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Shree Renuka Sugars Ltd

Adept institute of Management studies and research Dharwad Page 1

INDUSTRY PROFILE:

1.1 Introduction

THE HISTORICAL BACKGROUND OF THE INDIAN SUGAR INDUSTRY:

The sugar industry is proud to be an industry, which spreads the taste of sweetness to the

mankind. The history of origin of this industry is as old as the history of main it-self. Sugar isgenerally made from sugarcane and beet. In India, sugar is produced mainly from sugarcane.

India had introduced sugarcane all over the worlds and is a leading country in the making sugar

from sugarcane.

Saint Vishwamitra is known as the research person of the sugarcane in religious

literature. We can find the example of sugarcane in Vedic literature also as well as sugarcane.

We can also find the reference of sugar and the sugarcane in Patanjalis Mahabashya and the

treaty on the grammar of Panini. Greek traveler Niyarchus and Chinese traveler Tai-Sung

have mentioned in their travelogue that the people of India used to know the methods of making

sugar and juice from sugarcane the great Emperor Alexander also carried sugarcane with himwhile returning to his country.

Thus from different historical references and from some Puranas it can be concluded

that method of making sugar from sugarcane was known to the people of Bihar. The historical

Evidences of sugar industry prospering in ancient India concrete and this has helped to

develop and prosper the co-operative sugar movement in India.

Premier Association of theSugar Industry in India

The oldest industrial association in the country was established in 1932 when

tariff protection was granted to the industry. It is recognized by the Central and

State Governments as the Central Apex Organization to voice the cause of the sugar

industry. Sugar mills in the private sector as well as the public sector are eligible to

become members .
http://www.indiansugar.com/index.htmhttp://www.indiansugar.com/index.htmhttp://www.indiansugar.com/index.htm


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1.2 Global Scenario

The bullish sugar market seen in 2009 lost the momentum in early 2010 as production looked set

to exceed demand significantly in 2010-11 seasons. This was mainly on account of anticipated

surge in production in both Brazil and India, the two largest producers of the commodity.

However, the dynamic Capital Structure of sugar market started changing rapidly towards the

middle of the year in wake of poor weather affecting production in many countries including

Pakistan and China and Brazils production outlook weakened as well.

The bullish tendencies continued to increase throughout the second half of 2010 and the market

is currently in a red hot and extremely volatile state.

India and Brazil are two dominant players in the world sugar market and account for around 40%

of the world sugar production. Any shift in sugar production from India or Brazil has severe

impact on the world sugar prices. Global sugar output is expected to beat demand for the first

time in four years thanks to favorable weather in the Brazil and India, the two biggest sugarcane

growing nations. Global sugar production, raw value, for the 2011/12 marketing year is

forecasted at 168 million metric tons (MMT), up 8 MMT over the previous year. Concerns that


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global supplies will trail demand after crop damage from a storm in Australia and drought in

Russia cut output have been undermined by higher production in Brazil, China, India, and

Thailand. Global exports are forecasted at 56 MMT, up 3 MMT over the previous year.

Consumption is estimated at a record 162 MMT, up 2.7 MMT from a year earlier and ending

stocks are forecast at 29 million tons, down over 400,000 tons.

1.3 Indian sugar industry:

India is the largest consumer and second largest producer of sugar in the world (Source:

USDA Foreign Agricultural Service). In SY 2007-08 India, produced 26.3 million tons and

consumed 22.5 million tons of sugar. With an opening stock of 9.55 million tons in 2008-09,

India will end the year with stocks of around 4 million tons.

India is the world's largest sugar consumer, accounting for 15% of global consumption. It

is also a huge 'swing producer' - severe year-to-year production fluctuations affects its trade

status (and often the world's net balance by extension), as it alternates as a massive importer to

small sugar exporter. The following table shows the supply demand imbalance since 2004-05.

India had swung itself from a net importer to a potentially big exporter in two years. It has once

again become a net importer and is importing in 2009. This demonstrates the domestic sugar

industry's extreme cyclicality.


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The main contribution to the world sugar deficit this year is the large production shortfall in

India. Latest estimates from India's Sugar Mills Associations suggest sugar output will fall to

about 15 MT, down 43% from the 26.3 MT achieved in 2007-08. Following unprecedented

output growth, India is now entering the down phase of its production cycle. Higher alternative

crop prices began influencing cane growers back in 2006-07, causing a large switch to other

crops like paddy and wheat. India's cane area fell 16% to 4.41million hectares in 2008-09 from

the record area in 2007-08 of 5.29 million hectares.

The Indian sugar industry remains the second largest rural agro-industry, with a Rs. 700 billion

annual turnover, contributing almost Rs. 22.5 billion to the central and state exchequer as tax

and excise duty annually (Source: Ministry of Food, Government of India). It is the second

largest agro-processing industry in the country after cotton textiles. With over 600 operating

sugar mills across India, the industry remains a potent rural economy driver. About 50 million

sugarcane farmers and a large number of agricultural labourers are involved in sugarcane

cultivation and ancillary activities, constituting around 7.5% of the rural population. Besides, the

industry employs around 2 million rural skilled/semi-skilled workers, among others (Source:

ISMA).


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1.4 Current industry status:

In 2005-06, there were 581 sugar mills across India's 18 states with a cumulative 190 lakh MT

sugar capacity, of which only 455 are now operating. Around 312 of the total installed mills were

in the cooperative sector, 205 in the private sector and 64 in the public sector (Source:

Directorate of Sugar). The number of factories in the private sector increased by more than 15%,

indicating the corporatization. But majority of the industry is still fragmented with more than

50% of the industry represented by co-operatives.

1.5 Main problems of sugar industry:

Sugar industries in India Suffering from inadequate supply of sugarcane. Sugar industry was initially unevenly distributed in the country. It has the high cost of production. The crushing season is very short. It runs for nearly 100 to 110 days in a year. Inefficient management.

By product of sugar industry like bagasse, molasses, press mud etc are not properlyutilized.

Recovery of sugar juice from sugar cane is very low. The sugar mills are badly located from the point of raw material supply and also market

etc.


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2. COMPANY PROFILE:

2.1 Background and inception of the company

Name of the Company : Shree Renuka Sugars LTD

Founder : Mrs. Vidya Murkumbi and Mr. Narendra Murkumbi.

Incorporated : 1995

Registered Office : Belgaum

Corporate Office : Mumbai

Key People : Mrs. Vidya. M. Murkumbi Executive Chairperson

Mr. Narendra Murkumbi Vice Chairman & MD

Parent plant : Munoli (Karnataka)

Products : White Sugar, Ethanol, Distillery, power and bio fertilizer.

Revenue : 63,620.99 Million

Net profit : 1350.53 Million

Total Employees : 2000 plus

Website :www.renukasugars.com
http://www.renukasugars.com/http://www.renukasugars.com/http://www.renukasugars.com/http://en.wikipedia.org/wiki/Indian_rupeehttp://en.wikipedia.org/wiki/Indian_rupeehttp://en.wikipedia.org/wiki/Indian_rupeehttp://en.wikipedia.org/wiki/Indian_rupeehttp://en.wikipedia.org/wiki/Indian_rupeehttp://en.wikipedia.org/wiki/Indian_rupeehttp://www.renukasugars.com/http://en.wikipedia.org/wiki/Indian_rupeehttp://en.wikipedia.org/wiki/Indian_rupee


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MILESTONES OF SHREE RENUKA SUGARS LTD (SRSL):

1995-SRSL was incorporated.

1998-Initially it acquired a 1250 TCD sick unit from the Nizam Sugars Limited.

1999-The commissioning and trail production took place.

2000- Commencement of 11.2 MW Co-generation plant at Munoli.

2001- Start of 60 KLPD distillery at Munoli.

2002- Establishment of 250 TPD sugar refinery at Munoli.

2003- Leasing of First Co-operative mill.

2004- SRSL IPO Launched.

2005- Acquisition of green field project at Athani (Karnataka).

2006- Acquisition of sugar mill in Shindkheda and relocated to Havalga (Karnataka).

2007- Acquisition of KBK Chem Engineering Private Limited.

2008- Commissioning of 2000 TPD port based refinery at Haldia.

2009- Commissioning of Co-generation plant in Panchganga co-operative sugar mill.

2010-acquired 100% stake in Renuka Valve do Ivai S/A and 50.34% stake in Renuka do Brasil

S/A (Equipav).

2011 Commissioned a 3000 tonnes per day port-based refinery in Gujarat

2012-Increased stake in Renuka do Brazil S/A to 59.4% with a further investment of $115

million.


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2.2 NATURE OF BUSINESS:SRS has plants located in the states of Maharashtra and Karnataka, with Maharashtra presently

accounting for 27% of its capacities. At present, 10,250 tcd capacities are on lease with the

balance owned by the company. Also, being located at Maharashtra and Karnataka generates the

advantage while exporting/ importing sugar during times of surplus / deficit production. Nature

of business carried out in SRSL, is involved activity of manufacturing white crystal sugar

products which is the main product. The process of production involve convention of-Raw

sugarcane to sugar, Raw sugar into refined sugar, Molasses, Bagasses are its by products.

1) Molasses :Molasses is mainly used for the manufacture of ethyl alcohol (ethanol), yeast and cattle feed.

2) Bagasses:Bagasses is usually used as a combustible in the furnace to produce steam, which in turn is

used to generate power; it is also used as a raw material for production of paper and as feed stock

for cattle.

3) Power generation plant:Power plant uses the fiber of the processed sugarcane (Bagasses) as a fuel to generate

electricity in an environmental friendly manner. An integrated 11.2 MW power generates and

applies electricity to the state grid produced from sugar cane waste used to rotate turbines 7 MWpower is utilized plant remaining power is supplied to KPTCL.

4) Distillery plant:This facility uses the byproduct of sugar mills viz; Molasses as a raw material for the

production of spirits and alcohol namely spirit, ethanol and extra neutral alcohol. SRS, with a

capacity of 600 KLPD (900 KLPD by Mar09), has one of the largest distillery capacities in

India. Of its post expansion capacity, 67% will be located at Karnataka with balance based in

Maharashtra.


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COMPANY OVERVIEW:

The Company was originally incorporated as Shree Renuka Sugars

Limited vide certificate of incorporation no. 08-16046 dated

October 25, 1995 with Registrar of Companies, Karnataka atBangalore and received the certificate for commencement of

business on January 5,1996.

The Company was formed by Mr. Narendra Murkumbi and his

mother Mrs. Vidya. Murkumbi, not just dreamers but doers in their

own right. It is a fully integrated sugar company focused on sugar

manufacturing and trading with by-products such as power,

ethanol and bio-fertilizers. The Company has 9 subsidiaries, out of which 3 are in India, 2 in

Brazil, 2 in Sharjah, 1 in Dubai and 1 in Mauritius.

The Company has a total crushing capacity of 92500 TCD, distillery of 930 KPLD, Co-

generation capacity of 376 MW, and Refinery of 4000 TPD.

The Company is currently the 5th largest producer of sugar in the world, leading sugar

manufacturers in India & one of the largest refineries globally.

It has a significant presence in South Brazil, the most cost efficient and scalable production area

with a total cane crushing capacity of 14 million tons at its 4M.

2.3 VISION, MISSION STATEMENT AND QUALITY

POLICY

a) VISION STATEMENT:

To become the most efficient producer of sugar and the largest marketer of

sugarand ethanol in India with a renewable fuel business component.

b) MISSION STATEMENT: Its mission in meeting these objectives are to expand its installed

capacity, achieve end-to-end integration for all its plant to improve margins and reduce

cyclicality of business achieve greater raw material security, increase its focus of corporate and


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high value customers to reduce price risk in sugar by hedging, maintain a strong presence in

export market and expand a market for Ethanol.

To become a provider of the world class products to the nation To enhance the shareholders wealth by sustained profitability and financially sound

growth with prudent risk management system.

To fulfill national and social obligations as a responsible citizen.c) QUALITY POLICY:

Producing the best quality sugar with an integrated approach to satisfyall ranks consumers.

Bringing overall productivity and efficiency throughout oforganization.

Efficient waste management system Creating and maintaining continues learning and motivating atmosphere, participating in

the all round development of community.

d) GOALS AND OBJECTIVES:

Encouraging study of the goals of materials management is proved to be

significant. It mainly emphasizes on the following objectives or goals:-

Ensure an uninterrupted flow of fair required quality materials forthe purchase of production and rendering of services.

Procurement of required materials at fair and reasonable price keeping in view the pricetrends and market conditions.

To expand its installed capacity to achieve end to end integration for all its plants To improve margins and reduce cyclicality of business Achieve greater raw material security Increase its focus of corporate and high value consumers Maintain a strong presence in export market and expand for ethanol.

2.4 PRODUCTS / SERVICE PROFILE:

Basically Shree Renuka Sugars Limited is in manufacture of Various Sugar and its by products.

It is not a services oriented industry. SRSL is today stand for top 10- Sugar manufacturing and

exporters list. These following are the products produced by the Shree Renuka Sugars Limited:-

SUGAR: SRSL is one of the few fully integrated sugar companies, which have capabilities toextract maximum value from sugarcane. Sugar is the primary product of sugarcane. However,


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sugarcane crushing yields by-products like molasses that are used in facilities for the generation

of power and production of ethanol and fuel ethanol.

Shree Renuka Sugars produces EC II grade refined sugar which confirms to EU norms.

SRS uses phosphorisation process which produces sulphur less sugar. It is considered a higher

end product mostly used for direct consumption in European and African countries as well by

corporate for Industrial usage.

(MADHUR, A SUGAR BRAND OF SRSL)

This white crystal sugar is manufactured in the following grades:

1) L-30 [Large size sugar]

2) M-30 [Medium size sugar]

3) S1-30 [small size sugar]

4) S2-30 [very small size]


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ETHANOL:

SRSL produces alcohol from the molasses (Molasses is the

brown coloured residue after sugar has been extracted from

the juice. Molasses still contains some quantity of sugar, but

this sugar cannot be extracted by usual technology) left afterthe extraction of sugarcane juice, which can be used both for

potable purpose as well as an Industrial chemical. Further this

alcohol can be again purified to produce fuel grade ethanol

that can be blended with petrol.

MOLASSES:

Molasses is the final effluent obtained in the production of

sugar by repeated crystallization. Molasses is brown colored

residue after sugar has been traced from the juice. Molassesstill contains some quantity of sugar, but this sugar cannot be

extracted by usual technology.

BAGASSE:

It is a fibrous residue of cane stalk that is obtained after crushing an extraction of juice. It consist

of water, fiber a relatively small quantities of soluble solids, the composition of Bagasse varies

based on sugarcane quality and method of crushing it. The composition of it is given below

POWER:

In the process of crushing of sugar cane, Bagasse, a fibrous

by-product is produced which is used in the boilers to

generate steam. We produce power from Bagasse, which is

used in the manufacturing process as well as sold to the

state electricity boards. Further this Bagasse based

cogeneration plant is eligible for carbon credit

compensation under the Kyoto protocol

2.5 AREA OF OPEARATION

Renuka sugars Ltd manufacture is originally from Karnataka. The Head office of SRSL is in

Belgaum district. It expanded its business to the state of Maharashtra, Andra Pradesh, Uttar

Pradesh, Gujarat, Tamil Nadu, and West Bengal. And through-out the India. Belgaum and

Munoli plant are main manufacturing plant and Ajara and Arag are the other manufacturing


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(leased) units of SRSL. It is operated in other countries like Brazil. Besides having plant in

various locations such as

They have wholly owned subsidiary for sugar trading at Dubai DMCC. They have market for the

sugar outside India also with exporting sugar to countries like UK, Middle East, North Africa,Russia and Japan.

2.6 OWNERSHIP PATTERN:

Shree Renuka Sugars Limited is one of the privatized sugar manufacturing companies. Under the

Entrepreneurship of Vidya Murkumbi, established its branches in various parts of Karnataka and

Maharashtra with the share capital of 200 millions of Indian Rupees.

BOARD OF DIRECTORS:

Smt. Vidya M. Murkumbi Executive Chairperson

Shri Narendra M. Murkumbi Vice Chairman & Managing Director

Shri Sanjay K. Asher Independent Director

Mr. Vijendra Singh Whole Time Director

Shri Surender Kumar Tuteja Independent Director

Shri Hrishikesh Parandekar Independent Director

Mr. Robert Taylor Independent Director

Shri J. J. Bhagat Independent Director

Shri Sidram Kaluti Non Executive Director

Shri Nandan Yalgi Whole Time Director


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The current capacities of SRSL are as per the table below:

Unit Location Sugar(TCD) Power(MW) Distillery(KLPD) SugarRefinery(TPD)

Owned Units

I Munoli Karnataka 8000 35.5 150 1500

IV Athani,Karnataka

10000 68 300 2000

V Havalga,Karnataka

7500 25.5 180 1000

VII Pathri,Maharashtra

1750 - - -

IX Gokak, Karnataka 2500 14 - -

EI Khopoli,Maharashtra

- - 300 -

RI Haldia, WestBengal

- 15 - 2500

R2 Kandla,

Gujarat

- 45 - 3000

VII Panchganga,Maharashtra

6000 30 - -

VI Ajinkyatara,Maharashtra

- 24 - -

II Arag,Maharashtra

- 15 - -

Unit acquired on leaseX Raibag,

Karnataka2500 Capative

TOTAL 38250 272 930 10000


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2.7 COMPETITORS INFORMATION:

DKSSK, Chikkodi Loka Mangal Sugars fPvt. Ltd. (Bhandarkote) Siddeshwar Co-op Sugars. Ltd, (Solapur) Shree Santh Damaji Co-op Sugars Ltd. (Mangalaweda) Hira Sugars Co-op Ltd. (Hirebenur), are the major players in the sugar industry.

CUSTOMERS

Hindustan Coco Cola Beverages Private Limited. PepsiCo ITC Limited Britannia Industries Limited Nestle India Limited Cadbury India Limited Hindustan Unilever Limited Pantaloons (Big Bazaar)

Bannari Amman

Sugars Limited

Balrampur Chini

Mills Limited

Bajaj Hindustan

Limited

Competitor of

Shree RenukaSugars

Ugar Sugar

Limited

Godavari

Sugar Limited

Shree

Prabulingesh

war Sugars.

EDI Parry

(India)

Limited


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2.8 INFRASTRUCTURAL FACILITIES:

1) Self contained residential quarters are constructed for officers & worker.

2) The workers & their dependents are provided with free medical facilities.

3) Formed a cooperative consumer society.

4) Established at the factory site the employee cooperative credit bank.

5) Primary School, Balawadi & Anganawadi are run by the factory.

6) Arranged a mini-bus for transporting the school going children from colony to the schools.

7) Issued identity cards incorporating name of the blood group of each employees,

computerized punching cards to ensure discipline in & out.

8) Provided a well equipped ambulance to employees.

9) The factory has provided a playground at the colony.

10) For the entertainment of the colony residents, the factory has provided with TV antenna.


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2.9 ACHIVEMENTS AND AWARDS:

1995 SRSL was incorporated.

1998 Acquisition of assets of Nizam Sugars Limited.

1999 Shifting of plant from Hindupur to Munoli

1999 Commencement of commercial Production

2000 Commencement of 11.2 MW cogeneration plant

2002 Commencement of 60 KL distillery at Munoli in Karnataka

2003 Increase in co-generation capacity to 20.5 MW

2004 Expansion of refinery capacity to 1000 TPD

2004 Lease for operation of Unit II at Ajara in Maharashtra2004 setting up subsidiary in Dubai

2005 Lease for operation of Unit III at Mohan nagar in

Maharashtra

2005 Memorandum of understanding (MoU) with Haripriya

Sugar Works Limited.

AWARDS:

SRSL has been awarded TWICE

TWO STAR EXPORT HOUSES in 2005 and TWO STAR EXPORT HOUSESin 2006,for its operational efficiency.


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2.10 WORK FLOW MODEL (END TO END):


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SUGAR MANUFACTURING PROCESS:

The sugar commonly used is White Crystal Shape at Shree Renuka sugars Ltd the

organization follows an integrated system of manufacture. The conventional method was the old

method followed to produce sugar . The basic difference between integrated and the

conventional method is that it uses the waste to produce something productive. Like molasses is

used to produce alcohol and mud is used to produce Bio-Fertilizer for the crops.


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To produce different types of sugar different methods are used in the sugar factory. The

present system of sugar manufacturing is sub division into following stages.

1. Extraction of juice from sugarcane by milling2. Clarification of juice.3. Concentration of juice by evaporation to syrup.4. Crystallization of sugar by vacuum pan boiling.5. Centrifugation or separation of sugar and molasses from the massecuite.6. Drying and cooling of sugar.7. Sugar grading and packing.

Initially sugarcane weighted on the weigh bridge & is crushed in six mill tandem. The mixed

juice coming out of the mills is automatically weighed on the weighing machine. The weighed

juice is treated with lime & SO2 (sulphur dioxide) gas at about 75 degree centigrade & heated

further in the juice heater to about 102 degree centigrade finally. This treated juice is send to

settler known as Dorr clarifier where the juice is taken out from the top & mud is drawn out

continuously from the bottom of the Dorr. The clear juice thus, taken for further process. The

settled mud is filtered through Oliver filters & filtrated mud juice from the Oliver is again mixed

with mixed juice for further processing & mud passed out from the Oliver from the mud chutes.

The clear juice having the brix of 17 degree is sent to evaporators containing series of bodies for

concentration of juice, thus during this period of evaporation thick syrup is formed of about 55 to

58 degree brix. The boiling is done under vacuum, thus the vacuum is the last evaporator body is

of 25 degree. The final syrup is again treated with SO2 gas in syrup sulphiter. Where syrup PH is

maintained at about 5.0. This sulphited syrup is used for crystilation process in the vacuums pans

in which crystal are continuously formed & developed to a desired level by charging the syrup as

mother liquor under constant vacuum of 25 degree of mercury. This mass of crystals along with

mother liquor is called as A massecuite which is dropped in the crystallizer & cooled. This

massecuite from the crystallizer is future subjected to centrifugal machine for separation ofcrystals from mother liquor. The white sugar is taken on the hopper for drying. The size & color

Of the sugar is compared with I.S.S. standard bottles from time to time before it is being finally

taken to godown for storage.


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A heavy molasses that is separated from A massecuite in centrifugal is used for B

massecuite boiling & A light of higher purities is used for A boiling again. Similarly B

massecuite is purged in centrifugal & B heavy molasses coming out is used for C boiling for

low massecuite. B sugar is used as A footing for boiling A grade massecuite. Similarly C

massecuite is plugged in two stages where in the first final molasses coming out is weighted &

send to distillery for spirit manufacture as a by-product, & first cured sugar is mixed with C

light or water if necessary. This magma is future cured in 2 ndstage in the centrifugals. C sugar

thus obtained is either used for B footing or melted suitably. C massecuite boiling as low

grade massecuite. The granning method is adopted for C footing. Thus the cycle of processing

continue till the closure of the season.

2.11 FUTURE GROWTH AND PROSPECTS: Entered into a 5 year lease agreement to operate a 2,500 TCD plant ofBalaghat Shetkari

Sahakari Sakhar Karkhana Ltd., having its plant at Latur, Maharashtra.

Acquired Ratnaprabha Sugars for Rs238mn, a company with a crushing capacity of1,250 tcd and 30 KLPD distilleries. The unit is located in central Maharashtra.

Acquired 87% in Gokak Sugars Ltd., which has a capacity of 2,500 tcd along with a 14MW Co-gen plant (6 MW saleable). The acquisition cost of Rs693mn includes assumed

debt of Rs650mn. Thus, actual cash outflow for the acquisition was limited to Rs43mn. Awarded 30-year lease ofRaibag SSKN, a Karnataka based co-operative mill for a total

lease payment of Rs1.26bn over the lease period. The unit has a capacity of 2,500 tcd.

National Ethanol Programme. Access to the national power grid for cogeneration under the open-access system.


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3. MC KINSEYS 7-S FRAMEWORK:

Developed by Waterman, Peters and Phillips (1980), the 7-S model can be used as a framework

for thinking constructively about the complexity, interdependence and fragmentation of a change

programme. It is based on the concept that there are seven areas of an organization that need to

work in harmony with one another. The 7-S-Model is better known as the McKENSYS 7-S,

developed by Tom Peters and Robert Waterman.

1. Structure:The basic structure refers to organizational arrangements of various departments and reporting

lines and responsibility centers. It is one of the key variables for managing the company, SRSL

comprises of various plant facilities at various locations spread across India.

In SRSL the structure is centralized functional division use to control entire organization work

flow. It has implemented top down management system. It has nearly seven fully operational

units and two subsidiaries overseas.

Purchase Department1) Purchase of material.2) It enquires required material in the store.3) Maintaining the purchase account.


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Cane DepartmentThe cane department manages cane procurement through dedicated cane procurement teams.

Cane managers issue cutting orders or harvesting permits, based on data wise cum pre

harvesting maturity surveys. The Cane Department acts as a mediator between the Company and

the farmers where the Company purchases sugarcane directly from farmers through Cane

Department.

Process Department:The process department is responsible for looking after all the production activities. The process

department consists of major technicians who are responsible for carrying out the various

activities required to manage the process of conversion of raw material available as sugarcane to

the conversion of sugar.

Store Department1) To make the material requisitions for the purpose of knowing the quantity material.2) To make purchase order or in simple terms the tender.3) To make approval memo for verification of materials.4) The store department issued material with reference with store requisition.5) To make classification & codification of materials.6) Receipt of material.7) Inspect it with ordered quantity, quality & if any other specifications.8) Some of the material like chemical is to be sent to laboratory for incepatation & testing.

9) Getting indents from departmental head & issuing it.10) To make purchase return if the material are rejected.11) To maintain minimum level of materials.12) Informing purchase department when material required.

Sales Department:In the sugar industry sugar is sold according to central govt. guidance & release. Marketing

& advertising is not necessary in sugar industry. Anyhow customer relationship is necessary

to convert the stock into cash


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1) Getting order from parties.2) Arranging for delivery to parties.3) Maintaining record of sales. Engineering Department:1) Planning for new project.2) Water supply to the factory & quarters.3) Looking over cleanliness of the factory.4) Making arrangement for the functions.5) Maintenance of factory building. Administrative DepartmentOverseeing & carrying out office operations, preparing, systematizing& preserving written

communication, Distributing information, collecting accounts. Admin helps in HR functions

like employees pay, leaves, attendance, formalities in joining organisation etc.

General Account Department:Finance is the lifeblood of business one cannot imagine a business without finance

department because it is the central point of all business activities. Finance dept. of Hira

sugar factory plays a very important role, as it is here that decision with to procurement &utilization of funds are taken. Such decision includes the preparation of various budgets,

allocation of funds for various activities or division of the firm as well as distribution of

profits etc.

An account section is also including in the finance dept. it helps in achieving the objectives

of the company. Proper management of the fund is necessary for effective management.

HR Department:Human resource department helps out in recruitment, selection, training and development,

performance appraisal, rewards and recognition, compensation etc.


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THE ORGANISATION STRUCTURE OF SRSL:

2.Skills:These are the set of abilities needed to perform the job which employee

possess at work place. T&D ensures the necessary skills sets are acquired

by the employees. People in the organization need various skills, such as

managerial, functional, marketing, finance and planning, analysis and

interpretations.


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Some of the methods SRSL uses to upgrade the skills are:

On the job training methodso Job rotationo Training by experts

Off the job training methods Demonstrations Virtual training exercise3. Style:

Style has been observed in the organization that the behaviors of

superior the subordinates in pleasant they motivate fresher who are

working under them.

Style and its application:

Developing people: SRSL believes and works to develop theorganization by developing its people, whom it considers as

valuable asset.

Empowerment and autonomy to employees after putting rightman in the right place is way of SRSL operates.

SRSL has two approaches to style,

a)Top to bottomThe SRSL follows the top to bottom system of controlling and managing the HR with relates to

functioning of day to day activities set to them. Functions are carried under the participative

manner.

b) AuthorizationDecision making is centralized with the Head office. Authority is given to unit in-charge to take

decisions concerning of day to day affairs. Decision making is coordinated one and done with

wide consolation of top management of department manger.

To level

Second level Third level

Bottom level


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4. Strategy:The integrated vision and direction of the company, as well as the

manner in which it derives, articulates communication and implements

that vision and direction. Enhancing the capacity of our existing sugar mill.We intend to

increase the capacity of our existing sugar mill at Munoli from

2500 TCD to 7500 TCD. This would be a brown field

expansion.

Intend to use all the by-products of sugarcane like Bagasse and molasses toproduce value-added products like electricity, Ethanol and Fuel Ethanol, for all

our plants.

Fully integrated manufacturing facilities Acquisition, expansion and leasing out units to achieve operational efficiency. Prominent trading presence. Focus towards corporate and industrial buyers Superior technology.

5. System:It refers to the regulations and also procedures both formal

and in formal that complement the organizational structure. System

applies to many aspects of the firm. The system includes following

committees at SRSL

Audit committee Remuneration committee Investors grievances committee Price risk management committee6. Staff:

Staff is one of key asset of the company. Hiring selecting,

training and motivating them is a crucial work of management.

Staffing is process starts from collection of right people to placing

them at right place.


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Similarly SRSL follows effective staffing norms wherein forms like identification of skill sets

required, training and motivating them. The managerial position of staffing in organization is

done by- Recruitment policies, Training and development and Performance appraisal meeting.

7. Shared value:Shared values are guiding concepts, fundamental idea on which company is based. These

values must be simple and easy to implement and follow.

Some shared values at SRSL

Customer satisfaction Responsibility Commitment to quality Trust and team spirit Respect for the individual Integrity Work ethiCapital Structure

Code of conduct for all employees working in theSRSL:

Board members, officials of senior ranks, subordinate staffand other members of the company must comply with the

laws Conflicts of interest Protecting companys assets Integrity and honesty Confidentiality


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4 SWOT ANALYSIS OF THE COMPANY:

SWOT is the acronym for the strength, weakness, opportunities and threats. Strengths and

weaknesses are internal to the company and threats and opportunities are external to the concern.

STRENGHTS:

Better leadership and direction. Integrated mechanism for the sugar manufacturing. Unique business model. Plant load and capacity. Good yield of sugar cane. Major part in sugar export of India. Can enhance cane crushing capacity by acquiring / taking on

lease poor performing /loss making /sick sugar mills in the region.

Can produce sugar from not only cane but also from raw sugar. Higher capacity utilization and asset turnover as compared to industry due to longer

operating season in this region, higher sugar content in available cane, and dual raw

material capability

Largest sugar refinery in the region with 1000 TCD capacity.WEAKNESSES:

Obsolete cane cultivating technique. SRSL is specialized in manufacturing the refined

sugar, but Indian market has less demand of it, which

leads to extra cost.

Less availability of raw sugar Less concentration on domestic market

Labor turnover and attrition rate. Company has not adopted effective marketing channel.


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OPPORTUNITIES:

Expansion and acquisition of major players domestically and also cross country. Scope to implement ERP and SAP. Equipped with superior technology. Haldia SRSL has acquired a majority stake in KBK, an

engineering company primarily engaged in providing

turnkey solutions in the field of distilleries, Ethanol

plants and bio-fuels.

Expansion and increased market share due to major stakein Grupo Equipav one of the biggest conglomerates in

Brazil which will help company to make a presence in global market.

THREATS:

Competition prevailing in market. Changing job profile Technological development and changes Inflation and deflation & Pricing policy ofgovernment for sugar, cane and other products


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5. FINANCIAL STATEMENT ANALYSIS(Amounts in Million)

1) CURRENT RATIO:

YEARS 31-march-2012 30-sep-2010

CURRENT ASSETS 19973.53 15450.5

CURRENT LIABILITIES 12102.39 19028.20

CURRENT RATIO 1.65 0.814

Intrepretation: It can be inffered from the data that has been a step increase in the ratio which

is mainly due to increase in the level of inventory and debtors.

0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

1

#REF!

#REF!


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2) DEBTEQUITY RATIO:


OUT SIDERS FUND 38952.38 16922.15

SHAREHOLDERS FUND 22211.22 18030.73

DEBT-EQUITY RATIO 1.75 0.94

Intrepretation: The data infers that the firm has a sound debt-equity ratio as compared to the

year 2010 it can be understood that the firm has got good debt capacity.

0

0.2

0.4

0.6

0.8

1

1.2

1.4

1.6

1.8

2

1 2


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3)DEBTORS TURNOVER RATIO:


NET CREDIT SALES 1765.12 3159.4

AVERAGE DEBTORS 2462.26 2101.025

DEBTORS TURNOVER

ATIO

0.7230

= 22 days

1.530

= 45 days

Intrepretation: The companies suggest that the firm presently has improved on its collection

from its debtors this indicate a healthy credit policy of the firm.

0

5

10

15

20

25

30

35

40

45

50

1 2


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4)CREDITORS TURNOVER RATIO:


NET CREDIT PURCHASE 7805.26 17950.82

AVERAGE CREDITORS 12881.965 12782.125

CREDITORS TURN OVER

RATIO

0.6130

= 18 days

1.40430

= 42.13 days

Intrepretation: It can be inferred from the data that the firm is in a position to pay its creditors

easily and early which is indicated a very good sign for the firm.

0

5

10

15

20

25

30

35

40

45

1 2


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5)INVENTORY TURNOVER RATIO:


COST OF GOODS SOLD 17646.56 15039.87

AVERAGE INVENTORY 14275.5 10691.35

INVENTORY TURNOVER

RATIO

1.2430

= 37.2 days

1.430

= 42.2 days

Intrepretation: It can be inferred that the firm is in a position to process the raw material in tofinished goods which is positive indicator.

34

35

36

37

38

39

40

41

42

43

1 2


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FINANACIAL STATUS:

The financial status of the company can be ascertained based on the ratio analysis. Ratio

Analysis is a systematic use of ratios to interpret or assesses the performance of the firms, it isused as a tool for financial analysis.

Considering above calculated ratios, it can be ascertained that the company has a very good

financial standing and all the ratios fall within that of the industry norms

There has been an improvement in current ratio which is healthy sign, and depicts the liquidity

position of the company.

Debt /equity ratio is as per prevailing industry norms and it is a composition which helps thecompany to have more profits and less losses.

Other ratios relevant to the current assets, such as debtor turnover ratio and creditors turnover

ratio are also very much favorable and depicts a sound financial position of the company.


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6. LEARNING EXPERIENCE AT SHREE RENUKA SUGAR:

I had a good experience at Renuka Sugar limited; it was a great knowledge based and an

excellent training program in SRSL. All the staff members of SRSL I found were very co-

operative and friendly in their approach. Whenever I visited to any functional departments, the

higher authority of respective department had allocated their precious time, and explained me

each process carried in there.

The project incorporated various aspects like analysis of industry, factory and its various

functions, McKENSYS 7s framework and SWOT analysis helped me to bring in theoretical

aspects in practice.

I am very fortunate in having completed my training at such a company. As a result of which I

got to learn a lot of different things that will help me in future. It has also helped me to great

extent to have an insight into practical realities of the subjects.

As a person we tend to become more disciplined when we are in an actual plant working under

our superior. It helped me to get basic skills that we could require for making better decision.

The company is able to meet the ever-increasing demand for its product. If management is the art

of getting things done through people, it can be experienced fully in this company. It utilizes

human, financial, raw material and technological resources to the fullest extent through sufficient

planning, organizing, leading and controlling.


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I have learnt a lesson of how HRD department can day to day monitor manpower and

absenteeism, how it identifies training needs and how it organizes training programme for its

employees and monitor performance appraisal how it conducts interviews. The efficiency of the

workers is assured by all these steps.

Leadership in the company focuses on staying connected to employees and its customers. It is

flexible and adaptive to the needs of the situation. The company work is a team work and the

leadership here carries out efficiently team building process. It has contributed a lot in the

development of the organization.

The plant has become successful in meeting the challenges of market and globalization. The

quality of the product and it has become the basis for competition with other companies. It takes

utmost care for presenting the best quality product to its customers. In spite of this, if customer

complaint, they are received and corrective action is taken on these complaints immediately.

The Inplant training has given me a chance to witness actual production process in Sugar

business, I have observed what raw materials they use, in what way machinery and technology

they utilize and how they inspect the final products.

While going through maintenance department, I experienced the importance of looking after

various machines and tools used in the plant. I realized how reduction in breakdown percentage

increases the efficiency of machines.

I observed how the machines and tools can be maintained in good condition. I got the knowledge

of how the purchase department negotiates and procures the material from various vendors. The

well being of the company rest on its financial aspects. I have gone through its ways of fund

raising, the method they use to calculate depreciation, their main receipts and payments etc.

The measures are taken to minimize the wastage. It leads to more productivity. Reduction in

breakdown reduces the cost of production, controlling pollution and providing security to its

worker increase manpower productivity.

Altogether the inplant training in this company has taught me how management can lead a

company on path of progress and proper development.


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GENERAL INTRODUCTION:

Dictionary meaning of the term leverage refers to an increased means for accomplishing some

purpose. It is a kind of instrument used to get a desired result. For example, while lifting an

heavy object, it is the leverage that helps which would otherwise be impossible. In simple terms,

leverage refers to influence or power or effect. In financial analysis, leverage signifies influence

of one financial factor over some other related financial factor.

According to Christy & Roden leverage is the tendency of the profit to change at a faster rate

than the sales. Thus, leverage measures the kind of relationship that exists between two

different financial variables. It shows how one dependent financial variable changes to the

changes in the independent financial variable. How does change in the sales or fixed cost or

variable cost influence earning before interest and tax or earnings before tax is revealed by

leverages.

Following are the various kinds of leverages:

Financial leverage Operating leverage Total leverage

Financial Leverage

The financial leverage may be defined as the tendency of the residual net income to vary

disproportionately with operating profit. It indicates the change that takes place in the taxable

income as a result of change in the operating income. It signifies the existence of fixed interest /

fixed dividend bearing securities in the total capital structure of the company.

Thus, the use of fixed interest / dividend bearing securities such as debt and preference capital

along with owners equity in the total capital structure of the company, is described as financial

leverage. Where in the capital structure of the company, the fixed interest / dividend bearing

securities are greater as compared to the equity capital, the leverage is said to be higher. In a

reverse case the leverage will be said to be lower


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Favorable & Unfavorable Financial Leverage:

Financial leverage may be favorable or unfavorable depending upon whether the earnings made

by the use of fixed interest or dividend bearing securities exceed the fixed cost, the firm has to

pay for the employment of such funds, or not. The leverage will be considered to be favorable solong the firm earns more on assets purchased with the funds than the fixed costs of their use.

Unfavorable or negative leverage occurs when the firm does not earn as much as the funds cost.

The degree of financial leverage may be expressed as below:

Financial Leverage = EBIT/PBT

Where, EBIT = Earnings before Interest & Tax or Operating profit

PBT = Profit before Tax but after Interest

Utility / Importance: Financial leverage helps considerably the finance manager whiledevising the capital structure of the company. A high financial leverage means high fixed costs

and high financial risk. A finance manager must plan the capital structure in such a way that the

firm is in a position to meet its fixed financial costs. Increase in fixed financial costs requires

necessary increase in EBIT level. In the event of failure to do so, the company may be

technically forced into liquidation.

Operating Leverage:

The operating leverage may be defined as the tendency of the operating profit to vary

disproportionately with sales. It is said to exist when the firm has to pay fixed cost regardless of

volume of output or sales. The firm is said to have a high degree of operating leverage, if it

employs a greater amount of fixed cost and a small amount of variable cost. On the other hand a

firm will have low operating leverage when it employs a greater amount of variable costs and a

smaller amount of fixed costs.

Thus, the degree of operating leverage depends upon the amount of fixed element in the cost

structure. Operating leverage in a firm is a function of three factors:

1. The amount of fixed costs

2. The contribution margin

3. The volume of sales

Of course, there will be no operating leverage, if there are no fixed operating costs.


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Favorable & Unfavorable Operating Leverage: Operating leverage may be favorable

or unfavorable. In case the contribution (i.e. sales less variable cost) exceeds the fixed costs,

there is favorable operating leverage. In a reverse case, the Operating leverage will be termed as

unfavorable.

Operating leverage can be calculated by the following formula:

Operating Leverage = Contribution or C/Operating profit EBIT

Where, EBIT = Earnings before Interest & Tax

Operating leverage indicates the impact of change in sales on operating income. If a firm has a

high degree of operating leverage, a small change in sales will have a large effect on operating

income. In other words, the operating profit of such a firm will increase at a faster rate than the

increase in sales. Similarly, the operating profits of such a firm will suffer a great loss as

compared to reduction in its sales.

Generally, the firms do not like to operate under conditions of a high degree of operating

leverage. This is very risky situation where a small drop in sales can be excessively damaging to

the firms efforts to achieve profitability.

Total / Combined leverage:

This leverage is also known as combined leverage or Composite leverage. As explained above,

operating leverage measures percentage change in operating profit due to percentage change in

sales. It explains the degree of operating risk. Financial leverage measures percentage change in

taxable profit on account of percentage change in operating profit (EBIT). Thus, it explains the

degree of financial risk. Both these leverages are closely concerned with the firms capacity to

meet its fixed costs (both operating and financial).

In case both the leverages are combined, the result obtained will disclose the effect of change in

sales over change in taxable profit. Composite leverage, thus, expresses the relationship between

revenue on account of sales (i.e., contribution or sales less variable cost) and the taxable income.

It helps in finding out the resulting percentage change in taxable income on account ofpercentage change in sales.

Total leverage can be computed as follows:

Total leverage = C X OP = C

OP PBT PBT


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Where, C = Contribution (i.e., SalesVariable Cost)

OP = Operating profit or EBIT

PBT = Profit Before Tax but after Interest

Total leverage helps in understanding the extent of change that take place on profit before tax on

account of change in sales value or quantity. Similarly, combined leverage also helps in

measuring total risk. The total risk refers to the variability of earnings per share as a result of

change in sales. Greater the degree of total leverage, greater is the variability of EPS. Fixed costs

also are considered in this leverage.

Utility / Importance

Total leverage helps in understanding the extent of change that take place on profit before tax on

account of change in sales value or quantity. Similarly, combined leverage also helps in

measuring total risk. The total risk refers to the variability of earnings per share as a result of

change in sales. Greater the degree of total leverage, greater is the variability of EPS. Fixed cost

also are considered in this leverage

Cost of Capital:

The term cost of capital refers to the minimum rate of return a firm must earn on its investment

so that the market value of the companys equity shares does not fall. This is in consonance with

the overall firms objective of wealth maximization. This is possible only when the firm earns a

return on the projectsfinanced by equity shareholders funds at a rate which is at leastequal tothe rate of return expected by them. If affirm fails to earn return at expected rate, the marketvalue of the shares would falland thus result in reduction of overall wealth of the shareholders.Thus a firms cost of capital may be defined as the rate of return the firm requires frominvestment in order to increase thevalue of the firm in the market placeComputation of cost of capital

Computation of cost of capital involves:(i) Computation of cost of cash specific sources of finance termed as computation of specific

costs; and

(ii) Computation of composite cost termed as weighted average cost.


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Cost of Debt / Debenture Capital:

In measuring cost of capital, the cost of debt should be calculated first. For determining the real

cost of debt, it is necessary to consider not only contractual cost, but also imputed costs.

Generally cost of debt (debentures and long term debts) is defined in terms of the required rate of

return that the debt, investment must yield to protect the share holders interest. Hence cost of

debt is contractual interest rate, adjusted further for the tax liability of the firm as per formula.

Debt may be issued at par, at premium or discount. It may be perpetual or redeemable. The

technique of computation of cost in each case has been explained in the following slides.

Kd = (1-T) R

Where, Kd = Cost of debt capital

T = Tax rate applicable to the company

R = Contractual interest rate

Cost of Equity Capital:

The computation of the cost equity capital is a difficult task. Some people argue, as observed in

case of preference shares, that the equity capital does not involve any cost. The argument put

forward by them is that s not legally binding on the company to pay dividends to the equity

shareholders. This does not seem to be a correct approach because the equity shareholders invest

money in shares with the expectations of getting dividend from the company. The company also

does not issue equity shares without having any intention to pay them dividends. The market

price of the equity shares, therefore, depends upon the return expected by the shareholders.

Ke = D/P*100

Here, Ke = Cost of equity

D = Current dividend rate

P = current market price


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Cost of Retained Earnings:

The companies do not generally distribute the entire profits earned by them by way of dividend

among their shareholders. Some profits retained by them for future expansion of the business.

Many people feel that such retained earnings are absolutely cost free. This is not the correct

approach because the amount retained by company, if it had been distributed among the

shareholders. By way of dividend, would have given them some earning. The company has

deprived the shareholders of these earnings by retaining a part of profit with it. Thus, the cost of

retained earnings is the earning forgone by the shareholders.

In other words, the opportunity cost of retained earnings may be taken as the cost of the retained

earnings. It is equal to the income that the shareholders could have otherwise earned by placing

these funds in alternative investments. For example, if the shareholders could have got a return

of 10% this return of 10% has been forgone by them because of the company not distributing the

full profits to them. The cost of retained earnings may, therefore, be taken at 10%.

The above analysis can also be understood in the following manner. Suppose the earnings are not

retained by the company and passed on to the shareholders, are invested by the shareholders in

the new equity shares of the same company, the expectation of the shareholders from the new

equity shares would be taken as the opportunity cost of the retained earnings. In other words, if

earnings were paid as dividends and simultaneously an offer for the right shares was made, the

shareholders would have subscribed to the right shares on the expectation of certain return. This

expected return can be taken as the cost of retained earnings of the company.

Cost of retained earnings is calculated by using the following formula:

Kr = Ke (1T) (1-B)

Where, Kr = Cost of retained earnings

Ke = required rate of return to share holders

T = Tax Rate

B = Brokerage on purchase of securities


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Weighted Average Cost of Capital

After calculating the cost of each component of capital, the average cost of capital is generally

calculated on the basis of weighted average method. This may also be termed as overall cost of

capital. The computation of the weighted average cost of capital involves the following steps:

1. Calculation of the cost of each specific source of funds. This involves the determination of the

cost of debt, equity capital, preference capital, etc., as explained in the preceding pages. This can

be done either on before tax basis or after tax basis. However, it will be more appropriate to

measure the cost of capital on after tax basis. This is because the return to the shareholders is

an important figure in determining the cost of capital and they can get dividends only after the

taxes have been paid.

2. Assigning weights to specific costs. This involves determination of the proportion of each

source of funds in the total capital structure of the company. This may be done according to any

of the following methods:

Marginal weights method - In case of this method weights are assigned to each source of funds,

in proportions of financing inputs the firm intends to employ. The method is based on this logic

that our concern is with the new or incremental capital and not with capital raised in the past. In

case the weights are applied in a ratio different than the ratio in which the new capital is to be

raised, the weighted average cost of capital so calculated may be different from the actual cost of

capital. This may lead to wrong capital investment decisions. However, the method of marginal

weighting suffers from one major limitation. It does not consider the long- term implications of

the firms current financing. A firm may should give due attention to long-term implications

while designing the firms financing strategy. For example, a firm may accept a project giving an

after-tax return of 6% because it intends to raise funds required by issue of debentures having a

cost of 9%, it will have to reject a project which gives a return of only 8%. Thus, marginal

weighting method does not consider the fact that to- days financing affects tomorrows cost.

Historical weights method: According to this method the relative proportions of various sources

to the existing capital structure are used to assign weights. Thus, in case of this method the basis

of weights is the funds already employed by the firm. This is based on the assumption that the

firms maintained in the future also. Weights under historical system may be either (i) book


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value or (ii) market value weights. The weighted average cost of capital will be different,

depending upon whether book value weights are used or market value weights are used.

The use of market value weights for calculating the cost of capital is theoretically more

appealing on account of the following reasons:

(i) The market values of the securities closely approximate to the actual amount to be received

from the sale of such securities

(ii) The cost of each specific sources of finance which constitutes the capital structure is

calculated according to the prevailing market price

However, the use of market value as weights is subject to the following practical difficulties.

- The market values of the securities may fluctuate considerably.- Market values are not readily available as compared to the book values. The book values

can be taken from the published records of the firm.

- The analysis of the capital structure of the company, in terms of debt equity ratio, isbased on the book values and not on the market values. Thus, market value weights are

operationally inconvenient as compared to book value weights.

However, market value weights are theoretically consistent and sound; hence they are a better

indicator of the firms cost of capital.

3. Adding of the weighted cost of all sources of funds to get an overall weighted average cost of

capital.

CAPITAL STRUCTURE:

It is the proportion of debt and preference and equity shares or a firms balance sheet. Given the

objective of the firm to maximize the value of the equity shares, the firm should select a

financing mix/capital structure/financial leverage, which will help in achieving the objective of

financial management. As a corollary, the capital structure should be examined from the

viewpoint of its impact on the value of the firm. It can be legitimately expected that if the capitalstructure decision affects the total value of the firm, a firm should select such a financing mix as

will maximize shareholders wealth.

Such a capital structure referred to as the optimum capital structure. The optimum capital

structure may be defined as the capital structure or combination of debt and equity that leads to

the maximum value of the firm.


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The importance of an appropriate capital structure is thus, obvious. There is viewpoint that

strongly supports the close relationship between leverage and the value of a firm. There is an

equally strong body of opinion, which believes that financing mix or the combination of debt,

and equity has no impact on the shareholders wealth and the decision on financial structure is

irrelevant. In other words, there is nothing such as optimum capital structure.

In theory capital structure can affect the value of the company by affecting either its expected

earnings or cost of capital or both. While it is true that financing mix cannot affect the total

operating earnings of a firm as they are determined by investment decisions, it can affect the

shares of earning belonging to ordinary shareholders. The capital structure decision can influence

the value of the firm through the earnings available to the shareholders. But the leverage can

largely influence the value of the firm through the cost of capital. In exploring the relationship

between the leverage and value of firm we are concerned with the relationship between leverage

and cost of capital from the standpoint of valuation.

An appropriate capital structure is a critical decision for any business organization. The decision

is important not only because of the need to maximize returns to various organizational

constituencies, but also because of the impact such a decision has on an organizations ability to

deal with its competitive environment. The prevailing argument, originally developed by

Modigliani and Miller (1958), is that an optimal capital structure exists which balances the riskof bankruptcy with the tax savings of debt. Once established, this capital structure should provide

greater returns to stockholders than they would receive from an all-equity firm.

Despite its theoretical appeal, researchers in financial management have not found the optimal

capital structure. The best that academiCapital Structure and practitioners have been able to

achieve are prescriptions that satisfy short-term goals. For example, in a recent Harvard Business

Review article, readers were left with the impression that the use of leverage was one way to

improve the performance of an organization. While this can be true in some circumstances, it

fails to consider either the complexities of the competitive environment, or the long-term

survival needs of the organization.

It is argued that the use of leverage either to discipline managers or to achieve economic gain is

the easy way out, and, in many instances, can lead to the demise of the organization. The fact

that an optimal capital structure has not been found is an indication of some flaw in the logic. It


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is believed that the original question was framed incorrectly. Rather than: What is an optimal

mix of debt and equity that will maximize shareholder wealth; it should have been: Under what

circumstances should leverage be used to maximize shareholder wealth? Why? Because debt and

equity have profound long-term implications for corporate governance that far exceed the

exigencies of the moment.

A better understanding of the issues at hand requires a look at the genesis of the concept of using

debt to control managers and to reconcile this thinking with the need to survive in the

competitive environments of today.

Factors influencing Capital Structure

Following factors influence the capital structure of a company:

Seasonal needs: A firm needs funds for a short period during certain seasons that runsabout 2 to 3 months. It would be expensive to use long term financing that requires

interest or dividend to be paid on annual basis and hence a firm may prefer to borrow

from any financial institutions instead of collecting funds through shares and debentures.

Degree of risk: Borrowed funds increase the risk of a firm because, interest has to bepaid regularly whether firm makes profits or not. On the contrary, the equity shares

reduce the risk, since they are not to be repaid during the life time nor the dividend be

paid compulsorily. A firm that does not like to run the risk of business may prefer to have

more equity share capital

Ability to increase owners profit: A firm which is capable of running the businesssuccessfully and increasing the profits, may prefer to have more quantity of borrowed

funds in its capital structure, so that, after paying interest at fixed rate whatever surplus

remains goes to equity share holders.

Desire to control: A firm that does not like to surrender operational control to a fewmore equity share holders by issuing further shares that affects the interest of existingshare holders would like to collect funds by issuing debentures, bonds and other long

term borrowings. The equity shareholders have voting rights whereas, the debenture

holders do not have voting rights (they do not interfere with the management of the

affairs of the firm).


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Future flexibility: A firm is required to maintain balanced mixture of debt and equityshare capital. Excessive debt reduces its ability to borrow still further and thus reduces

the flexibility in borrowing. Issue of excessive share capital also restricts the flexibility.

General level of business activity: If the general level of business activity is rising,additional funds may be required for the expansion of the business that may be raised

through long term borrowings or issue of equity shares. On the contrary the general level

of business activity is declining, the available cash may be used in redeeming the

debenture loans.

Level of interest rates: If the rate of interest on debentures or other long term loans ishigher, the firm may prefer to collect the funds through the issue of equity shares and

other short term borrowings. On the contrary if the rate of interest is low, it would prefer

debentures to equity shares.

Trading on equity: It means increasing the return on investment of equity share holdersby using the funds on which fixed rate of interest or dividend has to be paid. When a firm

desires to trade on equity, its capital will be made-up of equity shares, preference shares

and / or debentures.

Nature of business: The nature & type of business also affects the capital structure of afirm. For example, a public utility concern that enjoys monopoly market for its product,

and has a stable earning, can easily raise capital by the issue of preference shares and

debentures. On the other hand, firms engaged in manufacturing and selling the products

under competitive environment and changing market conditions have to collect funds by

issuing equity shares only.

Purpose of finance: If the funds are needed for productive purposes such as, setting upof a new factory or new business, firm can collect funds by issue of equity shares or

preference shares or debentures. On the other hand, if the funds are required for un-

productive purposes such as, promoting art and culture or employee welfare programmes,

it would be difficult to raise funds through debentures or preference shares.

Period of finance: If the funds are needed almost permanently, then it would beadvisable to issue equity shares and if the funds are to be used for a short period, issue of

debentures or borrowings may be considered.


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Legal requirements: Capital structure is often influenced by requirements. For example,under banking regulations act 1949, a banking company cannot issue any other type of

shares other than equity shares

Stock market conditions: During boom period, investors are interested in speculativedealings, and it is the right time for issue of equity shares. Whereas, during depression

period the investors look to the security of their investment and hence, debenture may be

issued.

Investor preference: Equity shares are best suited to investors expecting higher rate ofreturn on their investments. Debentures meet needs of such investors who are interested

in the safety and security of their investments. Such investors feel satisfied with whatever

fixed income they get without exposing themselves to any business risks.

Government policies: Policies framed by central or state govt. also affect the capitalstructure. Monetary policy, fiscal policy, capital control act, etc., directly or indirectly

influence the capital structure of a firm.

Optimum Capital Structure

Optimum capital structure is one that maintains an ideal ratio between different types of

securities issued by a firm (company) constituting total capital that maximizes the market value

of equity shares and minimizes the average cost of capital. While determining appropriate capital

structure, finance manager has to aim at maximizing the long term market value of equity shares

and minimizing the average cost of capital.

Features of Optimum Capital Structure

A sound capital structure must possess the following features:

Profitability: An ideal capital structure should result in the maximum return to the equityshare holders and at the same time minimize the cost of capital

Solvency: Although, borrowed funds are cheaper, excessive debt damages the solvencyof the company. Hence capital structure should not contain more debt. Debt / equity ratio

should be such as to ensure solvency of the company


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Control: A sound capital structure should be such as to help the present management toretain the control over the company, because, if the equity shares are more in number, the

right of control gets spread over quite a large number of equity share holders .

Flexibility: It implies adjustability. Capital structure should be adjustable according tothe changing conditions. There cannot be an ideal static capital structure. Ratio may

change depending upon changing circumstances.

Capital Structure with equity shares, preference shares & debentures

Merits

Less costly: Financing with debentures is cheaper than preference shares and equityshares.

Benefit of trading on equity: Capital composed of equity shares, preference shares anddebentures facilitates trading on equity.

Interest on debentures: For taxation purpose, interest on debenture is treated as chargeagainst P&L a/c. Interest on debentures is an expenditure and debited to P&L a/c.

It helps to retain control: Use of debentures in capital structure helps to retain controlover the company by the existing equity share holders.

Capital Structure with equity shares, preference shares & debenturesDemerits

Creation of charge: Secured debentures require charge to be created on assets andproperty of the company that may affect the good will of the company.

Regular payment of interest: Regular payment of interest may impose burden on thepart of the company especially during depression. Interest has to be paid whether

company makes profit or not. Fear of insolvency: Excessive issue of debentures threatens the solvency of the

company.

Capital structure theories

1. Net Income Approach


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2. Net Operating Income Approach

3. Traditional Approach

4. MODIGIIANI- MILLER Approach

General Assumptions

1. There are only two sources of funds used by a firm: perpetual risk less debt and ordinary

shares.

2. There are no corporate taxes.

3. The dividend payout ratio is hundred i.e., the total earnings are paid out as dividend

to the shareholders and there are no retained earnings.

4. The total assets are given and do not change. The investment decisions are, in other words,

presumed to be constant.

5. The total financing remains constant. The form can change degree of leverage (capital

structure) either by selling shares and use the proceeds to retire debentures or by raising more

debt and reduce the equity capital.

6. The operating profits (EBIT) are not expected to grow.

7. All investors are assumed to have the same subjective probability distribution of the future

expected EBIT for a given firm.

8. Business risk is constant over time and is assumed to be independent of its capital structure

and financial risk.

9. Perpetual life of the firm.

1. Net income approach

According to the Net Income approach, suggested by the Durand, the capital structure decision is

relevant to the valuation of the firm. In other words, a change in the financial leverage will lead

to a corresponding change in the overall cost of capital as well as the total value of the firm. If,

therefore, the degree of financial leverage as measured by the ratio of debt to equity is increased,

the weighted average cost of capital will decline, while the value of the firm as well as marketprice of ordinary shares will increase. Conversely, a decrease in the leverage will cause an

increase in the overall cost of capital and a decline both in the value of firm as well as the market

price of equity shares.

The Net income approach to valuation is based on three assumptions:

1. There are no taxes


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2. Cost of debt is less than equity capitalization rate or the cost of equity.

3. The use of debt does not change there is perception of investors. That the financial risk

perception of the investors does not change with the introduction of debt or change in leverage

implies that due to change in leverage, there is no change in either the cost of debt or the cost of

equity.

The financial leverage, according to net income approach is an important variable to the capital

structure of a firm. With a judicious mixture of debt and equity, a firm can evolve an optimal

capital structure which will be the one at which value of the firm is highest and the over all cost

of capital is lowest. At that structure, the market price per share would be maximum. If the firm

uses no debt or if the financial leverage is zero, the over all cost of capital will be equal to the

equity capitalization rate. The weighted average cost of capital will decline and will approach the

cost of debt as the degree of leverage reaches one.

2. Net Operating Income Approach

Another theory of capital structure suggests by Durand, is the Net operating income approach.

This approach is diametrically opposite to the Net Income approach. The essence of this

approach is that capital structure decisions of a firm are irrelevant. Any change in leverage will

not lead to any change in the total value of firm and the market price of shares as well as the

overall cost of capital is independent of the degree of leverage.

The NOI approach is based on the following propositions:

1. Overall cost of capital/ capitalization rate (Ko) is constant

The NOI approach to valuation argues that overall capitalization rate of the firm remains

constant, for all the degree of leverage. The value of the firm, given the level of EBIT, is

determined by.

V = EBIT/Ko

V = Value of the Firm

EBIT= Earnings Before interest & Tax

Ko = Cost of Capital

In other words, the market evaluates the firm as a whole. The split of the capitalization between

debt and equity is, therefore not significant.


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2. Residual value of Equity

The value of equity is residual value, which is determined by deducting the total value of debt

(B) from the total value of the firm (V). Symbolically total market value of equity capital (S)

=V-B.

S= total market value of equity capital

V= total value of the firm

B= total value of debt

3. Changes in cost of equity capital

The equity capilisation rate / cost of equity capital (Ke) increases with a degree of leverage. The

increase in proportion of debt in the capital structure relative to equity shares would lead to an

increase in the financial risk to the ordinary shareholders. To compensate for the increased risk,

the shareholders would expect a higher rate of return on their investments. The increase in the

equity capitalization rate (or the lowering of the price earnings that is P/E ratio) would match the

increase in the debt equity ratio.

4. Cost of debt

The cost of debt (Ki) has two parts

(a) Explicit cost, which is represented by the rate of interest. Irrespective of the degree of

leverage, the firm is assumed to be able to borrow at a given rate of interest.

This implies that the increasing proportion of debt in the financial structure does not affect the

financial risk of the lenders and they do not penalize the firm by charging higher interest.

(b) Implicit cost as shown in the assumption relating to the changes in Ke, increase in degree of

leverage or the proportion of debt to equity causes an increase in the cost of equity capital. This

increase in Ke, being attributable to t

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