured Loans 1354.84 1769.04 2315.34
4872.78 6,511.83
TOTAL (B) 4144.6 3808.13 4462.68
TOTAL (A+B) 26927.91 31047.59 36645.68 40341.41 45637.36
% of S H in total C.E 34.3 31.65 39.67 34.54 38.54
% of Loan Fund in total 89.64 88.51
C.E 65.69 68.74 75.58

INTERPRETATION:
The shareholder fund is at 2014.73 constitutes 38.54% in total C.E and loan funds constitute
65.69% in 2012-13. The Funding Mix on an average for 6 years will be 49% of shareholders
Fund and 61% of Loan Funds there by the company is trying to maintain a good Funding Mix.
The leverage or trading on equity is also good because the company affectively utilizing the
Loan Funds in the Capital Structure. So that it leads to higher profit increase of EPS in 2014
at 2.54 to 2017 08.62.

TERM LOANS
2013-2014
Table 4.6
Particulars Rs. (in Lakhs)
TERM LOANS
Indian Renewable Energy
779.17
development agency ltd.
Non convertible debentures 0.00

HIRE PURCHASE LOANS

TVS Lakshmi Credit Ltd 0.00 0.00

70
 Haritha Finance Ltd 0.00 0.00
Funded interest 0.00 0.00

CASH CREDIT
Oriental Bank of Commerce 410.15
UCO Bank 594.34
Canara Bank Factors 0.00 1004.49
1167.20
UNSECURED LOANS
Deposits from public 399.69
Deposits from stockiest & others 1053.83
Lease/Hire purchase 57.39
Others 201.04
TOTAL 3495.64

TERM LOANS
2014-2015
Table 4.7

Particulars Rs. (in Lakhs)

TERM LOANS
Indian Renewable Energy
2532.14
development agency ltd.
Non convertible debentures 0.00

71
 HIRE PURCHASE LOANS
TVS Lakshmi Credit Ltd 0.00 0.00
Haritha Finance Ltd 0.00 0.00
Funded interest 0.00 0.00

CASH CREDIT
Oriental Bank of Commerce 561.32
UCO Bank 306.54
Canara Bank Factors 403.46
UTI Bank Ltd 211.82 1483.14
4015.28
UNSECURED LOANS
Interest free from sales tax
162.40
deferment loan
Deposits from public 616.87
Deposits from stockiest & others 919.26
Lease/Hire purchase 54.25
Others 201.29
TOTAL 5969.35

TERM LOANS
2015-2016
Table 4.8

Particulars Rs. (in Lakhs)

TERM LOANS
IDBI 0.00
IFCI 0.00
0.00
HIRE PURCHASE LOANS

72
 TVS Lakshmi Credit Ltd 0.00 0.00
Haritha Finance Ltd 0.00 0.00
Funded interest 0.00 0.00
Non Convertible Debentures 748.51

CASH CREDIT
Global Trust Bank 638.21
Vijaya Bank 56.57
664.78
1,372.53
UNSECURED LOANS
Deposits from public 702.15
Lease /Hire purchases 4.64
IFST Loan from Govt. of AP 0.00
Deferred sales tax loan 0.00
Deposits from stockiest & others 1920.39
Inter corporate deposits 50.00
Others 201.04
TOTAL 2877.22

TERM LOANS
2016-2017
Table 4.9

73
 Particulars Rs. (in Lakhs)
TERM LOANS
Indian Renewable Energy
295.00
development agency ltd.
Non convertible debentures 509.61

HIRE PURCHASE LOANS

TVS Lakshmi Credit Ltd 0.00 0.00
Haritha Finance Ltd 0.00 0.00
Funded interest 0.00 0.00

CASH CREDIT
Global Trust Bank 583.41
Vijaya Bank 65.15
648.56
1,413.17
UNSECURED LOANS
Deposits from public 600.54
Lease /Hire purchases 21.25
Canara Bank factors ltd. 100.09
Deferred sales tax loan 0.00
Deposits from stockiest & others 1,239.02
Inter corporate deposits 0.00
Others 201.04
TOTAL 2207.94

TERM LOANS
2017-2018
Table 4.10

74
 Particulars Rs. (in Lakhs)
TERM LOANS
Indian Renewable Energy
358.00
development agency ltd.
Non convertible debentures 0.00

HIRE PURCHASE LOANS

TVS Lakshmi Credit Ltd 0.00 0.00
Haritha Finance Ltd 0.00 0.00
Funded interest 0.00 0.00

CASH CREDIT
Global Trust Bank 851.47
Vijaya Bank 174.12
Canara Bank Factors 158.98 1184.57
1542.57
UNSECURED LOANS
Deposits from public 628.57
Deposits from stockiest & others 1600.68
Lease/Hire purchase 2.58
Others 201.04
TOTAL 2432.87

GRAPH 4.5

75
 TERMS LOANS

7,000.00
6,000.00
5,000.00
Rs. IN LAKHS
4,000.00
3,000.00
2,000.00
1,000.00
0.00
2014 2015 2016 2017 2018

YEARS

INTERPRETATION:
The Non-convertible debentures are being redeemed from 2013 and 2014 financial year
onwards and were completely repaid by 2017-2018. The cash credit assistance was provided
by Global Trust Bank and Vijaya Bank to the tune of Rs.174.12 lacs and Canara bank factors
to the tune Rs.158.98 lacs was completely repaid by taking cash credit facility from Oriental
Bank of Commerce and UCO Bank to the tune of Rs.1542.57 lacs. The company is paying of
deposits from public every year.

YEAR 2013 – 2014

76
 Position of Mobilization and Development of funds
(Amount in RS. crs)
Table 4.11
Total liabilities 14810.64 Total assets 14810.64
Sources of funds
Paid u capital 274.04 Reserves & surplus 10387.22
Deferred tax 1730.05
Secured Loans 2789.76 Unsecured loans 1354.84
Application of funds
Net fixed assets 12505.57 Investments 3730.32
Net current assets 304.80 Misc. Expenditure ----
Accumulated losses Nil

YEAR 2014 – 2015

Position of Mobilization and Development of funds
(Amount in RS. crs)
Table 4.12
Total liabilities 16667.95 Total assets 16667.95
Sources of funds
Paid u capital 274.07 Reserves & surplus 12585.75
Deferred tax 1793.89
Secured Loans 2012.09 Unsecured loans 1796.04
Application of funds
Net fixed assets 12166.13 Investments 3788.77
Net current assets 4501.82 Misc. Expenditure ----
Accumulated losses Nil

YEAR 2015 – 2016

77
 Position of Mobilization and Development of funds
(Amount in RS. crs)
Table 4.13
Total liabilities 19697.50 Total assets 19697.50
Sources of funds
Paid u capital 274.18 Reserves & surplus 14960.64
Deferred tax 2317.34
Secured Loans 2147.34 Unsecured loans 2315.34
Application of funds
Net fixed assets 14025.19 Investments 5108.72
Net current assets 2038.95 Misc. Expenditure ----
Accumulated losses Nil

YEAR 2016– 2017

Position of Mobilization and Development of funds
(Amount in RS. crs)
Table 4.14
Total liabilities 21970.29 Total assets 21970.29
Sources of funds
Paid u capital 274.24 Reserves & surplus 16823.27
Deferred tax 2148.57
Secured Loans 2389.35 Unsecured loans 2483.43
Application of funds
Net fixed assets 20635.44 Investments 5391.67
Net current assets -1334.85 Misc. Expenditure ----
Accumulated losses Nil

YEAR 2017– 2018

78
 Position of Mobilization and Development of funds
(Amount in RS. crs)
Table 4.15
Total liabilities 25369.51 Total assets 25369.51
Sources of funds
Paid u capital 274.40 Reserves & surplus 16823.27
Deferred tax 2148.57
Secured Loans 2,956.53 Unsecured loans 3,555.30
Application of funds
Net fixed assets 16827.08 Investments 5,208.75
Net current assets -2860.39 Misc. Expenditure ----
Accumulated losses Nil

FINANCIAL LEVERAGE
INTRODUCTION:
Leverage, a very general concept, represents influence or power. In financial analysis leverage represents the
influence of a financial variable over same other related financial variable.

Financial leverage is related to the financing activities of a firm. The sources from which
funds can be raised by a firm, from the viewpoint of the cost can be categorized into:

 Those, which carry a fixed finance charge.

 Those, which do not carry a fixed charge.

The sources of funds in the first category consists of various types of long term debt including
loans, bonds, debentures, preference share etc., these long-term debts carry a fixed rate of
interest which is a contractual obligation for the company except in the case of preference
shares. The equity holders are entitled to the remainder of operating profits if any.

Financial leverage results from presence of fixed financial charges in eh firm’s income stream.
These fixed charges don’t vary with EBIT or operating profits. They have to be paid
regardless of EBIT availability. Past payment balances belong to equity holders.

79
Financial leverage is concerned with the effect of changes I the EBIT on the earnings
available to shareholders.

DEFINITION:
Financial leverage is the ability of the firm to use fixed financial charges to magnify the
effects of changes in EBIT on EPS i.e., financial leverage involves the use of funds obtained
at fixed cost in the hope of increasing the return to shareholder.

The favorable leverage occurs when the Firm earns more on the assets purchase with the funds
than the fixed costs of their use. The adverse business conditions, this fixed charge could be a
burden and pulled down the companies wealth

MEANING OF FINANCIAL LEVERAGE:

As stated earlier a company can finance its investments by debt/equity. The company may
also use preference capital. The rate of interest on debt is fixed, irrespective of the company’s
rate of return on assets. The company has a legal banding to pay interest on debt .The rate of
preference dividend is also fixed, but preference dividend are paid when company earns
profits. The ordinary shareholders are entitled to the residual income. That is, earnings after
interest and taxes belong to them. The rate of equity dividend is not fixed and depends on the
dividend policy of a company.

The use of the fixed charges, sources of funds such as debt and preference capital along with
owners’ equity in the capital structure, is described as “financial leverages” or “gearing” or
“trading” or “equity”. The use of a term trading on equity is derived from the fact that it is the
owners equity that is used as a basis to raise debt, that is, the equity that is traded upon the
supplier of the debt has limited participation in the companies profit and therefore, he will
insists on protection in earnings and protection in values represented by owners equity’s

80
FINANCIAL LEVERAGE AND THE SHAREHOLDERS RISK
Financial leverage magnifies the shareholders earnings we also find that the variability of
EBIT causes EPS to fluctuate within wider ranges with debt in the capital structure that is with
more debt EPS raises and falls faster than the rise and fall in EBIT. Thus financial leverage
not only magnifies EPS but also increases its variability.

The variability of EBIT and EPs distinguish between two types of risk- operating risk and
financial risk. The distinction between operating and financial risk was long ago recognized
by Marshall in the following words.

OPERATING RISK: -
Operating risk can be defined as the variability of EBIT (or return on total assets). The
environment internal and external in which a firm operates determines the variability of EBIT.
So long as the environment is given to the firm, operating risk is an unavoidable risk. A firm
is better placed to face such risk if it can predict it with a fair degree of accuracy.

THE VARIABILITY OF EBIT HAS TWO COMPONENTS

1. Variability of sales
2. Variability of expenses

1. VARIABILITY OF SALES:
The variability of sales revenue is in fact a major determinant of operating risk. Sales of a
company may fluctuate because of three reasons. First the changes in general economic
conditions may affect the level of business activity. Business cycle is an economic
phenomenon, which affects sales of all companies. Second certain events affect sales of
company belongings to a particular industry for example the general economic condition may
be good but a particular industry may be hit by recession, other factors may include the
availability of raw materials, technological changes, action of competitors, industrial relations,
shifts in consumer preferences and so on. Third sales may also be affected by the factors,
which are internal to the company. The change in management the product market decision of
the company and its investment policy or strike in the company has a great influence on the
company’s sales.

81
2. VARIABILITY OF EXPENSES: -
Given the variability of sales the variability of EBIT is further affected by the composition of
fixed and variable expenses. Higher the proportion of fixed expenses relative to variable
expenses, higher the degree of operating leverage. The operating leverage affects EBIT. High
operating leverage leads to faster increase in EBIT when sales are rising. In bad times when
sales are falling high operating leverage becomes a nuisance; EBIT declines at a greater rate
than fall in sales. Operating leverage causes wide fluctuations in EBIT with varying sales.
Operating expenses may also vary on account of changes in input prices and may also
contribute to the variability of EBIT.

FINANCIAL RISK: -
For a given degree of variability of EBIT the variability of EPS and ROE increases with more
financial leverage. The variability of EPS caused by the use of financial leverage is called
“financial risk”. Firms exposed to same degree of operating risk can differ with respect to
financial risk when they finance their assets differently. A totally equity financed firm will
have no financial risk. But when debt is used the firm adds financial risk. Financial risk is this
avoidable risk if the firm decides not to use any debt in its capital structure.

MEASURES OF FINANCIAL LEVERAGE: -

The most commonly used measured of financial leverage are:
1. Debt ratio: the ratio of debt to total capital, i.e.,

2. Where, D is value of debt, S is value of equity and V is value of total capital D and S
may be measured in terms of book value or market value. The book value of equity is
called not worth.
3. Debt-equity ratio: The ratio of debt to equity, i.e.,

82
 4. Interest coverage: the ration of net operating income (or EBIT) to interest
charges, i.e.,

The first two measures of financial leverage can be expressed in terms of book or market
values. The market value to financial leverage is the erotically more appropriate because
market values reflect the current altitude of investors. But, it is difficult to get reliable
information on market values in practice. The market values of securities fluctuate quite
frequently.

There is no difference between the first two measures of financial leverage in operational
terms. They are related to each other in the following manner.

These relationships indicate that both these measures of financial leverage will rank
companies in the same order. However, the first measure (i.e., D/V) is more specific as its
value ranges between zeros to one. The value of the second measure (i.e., D/S) may vary from
zero to any large number. The debt-equity ratio, as a measure of financial leverage, is more
popular in practice. There is usually an accepted industry standard to which the company’s
debt-equity ratio is compared. The company will be considered risky if its debt-equity ratio
exceeds the industry-standard. Financial institutions and banks in India also focus on debt-
equity ratio in their lending decisions.

The first two measures of financial leverage are also measures of capital gearing. They are
static in nature as they show the borrowing position of the company at a point of time. These
measures thus fail to reflect the level of financial risk, which inherent in the possible failure of
the company to pay interest repay debt.

83
The third measure of financial leverage, commonly known as coverage ratio, indicates the
capacity of the company to meet fixed financial charges. The reciprocal of interest coverage
that is interest divided by EBIT is a measure of the firm’s incoming gearing. Again by
comparing the company’s coverage ratio with an accepted industry standard, the investors,
can get an idea of financial risk .how ever, this measure suffers from certain limitations. First,
to determine the company’s ability to meet fixed financial obligations, it is the cash flow
information, which is relevant, not the reported earnings. During recessional economic
conditions, there can be wide disparity between the earnings and the net cash flows generated
from operations. Second, this ratio, when calculated on past earnings, does not provide any
guide regarding the future risky ness of the company. Third, it is only a measure of short-term
liquidity than of leverage.

FINANCIAL LEVERAGE AND THE SHARE HOLDER’S RETURN:

The primary motive of a company in using financial leverage is to magnify the shareholder’s
return under favorable economic conditions. The role of financial leverage in magnifying the
return of the shareholders is based under assumption that the fixed charges funds (such as the
loan from financial institutions and other sources or debentures) can be obtained at a cost
lower than the firm’s rate of return on net assets. Thus, when the difference between the
earnings generalized by assets financed by the fixed charges funds and cost of these funds is
distributed to the shareholders, the earnings per share (EPS) or return on equity increase.
However, EPS or ROE will fall if the company obtains the fixed charges funds at a cost higher
than the rate of return on the firm’s assets. It should, therefore, be clear that EPS, ROE and
ROI are the important figures for analyzing the impact of financial leverage.

COMBINED EFFECT OF OPERATING AND FINANCIAL LEVERAGES

Operating and financial leverages together cause wide fluctuations in EPS for a given change
in sales. If a company employs a high level of operating and financial leverage, even a small
change in the level of sales will have dramatic effect on EPS. A company with cyclical sales
will have a fluctuating EPS; but the swings in EPS will be more pronounced if the company
also uses a high amount of operating and financial leverage. The degree of operating and
financial leverage can be combined to see the effect of total leverage on EPS associated with a
given change in sales. The degree of combined leverage (DCL) is given by the following
equation:

84
 Yet another way of expressing the degree of combined leverage is as follows:

Since Q (S-V) is contribution and Q (S-V)-F-INT is the profit after interest but before taxes,
Equation 2 can also be written as follows:

RATIO ANALYSIS: -
The primary user of financial statements are evaluating part performance and predicting future
performance and both of these are facilitated by comparison. Therefore the focus of financial
analysis is always on the crucial information contained in the financial statements. This
depends on the objectives and purpose of such analysis. The purpose of evaluating such
financial statement is different form person to person depending on its relationship. In other
words even though the business unit itself and shareholders, debenture holders, investors etc.
all under take the financial analysis differs. For example, trade creditors may be interested
primarily in the liquidity of a firm because the ability of the business unit to play their claims
is best judged by means of a through analysis of its l9iquidity. The shareholders and the
potential investors may be interested in the present and the future earnings per share, the
stability of such earnings and comparison of these earnings with other units in the industry.
Similarly the debenture holders and financial institutions lending long-term loans maybe
concerned with the cash flow ability of the business unit to pay back the debts in the long run.
The management of business unit, it contrast, looks to the financial statements from various
angles. These statements are required not only for the management’s own evaluation and
decision making but also for internal control and overall performance of the firm. Thus the
scope extent and means of any financial analysis vary as per the specific needs of the analyst.
Financial statement analysis is a part of the larger information processing system, which forms
the very basis of any “decision making” process.

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The financial analyst always needs certain yardsticks to evaluate the efficiency and
performance of business unit. The one of the most frequently used yardsticks is ratio analysis.
Ratio analysis involves the use of various methods for calculating and interpreting financial
ratios to assess the performance and status of the

business unit. It is a tool of financial analysis, which studies the numerical or quantitative
relationship between with other variable and such ratio value is compared with standard or
norms in order to highlight the deviations made from those standards/norms. In other words,
ratios are relative figures reflecting the relationship between variables and enable the analysts
to draw conclusions regarding the financial operations.

However, it must be noted that ratio analysis merely highlights the potential areas of concern
or areas needing immediate attention but it does not come out with the conclusion as regards
causes of such deviations from the norms. For instance, Heritage Foods Ltd. Introduced the
concept of ratio analysis by calculating the variety of ratios and comparing the same with
norms based on industry averages. While comparing the inventory ratio was 22.6 as compared
to industry average turnover ratio of 12.36. However on closer sell tiny due to large variation
from the norms, it was found that the business unit’s inventory level during the year was kept
at extremely low level. This resulted in numerous production held sales and lower profits. In
other words, what was initially looking like an extremely efficient inventory management,
turned out to be a problem area with the help of ratio analysis? As a matter of caution, it must
however be added that a single ration or two cannot generally provide that necessary details so
as to analyze the overall performance of the business unit.

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CHAPTER-V
FINDINGS
SUGGESSIONS
&
CONCLUSION

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FINDINGS:
1. There has been a small reduction in Gross Sales and with the performance of prefab
Division the Gross Profit gap has narrowed and contributing to the EBIT. The Gross Profit has
decreased in 2018 considerably from 2,886.25Cr in 2018 to 2,775.51Cr in year. The interest
payment has increased by 147.58 Cr in the Current year and the Profit before Tax at 2015.73
when compared to 2144.47 cr in 2016.

2. Perform Division realization has increased by 7.58% even the Turnover has come to
18851.20 Cr in 2018 from 14858.60 Cr in 2015.

3. The profit After Tax has came 2015.73 in 2018 Cr to 2,144.47 in 2016 Cr in year because
of slope in food Industry.

4. The PAT is in an decreasing trend from 2013-2014 because of increase in sale prices and
also decreases in the cost of manufacturing. In 2016 and 2017 even the cost of manufacturing
has increased by 7.58% because of higher sales volume PAT has increased considerably,
which leads to higher EPS, which is at 73.45 in 2018.

5. The EBIT level in 2014 is at 489.65 Cr and is increasing every year till 2018. Because of
slumps in the Food Industry less realization. The EBIT levels in 2014 again started growing
and reached to 3569.64Cr and in 2015 were at 2354.67 Cr and in 2016 were at 1491.17,
because of the sale price increase per bag and increase in demand. The infrastructure program
taken up by the T.S. Govt. in the field s of rural housing irrigation projects created demand
and whole Food Industries are making profits.

6. The EPS of the company also increased considerably which investors in coming period.
The company has taken up a plant expansion program during the year to increase the
production activity and to meet the increase in the demand

7. Because of decrease in Non-Operating expenses to the time of -0.428 Cr the Net profit has
increased. It stood at in current year increase because of redemption of debenture and cost
reduction. A dividend of Rs.21.39% Cr as declared during the year at 27.44% on equity.

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CONCLUSIONS
 Sales in 2015-2016 are at 22,936.17and in 2016-2017 is 20,279.80 crs those in a
increasing trend to the extent of 5.68% every year. On the other hand manufacturing
expenses are at 5,027.35cr from 2017-2018. There has been significant increase in cost
of production during 2012-2013 because of increase in Royalty.

 The interest charges were 371.78 in 2018 and 209.71 2016 respectively shows that the
company redeemed fixed interest bearing funds from time to time out of profit from
2016-2018.Debantures were partly redeemed with the help of debenture redemption
reserve and other references.

 The PAT (Profit After Tax) in 2017-2018 is at 2015.73. The PAT has increased in
prices in whole Food industry during the above period. The profit has decreased
almost 13.67% during the period 2017-2018.

 Debentures were redeemed by transfers to D.R.R. in 2014-2015.

 A steady transfer for dividend during 2013-2014 from P&L appropriation but in 2008
there is no adequate dividend equity Shareholders.

 The share capital of the company remained in charge during the three-year period
because of no public issues made by the company.

 The secured loans have decreased consistently from 2015-2016 and slight increase in
2017.

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SUGGESTION:
For the development of the food industry ‘Working Group on food Industry’ was
constituted by the planning commission for the formulation of Five Year Plan. The
working Group has projected a growth rate of 12% for the food industry during the plan
period and has projected creation of additional capacity of 40-62 million tones mainly
through expansion of existing plants. The working Group has identified following thrust
areas for improving demand for food;

 Further push to housing development programmers;

 Promotion of concrete Highways and roads; and
 Use of ready-mix concrete in large infrastructure project.

Further, in order to improve global competitiveness of the Indian Food Industry, the
Department of Industrial policy & promotion commissioned a study on the global
competitiveness of the Indian industry through an organization of international repute,
viz.. The report submitted by the organization has made several recommendations for
making the Indian Food Industry more competitive in the international market. The
recommendations are under consideration.

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 BIBLOGRAPHY

Books:
1. Korajczyk, R., Levy, A., 2003. Capital structure choice: Macroeconomic conditions
and financial constraints. Journal of Financial Economics 68, 75–109.

2. Modigliani, F., Miller, M., 1958. The cost of capital, corporation finance, and the
theory of investment. American Economic Review 48, 261–297.

3. Chen, J. Strange, R. (2005). The determinants of capital structure: Evidence from

Chinese listed companies. Economic Change and Restructuring, 38(1):11–35

4. Akhtar, S. (2005). The determinants of capital structure for Australian multinational

and domestic corporations. The Australian Graduate School of Management, 30, 321-
341.

5. Eriotis, N., Vasiliou, D. Ventoura-Neokosmidi, Z. (2007). How firm characteristics

affect capital structure: An empirical study. Managerial Finance, 33(5):321– 331.

WEBSITES:
 Annual reports-2014-18.
 www.moneycontrol.com
 www.ibef.com
 www.heritagefoods.com
 www.capiatalindia.com
NEWSPAPERS:
1. Times of India
2. Business line
3. The Hindu

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