Long Termsolvencyanalysis

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LONG-TERM SOLVENCY ANALYSIS OF A PRIVATE SECTOR COMPANY: A CASE

STUDY RELIANCE INDUSTRIES LTD
Article · July 2014
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GE-INTERNATIONAL JOURNAL OF MANAGEMENT RESEARCH
VOLUME -2, ISSUE -7 (JULY 2014) IF-3.142 ISSN: (2321-1709)
LONG-TERM SOLVENCY ANALYSIS OF A PRIVATE SECTOR

COMPANY: A CASE STUDY RELIANCE INDUSTRIES LTD.
Dr. Anshuja Tiwari, Firdous Ahmad Parray,

Assistant professor Research Scholar
Department of commerce Department of Commerce
Barkatullah University, Bhopal. Barkatullah University, Bhopal.
ABSTRACT
The present manuscript is an endeavour by the researcher to analyse the pattern of financing
adopted by private company. The sample company for this research has been Reliance
Industries Ltd. and the study period is five years (2010-2014).As a matter of fact the long
term creditors of a firm are primarily interested in knowing the firm’s ability to pay regularly
the interest on long term borrowings, repayment of the principle amount at the maturity and
the security of their loans. Accordingly long term solvency ratios indicate a firm’s ability to
meet the fixed interest and costs and repayment schedules associated with its long term
borrowings. Thisresearch work is an attempt to analyse the long term solvency of the
company under study. It provides insights into two widely used financial tools i.e., ratio
analysis. The objective of this paper is to analyse the Impact of debt and equity capital over
the performance of Reliance Industries Ltd and to help the reader understand how these tools
should be used to analysethe solvency position of a firm. To demonstrate the process of
solvency analysis, Reliance Industries Limited’svarious ratios calculated from balance sheet
and income statements are analysed in this paper. Various statistical tools like mean,
standard deviation and student’s t test have been utilized for testing null hypothesis.
Regarding main result it has been found that the capital structure of the company is equally
balanced by the outsiders and owners capital.
Keywords: Capital Structure, Debt-Equity, Proprietary, Solvency, Liquidity, Capital

gearing, ICR.
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Page 306
Introduction
Fundamentally, finance for businesses falls into two separate categories, debt and equity.
Debt, quite simply, is a cash advance of money that will have to be paid back, normally with
an interest figure on top. Business equity, on the other hand, is financing that comes from
investors and does not necessarily have to be repaid, although investors will normally expect
a degree of return for their investment.
Debt vs. equity financing is one of the most important decisions facing managers who need
capital to fund their business operations. Debt and equity are the two main sources of capital
available to businesses, and each offers both advantages and disadvantages. "Absolutely
nothing is more important to a new business than raising capital
Review of literature
Few studies focus on international samples to test capital structure models. Rajan and
Zingales (1995) and Booth, Aivazian, Demirgüç-Kunt, and Maksimovic (2001) are two
noticeable exceptions. Rajan and Zingales (1995) find similar levels of leverage across the
G7 countries, thus refuting the idea that firms in bank-oriented countries are more leveraged
than those in market-oriented ones. However, they recognize that this distinction is useful in
analyzing the various sources of financing. They also find that the determinants of capital
structure that have been reported for the U.S. (size, growth, profitability, and importance of
tangible assets) are important in other countries as well. They show that a good
understanding of the relevant institutional context (bankruptcy law, fiscal treatment,
ownership concentration, and accounting standards) is required when identifying the
fundamental determinants of capital structure. Booth et al. (2001) suggest that the same
determinants of capital structure prevail in ten developing countries, but national
environment is again important. These studies, however, do not shed any light on the
adjustment process of capital structure and fail to discriminate between the main theoretical
hypotheses.
Page 307
Modigliani and Miller (1958) claim that under perfect capital market conditions, a firm’s
value depends on its operating profitability rather than its capital structure. In 1963,
Modigliani and Miller (1963) fix the previous paper; argue that, when there are corporate
taxes then interest payments are tax deductible, 100% debt financing is optimal. This means
that the firm’s value increases as debts increases.
Since then, extensions of the Modigliani-Miller theory have been provided by the following
researches. Robichek and Myers (1965) argue that the negative effect of bankruptcy costs on
debt to prevent firms from having the desire to obtain more debt. Jensen and Meckling
(1976) identify agency cost in governing the corporation. The general result of these
extensions is that the combination of leverage related costs (such as bankruptcy and agency
costs) and a tax advantage of debt produces an optimal capital structure at less than a 100%
debt financing, as the tax advantage is traded off against the likelihood of incurring the costs.
Objectives of the study
 To study the capital structure of Reliance Industries Ltd.

 To analyse the Impact of debt and equity capital over the performance of Reliance
Industries Ltd.
 To provide suggestive measures on the basis of findings for further betterment of the
company under study.
Research Methodology
The present research work is analytical in nature and is entirely based on secondary data. The
data has been collected from various secondary sources such as annual reports of the
company, research papers, articles, dissertations, newspapers, magazines and internet as well.
Various statistical tools like student’s t test have also been utilized for testing of hypothesis.
Hypothesis
Ho: There is no significant difference between debt and equity capital of Reliance Industries
Ltd.
Page 308
Ha: There is significant difference between debt and equity capital of Reliance Industries
Ltd.
Solvency analysis of Reliance Industries Ltd.
Debt-equity ratio:Debt-to-Equity ratio indicates the relationship between the external

equities or outsiders’ funds and the internal equities or shareholders funds
𝐨𝐮𝐭𝐬𝐢𝐝𝐞𝐫𝐬𝐟𝐮𝐧𝐝
Debt equity ratio =
𝐬𝐡𝐚𝐫𝐞𝐡𝐨𝐥𝐝𝐞𝐫𝐬𝐟𝐮𝐧𝐝
Table 1
Statement of outsiders fund to shareholders fund
Rs in Crore
Outsiders fund Shareholders fund
Year Ratios (Times)
Rs Rs
2010 119467.51 141002.98 0.85
2011 153417.00 154093.00 1.00
2012 157746.00 169445.00 0.93
2013 180302.00 182055.00 0.99
2014 230156.00 198687.00 1.16
Source: Annual Report of Reliance Industries Ltd from 2010-2014
Interpretation: Table 1 indicates the level of soundness of long-term financial policies of

the company. It shows the relation between the portion of assets provided by the the
Page 309
stockholders and the portion of assets provided by creditors. During the study period it has
been analyzed that the company has used the capital equally as it shows 0.85 times of debt of
equity has been used in the year 2010 mounting Rs. 119467.51. A ratio of 1.00,0.93,0.99 &
1.16 has been observed in 2011,2012,2013 & 2014 respectively which means has that more
proportion of debt has been used in 2014 as compared to yester years. A ratio of 1 or 1: 1
means that creditors and stockholders equally contribute to the assets of the business.
Proprietary ratio: Proprietary ratio refers to a ratio which helps the creditors of the
company in seeing that their capital or loans which the creditors have given to the company
are safe. Proprietary ratio can be calculated as follows: – Proprietors funds/Total Assets.
𝒔𝒉𝒂𝒓𝒆𝒉𝒐𝒍𝒅𝒆𝒓𝒔𝒇𝒖𝒏𝒅
Proprietary ratio= ∗ 𝟏𝟎𝟎
𝒕𝒐𝒕𝒂𝒍 𝒂𝒔𝒔𝒆𝒕𝒔
Table 2
Statement of shareholders fund to total assets
Rs in Crore
Shareholders fund Total assets
Year Ratios (%)
Rs Rs
2010 141002.98 260468.16 54
2011 154093.00 307519.00 50
2012 169445.00 327191.00 52
2013 182055.00 362357.00 50
2014 198687.00 428843.00 46
Page 310
Interpretation Table 2 shows the contribution of stockholders’ in total capital of the

company. It represents the share of shareholders fund in total assets of the company. A
consistent share of stockholders fund has been contributed in total capital (Total assets)
during the study period i.e.54%, 50%, 52% and 50% in 2010, 2011, 2012 and 2013
respectively. In 2014 the figure has dropped down to 46% which is not a good sign for the
company.
Solvency ratio:The solvency ratio measures the size of a company's after-tax income;
excluding non-cash depreciation expenses, as compared to the firm's total debt obligations. It
provides a measurement of how likely a company will be to continue meeting its debt
obligations.
𝒕𝒐𝒕𝒂𝒍𝒍𝒊𝒂𝒃𝒊𝒍𝒊𝒕𝒊𝒆𝒔𝒕𝒐𝒐𝒖𝒕𝒔𝒊𝒅𝒆𝒓𝒔
Solvency ratio= ∗ 𝟏𝟎𝟎
𝒕𝒐𝒕𝒂𝒍 𝒂𝒔𝒔𝒆𝒕𝒔
Table 3
Statement of shareholders fund to total assets
Rs in Crore
Total liabilities to
Total assets
Year outsiders Ratios (%)
Rs Rs
2010 119467.51 260468.16 45.87
2011 153417.00 307519.00 49.89
2012 157746.00 327191.00 48.21
Page 311
2013 180302.00 362357.00 49.76
2014 230156.00 428843.00 53.67
Interpretation: Table 4 depicts the relationship between total liabilities to outsiders and
total assets .It shows the contribution of outsiders in total capital of the company. As per
analysis the contribution by the outsiders has been consistently about 50% from 2010 to
2013 but in 2014 it has increased up to 53.67 %.which means that the amount of outsiders
capital has increased to a large extend during last two years than that of formers years.
Capital gearing ratio: Capital gearing ratio measures the percentage of capital employed
that is financed by debt and long term financing. The higher the gearing, the higher the
dependence on borrowing and long term financing. Whereas, the lower the gearing ratio,
the higher the dependence on equity financing.
𝒆𝒒𝒖𝒊𝒕𝒚𝒔𝒉𝒂𝒓𝒆𝒄𝒂𝒑𝒊𝒕𝒂𝒍+𝒓𝒆𝒔𝒆𝒓𝒗𝒆𝒂𝒏𝒅𝒔𝒖𝒓𝒑𝒍𝒖𝒔
Capital gearing ratio=
𝒑𝒓𝒆𝒇𝒆𝒓𝒆𝒏𝒄𝒆 𝒄𝒂𝒑𝒊𝒕𝒂𝒍+𝒍𝒐𝒏𝒈 𝒕𝒆𝒓𝒎 𝒅𝒆𝒃𝒕
Table 4
Statement of shareholders fund to long term debt
Rs in crore
Shareholders fund Long term debt
Year Ratio(Times)
Rs Rs
2010 141002.98 64605.52 2.18
Page 312
2011 154102.00 79988.00 1.93
2012 169445.00 82635.00 2.05
2013 182055.00 89322.00 2.04
2014 198687.00 133811.00 1.48

Interpretation Table 5 represents the measure of capital structure analysis and financial
strength of the company and is of great importance for actual and potential investors. While
analyzing the table it has been found that the company under study has low geared capital
structure. In 2010, 2012 and 2013 the ratio has been above 2 , which means that equity
capital used by the company is twice than that of outsiders but in 2011 and 2014 that ratio
has dropped down to 1.93 and 1.48respectively. This shows that the company has increased
the proportion of outsider’s capital.
Debt-service or interest coverage: This ratio relates the fixed interest charges to the
income earned by the business. It indicates whether the business has earned sufficient profits
to pay periodically the interest charges.
𝒏𝒆𝒕𝒑𝒓𝒐𝒇𝒊𝒕(𝒃𝒆𝒇𝒐𝒓𝒆𝒊𝒏𝒕𝒆𝒓𝒆𝒔𝒕&𝒕𝒂𝒙)
Debt-service or interest coverage = ∗ 𝟏𝟎𝟎
𝒇𝒊𝒙𝒆𝒅 𝒊𝒏𝒕𝒆𝒓𝒆𝒔𝒕
Table 5
Statement of net profit to fixed interest
Rs in Crore
Net profit(before interest
Fixed Interest
Year and tax) Ratio (times)
Rs Rs
Page 313
2010 19243.75 2063.31 9.33
2011 23923.00 2411.00 9.92
2012 22107.00 2893.00 7.64
2013 21813.00 3463.00 6.30
2014 23598.00 3836.00 6.15

Interpretation:Table 5 reflects the relationship between net profits to fixed interest
expenses, Times interest earned ratio is very important from the creditors view point.
According to analysis the ratio in 2010 and 2011 has been 9.33 and 9.92 times respectively in
2012,2013and 2014 the ratio has dropped down to 7.64 , 6.30 and 6.15 times respectively. It
means that the interest expenses of the company are 7.4 times at an average for study
periodcovered by its net operating profit (profit before interest and tax).
Testing of Null Hypothesis (Ho)

Statement of calculation of t test
Outsiders Shareholder
Year fund (x1-x̄ 1) (x1-x̄ 1)² fund (x2-x̄ 2) (x2-x̄ 2)2
(x1) (x2)
2010 12.00 -4 16 14.00 -3 9
2011 15.00 -1 1 15.00 -2 4

Page 314
2012 16.00 0 0 17.00 0 0
2013 18.00 2 4 18.00 1 1
2014 23.00 7 49 20.00 3 9
A. Mean= ∑ x1-x̄ 1 ∑ (x1-x̄ 1)² A. Mean= ∑ x2-x̄ 2 = ∑ (x2-x̄ 2)2

N=5
16.00 =4 =70 17.00 -1 =23
x̄𝟏−x̄𝟐 n1n2
t.005= ∗
S n1+ n2
Where
𝟐 𝟐
∑ 𝐱𝟏 − x̄𝟏 + ∑ 𝐱𝟐 − x̄𝟐
S= 𝑛1 + 𝑛2 − 2
By putting the value in the formula the values of S= 3.41
𝟏𝟔−𝟏𝟕
t.05 = ∗ 𝟐. 𝟓
𝟑.𝟒𝟏
t.05 = 1/3.41 * 1.58

t.05 =0.46
Degree of freedom (v)= n1+n2 -2 = 5+5-2 = 8
Interpretation:After calculation of t -test for the Significance of the difference between the
Variances of the Two Samples the results depict that the calculated value of t = 0.46 where as
the table value of at 5% significance level = 1.860 .The calculated value of t is less than the
table value. There is no value to doubt the hypothesis, which means that there is no
significant difference between debt and equity capital of Reliance Industries Ltd.
Findings
 Regarding debt–equity ratio it has been found that the capital structure of the
company is equally balanced by the outsiders and owners capital. In 2010 the share of
Page 315
outsiders fund is 119467.51 and 1141002.98 is owners fund i.e., 0.85:1.In 2011, 2012
and 2013 the ratios are 1.00:1, 0.93:1 and 0.99:1 respectively. In 2014 the company
has increased the amount of external equity more than that of internal equity and the
ratio for that year is 1.16:1.
 With reference to shareholders fund ratio (Proprietary ratio) the figures has
remainedquite consistentduring the study period. The contribution of owners in the
total assets of the company from 2010-2103 has been up to 50%.In this year the
amount of total assets has increased to large amount than that of investment from the
shareholders.
 While analysing the solvency ratios, the trend has been increasing during the study
period which means that with the increase in total liabilities to outsiders the amount
of total assets has also increased .In 2014 this ratio has increased up to 53.67%.
 Regarding capital gearing ratio the company is found low geared during the study
period which shows that the amount of capital invested by shareholders is more than
that capital borrowed from outsiders. In 2014 a satisfactory increases in the long term
debt has been observed.
 While analysing interest coverage ratio figures in 2010 and 2011 has been 9.33 and
9.92 times respectively in 2012,2013 and 2014 the ratio has dropped down to 7.64 ,
6.30 and 6.15 times respectively. It means that the interest expenses of the company
are 7.4 times at an average for study period covered by its net operating profit (profit
before interest and tax).
Suggestions
 Generally speaking, a low ratio (Debt being low in comparison to shareholders fund)
is considered favourable form long term creditors point of view because a high
proportion of owner’s funds provide a larger margin of safety for them. While
considering this fact the company should maintain the balance as it has maintained
during the study period this will help in motivating more and more creditors to
finance the company and at the same time motivate its shareholders by increasing the
Page 316
amount of low cost fund to magnify their earnings by adopting a sound financial
policy.
 Equity ratios of the company are found unsatisfactory during the study periods
because higher the share of shareholders in the total capital of the company better is
the long term solvency position of the company. In order to overcome this problem
company needs to increase the amount of shareholders found but at the same time the
amount of capital invested in assets should be maintained as well.
 Solvency ratio is the variant of Equity ratio the larger the equity ratio smaller is the
solvency ratio. Solvency ratio is inversely proportionate to equity ratio any increase
in equity ratio will result in the decrease in the solvency ratio and vice versa ,because
lower the ratio of total liabilities to total assets , more satisfactory or stable is the long
term solvency position of a firm.
 Regarding capital gearing ratio, the company is dealing with low capital gear during
the study period. Gearing must be kept in such a way so that the company is able to
maintain a steady rate of dividend.
 While analysing the interest coverage ratio the figures has been found satisfactory
during 2010 and 2011 but afterwards this ratio has dropped down to 6.15 (times) in
2014 which is not a good sign from creditors point of view. The recommendation in
this regard for the company is to use the low interest debt that will be helpful in
increasing this ratio.
Conclusion
A properly conducted solvency analysis can provide positive assurance that after giving
consideration to the effect of the subject transactions, the company under study meets the
primary criteria for solvency. After analysis it can be concluded the solvency analysis is one
of the useful as well effective tool for identifying the long run functioning of the company.
This paper is an outcome of the efforts made by the researcher in order to find out the
financial policy of the company under study as well as its implementation. The study
suggests that the company should increase the proportion of outsider’s equity in order avail
the benefits of low cost debt.
Page 317
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Page 319
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LONG-TERM SOLVENCY ANALYSIS OF A PRIVATE SECTOR COMPANY: A CASE

Article · July 2014

Firdous Ahmad Parray

The user has requested enhancement of the downloaded file.

LONG-TERM SOLVENCY ANALYSIS OF A PRIVATE SECTOR

Dr. Anshuja Tiwari, Firdous Ahmad Parray,

Keywords: Capital Structure, Debt-Equity, Proprietary, Solvency, Liquidity, Capital

Objectives of the study

 To study the capital structure of Reliance Industries Ltd.

Solvency analysis of Reliance Industries Ltd.

Debt-equity ratio:Debt-to-Equity ratio indicates the relationship between the external

2010 119467.51 141002.98 0.85

2011 153417.00 154093.00 1.00

2012 157746.00 169445.00 0.93

2013 180302.00 182055.00 0.99

2014 230156.00 198687.00 1.16

Source: Annual Report of Reliance Industries Ltd from 2010-2014

Interpretation: Table 1 indicates the level of soundness of long-term financial policies of

2010 141002.98 260468.16 54

2011 154093.00 307519.00 50

2012 169445.00 327191.00 52

2013 182055.00 362357.00 50

2014 198687.00 428843.00 46

Source: Annual Report of Reliance Industries Ltd from 2010-2014

Interpretation Table 2 shows the contribution of stockholders’ in total capital of the

2010 119467.51 260468.16 45.87

2011 153417.00 307519.00 49.89

2012 157746.00 327191.00 48.21

2013 180302.00 362357.00 49.76

2014 230156.00 428843.00 53.67

Source: Annual Report of Reliance Industries Ltd from 2010-2014

2010 141002.98 64605.52 2.18

2011 154102.00 79988.00 1.93

2012 169445.00 82635.00 2.05

2013 182055.00 89322.00 2.04

2014 198687.00 133811.00 1.48

Source: Annual Report of Reliance Industries Ltd from 2010-2014

2010 19243.75 2063.31 9.33

2011 23923.00 2411.00 9.92

2012 22107.00 2893.00 7.64

2013 21813.00 3463.00 6.30

2014 23598.00 3836.00 6.15

Source: Annual Report of Reliance Industries Ltd from 2010-2014

Testing of Null Hypothesis (Ho)

2010 12.00 -4 16 14.00 -3 9

2011 15.00 -1 1 15.00 -2 4

2012 16.00 0 0 17.00 0 0

2013 18.00 2 4 18.00 1 1

2014 23.00 7 49 20.00 3 9

A. Mean= ∑ x1-x̄ 1 ∑ (x1-x̄ 1)² A. Mean= ∑ x2-x̄ 2 = ∑ (x2-x̄ 2)2

t.05 = 1/3.41 * 1.58

 MacKie-Mason, J. K., 1990, Do taxes effect corporate financing decisions?, Journal

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