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In this TMA you are asked to conduct a financial analysis of a listed Indian steel company, Tata Steel Ltd, at its financial year-end (31 March 2019).

You are required to find the appropriate financial information in Tata Steel’s financial statements and calculate the following ratios for the financial years 2017-18 and 2018-19:

  1. return on capital employed
  2. return on sales
  3. asset utilization ratio
  4. gross profit margin
  5. current ratio and quick ratio
  6. gearing
  7. interest cover
  8. stock days
  9. current trade receivables days*
  10. current trade payables days*
  11. return on equity.

Show all steps needed to calculate your results, including ratio definition and input values.

Further compute the above-mentioned ratios for Vedanta Ltd., one of the key competitors of Tata Steel.

Conduct a financial analysis of Tata Steel and Vedanta using the ratios calculated in Task 1 and describe what you observe about Tata Steel’s performance as well as the performance of its competitor. Explain possible causes for differences in performance and discuss implications for Tata Steel.

In your analysis, you should also discuss whether, according to their financial performance, Tata Steel should be concerned about Vedanta.

Your analysis should not be longer than 2,000 words, excluding bibliography.

If you use information that is not included in the financial statements but elsewhere in the company’s annual report (e.g., notes) or in external sources, please cite the exact location and source of this information.

Finding financial information

Tata steel limited is a public company that began its operations in 1907 in India. It is the leading steel-making company in the world with crucial activities in the Netherlands, United Kingdom, and Europe. According to Muruganandan (2015) main products include metallurgical machinery, steel ball bearings, household items, wire products, and steel casing pipes. Tata Company exists as a group company with a parent company and some subsidiaries. Annually, it manufactures 27.5 million tons of steel and employees 90000 employees. Vedanta Limited is the principal competitor of Tata steel limited. Vedanta Limited is a global diversified mining company found in India. It mines oil, gas, and metals. According to Dalal and Thaker (2019) metals comprise zinc, lead, and aluminum, copper, and silver. It also operates power plants in India and other countries in the world. It is a subsidiary company of Vedanta Resource Company by 50%, while the additional 50% is owned by the public, mutual funds, and foreign companies.

Type

Ratio

Tata

Vedanta

Liquidity ratio

Current ratio

1.11

0.79

Quick ratio

0.9

0.62

Gearing ratio

Capital gearing ratio

83%

83%

Debt equity ratio

135%

46%

Times interest cover

3.6

4.5

Profitability ratio

Gross profit margin

7%

16%

Return on capital employed

0.26

0.14

Asset utilization ratio

1.52

1.45

Return on equity

0.17

0.10

Return on the sales

0.2

0.1

Activity ratio

Debtor’s ratio

36

54

Creditor’s ratio

22

32

Stock days

8

39

 

Oosterbroek and Grol (2018) infer that a liquidity ratio measures the capacity of the company to convert its current assets into cash to settle current liabilities. Both the current and quick ratios of Tata Steel Limited are more than one depicting the capability of the Company to settle its current obligations when they fall due. Current assets include account receivables, cash on hand, cash equivalent and inventory. Current liabilities comprise creditors, bank overdrafts, and accrued expenses. Therefore, Tata Limited has a better liquidity position to timely settle its current obligations.

A gearing ratio indicates the proportion of debt to equity to determine the financial risk of the company. There are three types of gearing ratio; capital gearing, debt equity, and times interest cover. According to Kiarie et al. (2019) Tata Limited has a capital gearing ratio of more than 50%, indicating that the company has a high proportion of debt to equity; thus, it has a high financial risk of becoming bankrupt. The company uses debt to finance its operations and in return, pay a high amount of loan interest. It has a high likelihood of becoming bankrupt as a result of repaying loans with variable interest rates. Tata limited also have a debt-equity ratio of more than 100%, depicting that the company has more debt than equity. Therefore, Tata limited has a high financial risk of becoming bankrupt because it finances its operations using long-term debts. The ratio also indicates the inability of shareholder equity to meet outstanding long-term debts if the business overturns. In regard to times interest cover ratio, Tata limited has a ratio of more than1, indicating the capacity of the Company to generate enough operating profit to pay interest rates. Thus, lenders can give the company more loans because it has the ability to repay interest rates.   

Calculating financial ratios for the financial years 2017-18 and 2018-19

A profitability ratio depicts the capacity of a company to generate profit comparative to revenue. Profitability ratios include gross profit margin, asset utilization ratio, return on capital employed, return on equity, and return on sales ratio. The gross profit margin of Tata Limited is high, indicating that it is a viable business because it can efficiently produce, sell its products, and earn a profit. Jha et al. (2018) infers that the Company efficiently controls its cost of sales by effective use of labor and materials to generate earnings. More so, the company has suitable purchasing policies, appropriate selling price, flexible market competition, and correct sales promotion policies. Both Vedanta and Tata Limited Company are viable businesses because they have almost similar and high gross profit margins.

The asset utilization ratio determines the efficiency of the company to generate sales revenue from its assets. The asset utilization ratio of Tata Limited is high, depicting that the company can utilize its machinery, inventory, accounts receivables, cash on hand, and prepaid expenses to generate sales revenue. Thus, Johnson et al. (2019) infers that Tata limited is a profitable business because it can efficiently utilize its current assets and non-current assets to generate sales revenue as well as profits. Tata Limited is more profitable than Vedanta because it has a high asset utilization ratio.

A return on capital employed determines the efficiency of the company to generate profits from its capital. The capital consists of share capital, retained earnings, equity, and long-term borrowings. It also indicates the effectiveness of the company in utilizing assets while considering long-term financing. Tata Company has a high return on capital employed, suggesting that it efficiently uses share capital, retained earnings, and equity to generate profits Oulton and Sebastia (2017). Therefore, Tata Company is a profitable business as compared to Vedanta Company, which has a lower return on capital employed.

A return on equity indicates the capability of the company to generate shareholders' earnings from investment. Equity consists of share premium, ordinary share capital, and preferred share capital. Tata Company has a high return on equity, depicting it is efficient in utilizing shareholders' funds to generate shareholders' earnings. Kijewska (2016) infers that the high return on equity also indicates a high growth of Tata's dividends and shares. Both Tata Company and Vedanta have a similar performance on equity, inferring that they are both effective in generating shareholders earnings from equity.

Financial analysis of Tata Steel and Vedanta using the ratios

A return on sales determines the capability of a company to generate profits from revenue. It shows the capacity of the management to run its business effectively by minimizing the cost to maximizing revenue. Tata Limited has a high return on sales, indicating that it generates a 20% profit from its revenue. Thus it has a low cost of sales, high sales revenue, suitable purchasing policy, and proper management. Both Tata Company and Vedanta have high return on sales, depicting that they are both efficient and profitable businesses.

The activity ratio depicts the operational efficiency of the company to convert debtors and stock into cash. The ratio also indicates the number of days required by the management to convert debtors, creditors and stock into cash. Tata Limited has a lower debtor's ratio, which shows that the company collects its debts within a short time and thus eliminates cash flow problems. Tata Limited also has a lower creditor's ratio, which indicates that the company repays its debts within a short time to advantage of discounts and thus eliminates cash flow problems. According to Nassef and Khater (2016) Tata limited has a few stock days, which depicts that the company takes a short time to convert its inventory into sales.

A liquidity ratio measures the capacity of the company to convert its current assets into cash to settle current liabilities. Both the current and quick ratios of Vedanta Limited are more than one depicting the capability of the Company to settle its current obligations when they fall due. Patil et al. (2017) infers that current assets include account receivables, cash on hand, cash equivalent and inventory. Current liabilities comprise account payables, short term loans, bank overdrafts, and accrued expenses. Therefore, Vedanta Limited has a better liquidity position to timely settle its current obligations.

The gearing ratio depicts the financial wellness of a company as per the amount of debt and equity. There are three types of gearing ratio; capital gearing, debt-equity, and times interest cover. Vedanta Limited has a capital gearing ratio of more than 50%, indicating that the company has a high proportion of debt to equity; thus, it has a high financial risk of becoming bankrupt. The company uses debt to finance its operations and in return, pay a high amount of loan interest. It has a high likelihood of becoming bankrupt as a result of repaying loans with variable interest rates. Ravivarman et al. (2019) infer that Vedanta Limited also has a debt to equity ratio of less than 100%, depicting that the Company has a low proportion of long-term debt to equity. Therefore, Vedanta Limited has a low financial risk of becoming bankrupt because it does not finance its operations using debts. The ratio also indicates the ability of shareholders' equity to meet outstanding long-term debts in liquidation scenarios. Concerning times interest cover ratio, Vedanta limited has a ratio of more than1, indicating the capacity of the Company to generate enough operating profit to pay interest rates. Thus, lenders can give the company more loans because it has the ability to repay interest rates.

Observations on Tata Steel's performance and its competitor

The profitability ratio depicts the ability of a company to generate profit comparative to revenue. Profitability ratios include gross profit margin, asset utilization ratio, return on capital employed, return on equity, and return on sales ratio. The gross profit margin of Vedanta Limited is high, indicating that it is a viable business because it can efficiently produce, sell its products, and earn a profit. The Company efficiently controls its cost of sales by effective use of labor and materials to generate earnings. More so, Ernayani and Robiyanto (2016) infer that the company has suitable purchasing policies, appropriate selling price, flexible market competition, and correct sales promotion policies. Both Vedanta and Tata Limited Company are viable businesses because they have nearly similar and high gross profit margins.

The asset utilization ratio determines the efficiency of the company generate sales revenue from its assets. The asset utilization ratio of Vedanta limited is low, depicting that the Company is inefficient in utilizing its machinery, inventory, accounts receivables, cash on hand, and prepaid expenses to generate sales revenue. Dion (2016) infer that it is an unprofitable business because it generates small sales revenue from its current assets and non-current assets. Vedanta limited is less than Tata Company because it has a low asset utilization ratio.


A return on capital employed determines the efficiency of the company to generate profits from its capital. The capital consists of share capital, retained earnings, equity, and long-term borrowings. It also indicates the effectiveness of the company in utilizing assets while considering long-term financing. Vedanta Limited has a low return on capital employed, suggesting that it is inefficient in generating profits through its share capital, retained earnings, and equity. Therefore, Taylor et al. (2016) infer that Vedanta Company is less profitable as compared to Tata Limited, which has a higher return on capital employed.

A return on equity indicates the capability of the company to generate shareholders' earnings from equity. Equity consists of share premium, ordinary share capital, and preferred share capital. Vedanta Company has a high return on equity, depicting it is efficient in utilizing shareholders' funds to generate shareholders' earnings. According to Nurfadillah (2016) the high return on equity also indicates a high growth of Vedanta's dividends and shares. Both Tata Company and Vedanta have similar returns on equity, inferring that they are both effective in generating shareholders earnings from equity.

A return on sales determines the capability of a company to generate profits from sales revenue. It shows the ability of the management to run its business effectively by minimizing the cost to maximize revenue. Tata Limited has a high return on sales, indicating that it generates a 10% profit from its revenue. Thus it has a low cost of sales, high sales revenue, suitable purchasing policy, and good management. Both Tata Company and Vedanta have high return on sales, depicting that they are both efficient and profitable businesses.

Causes for differences in performance

The activity ratio depicts the operational efficiency of the company to convert debtors and stock into cash. Vedanta Limited has a higher debtor's ratio illustrating that the company takes a more extended period to collect debts and thus creates a cash flow problem. According to Setiawan and Amboningtyas (2018) Vedanta Limited has a higher creditor's ratio, which indicates the company repays its debts after many days and therefore does not take advantage of discounts and thus create cash flow problems. Vedanta Limited has many stock days, which depicts that the company takes a long time to convert its inventory into sales.

By the financial analysis, Tata Limited should not develop any concern about Vedanta limited because Tata has a better financial performance than Vedanta limited. For example, profitability ratios show that Tata limited is profitable than Vedanta as depicted by asset utilization ratio and return on capital employed. Activity ratios also indicate that Tata Limited eliminates its cash flow problem by repaying its debts and collect its debts within a short time. Gearing ratio also suggests that Tata Limited is highly geared, but it generates more operating profit to repay the loan interest and thus reduce its financial risk.

References

Dalal, K.K., and Thaker, N., (2019) ESG and Corporate Financial Performance: A Panel Study of Indian Companies. IUP Journal of Corporate Governance, 18(1), pp.44-59.

Dion, M., (2016) Agency theory and financial crime: the paradox of the opportunistic executive. Journal of Financial Crime, 23(3), pp.574-587.

Ernani, R., and Robiyanto, R., (2016) The effect of the cash flows, gross profit, and company size on Indonesian stock returns (a study on the chemical and basic industry companies during the periods of 2009-2014). International Journal of Applied Business and Economic Research, 14(3).

Jha, A.K., Pathak, A., Yang, F., Pineda, I.C., Zhu, R., So, B.S.H. and Raman, R., Oracle International Corp, (2018). Cost impact simulator and gross profit analyzer. U.S. Patent 10,049,374.

Johnson, C.D., Toledano, D.S., Perez, V.M., Marchment, G., Mathew, R., Umang, N., Rasheed, A. and Thanos, A.E., General Electric Co,  (2019). Constrained cash computing system to optimally schedule aircraft repair capacity with closed loop dynamic physical state and asset utilization attainment control. U.S. Patent Application 10/318,903.

Kiarie, J., Kirori, G.N., and Wachira, D., (2019) Moderating Effect of Gearing Ratio on the Relationship between Loyalty Programs and Financial Performance of Selected Firms in Service Industry in Kenya. Journal of Economics, 3(1), pp.86-98.

Kijewska, A., (2016) Determinants of the return on equity ratio (ROE) on the example of companies from metallurgy and mining sector in Poland. Metalurgija, 55(2), pp.285-288.

Muruganandan, S., (2015) A Comparative Study on Financial Strength of Tata Steel Ltd and SAIL. The Management Accountant Journal. 50(8), pp.72-75.

Nassef, M.H. and Khater, A.M., (2016) Analysis of Uranium Concentration, and 235U/238U Activity Ratio in Low Grade uranium Ore material by Inductively Coupled Plasma Mass Spectrometry (ICP-MS) and Gamma Ray Spectrometry. International J. of Life Sciences, 4(4), pp.461-466.

Nurfadillah, M., (2016) Analisis Pengaruh Earning per Share, Debt to Equity ratio and Return on Equity terhadap harga saham pt unilever indonesia Tbk. Jurnal Manajemen dan Akuntansi, 12(1).

Oosterbroek, C., and Grol, R., (2018) Active Learning in Business: Liquidity and Debt Servicing Ability. Teaching Business & Economics, 22(3), pp.13-16.

Oulton, N. and Sebastiá?Barriel, M., (2017) Effects of financial crises on productivity, capital and employment. Review of Income and Wealth, 63, pp.S90-S112.

Patil, A., Kenjale, P. and Kanade, A., 2017, April. IFRS Impact on Profitability and Liquidity Parameters for the Indian IT Sector-Case Study Approach. In International Conference on" Emerging Trends in Applied Finance and Business Economics.

Ravivarman, R., Palaniradja, K., and Sekar, R.P., (2019) Performance enhancement of normal contact ratio gearing system through correction factor. Journal of Mechanical Engineering and Sciences, 13(3), pp.5242-5258.

Setiawan, H. and Amboningtyas, D., (2018) FINANCIAL RATIO ANALYSIS FOR PREDICTING FINANCIAL DISTRESS CONDITIONS (Study on Telecommunication Companies Listed In Indonesia Stock Exchange Period 2010-2016). Journal of Management, 4(4).

Taylor, L., Rezai, A. and Foley, D.K., (2016) An integrated approach to climate change, income distribution, employment, and economic growth. Ecological Economics, 121, pp.196-205.

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