Contents

Introduction:........................................................................................................................ 1
Financial leverage:........................................................................................................... 1
Financial Leverage of Indian Companies..........................................................................7
Financial Analysis of Company................................................................................................. 9
Ratio Analysis of Ashika Textile Limited................................................................................... 10
R.K. Chemicals Pvt. Ltd..................................................................................................... 15
Ratio Analysis of R.K. Chemicals............................................................................................ 18
Data analysis by using SPSS technique......................................................................24
Example of Financial Leverage.......................................................................................... 30
Conclusion......................................................................................................................... 31
Bibliography...................................................................................................................... 32

Introduction:
Our topic is about Financial Leverage of companies of India, we have conducted research to find out
the reasons that why the companies go for debt financing. We analyzed companies solvency ratios. We
have analyzed final report of selected companies of different sectors, and looked at their balance sheet
and tried to find out the effects of financial leverage on companies business operations.

Leverage:
Leverage is a business term that refers to borrowing. If a business is "leveraged," it means that the
business has borrowed money. If the company has too much borrowing, it may not be able to pay back
all of its debts.

Types of leverage
Operating leverage
Financial leverage
Combined leverage

Financial leverage:
The degree to which an investor or business is utilizing borrowed money. The ability of a company to
earn more on its assets by taking on debt that allows it to buy or invest more in order to grow its
business.

High Leverage:
It is more risky for a company to have a high ratio of financial leverage. Companies that are highly
leveraged may be at risk of bankruptcy if they are unable to make payments on their debt; they may
also be unable to find new lenders in the future.
Low Leverage:
It is less risky for a company to have a low ratio of financial leverage. With a low leverage companies
can meet its debt obligations and there is an opportunity for it to find new lenders in the future.

Effects of Financial Leverage

One of the best ways in which company increases its profit is through financial leverage. Financial
leverage uses debt instruments so that the anticipated level return on the company's equity would
increase. The level of financial leverage of a certain company is determined by getting the total value
of debt and the equity and the ratio of debt.
There are four positions which show a relationship with the level of financial leverage. First, is the
relation of equity and debt, for instance, the rate of capital? Another is the influences on business
production and cycle of financial leverage. Then the company's industry and branch whole financial
Leverage level. And also the correlation between the current financial leverage ratio of the company
and the middle leverage level. Lastly, the conformity of company's mission and philosophy with the
situation connected to the relation of financial leverage.
The outcome of the financial leverage can also be utilized to boost income and growth however, it is
much common for business industries in the phase of the young and teens. Financial leverage ratio is
relative to variability of profit and contrary to stability. Company's profits with high rate leverage level
differ with the same condition as with the company's profits with lesser leverage level.
Another factor that affects leverage ratio is the company's flexibility, its dynamics and openness that
concerns on the changes and development of technology, possibilities and industry. Companies having
high leverage levels has lower flexible procedure because of the fact that they are more accountable for
all the creditors and sometimes must fill some restrictions and agreements on their investments and
capital use.
Companies with high leverage level usually become less successful due to situation of transforming
environment and the need of taking uncertain decisions. Because of this, they might not able to apply
or utilize growth opportunities for expansion of business.
One more risk of using financial leverage as a tool to increase revenue is the reality that the change
between profits and company's debt remains positive. If the company's profit relative amount to equity

is higher, the debt exceeds the amount of the profit then the effect of leverage is gone and the debt
remains.
It is therefore that the level of financial leverage must have a good understanding of financial or
business management. To determine the return rate upon return of leverage simply calculate the
difference among the rate of interest on assets and debts, then multiply the difference to the relative
amount of liability or debt to the equity and add up the anticipated return on assets.
Industries that are growing fast allocate only little level of than those stably growing company.
In most cases, the effects of financial leverage are used to improve the company's financial condition
and earnings but it should not be accepted as a principle rather it requires comprehensive analysis of
the present condition of the environment.

Objective of research
Objective of this study is to find out the financial leverage of Indian companies that why it resorts to
debt financing and not equity only. Our research is based on results that how financial leverage effects
the companys business operations.

Literature Review
Summary:
This article provides important contributions to the literature and policy debates concerning corporate
governance implications of various ownership patterns. In this paper the aim to close some of these
gaps between fixed-claim holders and dominant shareholders, and develop a conceptual framework that
analyses the effects of possible collusion between concentrated shareholders and fixed claim holders, in
countries with relatively low protection of minority investor.

This paper also underlines the joint problematic of the existence of private benefits and the one of the
choice of debt are linked in the framework of financial governance. Also want to evidence the
interrelations and balances that result in complementary and shared logics between majority and
minority shareholders. The asymmetry of information between these two groups of actors leads
complex behaviors.

In this paper, the managers and the controlling shareholders elaborate and take the strategic decisions
of the firm and appropriate for themselves a part of the gross economic profit. The concept of private
benefits is associated with the concentration of the power by the dominant shareholders. The
appropriation of a part of the economic cash flow introduces a conflict with outside shareholders who
endure an expropriation. This situation finality is to protect the investors.

Ownership concentration may result in lower efficiency, measured as a ratio of a firm's debt to
investment, and this effect depends on the identity of the largest shareholder.
It provides further support for the case of strong regulatory and capital market
Institutions and effective enforcement of the good corporate governance rules, especially concerning
the protection of minority shareholders. So far, most studies of corporate governance problems have
focused on issues related to the consequences of opportunistic behavior of insiders and their opposition
to outside control.

This article shows that the protection of minority shareholders from the block holders opportunism is
as important for enterprise restructuring and development of an efficient system of corporate
governance as protection against entrenched management. In addition, we extend this conclusion to an
environment where debt finance is predominant and equity finance plays a minor role. We demonstrate
that in such an environment, the collusion between dominant owners and financial institutions may lead
to further efficiency distortions.

Summary:
This article discusses the introduction of financial leverage concepts using examples based on
accounting rates of return. This article basically describe about the art and science of Financial
Leverage. It describes the concept of financial leverage in detail.
The use of financial leverage to impact corporate rates of returns and corporate values is one of the
clear examples in which financial management theory has found its way out of academia and has
become an established technique of financial management in practice. Experience has shown the
impact of financial leverage to be one of the more difficult concepts for beginning students of corporate
financial. Basically many introductory financial management course outlines, the use of financial ratios
to analyze financial statements is presented before the financial leverage module is presented.
In the case of the financial leverage course module, beginning the presentation with a short, selfcontained numerical example serving as the hook can bridge the gap between the students preferred
cognitive style and the need to present a detailed comprehensive example to explain the full complexity
of the management issue.

Finance educators have developed various approaches to introduce the topic of financial leverage.
Clearly, the dominant approach is to present the student with two sets of sample income statements and
balance sheets. These representative financial statements are structured so that the impact of adding
financial leverage can be clearly seen to increase both the expected level of, and volatility of, equity
returns as measured by EPS or ROE. These examples are also used in various textbooks for finance
students to understand financial Leverage. In some text books to make understanding of financial
leverage, operating leverage is also linked with financial leverage. An admiration and general
understanding of the impact debt financing is also linked with financial leverage.
Author also discussed that it is important, since the idea is to clearly convey that the difference in
shareholder return is based on financial leverage alone. The goal is to demonstrate that something
important is occurring and to capture the attention of the students.

Summing up This article has discussed the qualities of using an updated alternative presentation as
an introductory hook for a course module on the topic of financial leverage.

Summary:
This article discussed the importance of financial leverage in the selection of risk management
strategies. These results indicate that risk-management decisions should not be made without
considering the impact of financial leverage. While we consider the importance to financial leverage in
selection of risk-management strategies, risk aversion is also very important. By combining these two
assumptions the company can reduce the set of strategies that merit managerial attention.
The result of these strategies shows that the level of the risk-free return is an important consideration.
Because lower levels of the risk-free return make borrowing a more attractive alternative, this is
especially important when evaluating risk-management strategies that present the decision maker with
a reduced risk for decreased expected return trade-off.
This article addresses the problem of choice among risk-management strategies and applies the
stochastic dominance with risk-free asset (SDRA) criteria to address the choice problem. SDRA
incorporates financial leverage into ordinary stochastic dominance (SD) and can significantly improve
SD discriminatory power. This article gives an indication of the importance of alternative assumptions
about economic behavior in risk-management contexts and gives directions for future work in riskmanagement research and education.
Most risk-management tools are designed to control business risks, for example, price hedging and
output insurance. Financial risks are adjusted by varying the proportion of debt funds used to finance
the business. Debt funds "leverage" the return to equity funds by magnifying both positive and negative
returns. Thus, a producer might use risk-management tools to reduce business risk and consequently
reduce expected return.
According to this article, Decision makers who are risk averse and do not willing to take risk, are able
to adjust financial leverage, would choose from the second-degree SDRA efficient set which contained

three of the twenty-three strategies. Each individual decision maker would leverage these strategies
according to their own risk preferences. However, no risk adverse decision maker able to make this
leverage adjustment would select a strategy not contained in this set.

Summary:
In this article the writer quantify the effect of financial leverage on stock return volatility in a dynamic
general equilibrium economy with debt and equity claims. The effect of financial leverage is studied
both at a market and a firm level where the firm is exposed to both idiosyncratic and market risk.
They study two different economies. In both economies, the cash flows generated by a firms assets are
specified exogenously, have a constant volatility, and are split into an exogenously specified risk less
debt service and a dividend stream to equity holders. They derive the equilibrium prices and dynamics
of all financial claims and identify the economic forces behind the dynamics of stock volatility and
quantify the effect of financial leverage on the dynamics of stock volatility
In the first economy the study is consistent with the assumptions macroeconomic conditions are fixed
and financial leverage is the only driving force behind the dynamics of stock volatility. Financial
leverage generates little variation at the market level where cash flow volatility is low, and significant
variation at the firm level where cash flow volatility is higher. When financial leverage is the only
factor affecting the dynamics of stock volatility, the leverage effect hypothesis holds at the firm level
although stock volatility does not vary enough to be consistent with empirical evidence.
The second economy has a representative more realistic asset prices than in the first economy. The
driving force in this economy is counter-cyclical risk aversion caused by external habit formation in the
representative agents preferences. The model is calibrated to several features of empirical asset prices,
including the level and variation of the equity premium, the risk less rate, and the market price of risk.
We simulate the economy and explore the time-series behavior of a firms stock returns and volatility
allowing for both debt and equity. The assumptions of the leverage effect hypothesis are not satisfied in
our calibrated economy. Because of the time-variation in risk less rate and market price of risk, the
value of a firms assets will have a time-varying volatility and the value of debt contracts will be
exposed to interest rate risk
In an economy that generates time-variation in interest rates and the price of risk, there is significant
variation in stock return volatility at the market and firm level. In such an economy, financial leverage
has little effect on the dynamics of stock return volatility at the market level. Financial leverage
contributes more to the dynamics of stock return volatility for a small firm.
Overall, our analysis provides some support that financial leverage drives the dynamics of stock
volatility at the firm level. This feature is driven by individual risk influencing the firms equity value
and not the firms debt value. Hence, the firms financial leverage can move independent of market
conditions in contrast to our market-wide analysis. Time-varying market conditions are still important
determinants of even firm Is equity volatility. Given the firms debt value is still driven by systematic

interest rate risk, variations in financial leverage are still partially explained by systematic risk which
ultimately feeds into the variation in the firms equity volatility.

Summary:
In a financial system where balance sheets are continuously marked to market, asset price changes
show up immediately as changes in net worth, and obtain responses from financial intermediaries who
adjust the size of their balance sheets. Aggregate liquidity can be seen as the rate of change of the
aggregate balance sheet of the financial intermediaries.
The focus in this paper is on the reactions of the financial intermediaries to changes in their net worth,
and the market-wide consequences of such reactions. If financial intermediaries were passive and did
not adjust their balance sheets to changes in net worth, then leverage would fall when total assets rise.
Change in leverage and change in balance sheet size would then be negatively related. The evidence
points to financial intermediaries adjusting their balance sheets actively, and doing so in such a way
that leverage is high during booms and low during recession.
From the point of view of each institution, decision rules that result are readily understandable.
However, there are aggregate consequences of such behavior for the financial system as a whole that
might note taken into consideration by individual institutions. The discussion focuses on the
intermediaries balance sheets. However, the added insight from discussions is on the way that marking
to market enhances the role of market.
Aggregate liquidity can be understood as the rate of growth of the aggregate financial sector balance
sheet. When asset prices increase, financial intermediaries balance sheets generally become stronger,
andwithout adjusting asset holdingstheir leverage tends to be too low. The financial intermediaries
then hold surplus capital, and they will attempt to find ways in which they can employ their surplus
capital. In analogy with manufacturing firms, we may see the financial system as having surplus
capacity. For such surplus capacity to be utilized, the intermediaries must expand their balance sheets.
On the liability side, they take on more short-term debt. On the asset side, they search for potential
borrowers. Aggregate liquidity is intimately tied to how hard the financial intermediaries search for
borrowers.

Financial Leverage of Indian Companies

We have taken samples of Five Listed Companies of India, from different sectors. We have used
random sampling technique for the selection of these companies. We have analyzed the Companies
introduction, their financial conditions and financial reports.
Following are the companies we have selected and analyzed for our Project and we have analyzed the
data of previous four years. (2005-2008)

Ashika Textiles Limited

R.K. Chemicals Pvt. Ltd.

Ashika Textiles Limited:Company Introduction:

One of the largest manufacturers and exporters of textile products in India, Ashika technology
comes from Europe, Japan and USA. Capitalizing on the regions principal crop, cotton, we
source this locally, and augment our offerings by providing imported fiber from the worlds best
crops. We work with specialized fibers bringing in the newest innovations from major fiber and
chemical producers, and our manufacturing from yarn to finished fabric is performed in our
facilities in India. Synergies are formed with offshore garment manufacturing companies. Our
products are marketed to the industry's biggest names in Asia, Europe, Australia, and North
America.

Mission:
To build flexible manufacturing capabilities in the textile industry to cater to the growing and evolving
global demands, keeping a lead position in our business, maintaining our values based on good
business and ethics, and at the same time contributing in the development of the community in which
we work and live in.

Values:

P people
R relationship
I integrity
D diversity
E environment

Data Collected through Questionnaire

Ashika group have two sources of borrowing. That is banks and financing by private investor.
The rate of interest is both fixed and floating.
Ashika group tackle their interest rate fluctuations by using FRA (forward rate agreement) and
interest rate swap.
Borrowing is supported by collateral security.
Ashika group is also having covenants which help the company to better monitor its business
decisions.
Company is meeting its debt requirement through operating profit.
Company resort to debt financing rather than equity financing because its best cost of capital.

 Company goes for other sources of financing that are bank overdraft, bonds and debentures.
Company is utilizing its borrowing for long term and short term investment.

Financial Analysis of Company

Proportions of Debt and Equity of Ashika textile limited
2005

2006

2007

2008

Shareholders
Equity

2797.114

3893.928

6018.868

5577.492

Long term
Debt

1174.78

934.54

722.264

446.199

Total

3971.894

4828.468

6740.95

6023.691

Proportion of
Equity

70%

81%

89%

93%

Proportion of
Debt

30%

19%

11%

7%

Graphical representation of Debt and Equity Proportion:

100%
90%
80%
70%
60%
Equity

50%

Debt

40%
30%
20%
10%
0%
2005

2006

2007

2008

The above table shows that the Ashika textile limited has raised capital by 70% of Equity and 30%
Debt in the year 2005. We have calculated these proportions by taking values of long term debt and
equity from the companys annual reports.
We have added shareholder equity and debt to get the total. We have taken the total as 100 percent, and
then divided each by total to get the proportion.
We have seen that in the year 2006 the proportion of equity is increased from 70% to 81% and on the
other hand the debt of the company is decreased from 30% to 19%. Where as in 2007 the proportion of
equity is increased from 81% to 89% and proportion of debt is decreased from 19% to 11%.
In 2008 the debt has decreased to 7% and equity has increased to 93%.

Ratio Analysis of Ashika Textile Limited

Debt Equity Ratio:
The Debt to Equity Ratio measures how much money a company should safely be able to borrow over
long periods of time. Debt/equity ratio is equal to long-term debt divided by common shareholders'
equity. Typically the data from the prior fiscal year is used in the calculation. Investing in a company
with a higher debt/equity ratio may be riskier, especially in times of rising interest rates, due to the

additional interest that has to be paid out for the debt. It is important to realize that if the ratio is greater
than 1, the majority of assets are financed through debt. If it is smaller than 1, assets are primarily
financed through equity.

Debt Equity Ratio = Long Term Debt/ Shareholders Equity

Debt Equity ratio of Ashika Textile Limited

Ratios

2005

2006

2007

2008

Debt to Equity

0.42

0.24

0.12

0.08

Graphical representation of Debt-Equity Ratio of Ashika Textile

Limited

0.45
0.4
0.35
0.3
0.25

2005

0.2

2007

2006
2008

0.15
0.1
0.05
0
Debt to Equity

The above table is showing solvency ratios of company. We have taken the value from annual
report. We have calculated the debt to equity ratio of Ashika textile limited with dividing the
long term debt by equity. We have seen the results that the debt to equity ratio is decreasing
every year, like in 2005 debt-equity ratio is 0.42 but it decreased to 0.24 in the year 2006 and
shows the continuous decrease in 2007 and 2008 that is 0.12 and 0.08 respectively. This shows
that the company has lesser reliance on debt as a source of financing.

Debt to Capital Ratio:

Debt to Capital ratio shows the proportion of a company's debt to its total capital, which
consists of the sum of its debt and equity combined. The ratio compares a firm's total debt to its
total capital. The total capital is the amount of available funds that the company can use for
financing projects and other operations. A high debt-to-capital ratio indicates that a high
proportion of a company's capital is comprised of debt.

Debt to Capital = Debt/Shareholders Equity + Debt

Debt to Capital ratio of Ashika Textile Limited

Ratio

2005

2006

2007

2008

Debt to Capital

0.30

0.19

0.11

0.07

Graphical Representation of Debt to Capital ratio of Ashika Textile

Limited
0.35
0.3
0.25
2005

0.2

2006

0.15

2007

0.1

2008

0.05
0
Debt to Capital

We have calculated the debt to capital ratio of Ashika textile limited with dividing the long term
debt by the sum of total debt and shareholders equity. We have seen the results that the debt to
capital ratio is decreasing every year like in 2005 debt capital ratio is 0.30 but it decreased to
0.19 in the year 2006 and shows the continuous decrease in 2007 and 2008 which is 0.11 and
0.07 respectively. This shows that the company has more reliance on capital rather than debt.

Debt to Assets Ratio:

The debt/asset ratio shows the proportion of a company's assets which are financed through
debt. If the ratio is less than one, most of the company's assets are financed through equity. If
the ratio is greater than one, most of the company's assets are financed through debt. Companies
with high debt/asset ratios are said to be "highly leveraged".

Debt to Assets Ratio = Debt/Total Assets

Debt to Assets ratio of Ashika Textile Limited

Graphical Representation of Debt to Assets ratio of Ashika textile limited

Ratio

2005

200 200 200

0.18

0.06

0.04

0.16
0.14
0.12
0.1

2005

0.08

2007

2006
2008

0.06
0.04
0.02
0
Debt to Assets

0.16

Debt to Assets

0.10

We have calculated the debt to assets ratio of Ashika textile limited with dividing the debt by assets. We
have seen the results that the debt to assets ratio is decreasing every year like in 2005 debt to assets
ratio is 0.16 but it decreased to 0.10 in the year 2006 and shows the continuous decrease in 2007 and
2008 which is 0.06 and 0.04 respectively. This shows that the company is having positive net worth.

Financial Leverage:
The financial leverage ratio indicates the extent to which the business relies on debt financing. A high
financial leverage ratio indicates possible difficulty in paying interest and principal while obtaining
more funding.

Financial Leverage = Total Assets /Shareholders Equity

Ratio

2005

2006

2007

2008

Financial Leverage

2.62

2.37

1.85

2.21

Graphical Representation of Financial leverage ratio Ashika textile

limited
3
2.5
2
2005
2006

1.5

2007
2008

1
0.5
0
Financial Leverage

The calculation of financial leverage is done with dividing total assets by total shareholders
equity. The financial leverage of the company in the year 2005 is 2.62 and is decreasing to 2.37
and 1.87 in the years 2006 and 2007 respectively. That shows the company has greater reliance
on equity till 2007. But in 2008 the leverage ratio is increased to 2.21 because of decrease in
equity from 6018.868 to 5577.492.

Comments
With our analysis of Ashika textile limited we come to this conclusion that the company is
overall low leverage company as we have seen companys reliance is more on equity rather than
debt. Due to which the debt equity ratio, debt capital ratio and debt to asset ratio of Ashika
textile limited is decreasing from 2005 to 2008. Whereas the financial leverage ratio has shown
an increase in 2008 because owners equity has shown a decrease in 2008 as compare to 2007
I-e 6018.868 to 5577.492. Whereas the assets are increasing.

R.K. Chemicals Pvt. Ltd.

The R.K. Chemicals Group, a distinguished and trusted name in India, traces its origins back to almost
a century ago. The Group owns companies ranging from fertilizer, textiles, business and finance.
Through its diverse businesses, the R.K. Chemicals Group of Companies delivers some of the top
brands and the highest quality services. Most of the Group Companies consistently ranks amongst the
top 25 companies of KSE. The Group comprises of the following companies.
R.K. Chemicals Chemicals
R.K. Chemicals Lawrenceburg
Central Insurance Company
Inbox Business Technologies
Elixir Securities

R.K. Chemicals
R.K. Chemicals Chemicals Limited was incorporated as a public limited company on 17th April 1968,
as a joint venture between R.K. Chemicals Group of Industries and Hercules Inc. USA. It was the first
private sector venture in India to receive a loan from the World Bank and was the largest ammonia/urea
plant in country at that time. Initially the plant's capacity was 345,000 metric tons of urea per annum.
The plant was revamped in 1989 / 1991 to enhance the capacity to 445,500 metric tons of urea per
annum. Also, it made the manufacturing facilities more energy efficient and environment friendly. In
recent years, R.K. Chemicals has made a colossal investment to incorporate the latest technology; the
most significant are the construction of new Pilling tower in a record time; the tallest industrial
structure in India, replacement of Primary Waste Heat Exchanger. Primary Reformer Harps Assemblies
and conventional instrumentation (with Distributed Control System).R.K. Chemicals has the privilege
of becoming the first fertilizer manufacturing company to obtain ISO-9000:2000 certification.

Vision & Mission

To excel in the fertilizer and allied business at national and international level by maintaining highest
standards of product quality thereby playing our role in the development of the country's economy and
adding value to the shareholders' investment.
To offer consistent dividends to the shareholders.
To chalk out a plan to improve production techniques and quality standards.
To provide career grooming opportunities to the talented professionals.
To become a good corporate citizen.
To develop long-term relationship with the employees.
To create high performing Organizational Environment in which ideas are generated and nurtured.
To inculcate honest and ethical behavior.
To create safe, healthy environment and friendly atmosphere for the employees.
To improve quality of life for the employees.
To make the farmer community prosper.

Data collected from Questionnaire of R.K. Chemicals:

R.K. Chemicals is borrowing from both banks and private institutions.

The rate of interest on borrowing is both fixed and floating.
R.K. Chemicals tackles their interest rate fluctuations by using interest rate swap.
Borrowing is supported by collateral security.
R.K. Chemicals is having covenants which provide discipline.
R.K. Chemicals is meeting its debt requirement from operating profit.
Company resorts to debt financing rather than equity financing to get optimal cost of capital.
R.K. Chemicals goes for other sources of financing that are bonds and debentures.
Company is utilizing its borrowing for long term and short term investment.

Debt and Equity Proportions of R.K. Chemicals

2005

2006

2007

2008

Shareholders
Equity

9355.24

9273.14

18889.33

17382.66

Long term
Debt

6500

6302.5

total

9355.24

9273.14

25389.33

23685.16

Proportion of
Equity

100%

100%

74%

73%

Proportion of
Debt

0%

0%

25%

26%

Graphical Representation of Debt and Equity proportions of R.K. Chemicals

100%
90%
80%
70%
60%
Equity

50%

Debt

40%
30%
20%
10%
0%
2005

2006

2007

2008

The above table shows that the R.K. Chemicals has raised capital 100% of Equity in 2005 and 2006
and has not taken any debt. We have calculated these proportions by taking values of long term debt
and equity from the companys annual reports.
We have added shareholder equity and debt to get the total. We have taken the total as 100 percent, and
then divided each by total to get the proportion.
Where as in 2007 the proportion of equity is decreased from 100% to 74% and proportion of debt is
increased to 25%
In 2008 the debt has increased to 26% and equity has decreased to 73%.

Ratio Analysis of R.K. Chemicals

Debt Equity Ratio:
The Debt to Equity Ratio measures how much money a company should safely be able to borrow over
long periods of time. Debt/equity ratio is equal to long-term debt divided by common shareholders'
equity. Typically the data from the prior fiscal year is used in the calculation. Investing in a company
with a higher debt/equity ratio may be riskier, especially in times of rising interest rates, due to the
additional interest that has to be paid out for the debt. It is important to realize that if the ratio is greater
than 1, the majority of assets are financed through debt. If it is smaller than 1, assets are primarily
financed through equity.

Debt Equity Ratio = Long Term Debt/ Shareholders Equity

Debt Equity ratio of R.K. Chemicals

Ratios

2005

2006

2007

2008

Debt to Equity

0.34

0.36

Graphical Representation of Debt to Equity ratio of R.K. Chemicals

0.4
0.35
0.3
0.25

2005
2006

0.2

2007
0.15

2008

0.1
0.05
0
Debt to Equity

We have taken the value from annual report. We have calculated the debt to equity ratio of R.K.
Chemicals with dividing the long term debt by equity. We have seen the results that the debt to equity
ratio in 2005 and 2006 the company had not borrowed any debt and has total reliance on equity.
Whereas in 2007 and 2008 the company have 25% and 26% debt borrowing due to which the debt and
equity ratio of R.K. Chemicals have continuously increased from nil to 0.34 and 0.36 respectively.

Debt to Capital Ratio:

Debt to Capital ratio shows the proportion of a company's debt to its total capital, which consists of the
sum of its debt and equity combined. The ratio compares a firm's total debt to its total capital. The total
capital is the amount of available funds that the company can use for financing projects and other
operations. A high debt-to-capital ratio indicates that a high proportion of a company's capital is
comprised of debt.

Debt to Capital = Debt/Shareholders Equity + Debt

Debt to Capital ratio of R.K. Chemicals

Ratio

2005

2006

2007

2008

Debt to
Capital

0.25

0.26

Graphical Representation of Debt to Capital Ratio of R.K. Chemicals

0.3
0.25
0.2
2005
2006

0.15

2007
2008

0.1
0.05
0
Debt to Capital

We have calculated the debt to capital ratio of R.K. Chemicals with dividing the long term debt by the
sum of total debt and shareholders equity. We have seen the result that the debt to capital ratio is
decreasing from 2005 to 2006 is nil as the companys total reliance is on capital rather than debt. As the
table shows that debt to capital ratio is increasing in 2007 and 2008 that is 0.25 and 0.26 respectively,

Debt to Assets Ratio:

The debt/asset ratio shows the proportion of a company's assets which are financed through debt. If the
ratio is less than one, most of the company's assets are financed through equity. If the ratio is greater
than one, most of the company's assets are financed through debt. Companies with high debt/asset
ratios are said to be "highly leveraged".

Debt to Assets Ratio = Debt/Total Assets

Debt to Assets ratio of R.K. Chemicals

Ratio

2005

2006

2007

2008

Debt to Assets

0.22

0.24

0.3

0.25
0.2
2005
2006

0.15

2007
2008

0.1

0.05
0
Debt to Assets

We have calculated the debt to assets ratio of R.K. Chemicals with dividing the debt by assets. We have
seen the results that the debt to assets ratio is increasing in 2007 and 2008 that is 0.22 and 0.24
respectively. Whereas the company has no long term debt in 2005 and 2006 due to which the debt
equity ratio for both years is nil.

Financial Leverage:
The financial leverage ratio indicates the extent to which the business relies on debt financing. A high
financial leverage ratio indicates possible difficulty in paying interest and principal while obtaining
more funding.

Financial Leverage = Total Assets /Shareholders Equity

Financial Leverage of R.K. Chemicals

Ratio

2005

2006

2007

2008

Financial
Leverage

1.36

1.74

1.5

1.47

Graphical Representation of Financial Leverage ratio of R.K. Chemicals

2
1.8
1.6
1.4
1.2

2005

2006
2007

0.8

2008

0.6
0.4
0.2
0
Financial Leverage

The calculation of financial leverage is done with dividing total assets by total shareholders equity.
The financial leverage of the company in the year 2005 is 1.36 and is increased to 1.74 in the year
2006, and also showed the decreasing trend in 2007 and 2008 that is 1.5 and 1.47 respectively.

Interest Coverage Ratio:

A calculation of a company's ability to meet its interest payments on outstanding debt. The lower
the interest coverage ratio, the larger the debt burden is on the company, also called interest
coverage.
Interest Coverage Ratio = EBIT/Interest Payment

Interest Coverage ratio of R.K. Chemicals

Ratio

2005

2006

2007

2008

Interest
Coverage

3.87

1.81

1.36

2.82

Graphical Representation of Interest Coverage ratio of R.K. Chemicals

4.5
4
3.5
3
2.5

2005

2007

2006
2008

1.5
1
0.5
0
Interest Coverage

The calculation if interest coverage ratio is done by dividing earnings before interest and taxes by the
total interest paid. The interest coverage ratio of R.K. Chemicals is falling from 2005 to 2007 that is
3.87, 1.81and 1.36 respectively. Whereas it increased in 2008 to 2.82.This shows that the firm is not
having difficulty in meeting its debt obligations

Comments
R.K. Chemicals is a low leverage firm as the company is not doing any sort of debt borrowing in 2005
and 2006 and only took 26% debt in 2008 .Due to which the Debt to Equity, Debt to Capital and Debt
to asset ratio are showing a declining trend. The interest coverage ratio of R.K. Chemicals is
continuously increasing which means that the company will have no problem in meeting its debt
obligation

Data analysis by using SPSS technique

Frequency table:
We have calculated frequencies of each question by entering data into SPSS sheets. These frequencies
are showing following information.

What are your sources of borrowing?

Valid

Banks
Combination
of banks and
financing by
any private
investor
Total

Valid
Cumulative
Percent
Percent
40.0
40.0

Frequency
2

Percent
40.0

60.0

60.0

100.0

100.0

100.0

According to this table source of borrowing is mostly done by combination of both banks and financing
by any private investors. As the 60 % goes to the 2nd option and 40% is for banks only.

What is the rate of interest?

Valid

Floating

Frequen
cy
1

Percent
20.0

Valid
Cumulativ
Percent
e Percent
20.0
20.0

Both fixed
and
floating
Total

80.0

80.0

100.0

100.0

100.0

Rate of interest for most of the companies is both fixed and floating. And only one company is paying
interest on floating rate.

How you tackle the interest rate fluctuations?

Valid

FRA
Interest
rate swap
FRA and
Interest
rate swap
Total

Frequency Percent
1
20.0

Valid
Percent
20.0

Cumulative
Percent
20.0

60.0

60.0

80.0

20.0

20.0

100.0

100.0

100.0

There are three ways to tackle interest rate fluctuations. Mostly companies are using interest rate swap
for this purpose as the 60% is showing in the table. While one company is using only FRA and one is
combination of FRA and interest rate swap.

Is the borrowing supported by collateral security?

Frequency Percent
Valid yes

100.0

Valid
Percent
100.0

Cumulative
Percent
100.0

The percentage of borrowing supported by collateral security is 100% because all the companies have
borrowings backed by securities.

Do you have any covenants?

Valid yes

Frequency Percent
5
100.0

Valid
Percent
100.0

Cumulative
Percent
100.0

Covenants are the restrictions on borrowing and all the companies have covenants that restrict their

borrowings.
If yes then how they affect your business decisions?

Valid

Provide
discipline
Timely
payments
No direct
effect
No effect
Total

Valid
Percent

Cumulative
Percent

Frequency

Percent

40.0

40.0

40.0

20.0

20.0

60.0

20.0

20.0

80.0

1
5

20.0
100.0

20.0
100.0

100.0

40% of spas analysis shows that most of the companies think that covenants have positive effects on
their business operations as they help to maintain discipline and make timely payment. And some of the
companies say that there is no effect of covenants on their business decisions.

How you meet your debt requirement?

Frequency Percent
Valid

Operating
profit
Any other
Total

Valid
Percent

Cumulative
Percent

80.0

80.0

80.0

1
5

20.0
100.0

20.0
100.0

100.0

Almost all the companies meet their debt requirement through operating profit.

Why you resort to debt financing why not equity only?

Frequenc
y

Percent

Valid
Percent

Cumulative
Percent

Valid

Best cost of
capital
Working
capital
requirement
Timing
difference
of cash
flows
as per
company
policy
Total

40.0

40.0

40.0

20.0

20.0

60.0

20.0

20.0

80.0

20.0

20.0

100.0

100.0

100.0

Companies go for debt financing because they think it provides best cost of capital and also meet their
working capital requirements. Another reason for debt financing is to fill time gap between cash
inflows and outflows.

Do you go for other sources of financing?

Frequency Percent
Valid

Bonds and
debentures
Overdraft
borrowings
Both bonds
and
debentures
and
overdraft
bowings
Total

Valid
Percent

Cumulative
Percent

20.0

20.0

20.0

40.0

40.0

60.0

40.0

40.0

100.0

100.0

100.0

Companies dont only rely on debt financing they also go for other sources like bonds, debentures and
overdraft borrowings.

How company utilizes its borrowings?

Frequen
cy

Percent

Valid
Percent

Cumulativ
e Percent

Valid

Both short
term and
long term
investment
For any
other
purpose
Total

80.0

80.0

80.0

20.0

20.0

100.0

100.0

100.0

The companies utilize their borrowings for the purpose of short term and long term investment.

Do you think financial sector reforms have improved the efficiency of the financial leverage?

Frequency Percent
Valid agree

100.0

Valid
Percent

Cumulative
Percent

100.0

100.0

All the companies agree that financial reforms have improved the efficiency of the financial leverage.

Findings
After conducting this overall research we can conclude that most of the companies in India are low
leveraged that means that their greater reliance is on equity as a source of financing rather than debt
due to which they have many benefits.
It is less risky for a company to have a low ratio of financial leverage. With a low leverage companies
can meet its debt obligations and there is an opportunity for it to find new lenders in the future.
Companies with low leverage can easily expand their business they can buy new assets which enhance
companies production capacity.
Companies that are not in equity market, debt financing allows a firm to raise capital without having to
sell shares to investors

Recommendations:
The companies with high leverage dont have capacity to borrow more funds whereas the low leverage

companies can borrow funds at the time they need.

Any time companies use debt financing, they are running the risk of bankruptcy. The more debt
financing it uses, the higher the risk of bankruptcy. If you dont make loan payments on time, you can
ruin your credit rating and make borrowing in the future difficult or impossible.
Company can do both debt and equity financing but the proportion of debt should be lower than
proportion of equity so that the leverage ratio would be lower and it is beneficial for the company to
pay off its debt.

It is more risky for a company to have a high ratio of financial leverage. Companies that are highly
leveraged may be at risk of bankruptcy if they are unable to make payments on their debt; they may
also be unable to find new lenders in the future.
In short what is best; debt or equity financing? It depends on the situation. Your financial capital,
potential investors, credit standing, business plan, tax situation, the tax situation of your investors, and
the type of business you plan to start all have an impact on that decision.

Example of Financial Leverage

A firm has sales of ` 10,00,000, variable cost of ` 7,00,000 and fixed costs of ` 2,00,000 and debt
of ` 5,00,000 at 10% rate of interest. What are the operating, financial and combined leverages?
It the firm wants to double its Earnings before interest and tax (EBIT), how much of a rise in
sales would be needed on a percentage basis?
Solution:
Statement of Existing Profit
Sales ` 10,00,000
Less : Variable Cost 7,00,000
Contribution 3,00,000
Less : Fixed Cost

2,00,000

EBIT 1,00,000
Less : Interest @ 10% on 5,00,000
Profit before tax (PBT)

50,000

Sales ` 13,33,333
Variable Cost (70%) 9,33,333
Contribution 4,00,000
Fixed Costs

2,00,000

EBIT 2,00,000
Verification

50,000

Conclusion
Financial Leverage is the extent to which a company is committed to fixed charges related to
interest payments. Capital Structure is the mix of debt & equity that makes up a companys total
market value.
Also help to know the financial conditions of Companies which help to take decision for Future
requirement of companies.

Bibliography
www.acmills.in
www.pepsicoindia.co.in
www.icmai.in
www.scribd.com