SSRN Id1672242

ANALYSIS OF THE PROFITABILITY RATIOS OF HCL1
COMPANY PROFILE: HCL
Company overview
HCL Enterprise is a leading Global Technology and IT enterprise that comprises two
companies listed in India - HCL Technologies & HCL Infosystems. The 3-decade-old
enterprise, founded in 1976, is one of India's original IT garage startups. Its range of offerings
spans Product Engineering, Custom & Package Applications, BPO, IT Infrastructure
Services, IT Hardware, Systems Integration, and distribution of ICT products. The HCL team
comprises approximately 45,000 professionals of diverse nationalities, who operate from 17
countries including 360 points of presence in India. HCL has global partnerships with several
leading Fortune 1000 firms, including leading IT and Technology firms.
HCL Technologies is one of India's leading global IT Services companies, providing
software-led IT solutions, remote infrastructure management services and BPO. Having made
a foray into the global IT landscape in 1999 after its IPO, HCL Technologies focuses on
Transformational Outsourcing, working with clients in areas that impact and re-define the
core of their business. The company leverages an extensive global offshore infrastructure and
its global network of offices in 18 countries to deliver solutions across select verticals
including Financial Services, Retail & Consumer, Life Sciences & Healthcare, Hi-Tech &
Manufacturing, Telecom and Media & Entertainment (M&E). For the quarter ended 31st
December 2007, HCL Technologies, along with its subsidiaries had last twelve months
(LTM) revenue of US $ 1.65 billion (Rs. 6715 crores) and employed 47,954 professionals.
Born in 1976, HCL has a 3 decade rich history of inventions and innovations. In 1978,
HCL developed the first indigenous micro-computer at the same time as Apple and 3 years
before IBM's PC. This micro-computer virtually gave birth to the Indian computer industry.
The 80's saw HCL developing know-how in many other technologies. HCL's in-depth
knowledge of Unix led to the development of a fine grained multi-processor Unix in 1988,
three years ahead of Sun and HP.
HCL's R&D was spun off as HCL Technologies in 1997 to mark their advent into the
software services arena. During the last eight years, HCL has strengthened its processes and
applied its know-how, developed over 30 years into multiple practices - semi-conductor,
1
Tarumoy Chaudhuri, Student pursuing B.B.A. L.L.B. (Hons.) at National Law University (Jodhpur).
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operating systems, automobile, avionics, bio-medical engineering, wireless, telecom
technologies, and many more.
Today, HCL sells more PCs in India than any other brand, runs Northern Ireland's
largest BPO operation, and manages the network for Asia's largest stock exchange network
apart from designing zero visibility landing systems to land the world's most popular
airplane.
INTRODUCTION TO RATIO ANALYSIS
When it comes to investing, analyzing financial statement information (also known as

quantitative analysis) is one of the most important elements in the fundamental analysis
process. At the same time, the massive amount of numbers in a company's financial
statements can be bewildering and intimidating to many investors. However, through
financial ratio analysis, they will be able to work with these numbers in an organized fashion.
Purposes and Considerations of Ratios and Ratio Analysis
Ratios are highly important profit tools in financial analysis that help financial
analysts implement plans that improve profitability, liquidity, financial structure, reordering,
leverage, and interest coverage. Although ratios report mostly on past performances, they can
be predictive too, and provide lead indications of potential problem areas.
Ratio analysis is primarily used to compare a company's financial figures over a
period of time, a method sometimes called trend analysis. Through trend analysis, you can
identify trends, good and bad, and adjust your business practices accordingly. You can also
see how your ratios stack up against other businesses, both in and out of your industry.
There are several considerations one must be aware of when comparing ratios from
one financial period to another or when comparing the financial ratios of two or more
companies.
 If one is making a comparative analysis of a company's financial statements over a
certain period of time, an appropriate allowance for any changes in accounting

policies that occurred during the same time span should be made
 When comparing one business with another in the same industry, any material
differences in accounting policies between your company and industry norms should
be allowed.
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 When comparing ratios from various fiscal periods or companies, inquiry about the
types of accounting policies used should be done. Different accounting methods can
result in a wide variety of reported figures.
 Determine whether ratios were calculated before or after adjustments were made to
the balance sheet or income statement, such as non-recurring items and inventory or
pro forma adjustments. In many cases, these adjustments can significantly affect the
ratios.
 Any departures from industry norms should be carefully examined.
When we use ratio analysis we can work out how profitable a business is, we can tell
if it has enough money to pay its bills. Ratio analysis can also help us to check whether a
business is doing better this year than it was last year; and it can tell us if our business is
doing better or worse than other businesses doing and selling the same things. The key
question in ratio analysis isn't only to get the right answer: for example, to be able to say that
a business's profit is 10% of turnover.
We can use ratio analysis to try to tell us whether the business
1. is profitable
2. has enough money to pay its bills
3. could be paying its employees higher wages
4. is paying its share of tax
5. is using its assets efficiently
6. has a gearing problem
7. is a candidate for being bought by another company or investor
and more, once we have decided what we want to know then we can decide which ratios we
need to solve the problem facing us.
Any successful business owner is constantly evaluating the performance of his or her
company, comparing it with the company's historical figures, with its industry competitors,
and even with successful businesses from other industries. To complete a thorough
examination of your company's effectiveness, however, you need to look at more than just
easily attainable numbers like sales, profits, and total assets. You must be able to read
between the lines of your financial statements and make the seemingly inconsequential
numbers accessible and comprehensible.
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This massive data overload could seem staggering. Luckily, there are many well-
tested ratios out there that make the task a bit less daunting. Comparative ratio analysis helps
you identify and quantify your company's strengths and weaknesses, evaluate its financial
position, and understand the risks you may be taking.
As with any other form of analysis, comparative ratio techniques aren't definitive and
their results shouldn't be viewed as gospel. Many off-the-balance-sheet factors can play a role
in the success or failure of a company. But, when used in concert with various other business
evaluation processes, comparative ratios are invaluable.
Not everyone needs to use all of the ratios we can put in these categories so the table
that we present at the start of each section is in two columns: basic and additional.
The basic ratios are those that everyone should use in these categories whenever we are
asked a question about them. We can use the additional ratios when we have to analyse a
business in more detail.
Use and Limitations of Financial Ratios
Attention should be given to the following issues when using financial ratios:
 A reference point is needed. To be meaningful, most ratios must be compared to
historical values of the same firm, the firm's forecasts, or ratios of similar firms.
 Most ratios by themselves are not highly meaningful. They should be viewed as
indicators, with several of them combined to paint a picture of the firm's situation.
 Year-end values may not be representative. Certain account balances that are used to
calculate ratios may increase or decrease at the end of the accounting period because
of seasonal factors. Such changes may distort the value of the ratio. Average values
should be used when they are available.
 Ratios are subject to the limitations of accounting methods. Different accounting
choices may result in significantly different ratio values.
USERS OF ACCOUNTING INFORMATION

The list of categories of readers and users of accounts includes the following people
and groups of people:
 Investors
 Lenders
 Managers of the organisation

 Employees
 Suppliers and other trade creditors
 Customers
 Governments and their agencies
 Public
 Financial analysts
 Environmental groups
 Researchers: both academic and professional
WHAT DO THE USERS OF ACCOUNTS NEED TO KNOW?
Investors to help them determine whether they should buy shares in the
business, hold on to the shares they already own or sell the shares they
already own. They also want to assess the ability of the business to
pay dividends.
Lenders to determine whether their loans and interest will be paid when due
Managers might need segmental and total information to see how they fit into
the overall picture
Employees information about the stability and profitability of their employers to

assess the ability of the business to provide remuneration, retirement
benefits and employment opportunities
Suppliers and other businesses supplying goods and materials to other businesses will read
trade creditors their accounts to see that they don't have problems: after all, any
supplier wants to know if his customers are going to pay their bills!
Customers the continuance of a business, especially when they have a long term
involvement with, or are dependent on, the business
Governments and the allocation of resources and, therefore, the activities of business. To
their agencies regulate the activities of business, determine taxation policies and as
the basis for national income and similar statistics
Local community Financial statements may assist the public by providing information

about the trends and recent developments in the prosperity of the
business and the range of its activities as they affect their area
Financial analysts they need to know, for example, the accounting concepts employed
for inventories, depreciation, bad debts and so on
Environmental many organisations now publish reports specifically aimed at

groups informing us about how they are working to keep their environment
clean.
Researchers researchers' demands cover a very wide range of lines of enquiry

ranging from detailed statistical analysis of the income statement and
balance sheet data extending over many years to the qualitative
analysis of the wording of the statements
WHICH RATIOS WILL EACH OF THESE GROUPS BE INTERESTED IN?
Interest Group Ratios to watch
Investors Return on Capital Employed
Lenders Gearing ratios
Managers Profitability ratios
Employees Return on Capital Employed
Suppliers and other trade creditors Liquidity
Customers Profitability
Governments and their agencies Profitability
Local Community This could be a long and interesting list
Financial analysts Possibly all ratios
Environmental groups Expenditure on anti-pollution measures
Researchers Depends on the nature of their study

Therefore from the above table it is clear that profitability ratios are generally
required by owners, managers, customers, governments and their agencies. There can be still
more interest groups who will be interested in these ratios.

PROFITABILITY RATIOS
Profitability ratios are a class of financial metrics that are used to assess a business's
ability to generate earnings as compared to its expenses and other relevant costs incurred
during a specific period of time. For most of these ratios, having a higher value relative to a
competitor's ratio or the same ratio from a previous period is indicative that the company is
doing well. Profitability ratios focus on how well a firm is performing. Profit margins
measure performance with relation to sales. Rate of return ratios measure performance with
relation to the size of the investment.
The owners and management or the company itself are interested in the financial
soundness of the firm apart from its creditors. The management of the firm is naturally eager
to measure its operating efficiency. Similarly, the owners invest their funds in the expectation
of reasonable returns. The operating efficiency of a firm and its ability to ensure adequate
returns to its shareholders depends ultimately on the profits earned by it.
In other words, the profitability ratios are designed to provide answers to questions
such as
(i) Is the profit earned by the firm adequate?
(ii) What rate of return does it represent?
(iii) What is the rate of profit for various divisions and segments of the firm?
(iv) What are the earnings per share?
(v) What was the amount paid in dividends?
(vi) What is the rate of return to equity shareholders?
The profitability ratios can be sub-divided into two categories:
A. In relation to sales which include gross profit ratio, net profit ratio and operating
profit ratio
B. In relation to investments which include return on assets, return on return on
capital employed and return on shareholder’s equity
Profit is the difference between turnover, or sales, and costs: that is,
Profit = Sales – costs
A profit margin is one of the profit figures we just mentioned shown as a percentage
of turnovers or sales. They always tell us how much profit, on average, our business has
earned per Rupee of turnover or sales.
In the following pages, these ratios have been evaluated and analysed in detail.

A. Profitability Ratios Related to Sales
These ratios are based on the premise that a firm should earn sufficient profit on each rupee
of sales. If adequate profits are not earned on sales, there will be difficulty in meeting the
operating expenses and no returns will be available to the owners. These ratios are of three
types which are discussed below.
1. Gross profit Margin:
A company's cost of sales, or cost of goods sold, represents the expense related to
labor, raw materials and manufacturing overhead involved in its production process. This
expense is deducted from the company's net sales/revenue, which results in a company's first
level of profit, or gross profit. The gross profit margin is used to analyze how efficiently a
company is using its raw materials, labor and manufacturing-related fixed assets to generate
profits. A higher margin percentage is a favorable profit indicator.
It is also known as gross profit ratio. Profit margin measures the relationship
between profit and sales. Gross profit ratio is calculated by dividing gross profit by sales.
Thus,
Gross Profit Margin = Gross Profit x 100

Sales
Significance and uses of gross profit ratios

Gross profit ratio reveals profit earning capacity of the business with reference to its
sale. Increase in gross profit ratio will mean reduction in cost of production or direct expenses
or sale at reasonably good price and decrease in the ratio will mean increased cost of
production or sales at lesser price. The true efficiency or profitability of the business cannot
be understood by gross profit because profitability may be lesser, whereas gross profit is
more. So the gross profit ratio has to be calculated in order to have the correct view of the
business.
The gross profit ratio also acts as a guide to the management in determining its selling
and distribution expenses. There is no ideal standard for gross profit but it should be
sufficient to cover the selling expenses o the firm.
The effective stock control system can be adopted on the basis of gross profit ratio.
Higher gross profit ratio is always in the interest of the business.

Causes responsible for increase in gross profit ratio
Gross profit ratio may increase due to the following reasons:
1. Increase in the sale proceeds without corresponding increase in the cost of production
or purchase price of goods.
2. Under valuation of opening stock
3. Over valuation of closing stock
4. Decrease in the cost of production or purchase price without corresponding decrease
in sale price.
5. Decrease in direct expenses that is, expenses on acquiring or manufacturing goods
6. Omission of the invoices regarding purchases
Causes for decline in gross profit ratio

1. Purchasing of goods at relatively higher price. If the goods are purchased at
comparatively higher price the cost of goods will increase and reduce the margin of
profit.
2. Shortage of goods. Loss of goods due to theft, pilferage and spoilage will reduce the
quantity of goods to be sold and the sales will decrease. As the firm has paid for these
goods but is nor able to sell, the gross profits will fall.
3. Increase in the manufacturing expenses. An increase in the manufacturing expenses
such as carriage, freight, wages and power will increase the cost of production and
reduce the margin of profit.
4. Sales at comparatively low rates. Sales at lower rates will reduce margin of profit.
Efforts should be made to sell goods at competitive price.
The decline in the gross profit ratio must receive due attention of the management.
Possible reasons for its decline should be identified, thoroughly investigated and the remedial
measures applied.
HCL Infosystems ends its financial year in the month of June. Let us now look at the Gross
profit margin / Ratio of HCL Infosystems for the last three years:
June 2005
(Rs. in crores)

7787-7141
Gross Profit Margin = x 100
7787
646
= x 100
7787
= 8.3 %
June 2006
(Rs. in crores)
11455-10588
11455
867
= x 100
11455
= 7.57 %
June 2007
(Rs. in crores)
11855-10800
11855
1055
= x 100
11855
= 8.9 %

Gross profit Ratio
9
8.9
8.5
8.3
Gross Profit (in %)
Gross Profit
7.57
7.5
6.5
2005 2006 2007
Year
From the above chart it is clear that the gross profit ratio has dipped in the year 2006
before going to an all-time high of 8.9 % in 2007. The gross profit might have increased in
absolute terms but it has not done so in relation to sales. The total business revenue in terms
of sales has increased constantly over the years. But the gross profit ratio has not increased
constantly.
2. Operating Profit ratio

By subtracting selling, general and administrative (SG&A), or operating, expenses
from a company's gross profit number, we get operating income. Management has much
more control over operating expenses than its cost of sales outlays. Thus, investors need to
scrutinize the operating profit margin carefully. Positive and negative trends in this ratio are,
for the most part, directly attributable to management decisions.
A company's operating income figure is often the preferred metric (deemed to be
more reliable) of investment analysts, versus its net income figure, for making inter-company
comparisons and financial projections.
Operating profit = Profit before interest depreciation and taxes

= Profit before tax + Depreciation + Finance Charges

Operating Profit
Operating Profit Margin = X 100
Sales
June 05
(Rs. in crores)
Operating Profit Margin = 308 X 100

7787
= 3.96 %
June 06
(Rs. in crores)

11455
= 3.46 %
June 07
(Rs. in crores)

11855
= 3.83 %

Operating Profit Ratio
4
3.96
3.9
Operating Profit (in %)
3.83
3.8
3.7
3.6 Operating Profit
3.5
3.46
3.4
3.3
3.2
2005 2006 2007
Year
The operating profit ratio has seen a steep decline in the year 2006. The ratio has
recovered in the year 2007 but still it has not been able to reach the previous level of 3.96%.
3. Net Profit ratio
Often referred to simply as a company's profit margin, the so-called bottom line is the
most often mentioned when discussing a company's profitability. While undeniably an
important number, investors can easily see from a complete profit margin analysis that there
are several income and expense operating elements in an income statement that determine a
net profit margin. It behooves investors to take a comprehensive look at a company's profit
margins on a systematic basis.
The net profit ratio tells us the amount of net profit per Rupee of turnover a business
has earned. That is, after taking account of the cost of sales, the administration costs, the
selling and distributions costs and all other costs, the net profit is the profit that is left, out of
which they will pay interest, tax, dividends and so on.
Significance of net profit ratio

Net profit ratio shows the operational efficiency of the business. Decrease in the
ratio indicates managerial inefficiency and excessive selling and distribution expenses. In the
same way, increase shows better performance. Increase or decrease in the ratio is determined
in comparison to previous year’s performance. In case of increase, performance of the
management should be appreciated and plus points reinforced. In case of decline in the net

profit ratio an investigation to find out causes for the decline in the net profit is made and
corrective action should be taken to remove the causes responsible for the fall in the net profit
ratio.
Net profit = earnings after depreciation, interest and taxes
Net Profit Ratio = Net Profit X 100

Sales
June 05
(Rs. in crores)
Net Profit Ratio = 228 X 100

7787
= 2.93 %
June 06
(Rs. in crores)

11455
= 2.44 %
June 07
(Rs. in crores)

11855
= 2.67 %

Net Profit ratio
3.5
3 2.93
2.67
Net Profit (in %)
2.5 2.44
2
Net Profit
1.5
0.5
0
2005 2006 2007
Year
The net profit ratio has also declined in the year as it is not immune to the effects of
the other ratios. But a point to be noted here is that the net profit ratio has not declined as
steeply as the gross profit or operating profit ratios. This might be due to less dividend or
interest paid.
Users of the accounting information need to understand that the absolute numbers in
the income statement don't tell us very much, which is why we must look to margin analysis
to discern a company's true profitability. These ratios help us to keep score, as measured over
time, of management's ability to manage costs and expenses and generate profits. The
success, or lack thereof, of this important management function is what determines a
company's profitability. A large growth in sales will do little for a company's earnings if costs
and expenses grow disproportionately.
B. Profitability ratios related to Investments

RETURN ON INVESTMENTS
1. RETURN ON ASSETS
This ratio indicates how profitable a company is relative to its total assets. The return
on assets (ROA) ratio illustrates how well management is employing the company's total
assets to make a profit. The higher the return, the more efficient management is in utilizing its
asset base. The ROA ratio is calculated by comparing net income to average total assets, and
is expressed as a percentage.

Variations:
Some investment analysts use the operating-income figure instead of the net-income
figure when calculating the ROA ratio.
The need for investment in current and non-current assets varies greatly among
companies. Capital-intensive businesses (with a large investment in fixed assets) are going to
be more asset heavy than technology or service businesses.
In the case of capital-intensive businesses, which have to carry a relatively large asset
base, will calculate their ROA based on a large number in the denominator of this ratio.
Conversely, non-capital-intensive businesses (with a small investment in fixed assets) will be
generally favored with a relatively high ROA because of a low denominator number.
It is precisely because businesses require different-sized asset bases that investors
need to think about how they use the ROA ratio. For the most part, the ROA measurement
should be used historically for the company being analyzed. If peer company comparisons are
made, it is imperative that the companies being reviewed are similar in product line and
business type. Simply being categorized in the same industry will not automatically make a
company comparable.
As a rule of thumb, investment professionals like to see a company's ROA come in at
no less than 5%. Of course, there are exceptions to this rule. An important one would apply to
banks, which strive to record an ROA of 1.5% or above.
Return on Assets = Net Profit X 100

Average Total Assets
Total Assets = Fixed Assets + Investments + Current Assets

Average total assets = (Opening Balance of Assets + Closing balance of Assets) / 2
June 05
(Rs. in Crores)
Return on Assets = 228 X 100
1351
= 16.88 %
June 06

(Rs. in Crores)
1721
= 16.27 %
June 07
(Rs. in Crores)
2260
= 13.98 %
Return on Assets
18
16.88 16.27
16
14 13.98
12
ROA (in %)
10
ROA
8
6
4
2
0
2005 2006 2007
Year
Here, it can be seen that there has been a steeper decline in the ROA ratio in the year
2007 as compared to the previous year. This is because the total assets have increased at a
greater rate in the latter year rather than the previous year. This has resulted in a greater
increase in the denominator of the ROA ratio as compared to its numerator which is the net
profit.
2. Return on Capital employed
This is one of the most important ratios for the measure of profitability. It is also
known as Return on Investment ratio. It indicates the relationship of net profit with capital
employed in the business. Here, return for calculating the return on investment will mean the
net profit before interest, tax and preference dividend. Net profit means net profit of the year

excluding undivided profit and reserves. Investment here means capital employed meaning
long term funds.
Significance
Return on investment ratio measures, the operational efficiency and borrowing policy
of the enterprise. It also shows how effectively the capital employed in the business is used. It
shows the earning capacity of the net assets of the business. The ratio judges the performance
of even dissimilar business or different departments of the same business.
Loan component in capital employed

Capital employed consists of shareholder’s funds and long term loans. Loans have
always been a blessing for an efficient company, because it earns income at rates higher than
the rate of interest paid by it on loans. Loans, if judiciously used in productive activities earn
income more than what the interest is paid on them, so in these cases shareholders gain from
loan being as part of capital employed.
Uses:
1. Return on investment is a very significant ratio for measuring operation efficiency of
the management.
2. It measures overall profitability of the business.
3. It is used for comparing the performance of the different departments and sections of
the organization.
4. It can also be used to compare the profitability of the firm with other firms of the
industry.
5. It helps in making investment decisions.
6. It also assists in planning capital structure of the company. It enables the enterprise in
deciding the ratio of various long term sources in the capital structure of the company.
7. It helps in determining the price of the product.
The return on capital employed (ROCE) ratio, expressed as a percentage,

complements the return on equity (ROE) ratio by adding a company's debt liabilities, or
funded debt, to equity to reflect a company's total "capital employed". This measure narrows
the focus to gain a better understanding of a company's ability to generate returns from its
available capital base.

By comparing net income to the sum of a company's debt and equity capital, investors
can get a clear picture of how the use of leverage impacts a company's profitability. Financial
analysts consider the ROCE measurement to be a more comprehensive profitability indicator
because it gauges management's ability to generate earnings from a company's total pool of
capital.
Variations:
Often, financial analysts will use operating income (earnings before interest and taxes
or EBIT) as the numerator. There are various takes on what should constitute the debt
element in the ROCE equation, which can be quite confusing. Our suggestion is to stick with
debt liabilities that represent interest-bearing, documented credit obligations (short-term
borrowings, current portion of long-term debt, and long-term debt) as the debt capital in the
formula.
Significance:
The return on capital employed is an important measure of a company's profitability.
Many investment analysts think that factoring debt into a company's total capital provides a
more comprehensive evaluation of how well management is using the debt and equity it has
at its disposal. Investors would be well served by focusing on ROCE as a key, if not the key,
factor to gauge a company's profitability. An ROCE ratio, as a very general rule of thumb,
should be at or above a company's average borrowing rate.
Unfortunately, there are a number of similar ratios to ROCE, as defined herein, that
are similar in nature but calculated differently, resulting in dissimilar results. First, the
acronym ROCE is sometimes used to identify return on common equity, which can be
confusing because that relationship is best known as the return on equity or ROE. Second, the
concept behind the terms return on invested capital (ROIC) and return on investment (ROI)
portends to represent "invested capital" as the source for supporting a company's assets.
However, there is no consistency to what components are included in the formula for
invested capital, and it is a measurement that is not commonly used in investment research
reporting.
Return on Capital Employed = Net Profit X 100

Average Total Capital Employed

Total Capital = Shareholder’s Funds + Loan Funds
Average total Capital Employed = (Opening Balance of Total Capital + Closing Balance
of Total Capital) / 2
June 05
(Rs. in Crores)
Average Capital Employed = (644 + 500) / 2 = 646
Return on Capital Employed = 228 X 100

646
= 35.3 %
June 06
(Rs. in Crores)

719
= 38.94 %
June 07
(Rs. in Crores)

951
= 33.23 %

Return on Capital Employed
40
39 38.94
38
ROCE (in %)
37
36
35 35.3 Return on Capital Employed
34
33 33.23
32
31
30
2005 2006 2007
Year
There had been a phenomenal increase in the average total capital employed in the
year 2007 in comparison to the year 2006. On the other hand, the net profit has not been able
to keep pace with this increase in capital employed. This has resulted in a steep decline in the
ROCE ratio after a modest rise in the previous year.
2. Return on Shareholder’s Equity
This ratio indicates how profitable a company is by comparing its net income to its
average shareholders' equity. The return on equity ratio (ROE) measures how much the
shareholders earned for their investment in the company. The higher the ratio percentage, the
more efficient management is in utilizing its equity base and the better return is to investors.
Significance of Return on equity

This ratio reflects how effectively equity shareholders funds are utilized. It measures
the operational efficiency of the management. Higher ratio is always in the interest of the
enterprise, because it proves efficiency of the management. This ratio helps in the
comparison of performance and decision making regarding declaration of dividend and
creation of reserve.
Variations:
If the company has issued preferred stock, investors wishing to see the return on just
common equity may modify the formula by subtracting the preferred dividends, which are
not paid to common shareholders, from net income and reducing shareholders' equity by the

outstanding amount of preferred equity.
Significance:
Widely used by investors, the ROE ratio is an important measure of a company's
earnings performance. The ROE tells common shareholders how effectively their money is
being employed. Peer company, industry and overall market comparisons are appropriate;
however, it should be recognized that there are variations in ROEs among some types of
businesses. In general, financial analysts consider return on equity ratios in the 15-20% range
as representing attractive levels of investment quality.
While highly regarded as a profitability indicator, the ROE metric does have a
recognized weakness. Investors need to be aware that a disproportionate amount of debt in a
company's capital structure would translate into a smaller equity base. Thus, a small amount
of net income (the numerator) could still produce a high ROE off a modest equity base (the
denominator).
Return on Shareholder’s Equity = Net Profit X 100

Average Total Shareholder’s Equity
Total Shareholder’s Equity = Capital + Reserves and Surplus
June 05
(Rs. in Crores)
Average Total Shareholder’s Equity = (555 + 423) / 2 = 489
Return on Shareholder’s Equity = 228 X 100

489
= 46.63 %
June 06
(Rs. in Crores)

627
= 44.66 %

June 07
(Rs. in Crores)

779
= 40.56 %
Return on Shareholder's Equity
48
47
Return on Equity (in %)
46.63
46
45 44.66
44
43 Return on Shareholder's
42 Equity
41
40.56
40
39
38
37
2005 2006 2007
Year
The return on equity ratio has gone down over the period of three years which is a
natural consequence of the gradual increase in the net profit and a rapid increase in the
amount of loans and reserves and surplus without any increase in the equity capital. As a
result the numerator of the ratio has increased gradually and the denominator has increased
rapidly. This has brought down the ratio.

OTHER PROFITABILITY RATIOS:
1. EARNINGS PER SHARE
Earning per share
The ratio measures the market worth of the shares of the company. Higher earning per
share shows better future prospects of the company. It measures the return per share
receivable by equity shareholders.
Earnings per Share = Net Profit available to Equity holders

No. of Equity shares Outstanding
June 05
(Rs. in Crores)
Earnings per Share = 2280000000

33,436,354
= Rs. 68.19
June 06
(Rs. in Crores)

168729255
= Rs. 16.59
June 07
(Rs. in Crores)

169152650
= Rs. 18.68
Earnings per Share
80
70 68.19
60
EPS (in Rs.)
50
40 Earnings per Share
30
20 18.68
16.59
10
0
2005 2006 2007
Year

The earning per share had a steep decrease in the year 2006. This was a direct
consequence of the sudden rise in the number of shares in the year 2006. The company had
tried to come back by bringing up the EPS in 2007 to a modest 18.68 as the number of shares
had not increased much during that period.
2. DIVIDEND PER SHARE

It is the amount of the dividend that shareholders have (or will) receive, over an year,
for each share they own. It is similar to the EPS. Here the proposed dividend (the dividend
declared by the company) is divided by the total number of ordinary shares.
Dividend per Share = Dividend paid to Ordinary Shareholders

No. of ordinary Shareholders outstanding
June 05
(Rs. in Crores)
Dividend per Share = 334694000

33,436,354
= Rs. 10
June 06
(Rs. in Crores)

168729255
= Rs. 2
June 07
(Rs. in Crores)

169152650
= Rs. 2

Dividend per Share
12
10 10
DPS (in Rs.)
6 Dividend per Share
2 2 2
0
2005 2006 2007
Year
The dividend per share has also fallen drastically from Rs. 10 to Rs. 2 in the last two
years. This is because the proposed dividend of the company depends upon two factors,
namely, the profits available for appropriation and the number of shares. As there was a great
increase in the number of shares, the proposed dividend had to come down especially due to
the slow rise in profits.
3. PRICE EARNINGS RATIO
In general, a high P/E suggests that investors are expecting higher earnings growth in
the future compared to companies with a lower P/E. However, the P/E ratio doesn't tell us the
whole story by itself. It's usually more useful to compare the P/E ratios of one company to
other companies in the same industry, to the market in general or against the company's own
historical P/E. It would not be useful for investors using the P/E ratio as a basis for their
investment to compare the P/E of a technology company (high P/E) to a utility company (low
P/E) as each industry has much different growth prospects.
The P/E is sometimes referred to as the "multiple", because it shows how much
investors are willing to pay per dollar of earnings. If a company were currently trading at a
multiple (P/E) of 20, the interpretation is that an investor is willing to pay $20 for $1
of current earnings.
It is important that investors note an important problem that arises with the P/E
measure, and to avoid basing a decision on this measure alone. The denominator (earnings) is

based on an accounting measure of earnings that is susceptible to forms of manipulation,
making the quality of the P/E only as good as the quality of the underlying earnings number.
Price Earnings ratio = Market price of shares

Earning per share
June 05
(Rs. in Crores)
Price Earnings ratio = 756

68.19
= 11.09
June 06
(Rs. in Crores)
Price Earnings ratio = 140

16.59
= 8.44
June 07
(Rs. in Crores)
Price Earnings ratio = 185.3

18.68
= 9.92
Price Earnings Ratio
12
11.09
10 9.92
8.44
8
P/E Ratio
6 Price Earnings Ratio
0
2005 2006 2007
Year
The market value of the shares of HCL Infosystems has fallen in the year 2006 due to
reduced EPS. This ratio reflects the price currently being paid by the market for each rupee of
currently reported EPS. Since the EPS had fallen steeply in 2006, the Price earnings ratio has
also come down. Then with an increase in the EPS the market had also reposed some trust in
the company due to which the P/E ratio has risen in 2007.

SWOT ANALYSIS
Strengths:
 It has a large customer base in South India that can be utilized for introducing new
products.
 Infosystems, network integration is a logical high that it had to take in a network-centric
IT world.
 In the process, it gave its IT services customers benefit of a one-window source for not
only IT hardware/software solutions, but also their networking needs. This IT
powerhouse strongly believes that at the end of the day, applications is what matters to
customers.
 HCL Infosystems has built a service model that utilizes all its intrinsic advantages. It has
a layer of IT/networks support available in 151 locations as its foundation.
 For this integrator, the emphasis has been on the traditional manufacturing, and banking
and finance sectors. It won two huge orders for networking—Bank of Rajasthan and
Indian Overseas Bank.
Weaknesses:
 Networking is a relatively new field for HCL
 It is not known for its networking solutions
 The initial research costs have run high which is reflected in its profitability ratios
 Large companies may opt for relatively experienced network service providers
Opportunities:
 However, it is aggressively looking to tap emergsing markets like the ISP and telecom
sector.
 It has already done a few projects in this area with the implementation of its own sister
company HCL Infinet.
 Likewise, this year HCL Infosystems is confident to do well in CTI, unified messaging
and e-business solutions area, with the recent tie-up with Intel.
Threats:
 There are more established and focused players in the software market in India like
Infosys.

 Besides, software piracy has a direct effect on the revenue of these firms. To prevent this,
a lot of money has to be spent.
RECOMMENDATIONS
On the basis of the above profitability analysis, the following recommendations are
made:
1. Profitability ratios related to sales:
Special attention has to be paid to the profitability ratios related to sales. The gross
profit ratio has to be paid special attention to ensure that it grows at the same pace in
which it has started growing from the last year. For this the cost of sales has to be
brought down on the one hand and on the other hand, the revenue from sales has to be
increased. For increasing sales, aggressive advertising and marketing strategies have
to be taken. This might result in increase of selling expenses initially thereby affecting
the operating profit. But it would reap benefits for the company ion the long term.
Funds could also be diverted towards research and development of new software and
improved hardware as these markets are very dynamic and there is strong competition
in these markets. If the profit margins go down again like what happened in 2006,
investor confidence on the ability of the company’s capacity to give steady returns
will diminish.
Special attention should also be paid to the operating and net profit ratios which have
not been able to come up to the levels achieved during 2005. For this, the
administrative and selling expenses have to be brought down by way of efficient
management. Also, a proper and effective dividend policy has to be adopted. If very
low dividends are proposed then the net profit may be high but the market prices of
shares may go down. So an optimum level of dividend has to be proposed.
2. Return on Assets:
Coming to the profitability ratios related to investments, the ROA ratio has shown a
trend of going down which is not good. The gross block has gone up but the
investments have come down which is not a very healthy sign. The company should
concentrate more on investments so that it can get return on its investment. The
present investment policies do not seem to be very fruitful. The company should
invest in places where the rate of return is higher.

3. Return on Capital Employed:
The return on investment or capital employed is in a serious situation indeed. The
number of shares has increased rapidly in the last year.the sudden increase in capital
in the last year has been due to two main reasons, namely, increase in reserves and
surplus and increase in unsecured loans. On the other hand, there has been no increase
in the capital at all. So this shows that the funds of the company by way of reserved
profits are not utilized properly. The held up reserves and surpluses are not even
invested fruitfully. Besides, the quantum of unsecured loans has also increased which
is another ominous sign for the business. So the company should try to pay off its
debts and raise more equity capital from the market. All these can happen only if the
company makes proper policies in order to enhance sales, make fruitful investments,
increase its goodwill in the market, etc.
4. Return on shareholder’s equity:

The return on shareholder’s equity has also gone down simply because there had been
a phenomenal rise in capital employed in the form of unsecured loans and reserves
and surplus with little increase in the net profit on the other hand. This situation
should be tackled as soon as possible or else the shareholder’s will lose confidence in
the company’s performance capacity and withdraw their money.
5. Earnings per Share, Dividend per Share & Price Earnings ratio:
The EPS had taken a nosedive in the year 2006 due to the sudden rise in the number
of shares. The EPS had now become stable because there had not been much rise in
the number of shares in the last year. But the point of concern for the company should
be that the EPS is very low, a mere Rs. 18.68. The EPS can be increased by only one
way presently that is by increasing the amount of profit available for appropriation.
The company should distribute a part of is reserves and surplus as it cannot invest that
money efficiently now. The benefit of doing this would be that the DPS and the P/E
ratio would go up and thus repose investor’s confidence in the company for the time
being. The DPS and the P/E ratio are directly affected by the EPS. So they have also
gone down along with the EPS though the P/E ratio has shown some signs of
improving.

LIMITATIONS
1. Difficulty in comparison
Firstly, HCL Infosystems closes its books on June 30 every year which is not the
usual date of year ending for most of the companies. This creates difficulty in
comparing the financial figures of HCL Infosystems with other companies in the same
industry.
2. Conceptual diversity
The companies operating in the same industry might follow different accounting
policies. The choices of accounting policies may distort inter company comparisons.
3. Creative accounting or Window Dressing
The businesses apply creative accounting in trying to show the better financial
performance or position which can be misleading to the users of financial accounting.
In order to improve on its profitability level the company may select in its revaluation
programme to revalue only those assets which will result in revaluation surplus
leaving those with revaluation deficits still at depreciated historical cost.
4. Ratios are not definitive measures
Ratios need to be interpreted carefully. They can provide clues to the company’s
performance or financial situation. But on their own, they cannot show whether
performance is good or bad. Ratios require some quantitative information for an
informed analysis to be made.
5. Outdated information in financial statement
The figures in a set of accounts are likely to be at least several months out of date, and
so might not give a proper indication of the company’s current financial position.
6. Seasoned factors
As stated above, the financial statements are based on year end results which may not
be true reflection of results year round. Businesses which are affected by seasons can
choose the best time to produce financial statements so as to show better results.
CONCLUSIONS
On the basis of the above analysis and discussion, it can be said that HCL Infosystems
are in the recovery stage now after going through a recessionary phase in 2006. But if the top

management does not frame suitable, efficient and affective policies at this stage, the overall
profitability of the company may go down again.
The recommendations made could be effective if they are implemented after doing a
thorough cost analysis of the various departments. The company has to make a favorable
impression in the minds of the investors. Only then it can aim for the success of its products
and services. If the investors’ faith goes away, they may withdraw their money from the
company which would result in a financial crunch for the company.
The profitability ratios present a true picture of the company’s performance. The
actual figures may mislead the management if they are not compared with other ratios by way
of various ratios.

ANNEXURE
2005

2006

2007


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ANALYSIS OF THE PROFITABILITY RATIOS OF HCL1

COMPANY PROFILE: HCL

INTRODUCTION TO RATIO ANALYSIS

When it comes to investing, analyzing financial statement information (also known as

 If one is making a comparative analysis of a company's financial statements over a

certain period of time, an appropriate allowance for any changes in accounting

We can use ratio analysis to try to tell us whether the business

Electronic copy available at: https://ssrn.com/abstract=1672242

 A reference point is needed. To be meaningful, most ratios must be compared to

choices may result in significantly different ratio values.

USERS OF ACCOUNTING INFORMATION

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WHAT DO THE USERS OF ACCOUNTS NEED TO KNOW?

Employees information about the stability and profitability of their employers to

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Environmental many organisations now publish reports specifically aimed at

Researchers researchers' demands cover a very wide range of lines of enquiry

WHICH RATIOS WILL EACH OF THESE GROUPS BE INTERESTED IN?

Interest Group Ratios to watch

Investors Return on Capital Employed

Lenders Gearing ratios

Managers Profitability ratios

Employees Return on Capital Employed

Suppliers and other trade creditors Liquidity

Governments and their agencies Profitability

Local Community This could be a long and interesting list

Financial analysts Possibly all ratios

Environmental groups Expenditure on anti-pollution measures

Researchers Depends on the nature of their study

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1. Gross profit Margin:

Gross Profit Margin = Gross Profit x 100

Significance and uses of gross profit ratios

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Causes for decline in gross profit ratio

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2. Operating Profit ratio

Operating profit = Profit before interest depreciation and taxes

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Operating Profit Margin = 308 X 100

Operating Profit Margin = 396 X 100

Operating Profit Margin = 454 X 100

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3. Net Profit ratio

Significance of net profit ratio

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Net profit = earnings after depreciation, interest and taxes

Net Profit Ratio = Net Profit X 100

Net Profit Ratio = 228 X 100

Net Profit Ratio = 280 X 100

Net Profit Ratio = 316 X 100

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B. Profitability ratios related to Investments

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Return on Assets = Net Profit X 100

Total Assets = Fixed Assets + Investments + Current Assets

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2. Return on Capital employed

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Loan component in capital employed