Indian Tobacco Corporation
1. Working Capital Analysis
Hindustan Unilever Ltd.
2. Capital Structure Analysis
FINANCIAL MANAGEMENT PROJECT
- Shradha Diwan, Class of 2010, IBS Kolkata
Serial # CONTENTS Page #
1 EXECUTIVE SUMMARY 3
2 ENVIRONMENTAL ANALYSIS 4
3 COMPANY OVERVIEW : ITC Ltd 6
4 WORKING CAPITAL ANALYSIS 7
(i) Current Ratio Analysis 8
(ii) Quick Ratio Analysis 9
(iii) Inventory Days 10
(iv) Debtor Days
(v) Creditor Days
(vi) Tracing changes in Working Capital 12
5 CAPITAL STRUCTURE ANALYSIS 14
(i) Capital Gearing 15
(ii) Debt-to-Equity Ratio 16
6 REFERENCES 17
The project assigned to us was to assess the financial health of ITC ltd. by the analysis of its
Working Capital requirement. Furthermore, the company’s Capital Structure was also analyzed.
While studying the intricacies of the financials of the company, it became more meaningful to
compare the working capital needs and financial structure of ITC ltd. with that of a
corresponding high value company in the same sector. For the purpose, we chose to analyze
the financial health of Hindustan Unilever Ltd. which happens to be the largest FMCG company
in the country. A face-to-face analysis of the two companies gives a better insight into the
financial stature of ITC ltd. in its respective sector.
Through a thorough analysis of the business environment, industry, and the company, we aim
to understand the external factors influencing the company and its decision making.
The financial statements of the last 5 years of ITC ltd are analyzed. As a benchmark, we also
analyze the various components of the company vis-à-vis Hindustan Unilever, a competitor
operating in the same segment.
Every business decision is associated in one way or another with the financial condition of the
organization. The results of a working capital analysis will assist in the determination of the
organization’s ability to remain in a particular line of business.
As in all businesses, including ITC, it must be considered that there is always room for
The Indian FMCG sector is the fourth largest in the economy with a total market size in excess
of US$13.1 billion. It has a strong MNC presence and is characterized by a well established
distribution network, intense competition between the organized and unorganized segments
and low operational cost. Availability of cheap raw materials, cheaper labor costs, and presence
across the entire value chain gives India a competitive advantage.
The FMCG market is set to treble from US$11.6 billion in 2003 to US$ 33.4 billion in 2015.
Penetration level as well as per capita consumption in most product categories like jams,
toothpaste, skin care, hair wash etc. in India is low, indicating the untapped market potential.
Burgeoning Indian population, particularly the middle class and the rural segments, presents an
opportunity to makers of branded products to convert consumers to branded products.
Growth is also likely to come from consumer “upgrading” in the mature product categories.
With 200 million people expected to shift to processed and packaged food by 2010, India needs
around US$ 28 billion of investment in the food processing industry.
LEVERAGING THE COST ADVANTAGE
Global major, Unilever, sources a major portion of its product requirements from its Indian
subsidiary. HLL. In 2003-04, Unilever outsourced around US$ 218 million of home and personal
care along with food products to leverage on the cost arbitrage opportunities in the west.
To take another case, Proctor and Gamble (P&G) outsourced the manufacture of Vicks Vaporub
to contract manufacturers in Hyderabad, India. This enables P&G to continue exporting Vicks
Vaporub to Australia, Japan, and other Asian countries, but at more competitive rates, whilst
maintaining its high quality and cost efficiency.
The following factors make India a competitive player in the FMCG sector:
1. Availability of raw materials
2. Low cost labor
3. Presence across value chain
THE TOP 10 COMPANIES IN THE INDIAN FMCG SECTOR
1. Hindustan Unilever Ltd.
2. ITC (Indian Tobacco Company)
3. Nestle India
4. GCMMF (AMUL)
5. Dabur India
6. Asian Paints (India)
7. Cadbury India
8. Britannia Industries
9. Procter & Gamble Hygiene and Health Care
10. Marico Industries
ANALYSIS OF THE INDIAN FMCG SECTOR
1. Low operational costs 1. Lower scope of investing in technology
2. Presence of established distribution and achieving economies of scale,
networks in both urban and rural areas especially in small sectors
3. Presence of well-known brands in 2. Low exports levels
FMCG sector 3. "Me-too" products, which illegally
mimic the labels of the established
brands. These products narrow the
scope of FMCG products in rural and
1. Untapped rural market 1. Removal of import restrictions resulting in
2. Rising income levels, i.e. increase in replacing of domestic brands
purchasing power of consumers 2. Slowdown in rural demand
3. Large domestic market- a population of 3. Tax and regulatory structure
over one billion.
4. Export potential
5. High consumer goods spending
INDIAN TOBACCO CORPORATION (ITC) Ltd.
ITC is one of India's foremost private sector companies with a market capitalization of nearly US
$ 19 billion and a turnover of over US $ 5.1 Billion.
ITC is rated among the World's Best Big Companies, Asia's 'Fab 50' and the World's Most
Reputable Companies by Forbes magazine, among India's Most Respected Companies by
BusinessWorld and among India's Most Valuable Companies by Business Today.
ITC ranks among India's `10 Most Valuable (Company) Brands', in a study conducted by Brand
Finance and published by the Economic Times. ITC also ranks among Asia's 50 best performing
companies compiled by Business Week.
Presence in diversified areas such as
• Paperboards and specialty papers FMCG PRODUCTS
• Agri – business
• Packaged foods and confectionary
• Information technology
• Branded apparel
• Greeting cards
• Safety matches
WORKING CAPITAL ANALYSIS
Working capital management is concerned with making sure we have exactly the right amount of money
and lines of credit available to the business at all times.
Cash is the life-blood of any business, no matter how large or small. If a business has no cash and no way
of getting any cash, it will have to close down. It’s that simple! Following on from this we can see that if
a business has no idea of its liquidity and working capital position, it could be in serious trouble.
Higher the current assets of a company and lower the current liabilities, greater is the working capital. A
larger chunk of working capital can be used to fund the long term liabilities of the company and
therefore, the larger the working capital, the better it is for the company.
Why Working Capital analysis?
Working Capital analysis of a company tells us what would be left if a company raised all of its short
term resources, and used them to pay off its short term liabilities.
One of the main advantages of looking at the working capital position is being able to foresee any
financial difficulties that may arise. Even a business that has billions of dollars in fixed assets will quickly
find itself in bankruptcy court if it can’t pay its monthly bills.
Working Capital = Current Assets – Current Liabilities
Poor Working Capital leads to a poor credit rating of a company which in turn increases the interest
charged by the banks on loans given to the company and this leads to greater cost disadvantages.
Working Capital Cycle = Operating Cycle + Cash Conversion Cycle
The following ratios and components of the working capital cycle of ITC ltd. will be compared
vis-à-vis the similar components of Hindustan Unilever Ltd. to get a fair idea about the working
capital structure of ITC ltd.
1. Current Ratio or the Working Capital Ratio
2. Quick Ratio
3. Inventory Days
4. Debtor Days
5. Creditor Days
6. Working Capital Days
7. Working Capital Trend
CURRENT (WORKING CAPITAL) RATIO ANALYSIS
Current Ratio = Current Assets – Current Liabilities
The current ratio is a measure of the firm’s short-term solvency. It is normally presented as a
real ratio. It is also a measure of the “margin of safety” for the creditors.
Current Ratio Trend Analysis
current assets / current liabilities
1.5 ITC ltd
1 Hindustan Unilever Ltd
2004 2005 2006 2007 2008
We observe that the current ratio of ITC ltd. is increasing over the 5 year period taken into
consideration (2004 - 2008).
The reason why the ratio increases mainly is because of a more than proportionate increase of
the Current Assets when compared to the Current Liabilities. ITC has been diversifying into
many areas over the past few years. Launch of new products and plans call for immediate
funding requirements because of which ITC has had to maintain a considerable amount of
A current ratio of 2:1 is generally considered satisfactory. A ratio < 1.5 generally signifies an
Here, the short term solvency of ITC is much better over the years as compared to HUL. Even
though HUL is a bigger player than ITC in the FMCG sector, its financial strength as depicted by
the current ratio trend analysis is not very promising. However, FMCG companies normally do
not have a high current ratio because of the ready and fast conversion of inventory into cash.
Therefore, the other factors need to be considered before coming to any conclusion about the
relative financial strength of the 2 companies.
QUICK (ACID TEST) RATIO ANALYSIS
The acid test ratio is also known as the liquid or the quick ratio. The idea behind this ratio is that stocks
are sometimes a problem because they can be difficult to sell or use. That is, even though a supermarket
has thousands of people walking through its doors every day, there are still items on its shelf that don’t
sell as quickly as the supermarket would like. Similarly, there are some items that sell very well.
Acid test ratio = (current assets – inventories) / current liabilities
Quick Ratio Trend analysis
(current assets - inventory) / current
2004 2005 2006 2007 2008
Generally, a quick ratio of 1:1 is considered a satisfactory current financial condition.
The quick ratio for ITC ltd. has increased over the period of time where as that of HUL ltd. has declined
continuously. This shows that ITC ltd has been stocking fewer inventories as compared to HUL ltd. An
increase in quick ratio is normally considered to be a good thing because it implies a stronger liquidity
position than before.
ITC, with a high value of quick ratio, has to be careful because it may suffer from a shortage of funds if it
has slow-paying, doubtful and long-duration outstanding debtors. On the other hand, HUL may be
prospering and paying its current obligations in time if it has been turning over its inventories efficiently.
This will be analyzed in the coming sections.
Inventory turnover measures how well a company converts stocks into revenues.
Inventory Days = (Stocks / Cost of sales) x 365 days
It measures how well a company is making use of the working capital that is invested in stock.
(stocks / cost of ssales) x 365 days
2005 2006 2007 2008
Inventory days measure the average number of days goods remain in inventory before being
sold. As a measure of short term sales potential, a number above the industry norm indicates
problems with sales forecasts. And a number below the norm indicates loss of sales due to the
firm’s inability to fulfill demand.
Here we see that the inventory days of ITC have increased over the years whereas those of HUL
have decreased. The graphs indicate that HUL’s sales forecasts and hence short term sales
potential is better than that of ITC. Since HUL has a higher market share compared to ITC, this
trend is an expected feature. However, ITC should be careful in its sales forecasts, lest it might
idle up a large amount of working capital in holding inventory.
Most businesses make a large proportion of their sales on credit. Debtor days are a measure of
the average time payment takes. Increase in debtor days may be a sign that the quality of the
company’s debtors is decreasing. This could mean a greater risk of default (so it does not get
paid at all). It could also be an indicator that cash flow is likely to weaken or that more working
capital will be required.
Debtor Days = (Trade Debtors / Sales) x 365
(Trade Debtors / Sales) x 365
2005 2006 2007 2008
Generally, lower debtor number days are better. Here we see that the ITC’s debtor quality is
good and has remained so over the past years.
Increased cash based sales
Efficient collection of receivables
On the other hand, HUL has succeeded in maintaining its quality of debtors as per the existing
standards in the industry (considering that ITC and HUL define the parameters). It should be
noted that HUL may be in a stronger position as it specializes in credit selling to its customers
which is one of the reasons why it has the largest market share. ITC, though with a considerably
strict credit policy, can still work harder to improve on its quality of debtors.
Investors should be aware of why changes in debtor days are happening, especially if there is a
very large increase or a clear long term increasing trend. It may reflect a change in how the
business operates, or its environment. This is not necessarily bad, but it can be an indication of
a potentially serious problem.
Creditor days are the average time a company takes to pay to its creditors.
Creditor Days = (Trade Creditors / Annual Purchases) x 365
(Trade Creditors / Annual Purchases) x
250 ITC ltd
200 HUL ltd
2005 2006 2007 2008
ITC’s creditor days has decreased significantly over time. This indicates a strong financial
position of ITC. It indicates that ITC’s working capital has been utilized efficiently to manage its
short term liabilities.
However, HUL’s creditor days have been increasing over the years. Lengthening creditor days
may mean that the company is heading for financial problems as it is failing to pay creditors.
On the other hand, it may also mean that HUL is simply getting better at getting good credit
terms out of its suppliers (improving its working capital management), or that its pattern of
purchasing has changed.
In either of the situations, it may be said that both ITC and HUL have been managing their
working capital well. This also explains the increasing trend in the current ratio of ITC and the
decreasing trend in case of HUL. It indicates that ITC has been maintaining a good amount of
current assets and this has added to its credit rating. HUL is keeping it low so that it can take
advantage of its suppliers’ credit and invest its working capital.
TRACING CHANGES IN WORKING CAPITAL TREND
Working Capital Trend
Current Assets - Current Liabilities
-2000 2004 2005 2006 2007 2008
From the trend observed above it is clear that ITC ltd. has maintained a continuous growth in its
working capital. On the other hand, HUL ltd. has been on a decline with respect to the amount
of working capital held by the company.
There may be many reasons for this and a decreasing trend in case of HUL may not necessarily
indicate a very unstable financial position of the company.
ITC has been diversifying into various areas of FMCG goods. Continuous production and launch
of new products require ITC to maintain a high net working capital to keep up with its liquidity
requirements. ITC has been launching various products of late and continuous advertising and
promotional expenditure entails a huge amount of working capital.
HUL ltd. has witnessed a continuous decline. This does not mean that HUL is not managing its
working capital efficiently. It is noteworthy that HUL is able to meet its creditors’ payment on
time and has constantly maintained a declining number of creditor days. Therefore, it might be
leveraging the advantages conferred upon it by the creditors, indicating that it enjoys a liberal
credit policy of its suppliers.
ITC’s financial position is strong and it will continue to be so as long as the working capital
needs and availability keep pace with the diversification of the company.
CAPITAL STRUCTURE ANALYSIS OF ITC Ltd.
Capital Structure refers to the way a corporation finances its assets through some combination
of equity, debt, or hybrid securities. A firm’s capital structure is then the composition or
structure of its liabilities.
The firm’s ratio of debt to total financing is referred to as the firm’s leverage.
FMCG companies are mostly dependent on equity financing. Long term debts form a very
insignificant portion of their total financing. As a result, FMCG companies are low geared
The capital Structure of ITC ltd can be analyzed using the following 2 important aspects:
1. Capital Gearing
2. Debt-to-Equity Ratio
Capital gearing ratio is mainly used to analyze the capital structure of a company.
Capital Gearing Ratio = Equity Share Capital / Fixed Interest Bearing Funds
Low Geared-------High Equity Share Capital (as in the case of FMCG companies)
Capital gearing ratio is important to the company and the prospective investors. It must be
carefully planned as it affects the company’s capacity to maintain a uniform dividend policy
during difficult trading periods. It reveals the sustainability of the company’s capital .
The Capital Gearing trend of ITC ltd can be understood with the help of the following graphical
Owners’ fund as a percentage of total source:
2004 2005 2006 2007 2008
Owners’ fund comprises of equity capital as the major portion. Rather, it can be assumed to be
the only source of owners’ capital.
The outsiders’ fund has been very insignificant over the considered length of time, thereby
showing that ITC ltd. is a low geared company.
With respect to the current economic and financial scenario, companies which are dependent
for expansion on borrowed capital are going to be I some kind of a trouble for the next 1 year
or so. Highly geared companies are unattractive for inventors because the company may have
difficulty in paying the interest due on its borrowings if their operations fail to generate enough
cash. “Low Geared” companies are attractive for the opposite reason. Thus, ITC’s capital
structure is attractive and strong both for the company and its owners.
Debt-to-Equity ratio indicates the relationship between the external equities or outsiders’ funds
and the internal equities or shareholders’ funds. It is also known as external-internal equity
ratio. It is determined to ascertain the long term financial policies of the company.
Debt Equity Ratio = Internal Equities / External Equities
= Outsiders’ Funds / Shareholders’ Funds
= Total Long-term Debts / Total Long-term Funds
ITC’s debt-to-equity ratio:
Year 2008 2007 2006 2005 2004
Long term .01 .01 .01 .01 .01
debt / equity
The ratio indicates the proportionate claims of owners and the outsiders against the firm’s
assets. The purpose is to get an idea about the cushion available to outsiders on the liquidation
of the firm. However, the interpretation of the ratio depends upon the financial and business
policy of the company. The owners want to do business with maximum of outsiders’ funds in
order to take lesser risk of their investment and to increase their earnings (per share) by paying
a lower fixed rate of interest to outsiders. The outsiders (creditors) on the other hand, want
that shareholders should invest and risk their share of proportionate investments.
A ratio of 1:1 is usually considered to be a satisfactory ratio. Theoretically, if the owners’
interests are greater than that of creditors, the financial position is highly solvent. In analysis of
the long-term financial position, it enjoys the same position as the current ratio in the analysis
of short-term financing.
ITC has maintained a constant debt-to-equity ratio of .01 over the past 5 years. This is a clear
indication of ITC’s heavy reliance on equity capital as a source of finance. In the present
financial scenario, companies with a high debt-equity ratio are likely to witness a period of high
interest costs. Therefore, it makes more sense for investors to look for companies with low
ITC ltd is highly solvent and with a very strong capital structure in the present financial
situation. Though debt capital financing is preferred by companies since it involves less risk and
comes with the bonus of a tax shield, the present scenario dictates that companies with low
debt financing are definitely at the summit.
Financial Management (ninth edition) – I. M. Pandey
Principles of Corporate Finance – Brealey and Myers