Case 5 HINDUSTAN PETROLEUM CORPORATION LIMITED (HPCL)—FINANCIAL EVALUATION OF EXISTING RETAIL OUTLET SHIVA FILLING STATION BACKGROUND OF THE COMPANY Shiva Filling Station was established in 1986 and has been in the business of trading of petrol, diesel and engine oil. ‘The business was set up as sole proprietorship by Shiva Lal. Initially, chis retail outlet of HPCL faced number of problems. The sale remained stagnant at low levels for quite sometime. However, the business continued its operations as its sales were expected to grow. This was because the filling station was going to be part of a newly created ring road. ‘This expectation helped Shiva Filling Station to stay on as well as HPCL providing support to this outlet. With the construction of ring road in 1994 and development of residential housing blocks in and around the area subsequently, the location of Shiva Filling Station proved to be a prime one. The sales started increasing and finally operations turned to be profitable. The performance of outlet showed considerable improvement and it started reporting positive profits after 1996. The annual turnover of petrol and diesel was then in the range of 900 kls and 600 kls per annum, respectively. The sales of lubes were still on the lower side but were expected to grow in future. NATURE OF THE BUSINESS Over the years, the demand from consumers increased at a significant rate. Further, many new housing blocks were developed and the region experienced a significant growth of townships in and around Shiva's location. In order to meet this growing demand, a number of other filling stations came up in the vicinity of Shiva Filling Station. This in some way started affecting the sales of Shiva Filling Station. Shiva observed that with this growth of townships and growing competition, some of the customers who were loyal to his station started using other outlets occasionally. One of the things Shiva realized was that the expectations of the customers were changing. He had not responded to these changes in any significant manner and was doing the business as usual. For example, Shiva had not introduced any new services for quite some time. Somehow he felt it was not necessary. For example, neither did he focus on improving the look of18 mt Cases IN FINANCIAL MANAGEMENT his outlet nor introduced any new initiative to attract the customers to meet their requirements. However, he soon realized this as one of factors that could have affected the loyalty of his customers. HPCL has also over the years emphasized the customer vision and strengthening of retain outlets, For example, the vision of the retail SBU suggested the following: © Ensure customer delight at the point of interface. Fulfil the stated and latent needs of customer through innovative products and services * Competent, committed and empowered employees © Conducting business in a fair, transparent and ethical manner ‘# Sense of pride and mutual trust and camaraderie * To perform consistently better than competitors to sustain growth and profitability Vikram Chadda, Sales Officer In-charge of the region, was concerned about the operations of this outlet. He was constantly monitoring its performance. Vikram was of the view that for the filling station to meet the expectations of consumers, Shiva needed to introduce a number of new initiatives. However, this required more funds as new initiative would need investments. From his interaction, he fele chat Shiva was not sure about the economic and financial potential of these new initiatives. Shiva would be apprehensive about whether he would earn reasonable return on these investments. ‘As a starting point, Vikram thought of having a look at its existing operations and understand the financial position before he made any suggestions on future course of action. He also remembered that of late though the sales of the outlet had increased, Shiva was happy with his financial performance. This was quite visible as the competition was intensifying. FINANCIAL PERFORMANCE OF SHIVA FILLING STATION, Shiva’s financial performance revealed the following points: The sales of Shiva Filling Station increased from Rs. 1.4 crore in 1996 to Rs. 4,34 crore in 2003. Profits have not risen at the same rate, Shiva’ profits in 2003 had been about Rs. 1 lakh only. Vikram was interested in finding out how had this outlet performed on financial parameters and explored whether it had potential for future growth and profitability if new initiatives were developed and implemented. Vikram proposed that the following questions were needed to be answered to fully understand the performance of this outlet: * How profitable were its current operations? How would new initiatives and growch affect the future profitability of the outlet? © What factors had contributed to the operating performance of Shiva? What was the role of profitability margin and asset utilization in this? © How had Shiva performed in terms of return on equity? What was the contribution of the way the business had been financed over the period?Hinoustan Peraoueum Corporation Lintreo (HPCL)... mi 19 © Could the outlet sustain growth and improve its profitability given the competitive and other environmental situations? © Where were his resources invested in the business? How effectively had che firm utilized these assets in generating sales? © How had Shiva financed its growth in the past? What was the contribution of internally generated funds? © Given the outlets operating circumstances, was its current financial structure appropriate? © What kind of financial pressures might the outlet face in future? Would it be able to raise necessary funds at acceptable terms? How to assess the future initiatives from investment point of view? Financial Statements For this purpose, Vikram collected the previous year's financial statements of Shiva Filling Station. Exhibits 1-5 contain these statements. Vikram also scheduled a meeting with Shiva. ‘The following is the summary of points based on the financial information Vikram collected and the discussion he had with Shiva Lal: The outlet prepared its accounts based on accrual basis of accounting and never changed its accounting system. From the beginning, the outlet has been preparing its statements of accounts based on accrual system of accounting. Exhibits 1 and 2 provide the balance sheet and profit and loss account of the firm. The stocks were always valued at market price. The description of its assets is provided in Exhibic 3. The depreciation of fixed assets was provided as per the written down value method provided in Income ‘Tax Act. All fixed assets were stated at the cost price. During the last year of operations, Shiva had expanded its facilities by investing resources in various facilities. For example, Shiva had installed water cooler and aquaguard. Some funds were also invested in fire safety equipments. The irregular power supply had also forced Shiva to invest some resources in generator. The total amount of investments in expanding the facilities totalled about Rs. 7.31 lakh. These investments had put a lot of strain on finances of the outlet. “They at times faced cash shortages. This also resulted in deferring a number of expenditures. For example, Shiva deferred lease rental payments and other expenses (see Exhibit 4 section C). ‘The total payables worked out Rs. 0.76 lakh. The development of these facilities certainly needed more funds. Shiva had brought in his own savings to finance these requirements. However, his contribution was not adequate to meet all the requirements. To meet the gap, he had to borrow a substantial amount from his friends and relatives. Therefore, the level of borrowings increased substantially in comparison to his funds contribution. Vikram anticipated that this would have significant impact on the ability of the outlet to raise funds in fucure, They needed fands to plan for berter growth in future. One of the factors that bothered Vikram was the level of stocks as shown in the Balance Sheet of the outlet. The outlet was having an inventory stock of Rs. 11 lakh. This represented about 10 days of stock. This was very unusual as Vikram observed that many outlets kept very low stocks and many times, the outlets went dry and lost a lot of sales. In contrast to that,20 Cases in FiNANcIAL MANAGEMENT Shiva had locked substantial amount of funds in inventory. Vikram was wondering whether this was the stock the firm maintained throughout the year. He examined the month-end stock levels during the previous year and found on an average the firm was maintaining 7 days of stock. This required funds as 7 days of stock needed to be maintained. “To support the high levels of stocks, no formal channel of financing was available to outlets like Shiva. Having no credible standing in the market, banks were not interested in extending the cash credit to firms like Shiva. There were some filling stations that were able to raise money for working capital based on their standing and relationship with the bank. HPCL had also initiated some steps to negotiate with banks to recommend to them to extend the credie to filling stations, However, the experience from this initiative had been mixed. Shiva, in the past, had approached to his bank but was not extended the credit. Options to raise funds to finance the working capital requirements of the filling stations remained limited and in most cases filling station owners were required to mobilize resources from their own sources. Borrowings from friends and relatives were generally the main source of funds. ‘This source of finance had many limitations. In a number of cases, the outlets borrowed money from informal sources sometimes paying very high cost on these funds. Given the low margins, the high interest cost, critically affected the profitability of operations. Vikram also found that substantial funds were locked in accounts receivables. During the past few years, the accounts receivables of several outlets had gone up in pursuit to sell more. In the process, many outlets in region suffered because several of these accounts could not be recovered. However, in case of Shiva, Vikram found that almost all of these accounts were good and there was no risk of bad debt losses. The outlet had high cash balances with their bank. Vikram observed that this may be a typical situation as on year-end basis. However, this was not true, On an average, the firm had to buy Rs. 1.20 lakh worth of fuel every day and cash payments were needed for this purpose. Shiva’ sales though at levels of Rs. 4 crore were much berter than the other similar filling stations in the region, it still faced high operating risk. Vikram was wondering that given the competition the levels of sales may dip in future if something significant was not done. In case necessary steps were not taken at this stage, Shiva might lose interest in business and HPCL might lose a potentially profitable partner in the process. The cost structure of the filling station was generally biased cowards the variable cost for being the cost of fuel and supplies. Almost 95 — 97 per cent of costs were cost of fuels and supplies. ‘The profits were, thus, dependent on sales volume performance. Vikram was wondering what was safety of margin of Shiva. That is, how far he could sustain the decline in sales assuming all other expenses were fixed in nature and the only variable cost was cost of fuel. While examining expenses of Shiva, Vikram was bothered about two main items. One was interest cost and second was expenses towards lease rentals, Most of the borrowings were from friends and relatives. Vikram had apprehension that most of these funds belonged to Shiva himself. He was pethaps not interested in bringing all his money in the form of equity capital, but would prefer to lend the funds to the outlet. This ensured him certain cash flows in from interest payments and also helped him to plan his taxes better as interest is tax deductible expense. TheHivoustan Peraoveum Conporarion Limtrep (HPL)... 21 other expense was lease rentals. Vikram also found that the land that had been leased by Shiva belonged to his brother. Vikram was wondering whether these two items should qualify for the expenses in operating sense. For quite some time, Shiva had been showing profits. One of the sources of funds to finance new requirements was internally generated funds. During the year, Shiva had withdrawn an amount of Rs. 42,000 for his personal expenses. Vikram was also interested in knowing the role of internally generated funds and whether Shiva had been ploughing back adequate resources to finance its growth. DISCUSSION QUESTIONS 1. How has Shiva Filling Station performed? How would you use financial information provided in the case to evaluate performance of Shiva Filling Station? 2. How would you find whether Shiva is running profitable operations or not? What are drivers of its financial and operating performance? 3. What strategies you suggest to improve financial and operating performance of the company? What would you suggest to change and why?22 mi Cases iN FINANCIAL MANAGEMENT Exhibit | SHIVA FILLING STATION Balance Sheet ‘As on March 31, 2003 Particulars ‘Amount Rs. ‘Amount Rs. Sources of Funds Capital Account (last year balance of capital was Rs. 205,000) 464,577 464,577 Loan Funds Secured Loan 0 o Unsecured Loan 1,160,000 1,160,000 Total 1,624,577 Application of Funds Fixed Assets Gross Block 730,961 Less: Depreciation 98,701 Net Block 632,260 Current Assets, Loans and Advances Stock 1,115,928 Accounts Receivables 97,408 ‘Cash and Bank 227,211 1,440,547 Creditors 300,356 Prepaid Amounts 72,000 Unpaid Expenses 75,874 448,230 Net Current Assets 992,317 Total 1,624,577Hinoustan Peraoueum Corporation Lintreo (HPCL). 23 Exhibit II SHIVA FILLING STATION Profit and Loss Account for the year ended March 31, 2011 Particulars Amount Rs. INCOME Trading Income 43,420,896 Other Income 1,000 Toral Income 43,421,896 EXPENDITURE Cost of Goods Sold 41,946,199 Operating Expenses 29,124 Administrative Expenses 1,246,296 Depreciation 98,701 Profit Carried Forward to Balance Sheet 101,576(Cases IN FINANCIAL MANAGEMENT 24 ogz'ze9 Loz‘e6 L96'08L 0 zsL'7si pseZLs — sse'so sy aunouly [E20] oos‘zt oos‘z o00'oz o o00'oz 0 0 43]005 s02e\ L908 60z'L eae 0 0 oes'y 0 duing ajqissouigns wes esZ sz09 0 sz0'9 0 0 soresa8iyay tp 89 ovs 0 ors 0 0 quawinnsuy see'ys s7u'aL oos'zz 0 0 ooszz =o 40181049) o1e'sz egs‘ZL cor'ee o £176 oesz'6c =o saunaig 79 aunaiuang s9sz ss ore 0 0 ozv'e 0 auauunaasuy Axayes aul g96'8s rev‘on z91'69 0 199% s6r'99, 0 uone|persu) 2422913 zoo'Lee eales. SeL'poe 0 LOL'’9 ez9'esz —ss9s9 Buiping z90'8e ser's oos‘er 0 oos‘er 0 0 Jomo ANY osi‘ee oso'eL ooz'zs o o ooz'zs =o 4ossaidwio any Lees £94 0019 0 oo1'g 0 0 paeng enby Lloz/e/te wonPpeddeg pre wonanpag, aaquiandes Z0/10/r0 s1a55y Jo ouiPNy wosy saquiaidas ‘auajag — sunjog sourjog sayy wonppy ——_uorppy Samad siassy paxig Jo p01g yeays aouejeg ayp jo wed Bunui0y anpayss, NOLLWIS ONITHS WAIHS mqHinoustan Pernoteum ConPoRarion Lint £0 (HPCL).... m 25 Exhibit IV SHIVA FILLING STATION Schedule forming part of the Balance Sheet ‘Amount Rs. Current Li & Provisions (A) Creditors Harsh Electronics 30,990 Heena Corporation 42,862 Hindustan Petroleum Corporation Ltd 184,138 Nebulla Impression 13,540 Rathod Welding Works 4,000 Saraswati Machineries Screen O Graphics Yash Marketing Total Amount (B) Account Deposit from party AJ Enterprise ‘Asal Marketing Pvt. Led. B &R Industrial Automation Pvt. Ltd. LCECO, L.P.& Sons Rakesh Gupta SP. Marketing Shiv Ashish Hostel Trivedi & Gupta Advocates Total Amount (C) Unpaid Expenses ‘Audit Fees Payable Lease Rent Payable Security Charges Payable ‘Telephone Payable Vakil Fees Payable Total Amount 300,356 2,000 4,000 10,000 10,000 5,000 4,000 8,000 25,000 4,000 72,000 5,000 60,000 2,500 5,374 3,000 75,874 (Contd.)26 m Cases In FINANCIAL MANAGEMENT SUMMARY Creditors, 300,356 Account Deposit from party 72,000 Unpaid Expenses 75,874 Total Amount 448,230 Exhibit V SHIVA FILLING STATION Schedules forming part of Accounts Particulars Rs. Opening Stock 303,919 Add: Purchase 42,758,208 Total stock available 43,062,127 Less: Closing Stock 1,115,928 Cost of Goods Sold 41,946,199 Diesel Expenses 19,024 Pump Operating Expenses 10,100 Operating Expenses 29,124 Account Charges 21,000 Advertisement Expenses 5,096 Audit Fees 5,000 Bank Charges 1,763 Consulting Charges 15,000 Conveyance Expenses 19,753 Donation Expenses 3,251 Electric Expenses 43,373, Gardening Expenses 22,485 Gift Expenses 11,970 Insurance Expenses 15,711 Interest Expenses 78,000 Lease Rent Expenses 330,000 Measurement Expenses 14,985 (Contd.)Membership Expenses Miscellaneous Expenses Office Expenses Opening Ceremony Expenses Postage & Courier Expenses Repair & Maintenance Expenses Salary Expenses Sales Promotion Expenses Security Charges Stationery & Printing Expenses Tea & Coffee Expenses Telephone Expenses Vakil Fees Vehicle Expenses ‘Water Charges Hinoustan Peraoueum Corporation Lintreo (HPCL). Administrative Expenses 5,500 2,789 30,324 27,000 2,730 8,611 339,000 66,103 30,724 55,162 25,944 24,075 5,500 18,672 16,775 1,246,296 27