REVIEW OF THE LITERATURE Dr. S.K. khartik titto Varghese, (2011) they found the profitability more or less depends upon the better utilization of resources and to manpower. It is worthwhile to increase production capacity and use advance technology to cut down cost of production and wage cost in order to increase profitability, not only against the investment, but also for investor‟s return points of view.
Eljelly (2004) elucidate, that efficient liquidity management involves planning and controlling current assets and current liabilities in such a manner that eliminates the risk of inability to meet due short-term obligations and avoids excessive investment in these assets. The study found that the cash conversion cycle was of more importance as a measure of liquidity than the current ratio that affects profitability. Vijayakumar Vijayakumar and Venkatachalan (2003) In their study indicated a moderate trend in the financial position and the utilization of working capital, variations in working capital size should be avoided attempts should also be made to use funds more effectively, by keeping an optimum level of working capital. Because, keeping more current assets cause a reduction i n profitability. Hence, efforts should be made to ensure a positive trend in the estimation and maintenance of the working capital. Shine and Soemen (1998) found that there is a strong negative relation between the cash conversion cycle and corporate profitability for a large sample of listed American companies for the 1975-1994 periods. IRJC International Journal of Marketing, Financial Services & Management Research
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Saravanan (2001) made a study on working capital management in ten selected non-banking financial companies. For this study the employed several statistical tools on different ratio is to examine the effective management of working capital. Marc Deloof (2003) stated that the companies have large amount of cash invested in working capital. It can therefore be expected that the way in which working capital is managed will have a significant impact on the profitability of companies. This a significant negative relation between gross operating income and the number of days accounts receivable, inventories and accounts payable of Belgian firm. Asha (1987) of reserve bank of India had worked out the required norms and techniques for evaluating the performance of public sectors banks. She has reinvaded the different techniques adopted by different agencies and criteria for evaluating the banking performance. The empirical findings of her study shows a positive trend in terms of opening new branches deposits mobilization and advances over a period. Asha Sharma and R.B. Sharma2011, These attempts identify and study the movement of key financial parameters and their relationship with profitability of textile industry. It is an attempt to and the study whether the key identified parameters move in a synchronous way going up and
coming down with basic profitability parameters. All three comparably profit-making companies have been taken as the sample for the study for the period of 2006to2010. Aubry lyimo, Dr.Reubenj.L mwamakimbullah kiko F.S.Hamza, (2010) they found costs resulting from poles being rejected, reworked or down-graded were the highest at the study mill. The cost of quality were so high and as a result they negatively affect the financial performance of the mill.-cost of quality and its effect on company‟s profitability, the amount accrued from costs of quality was too high to reject the null hypothesis which claimed that costs of quality impacts negatively the profitability of the company. (P.value-0.4582)
Review of literature focuses on the earlier studies on financial performance. Thesestudies are helpful in assessing the limitations, findings and suggestions involved in such studies. A study by Das compares performance of Public Sector Banks for 3 years in the postreform period, 1992, 95, 98. He notes that while there is a welcome increase in emphasis on non-interest income, Banks have tended to show risk averse behavior by opting for relatively risk freeinvestments over risky loans. Manish Mittal and Aruna Dhade made a comparative study on Profitability and productivity in Indian Banks. A five years period (1999-00 to 2003-04) has been selected for evaluating the performance. In their study they found that the improved profitability is the onlykey parameter for evaluating performance from the shareholders point of view. Now it is up tothe bank management to decide how to strike a tradeoff between social and commercial bankingin order to improve market holdings and services and play the role of government¶s agent at thesame time. In our study, we found that the public sector banks are less profitable than the publicsector and foreign banks in terms of overall profitability (Spread ± Burden ratio) but profitabilityis improving over the last 5 years. Foreign banks top the list in terms of the net profitability. Non ± interest income of private sector banks is higher as compared to public sector banks because private sector banks are offering more and more fees based services to their differentcustomer categories (like commission, exchange brokerage etc). There is a pressing need for introducing more services to the customer by the public sector banks to have an advantage of competitive over private and foreign banks.Analysis of the Efficiency and Profitability of the Japanese Banking System prepared by Elena Loukoianov.
The paper analyzes the efficiency and profitability of Japanese banks from2000-06. It uses a non-parametric approach, the data envelopment analysis (DEA) to analyze banks¶ cost and revenue efficiency. One possible reason for the weak profitability of Japanese banks is their low level of risk taking. This paper presents the data on the level of profitability of Japanese banks and then examines the level of risk taking of (i) four segments of the Japa nese banking sector and (ii) banks in selected industrial countries. The data, which are present i n
terms of core profit, average return on assets (ROA), return on equity (ROE), and net interestmargin, indicate the low level of profitability of Japanese banks. P
rofitability in Banks: A Study by CRISIL According to a Credit Rating and Information Services of India (Crisil) study, Lower operating expenses including rationalization of employee costs have improved the profitability of banks, contrary to the popular perception that only trading profits helped the banking sector shore up their bottom lines. The reduction in operating expenses was achieved through large-scale voluntary retirement schemes implemented by public sector banks. Since this reduction inoperating expenses seems sustainable, it promises a brighter future for the bankin g sector.According to this study for private sector banks, the profitability improvement was mainly because of the increase in treasury income and not due to any material reduction in operatingexpenses. But since public sector and foreign banks account for over 80 per cent of the totalassets of all scheduled commercial banks, a reduction in their core operating expensescontributes significantly in improving the profitability of the entire Indian banking sector .
2.1 Literature Review The review of literature gives a broad outlook of various research studies made in the past and the details of such studies throw light on future studies to be made. It also strengthens the theoretical base of the research study. Inthe present day economy, finance is defined as the provision of money at the time when it is required. Every enterprise whether big, medium or small it requires finance to carry on various business operations and to achieve their predetermined goals. A basic definition of finance is “a branch of economies that deals with resource management.” In simple layman’s terms, finance is any area of study that helps us get manage and invest money. Profitability is the efficiency of a company or industry at generating earnings. Profitability is expressed in terms of several popular numbers that measure one of two generic types of performances: “how much they make with what they have got” and “how much they make from what they take in.” Analysis of profitability of a business is performed by professionals who prepare reports using ratios that make use of information taken from financial statements and other reports. Liquidity is the ability of the firm to meet its current liabilities as they fall due. Since liquidity is the basis of the continuous operations of the company, it becomes
necessary to determine the level of liquidity. While calculating current ratios, relatively high current ratios indicate that the firm is liquid and its ability to pay its current obligation in time and when they become due. The quick ratio establishes a relationship between quick or liquid assets and current liabilities. Following is the relevant literature reviews for the study.
Agarwal, B.D; (2005) 1 Profitability is the measure of the amount by which a company’s revenues exceed its relevant expenses. Profitability ratios are used to evaluate management’s ability to create earnings from revenues generating bases within the organization. As per Business dictionary.com profitability is the ability of a firm to generate net income on consistent basis. It is often measured by price to earnings ratio. Review of literature and theories on determinants of profitability explains that the profitability determinants were basically divided into two main categories, namely the internal determinants and the external determinants. The internal determinants include management controllable factors such as liquidity, investment in securities, investment in subsidiaries, loans, and overhead expenditure. Robert S. Kaplan and David P Norton (1992) 2argue that a comprehensive evaluation of company’s performance calls for looking at financial measures as well as operational measures, which indeed drive financial measures Woelfel C.J3quoted that, Analysis of financial statement is the systematic numerical evaluation of the relationship between one fact with the other to measure the profitability, operational efficiency and the growth potential of the business. Metcalf and Titard 4quoted that, Analyzing financial statement is a process of evaluating the relationship between the component parts of financial statement to obtain a better understanding of a firm’s position and performance. R.M Srivastava5has defined as “methods employed to examine the vertical as well as horizontal relationship of different financial variables with a view to study profitability and financial position of business is called tools of financial analysis”. In the words of J. Batty 6,”ratios can also assist management in its basic functions of forecasting, planning, co-ordination, control and communication”
Nelson A Tom and Miller Paul 7 quoted that “Financial analysis is an individual matter and value for a ratio which is perfectly acceptable for one company or one industry may not be at all acceptable in case of another Hunt, Williams and Donaldson 8 “The ratio analysis is an aid to management in taking correct decisions, but as a mechanical substitute for thinking and judgment, it is worse than useless. J.O.Horrigan 9 says “From a negative viewpoint, the most striking aspect of ratio analysis is the absence of an explicit theoretical structure. Kaplan and Urwittz 10found that, in general, a lower debt ratio, a higher interest coverage ratio, a higher return on asset ratio, a larger size, a lower market risk, and a lower unique risk had a favorable influence on bond rating. Av.kiran 11, Generally, the financial performance of banks and other financial institutions has been measured using a combination of financial ratios analysis, benchmarking, measuring performance against budget or a mix of these methodologies Chien Ho, and Song Zhu 12, 2004 showed in their study that most previous studies concerning company performance evaluation focus merely on operational efficiency and operational effectiveness which might directly influence the survival of a company. A paper in the title of efficiency, customer service and financing performance among Australian financial institutions Elizabeth Duncan, and Elliott 13, 2004showed that all financial performance measures as interest margin, return on assets, and capital adequacy are positively correlated with customer service quality scores. Bird and McHugh (1977) 14 adopt an efficient Shapiro-Wilk small-sample test for the normality of financial ratios for an Australian sample of five ratios over six years. Like Deakin they find in their independent study that normality is transient across financial ratios and time. Altman and Eberhar 15 (1994) reported the use of neural network in identification of distressed business by the Italian central bank. Using over 1,000 sampled firms with 10 financial ratios as independent variables, they found that the classification of neural
networks was very close to that achieved by discriminant analysis. They concluded that the neural network is not a clearly dominant mathematical technique compared to traditional statistical techniques. Gepp and Kumar 16 (2008) incorporated the time “bias” factor into the classic business failure prediction model. Altman (1968) and Ohlson’s 17 (1980) models to a matched sample of failed and nonfailed firms from 1980’s, they found that the predictive accuracy ofAltman’s model declined when applied against the 1980’sdata. The findings explained the impor tance ofincorporating the time factor in the traditional failureprediction models. Campbell, J., J. Hilscher and J. Szilagyi, 18 (2008), says that determinants of corporate failure and the pricing of financially distressed stocks whose failure probability, estimated from a dynamic logic model using accounting and market variables, is high. Since 1981, financially distressed stocks have delivered anomalously low returns. Eljelly, A.19 (2004) study empirically examines the relation between profitability and liquidity, as measured by current ratio and cash gap (cash conversion cycle) on a sample of joint stock companies in Saudi Arabia. Using correlation and regression analysis the study found significant negative relation between the firm’s profita bility and its liquidity level, as measured by current ratio. Gepp, A. and K. Kumar20 (2008) his study reveals that accurate business failure prediction models would be extremely valuable to many industry sectors, particularly in financial investment and lending. The potential value of such models has been recently emphasized by the extremely costly failure of high profile businesses in both Australia and overseas, such as HIH (Australia) and Enron (USA). Consequently, there has been a significant increase in interest in business failure prediction from both industry and academia. Ohlson, J.A,21(1980) selected nine independent variables that he thought should be helpful in predicting bankruptcy, but provided no theoretical justification for the selection. (The nine variables are described in the methodology section of this paper.) Ohlson then selected industrial firms from the period 1970-1976 that had been traded on a US stock exchange for at least 3 years. He ended up with 105 failed firms and 2000 non failed firms. Three models were estimated: the first to predict failure within 1 year, the second to predict
failure within 2 years and the third to predict failure in 1 or 2 years. He then used a logistic function to predict the probability of failure for the firms using each model. Beneda 22(2006) investigated returns, bankruptcies and firm distress for new US public companies that issued IPOs from 1995 through 2002. Beneda found that the average first year returns for IPO companies under-performed the market and that Ohlson’s model was effective in identifying companies that had a higher probability of bankruptcy and financial distress and earned lower than average returns. Padachi.K. 23 (2006)emphasized that the management of working capital is important to the financial health of businesses of all sizes. This importance is hinged on many reasons, first, the amounts invested in working capital are often high in proportion to the total assets employed and so it is vital that these amounts are used in an efficient way. Pandey I M (2005) 24 Ninth Edition Financial Management PP 517 - 544discusses the theories, concepts, assumptions, and mechanics underlying valuation, investment, financing, and dividend decisions and working capital management. It also discusses sources and instruments of short-term and long-term finances, mergers and acquisitions, international financial management and the interface between financial and corporate policies. Importantly, the book helps students to relate theories and concepts to practice.
Warren and Shelton (1971) 25 applied financial simulation8 to simulate future financial statements of a firm, based on a set of simultaneous equations. Financial simulation approach makes it possible to incorporate both the uncertainty of the future and the many interrelationships between current assets, current liabilities and other balance sheet accounts. The strength of simulation as a tool of analysis is that it permits the financial manager to incorporate in his planning both the most likely value of an activity and the margin of error associated with this estimate. Warren and Shelton presented a model in which twenty simultaneous equations were used to forecast future balance sheet of the firm including forecasted current assets and forecasted current liabilities. Agarwal (1983) 26 also studied working capital management on the basis of sample of 34 large manufacturing and trading public limited companies in ten industries in private
sector for the period 1966-67 to 1976-77. Applying the same techniques of ratio analysis, responses to questionnaire and interview, the study concluded the although the working capital per rupee of sales showed a declining trend over the years but still there appeared a sufficient scope for reduction in investment in almost all the segments of working capital. An upward trend in cash to current assets ratio and a downward trend in cash turnover showed the accumulation of idle cash in these industries.
Misra(1975)27studied the problems of working capital with special reference to six selected public sector undertakings in India over the period 1960-61 to 1967-68. Analysis of financial ratios and responses to a questionnaire revealed somewhat the same results as those of NCAER study with respect to composition and utilization of working capital. In all the selected enterprises, inventory constituted the more important element of working capital. The study further revealed the overstocking of inventory in regard to its each component, very low receivables turnover and more cash than warranted by operational requirements and thus total mismanagement of working capital in public sector undertakings. Appavadhanulu(1971)28recognizing the lack of attention being given to investment in working capital, analyzed working capital management by examining the impact of method of production on investment in working capital. He emphasized that different production techniques require different amount of working capital by affectin g goodsin-process because different techniques have differences in the length of production period, the rate of output flow per unit of time and time pattern of value addition. Different techniques would also affect the stock of raw materials and finished goods, by affecting lead-time, optimum lot size and marketing lag of output disposals. He, therefore, hypothesized that choice of production technique could reduce the working capital needs. He estimated the ratio of work-in-progress and working capital to gross output and net output in textile weaving done during 1960, on the basis of detailed discussions with the producers and not on the basis of balance sheets which might include speculative figures. His study could not show significant relationship between choice of technique and working capital. However, he pointed out that the idea could be tested in some other industries like machine tools, ship building etc. by taking more appropriate ratios representing production technique correctly. Lambrix and Singhvi(1979)29adopting the working capital cycle approach to the working capital management, also suggested that investment in working capital could
be optimized and cash flows could be improved by reducing the time frame of the physical flow from receipt of raw material to shipment of finished goods, i.e. inventory management, and by improving the terms on which firm sells goods as well as receipt of cash. However, the further suggested that working capital investment could be optimized also (1) by improving the terms on which firms bought goods i.e. creditors and payment of cash, and (2) by eliminating the administrative delays i.e. the deficiencies of paper-work flow which tended to extend the time-frame of the movement of goods and cash. Warren and Shelton (1971) 30applied financial simulationto simulate future financial statements of a firm, based on a set of simultaneous equations. Financial simulation approach makes it possible to incorporate both the uncertainty of the future and the many interrelationships between current assets, current liabilities and other balance sheet accounts. The strength of simulation as a tool of analysis is that it permits the financial manager to incorporate in his planning both the most likely value of an activity and the margin of error associated with this estimate. Warren and Shelton presented a model in which twenty simultaneous equations were used to forecast future balance sheet of the firm including forecasted current assets and forecasted current liabilities. Current assets and current liabilities were forecasted in aggregate by directly relating to firm sales. However, individual working capital accounts can also be forecasted in a larger simulation system. Moreover, future financial statements can be simulated over a range of different assumptions to portray inherent uncertainty of the future.
2.2. Works Cited
1. Agarwal, B.D ; (2005) Advanced financial a ccounting, New Delhi; Pitambar Publishing Company
2. Robert S. Kaplan and David P Norton, “The Balanced Scorecard – Measures That Drive Performance”, Harvard Business Review, January- February 1992.
3. 4. 5. 6. 7. 8.
Woelfel C.J, „An introduction to Financial Accounting‟ p.578 Metcalf and Titard, “Principles of Accounting,” p.157 R.M Srivastava, „Financial Decision- Making‟ p.47 Batty, “Management Accounting”,p.413 Nelson A Tom and Miller Paul. “Modern Management Accounting” (1977) Hunt, Williams and Donaldson, “Basic Business Finance”, (1971), p.116
9.Maheshwari S N, Principles of Management Accounting, SN Chand & Sons, New Delhi.
10. J.O.Horrigan, “A Short History of Financial Ratio Analysis,” The Accounting review, Vol.43, (April 1968), 284-94
11. R.S.Kalpan and G.Urwittz“Statistical Models of Bond Ratings: A Methodological Inquiry,” Journal of Business, vol. 52, (April 1979), 232-262.
12. Avkiran, N.K. (1995),” Developing an instrument to measure customer service quality in branch banking”, International Journal of Banks Marketing, Vol.12 No. 6, pp.10-18.
13. Chien T., Danw S.Z. (2004),” Performance measurement of Taiwan commercial banks”, International Journal of Productivity and Performance management, Vol. 5 3, NO. 5, pp.425-434.
14. Elizabeth D., Greg Elliot (2004),” Efficiency, customer service and financial performance among Australian financial institutions”, International Journal of Bank marketing, Vol.22, No.5, pp. 319-342. 15. Bird, R.G., and McHugh A.J. (1977), "Financial ratios - an empirical study", Journal Of Business Finance and Accounting 4/1, 29-45. 16. Altman, E., 1968. Financial ratios, discriminant analysis and the prediction of
Corporate bankruptcy. J. Finance, pp.: 589-609.
17.Altman, E.I. and A.C. Eberhart, 1994. Do seniority provisions protect bondholder Investments. J. Portfolio Manage, summer, 20(4): 179-194. 18. Campbell, J., J. Hilscher and J. Szilagyi, 2008. In search of distress risk. J. Finance. 63(6): 2899-2939 19. Eljelly, A., 2004. Liquidity-profitability trade off: An empirical investigation in Emerging market. Int. J. Comm. Manage., 14(2): 48-58. 20. Gepp, A. and K. Kumar, 2008. The role of survival analysis in financial distress Prediction. Int. Res. J. Finan. Econ., 16: 13-34. 21. Ohlson, J.A., 1980. Financial ratios and the probabilistic prediction of bankruptcy. J. Account. Res., 18(1): 109-131. 22.Padachi, K., 2006. Trends in working capital management and its impact on firms Performance: An analysis of Mauritian small manufacturing firms. Int. Rev. Bus.Res., 2(2): 45-56 23. Beneda, Nancy (2007). “Performance and distress indicators of new public companies.” Journal of Asset Management, Volume 8, Number 1, 24 24. Pandey I M (2005) Ninth Edition Financial Management PP 517 – 544 25. J. M. Warren and J. P. Shelton, “A Simultaneous Equation Ap proach to Financial Planning”, Journal of Finance, Volume 26, December 1976, pp.
1123-1142
26. N.K. Agarwal, Management of Working Capital, Sterling Publication Pvt. Ltd., New Delhi, 1983
27. V. Appavadhanulu, “Working Capital and Choice of Techniques”, Indian Economic Journal, JulySept. 1971, Vol. XIX, pp. 34-41.
28. Ram Kumar Misra, Problems of Working Capital (With Special Reference to Selected Public Understandings in India), Somalia Publications Private Limited, Mumbai, 1975. 29. R. J. Lambrix and S.S. Singhvi, “Managing the Working Capital Cycle”, Financial Executive, June 1979, pp.32-41.
30. J. M. Warren and J. P. Shelton, “A Simultaneous Equation Approach to Financial Planning”, Journal of Finance, Volume 26, December 1976, pp. 1123-1142.
