CHAPTER -2

REVIEW OF LITERATURE

Beaver1 has taken a trend of thirty financial ratios for 79 paired failed and
non-failed US firms and has found that there was a significant difference in
the ratios of both category of Firms. In 1969 he has made a comparison of
predictive ability of different ratios of the same paired firms, and he has
identified 3 ratios namely, cash flow to total debt, net income to total assets
and total debt to total assets ratio are the best indicators. He has identified that
the ratios of failed firms differed significantly from those of non-failed firms
and they deteriorated sharply during the 5 years prior to failure.
Altman2 took 66 firms in general and applied multiple discriminant analysis to
discriminate the failed firms from the non-failed firms. On the basis of the
weighted combination of 5 financial ratios, the weighted combination of
working capital to total liabilities, cumulative retained earnings before interest
and tax to total asset, market value of equity to book value of total debt and
sales to total assets was able to predict the bankruptcy with 45% degree of
accuracy. He also found that the predictive ability of the model declined very
sharply when the number of years prior to the failure increased.
Smith3 in his research work has discussed the dual goals of profitability and
liquidity and has suggested that achieving a trade-off between the two is the
job of a financial manager. He uses rate of return as a measure of profitability
and networking capital and current ratio as a measure of liquidity.
Smith4 in the second study discussed the individual and collective efforts of
accounts receivable inventories and accounts payable and other accounts on
probability and liquidity. The study observed that tightened inventory policy
reduced unnecessary borrowing to a lower level than the faster collection of
receivable or slower payments of current liabilities.
Ramamurthy5 admits profitability and solvency to be the twin objective of
working capital management survival and growth of the company thus depend
on its ability to meet the two sets of probability and solvency. He also viewed
that if liquid asserts are adequate to pay off current liabilities, a feeling of
confidence in the financial strength of the company automatically created and
its reputation is sustained.
Kulshrestha6 in his study stressed that corporate liquidity is a vital factor in
business. Excess liquidity, though a guarantor of solvency could reflect lower
profitability, deterioration in managerial efficiency through complacency,
increased speculation and unsatisfied expansion, extension of too liberal credit
and dividend policies. On the other hand, poor liquidity may create frustration
of business opportunities and weakening of morale. The control of liquidity
requires active working capital management.

Bhabatosh Banerjee7 (1982) in his study on “corporate liquidity and
profitability in India, has analyzed the trend of liquidity position of industries
of medium and large public limited companies in the corporate sector of India
during 1971-78 and has identified the relationship of liquidity with their
profitability. His study has evidenced that in industry groups belonging to
publishing and vice versa. But in other industry groups belonging tobacco, silk
and rayon textiles, a rise in liquidity has been found to have a decline in
profitability
Pandey and Bhat8 have analyzed the financial ratio patterns in Indian
manufacturing industries, by taking 612 companies from R.B.I data tape for
1965-66 to 1984-85.They have identified 3 groups of ratios which contain the
maximum amount of information about profitability and applied these ratios
for the analysis of only manufacturing and processing industries. The 3 groups
of financial ratios are
Vijay Kumar and Venkatachalam9 have made an empirical analysis on working
capital and profitability, taking 13 firms from sugar industry, covering a period
from 1982-83 to 1991-92. Correlation and regression analysis have been
employed to be measure the impact of working capital ratios on profitability.
Liquid ratio, receivable turnover ratio has been considered to measure their
impact on profitability. The study has revealed that inventory turnover ratio
and receivable turnover ratio have positively influenced the profitability and
liquid ratio and cash turnover ratio have negatively influenced profitability.
George Schilling10 in his article on working capital role in maintaining
corporate liquidity has explored how investment in working capital establishes
the liquidity position of a company. He has identified the significance of cash
conversion cycle in working capital management. He has explained how it is
referred to as a company’s net liquidity float, and how it is used as a tool in
arriving at optimum liquidity position. He has also illustrated how economic
value added concept can be applied in working capital management. His study,
thus establishes the fact that cash conversion cycle must be kept as short as
possible but maintained at a length that both consistent with the current level
of business activity and flexible enough to allow for achievement of overall
corporate business goals as they adjust to changes in the market place.
Desai11 has made a comparative study of a few cotton mills of Ahmedabad in
respect of their liquidity performance, their relationship with profitability the
pattern of financing of current assets and the turnover of working capital. He
has classified the selected firms into three group based on the size of the firms
and it’s statistically tested to determine how for the observations of the study
can be taken as a valid useful measure for future policy framework. It is
observed that the liquidity and profitability of the firms are not influenced by
the size.
Amit Mallika and Debasish sur12 have explored the relationship between ROI
and several ratios relating to working capital management by conducting a
case study on tea industry. They have used working capital management ratios
and ROI for that analysis. Simple correlation, multiple correlations and

multiple regression analysis have been applied to find out the relationship
between ROI and each of the working capital ratio to assess the joint effect of
those upon the profitability and to test the significance of cause and effect.
They have also examined capital leverage of the tea industry. Their study has
revealed that out of the 9 ratios selected for the study 5 ratios viz, working
capital ratio, acid test ratio, current assets to sales ratio, inventory turnover
ratio and debtor turnover ratio, have registered a negative correlation with
ROI. The regression results have evidenced that only inventory turnover ratio
has negative influence on profitability and the other 4 ratios have witnessed a
positive influence on profitability. The working capital leverage of the
company had recorded a fluctuating trend during the period under study and it
had always been less than unity, proving that the increase in the profitability of
the company was less than the proportion to the decrease in the working
capital.
Desai13 has assessed the capital structure of Gujarat steel tubes ltd, for 10 years
from 1980-81 to 1990-91 and found out that the real value of the equity shares
has been a below their book value and also inconsistent during the entire
period of study. He has found out that the company’s capital structures were
imbalanced and over capitalized financial plans have continued for a long
period of time, preventing the company from earning profits. In his study
though he has discussed various models of prediction of sickness, he has
applied Altman’s Z score model and has identified that from the year 1980-81,
till the latest year 1990-91, Gujarat steel tubes ltd had been scoring less than
the minimum cut off value of 2.675 as suggested by Altman. He has also
applied Argent’s score system for a subjective evaluation of defects in
management and accounting mistakes and symptoms. He has concluded by
analyzing the reasons for the sickness of the company.
Mahammad Rafiqul lsslam14 conducted a study on “Profitability of fertilizer
industry in Bangladesh” for a period from 1985-86 to 1994-95. Five out of
seven fertilizer enterprises in Bangladesh under the control of Bangladesh
chemical industries corporation, have been taken for the study and he has
examined the earning capacity of the selected enterprises. He has also
identified the responsible factors which affects the earning power of such
units. Ratio analysis has been used and he has found out that none of the
selected unit’s returns were consistent and all the units were played with
declining profits. Higher cost of production, poor investment policy, defective
capital structure, industrial unrest and frequent disruption of production
process due to power cuts were found to be some of the reasons attributable
for the uneven situation.
Sahu15 in his study on, analysis of corporate profitability-a multivariate
approach, has made an empirical study based on the secondary data from a
sample of 100 non-financial, on-government public limited companies, in
eastern India for a period of ten years from 1984-85 to 1993-94. He chose
profitability ratios and interest coverage ratio for the analysis. Cross sectional
spearmen rank correlation of the profitability ratios for all the companies have
been calculated and applied for selecting the ratio for analysis. He arrived at a

single index to measure the composite profitability of a firm and ranked the
companies based on the overall score.
Debasishsur16 has made a comparative analysis of liquidity management of 4
major companies in Indian power sector, covering a period from 1987-88 to
1996-97. The techniques of radio analysis, Motaal’s comprehensive rank test,
and simple statistical techniques like measures of central tendency and
spearman’s rank correlation analysis have been used for the analysis. The
liquidity ratios like current ratio, quick ratio, current assets to total assets ratio,
inventory turnover ratio and debtors turnover ratio have been used for
comparison and suitable interpretations have been made Motaal’s
comprehensive test is used to analysis the liquidity more precisely. To measure
the closeness of association between liquidity and profitability of the
companies, Spearman’s rank correlation co-efficient have been applied. The
study has revealed that the inventory turnover ratio has a positive impact on
profitability whereas the liquidity ratio, working capital turnover ratio and
working capital to total asset have negatively influenced the profitability.
Sathish Andre varshney17 has made a case study on trade credit and company
liquidity with special reference to steel authority of India and TATA iron and
steel Co, to find out more liquid companies give relatively more net trade
credit in these years. The period covered has been 1985-86—1996-97 and the
significant variables chosen are current asset, current liabilities, liquid assets,
networking capital, networking assets, cash and short term investments and
cost of goods sold. Ratio analysis and multiple regression analysis have been
employed. He has inferred a positive correlation of very high degree among
the variables chosen. Liquidity has been taken as the dependent variable and
inventory turnover and average collection period, debtor turnover and average
collection period have been taken as independent. The impact of average
change in net trade credit and change in stick in relation to liquidity has also
been measured and a significant linear relationship is found to be existent.
Mazumder and Ghoshal18 examined the strengths and weaknesses of Indian
steel industry. They prepared a SWOT analysis and identified major strengths,
weaknesses, opportunities and threats in Indian steel industry. Major strengths,
according to their study, included the availability of iron ore and cheaper
labour. weaknesses included higher cost of capital, low labour productivity,
and opportunities included wider domestic market, growth of allied sectors
and major threats included substitutes and technological changes. The study
concluded that if the threats and weaknesses are overcome, there will be a
turnaround in the Indian steel industry.
Elbaum19 emphasized the role of government intervention and the growth of
steel industry in Japan. He concluded that without industrial policy
intervention, Japan might have never become a major steel producer, for it had
little source of comparative advantage apart from the technical expertise and
capital investments it gradually accumulated over a long extended period. At
the least, without state intervention, industry development would have been
substantially delayed.

Planning Commission20 necessitated the need for government intervention in
the form of policy measures to make India a global producer. Some of the
important areas where government support is required are – providing
essential infrastructural facilities; assuring easy availability of critical inputs
such as iron ore, coal, gas and power; provision of training facility for
manpower development and creation of a consolidated and reliable data base
for informed decision making by all stakeholders.