Retained profits main source of India Inc funds

India Inc. generated 90% of its funds from profits in 2003-04.

With a cash flow of Rs 1,77,320 crore in the last three years, India's manufacturing sector had little need for either borrowed funds or money from the market in the last two years.

Instead, corporate India generated 90 per cent of its funds from retained profits in 2003-04, and repaid borrowings to the extent of Rs 4,310 crore in 2002-03 from retained profits.

A survey of the 1,200 companies that reported net profits in the last three years (2001-02, 2002-03 and 2003-04) shows that in 2003-04, the retained profits of these companies amounted to Rs 33,165 crore, higher than the Rs 24,516 crore in profits retained in 2002-03.

In second place as a source of funds was borrowing from banks. Incremental bank borrowings by the 1,200 companies rose by Rs 9,779 crore in 2003-04, well above the Rs 4,587 crore borrowed in 2002-03.

The precarious state of the development financial institutions ensured incremental borrowing from them was actually negative in both 2003-04 and 2002-03, implying that companies repaid more than they borrowed to these institutions.

Few companies raised money from the stock market in the last two years, as a result of which funding from the market was a distant third, compared with the other two sources of finance.

In 2003-04, the amount (equity plus share premium) raised by these companies from the stock market amounted to Rs 1,006 crore, up from Rs 417 crore in 2002-03.

Interestingly, few companies tapped the market for funds in 2003-04 even though the secondary market boomed during the year.

Analysts point out most companies were sitting on piles of cash, the result of low levels of capital expenditure on the one hand and of pruning of costs on the other, which led to higher retained profits.

Nevertheless, India Inc showed a marked reluctance to give the cash in its books back to shareholders.

Dividends paid in 2003-04 for the sample of 1,200 corporates amounted to Rs 14,870 crore, resulting in a payout ratio of 29.61 per cent. In comparison, dividends paid in 2002-03 amounted to Rs 12,734 crore, which results in a payout ratio of 33 per cent.

According to analysts, the reliance of India Inc on retained profits during the last two years has several implications.

First, the reduced supply of fresh equity meant that prices of stocks were boosted, especially once demand picked up in 2003-04 as foreign institutional investors started buying.

Secondly, the higher level of retained profits and the relative lack of fresh borrowing means that debt-equity ratios have improved substantially for Corporate India.

Together with the reduction in interest rates, this means debt service coverage ratios have increased, resulting in a healthier corporate sector. More importantly, if interest rates go up, companies will be better placed to withstand its effect.

And finally, now that they are more profitable and healthier, companies are better placed to access both the debt and the equity markets at favourable terms if they need to fund capital expenditure.