INDEX

1.0 INTRODUCTION 3

2.0 OBJECTIVES OF THE STUDY 4

3.0 METHODOLOGY 4

4.0 FINDINGS OF THE STUDY 7

5.0 CONCLUSION 12

6.0 BIBLIOGRAPHY 13

7.0 APPENDICES I,II &III

ABSTRACT
Every enterprise needs efficient Asset Management as overall corporate strategy to
create shareholder value. Asset Management is a business process and a decision
making frame work, it is the way in which assets are managed can have a significant
impact on both the liquidity and profitability of the company.

Asset turnover is the main tool to measure the degree of efficiency with which the
assets are being used. This is done by relating the asset turn over to the sales. The
conventional approach says that a low asset turnover is an indication of decreasing
profitability of a company. In our paper, we have tried to study relation between
asset turnover and profitability of a company and establish, if possible, a linkage
between the two parameters. The study is based on 10 selected companies in the
Indian industry for the period 2005 to 2007.

I. INTRODUCTION

Efficient asset management is supposed to be the most important ingredient of the overall
corporate strategy to create shareholder value. The speed with which assets are converted
into sales denotes the efficiency with which the assets are being used. The greater is the
rate of conversion, the more efficient is the utilization of assets. Assets management can
have a significant impact on both the liquidity and profitability of the company.

In this paper, we test the relationship between Return on Asset, Receivable Turn Over
Ratio, Inventory Turn Over Ratio and Asset Turn.

We examine whether considering the relative contributions of asset turnover and profit
margin to total operating profitability improves forecasts of changes in profitability,
defined as return on assets, one year ahead. We also test whether the year-to-year changes
in asset turnover and profit margin provide incremental information over the change in
total return on assets for forecasts of the change in return on assets one year ahead.
Asset turnover measures the firm’s ability to generate revenues from its assets while
profit margin measures the firm’s ability to control the costs incurred to generate the
revenues. The level of asset turnover, reflecting the firm’s asset utilization, and the profit
margin, reflecting the firm’s operating efficiency, are in part products of the firm’s
strategy.

Assets turnover is the primary mode for measuring the extent of efficient employment of
the assets by relating the assets to sales. It is an empirical question whether a high value
of asset turnover is beneficial for the company’s profitability. A firm can have larger
sales with a very liberal credit policy, which extends the age of debtors.

In this case, the longer age of debtors may result in higher profitability. However, the
traditional view of the relationship between asset turnover and corporate profitability is
that a low value of asset turnover hurts the profitability of a firm. In this paper, an attempt
has been made to investigate empirically the relationship between the firm’s efficiency in
asset management and its profitability.

The remainder of this paper is structured as follows. Section II presents the objectives of
the study. Section III deals with the methodology adopted in this study. In Section IV, the
findings of the study are discussed. Section V gives a brief conclusion about the study

II. OBJECTIVES OF THE STUDY

i To assess the effect of efficiency in asset management on profitability in the Indian

industry by computing Karl Pearsonís simple correlation coefficient between the selected
profitability measure and each of the selected ratios relating to measurement of efficiency
in asset management. The assessment is done for each of the companies selected in this
study and also taking all the selected companies as a whole.

ii To evaluate the joint influence of the selected efficiency ratios on the profitability
taking all the selected companies in a consolidated.
III. METHODOLOGY OF THE STUDY
The study is based on 10 selected companies in the Indian industry. These companies
selected for the study are :
i) Dabur
ii) BHEL
iii) GAIL
iv) Aditya Nuvo Birla
v) Cipla
vi) Tata Chem
vii) Essar Steel
viii) Mahindra & Mahindra
ix) Hero Honda
x) Hindustan Lever Ltd

The data of the above selected companies for the period 2005 to 2007 used in the study
has been collected from the websites of the respective companies. The data has been
analyzed by using statistical techniques like Karl Pearson Correlation analysis and
multiple regression analysis. The ratios used in this study for measuring asset
management efficiency are :
(a) Receivable Turnover Ratio (RTR)
(b) Inventory Turnover Ratio (ITR) and
(c) Asset Turnover ratio (ATR).
In this study the Return on Assets (ROA) has been taken as the profitability

The description of the above parameters are described as below:

Return on Assets (ROA)

Return on assets is an indicator of how profitable a company is before leverage, and is

compared with companies in the same industry. Since the figure for total assets of the
company depends on the carrying value of the assets, some caution is required for
companies whose carrying value may not correspond to the actual market value. Return
on assets is a common figure used for comparing performance of financial institutions
(such as banks), because the majority of their assets will have a carrying value that is
close to their actual market value. Return on assets is not useful for comparisons between
industries because of factors of scale and peculiar capital requirements (such as reserve
requirements in the insurance and banking industries).

ROA can be computed as:

ROA = Net income + Interest Expense / Total Assets

This number tells you "what the company can do with what it's got", i.e. how many
dollars of earnings they derive from each dollar of assets they control. It's a useful
number for comparing competing companies in the same industry. The number will vary
widely across different industries. Return on assets gives an indication of the capital
intensity of the company, which will depend on the industry; companies that require large
initial investments will generally have lower return on assets.

Receivable Turnover Ratio (RTR)

Receivable Turnover Ratio is one of the Accounting Liquidity ratios, a financial ratio.
This ratio measures the number of times, on average, receivables are collected during the
period. A popular variant of the receivables turnover ratio is to convert it into an Average
Collection Period in terms of days. Remember that the Receivable turnover ratio is
figured as "turnover times" and the Average collection period is in "days".

An accounting measure used to quantify a firm's effectiveness in extending credit as well

as collecting debts. The receivables turnover ratio is an activity ratio, measuring how
efficiently a firm uses its assets.

Formula:
Net Credit Sales
Receivable Turn over = --------------------------------------
Average account Receivable
Some companies' reports will only show sales - this can affect the ratio depending on the
size of cash sales. By maintaining accounts receivable, firms are indirectly extending
interest-free loans to their clients. A high ratio implies either that a company operates on
a cash basis or that its extension of credit and collection of accounts receivable is
efficient.
A low ratio implies the company should re-assess its credit policies in order to ensure the
timely collection of imparted credit that is not earning interest for the firm.

Inventory turnover ratio (ITR)

Inventory turnover reflects how frequently a company flushes inventory from its system
within a given financial reporting period. The measure can be computed for any type of
inventory—materials and supplies used in manufacturing or service delivery, work in
progress (WIP), finished products, or all inventory combined. With the exception of
finished product inventory, the measure applies to service and manufacturing businesses.
The guidance below addresses whatever type of inventory you choose to measure—
however, the benchmarks for good performance will vary by type of inventory and
industry.

Inventory turnover ratio is one of the Accounting Liquidity ratios, a financial ratio.
This ratio measures the number of times, on average, the inventory is sold during the
period. Its purpose is to measure the liquidity of the inventory. A popular variant of the
Inventory turnover ratio is to convert it into an average days to sell the inventory in
terms of days. Remember that the Inventory turnover ratio is figured as "turnover times"
and the average days to sell the inventory is in "days".

• Inventory turnover ratio = Cost of goods sold / Average inventory

• Average days to sell the inventory = 365 / Inventory Turnover Ratio

Asset Turn Over Ratio (ATR)

Formula:
Revenue
Asset Turn over = --------------------------------------
 Total Asset

Companies with low profit margins tend to have high asset turnover, those with high
profit margins have low asset turnover - it indicates pricing strategy.

This ratio is more useful for growth companies to check if in fact they are growing
revenue in proportion to sales

III. FINDINGS OF THE STUDY

The efficient asset management is linked with profitability or not is being examined in
Exhibit 1 and Exhibit 2. The 10 Indian companies are studied for 3 consecutive years
from 2005 to 2008. The Karl Pearson’s simple correlation coefficient has been calculated
between OROA and each of the selected ratios (ITR, RTR and AT). The significance test
is done by calculating ‘t’ value and significance level is tested with p value with
confidence limit of 95%. As we know that receivable management plays role in firms
profitability so it is expected that a positive relationship should exist between RTR and
OROA. Table 1 shows that in 5 out of 10 companies under study, RTR was positively
associated with OROA. However in none of the companies the relationship is found
statistically significant. Both positive and negative relationships are observed. All the
companies are taken as a whole and statistically significant positive association is
observed. At the same time simple regression analysis is done for the relationship of RTR
and OROA (Exhibit…) and it is observed that r2 is 0.407 which means that 40.7%
variability of OROA is linked with RTR. The relationship observed is
OROA = 0.218+ .0075 RTR
This means that for every 1 unit increase in RTR the OROA increase by .0075 units.

Table -1: Karl Pearsonís Simple Correlation Analysis between the selected
Profitability Measure and Ratios Indicating Efficiency in Asset Management of the
selected Companies in Indian Industry
 Correlation Correlation Correlation
Coefficient Coefficient t Coefficient
Between t Between ITR Valu Between
RTR and Value and e of OLTR and t Value
Company OROA(r1) of r1 OROA(r2) r2 OROA(r3) of r3
DABUR -0.28 -0.29 -0.96 -3.46 -0.20 -0.20
BHEL 0.69 0.94 0.94 2.78 0.9999 80.50
GAIL -0.31 -0.33 0.90 2.12 -0.62 -0.80
Aditya Birla
Nuvo -0.62 -0.80 0.34 0.36 -0.96 -3.28
Cipla 0.21 0.21 -0.94 -2.67 0.78 1.27
Tata Chem. -0.99 -6.21 0.87 1.75 0.97 4.15
Essar Steel -0.34 -0.37 0.996 11.11 0.79 1.27
M&M 0.33 0.35 0.87 1.73 -0.69 -0.96
Hero Honda 0.96 3.39* -0.23 -0.23 0.88 1.90
-
HLL 0.95 3.13* -0.999 20.20 0.84 1.56

* Significant at 5% level.
Table -2: Karl Pearsonís Simple Correlation Analysis Between The Selected
Profitability Measure and Ratios Indicating Efficiency in Asset Management of the
Selected Companies in The Indian Industry
(Taking All The Selected Companies in a Consolidated Manner)

Company Avg. ITR Avg.RTR Avg. AT Avg.OROA

Aditya Birla Nuvo 3.00 9.41 0.79 0.06
BHEL 1.98 1.90 1.84 0.36
Cipla 1.57 3.61 1.16 0.30
DABUR 3.94 22.34 3.18 0.51
Essar Steel 2.73 14.33 0.78 0.20
GAIL 17.11 18.18 1.10 0.25
Hero Honda 26.12 64.66 4.44 0.65
HLL 4.20 26.13 6.12 0.76
M&M 6.96 14.90 2.25 0.29
Tata Chem 2.44 6.57 0.98 0.16

Table no 3: Multiple Correlation Analysis and Multiple Regression Analysis of the

Selected Companies in The Indian Industry
(Taking All The Selected Companies in a Consolidated Manner)
Multiple Correlation of Regression Equation of OROA on RTR, ITR and AT:
OROA on RTR, ITR and AT : OROA = b0+b1 RTR+b2 ITR+b3 OLTR
Mode Sum of Mean
l Squares Df Square F Sig.
1 Regressio
.408 3 .136 23.331 .001(a)
n
Residual .035 6 .006
Total .442 9
a Predictors: (Constant), AT, RTR, ITR
b Dependent Variable: OROA

Model Summary

Std. Error
Mode Adjusted of the
l R R Square R Square Estimate
1 .960(a) .921 .882 .07630
a Predictors: (Constant), AT, RTR, ITR
Coefficients(a)
Unstandardized Standardized
Coefficients Coefficients t Sig.
Mode Std. Std.
l B Error Beta B Error
1 (Constant
.079 .043 1.831 .117
)
RTR .003 .007 .102 .394 .707
ITR -.001 .004 -.050 -.153 .883
AT .118 .023 .957 5.198 .002

OROA = .079+.003 RTR-.001 ITR+.118 AT

It is believed that more the ITR better is the profitability so positive relationship is
expected between ITR and OROA. Exhibit 1 shows that in 6 out of 10 companies under
study, ITR is positively associated with OROA. However one positive association and
one negative association depict statistically significant relationship. Both positive and
negative relationships are observed. All the companies are taken as a whole and
statistically insignificant positive association is observed between ITR and OROA. At the
same time simple regression analysis is done for the relationship of ITR and OROA
(Exhibit…) and it is observed that r2 is 0.117 which means that 11.7% variability of
OROA is linked with ITR. The relationship observed is
OROA = 0.286+ .0099 ITR
This means that for every 1 unit increase in ITR the OROA increase by .0099 units.

It is generally accepted that a higher Asset Turnover (AT) indicate efficient long-term
asset management and this in turn increases profitability. Exhibit 1 shows that in 6 out of
10 companies under study, AT is positively associated with OROA. However only one
positive association shows statistically significant relationship. Both positive and
negative relationships are observed. All the companies are taken as a whole and
statistically insignificant positive association is observed between AT and OROA. At the
same time simple regression analysis is done for the relationship of AT and OROA
(Exhibit…) and it is observed that r2 is 0.865 which means that 86.5% variability of
OROA is linked with AT. The relationship observed is
OROA = 0.097+ .114 AT
This means that for every 1 unit increase in AT the OROA increase by .114 units.

Multiple regression analysis is done and shown in Exhibit ….. By this analysis joint
influence of all the efficiency ratios (ITR,RTR, AT) on the profitability is studied. The
mean of the ratios used in this analysis have been taken. The‘t’ test with significance
value (p) is taken to check the statistically significance of the model.
The regression equation derived from the analysis is: OROA = X0+X1 RTR+X2 ITR+X3
AT
where X0 is the intercept, X1, X2 and X3 are the partial regression coefficients. It is
observed from exhibit.. that the relationship is OROA = .079+.003 RTR-.001 ITR+.118
AT

Table 3 shows that for one unit increase in ITR, the OROA decreased by 0.001 units.
For the one unit increase in RTR and AT the OROA increases by .003 and .118 units
respectively. Both ITR and RTR partial regression coefficients were found to be
statistically insignificant. The r2 value is 0.921 which shows that 92.1% variation in
OROA is influenced by receivable turnover, inventory turnover and asset turnover ratios.

V. CONCLUSION

As far as relationship between RTR and OROA is observed, no significant pattern was
found because both positive and negative relationship exists. But when examined as
whole there is significant positive relationship found between RTR and OROA. 40.7%
variability of OROA is linked with RTR. The relationship observed is
OROA = 0.218+ .0075 RTR

This means higher the RTR, the better is the profitability.

For the relationship of ITR with OROA there is no significant relationship is observed. In
simple and multiple regression analysis the association between ITR and OROA is found
to be insignificant. The combined position as observed in multiple regression shows
negative value which leads us to conclude that weak evidence exist for an inverse
relationship between inventory turnover and profitability.

Both positive and negative association/correlation exist between asset turnover and
profitability with different companies. But when examined as whole for all the 10
companies under study the AT shows strong positive correlation with OROA. Moreover
simple as well as multiple regression analysis shows significant positive association of
OROA with AT and as AT increases the OROA also increases. So widely accepted rule
of positive linkage of larger asset turnover with profitability is proved in this study.
• Findings of multiple regression analysis gives the equation of
OROA = .079+.003 RTR-.001 ITR+.118 AT
This shows asset management shows positive and significant contribution in
profitability. RTR is although positive but value in combine analysis is
insignificant and ITR is having insignificant inverse relationship. So AT is the
 only parameter in combined analysis by which profitability can be confidently
predicted.

• The multiple regression analysis shows that the r2 value is 0.921 which shows that
92.1% variation in OROA is influenced by efficient management of receivable
turnover, inventory turnover and asset turnover. So proper management of above
parameter is important and asset turnover is the most important parameter to
influence the profitability.

References:
1. Chandra Prasanna (2001) : Financial Management : Theory & Practice,
Tata McGraw – Hill publishing Co Ltd, Delhi
2. Ross, Westerfield, Jaffe (2004) : Corporate Finance, Tata McGraw – Hill
publishing Co Ltd, Delhi
3. Pandey IM (2005) ; Financial Management : Vikas Publishing House Pvt
Ltd, New Delhi

Websites:

http://en.wikipedia.org/

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