Satyam Computer Services Ltd in Terms of Profitability - Essay Example

Executive Summary: The aim of this report is to analyze Satyam Computer Services Ltd in terms of profitability, capital structure and liquidity of their financial statements. It utilizes financial statements for the past five years and incorporates current financial situation of the organization. Nevertheless, the report utilizes past and current information in predicting the future financial status of the organization. Analysis of financial statements for the last 5 years: 1. The company relies on their equity to finance their assets. 2. The amount of cash was higher in terms of percentage when compared to other assets. 3. The company’s liquidity was high and could be able to meet its obligations. Analysis after taking into consideration the current information where the financial statements cooked up: 1. Based on chairperson’s letter, the company had inflated some figures including cash, accrued interest, revenue and debtors. 2. These changes have huge impacts on profitability, capital structure and liquidity for the company. Future prediction: The company will likely face crisis in the future, which may be in terms of finance, share market and stock market. 1. Introduction: Satyam Computer Services Ltd was established on June 24, 1987. It is a leading global business specializing in information technology and some of their business activities include supplying information technology components, consultancy services, systems integration, and outsourcing solutions to clients in more than twenty industries spanning over 65 countries. Its headquarters is located in Hyderabad, India. The company which has more that 654 customers most of them located in US, Canada, Egypt, Malaysia, China and Australia employs 52,865 workers; working in their offices, subsidiaries and joint ventures. Satyam offers wide range solutions for customers’ complex requirements and these high quality supplements are based on strategic alliances, technology vendors, and system integrators. While the alliance partner provides the software application, Satyam offers professional services including business process consulting, systems integration, custom application development, content development and other consulting and implementation expertise collaborating with Adobe Systems Incorporated, Fujitsu, IBM, Microsoft, Oracle and Siemens. In 2008 fiscal report, revenues of the company was US$2b. It became the first company to launch a secondary listing on Eurotext Amsterdam under NYSE Euronext’s new “Fast Path” process for cross listings in New York and Europe and first one to be invited by the National Stock Exchange (NSE) to ring the open bell. Moreover, Satyam as acquired five companies: 1. S&V Management Consultants 2. Bridge Strategy Group 3. Citisoft 4. UK-based Nitor Global Solutions Limited 5. Knowledge Dynamics 2. Financial analysis for the last five years: 2.1 Profitability Analysis: 31 Mar 2004 31 Mar 2005 31 Mar 2006 31 Mar 2007 31 Mar 2008 Return on Equity (ROE) 21.16% 23.91% 29.98% 27.90% 25.98% Return on Assets(ROA) 22.75% 26.32% 34.24% 29.52% 28.30% Table 1 The Return On Equity (ROE) has been stable over the last 5 years lying between 20% and 27% with a slightly increase in 2006; it reached 30% because earnings after taxation increased by 38% while the equity increased by 21%. Conversely, the decrease of ROE from 30% to 27% was attributed to the slightly increase of EAT comparing to the previous periods. All of these mean that the company is able to generate about 20 to 30 cents per $1 of equity. On the other hand, Return On Assets (ROA) had almost the same scenario as ROE with a percentage of 34.24% in 2006. This may be attributed to the increase of earnings before taxation and increase of assets at the same period. 2.2 Capital Structure: 31 Mar 2004 31 Mar 2005 31 Mar 2006 31 Mar 2007 31 Mar 2008 Debt to equity: 13.15% 13.85% 18.89% 19.86% 22.99% Debt ratio 11.62% 13.53% 17.81% 18.81% 21.83% Equity ratio 88.38% 97.66% 94.27% 94.73% 94.95% Table 2 2.2.1 Debt to equity ratio: Eighty percent of their sources in the past five years, they depended on equity and they did not use other instruments to finance their assets. As a result, this affects the financial structure of the company because they did not diversify their financial sources. 2.2.2 Debt ratio: This shows that every 1 dollar from assets have 10-21 cents liabilities over the last 5 years. This maybe attributed to the service nature of the company’s activities - "IT services" thus no much account payable, which in most cases, has the highest percentage of liabilities when combined. 2.2.3 Equity Ratio: This ratio shows the high reliance to equity on the financing of assets, which was 88% in 2004 and it then increased to 95% in 2008. This shows that the company as concentrated on self-financing and have not diversified their financing strategies. Thus, the financial risk has not been distributed between shareholders and liabilities but as concentrated on equity. 2.3 Liquidity Analysis: Figure 1 2.3.1 Current ratio: The current ratio for the past five years lies between 7.6:1 and 5.2:1. This means that the company relies on their equity for acquiring their current assets. Moreover, the decrease in the current ratio may be attributed to an increase of the current liabilities when compared with the increase of the current assets. Generally, the ratio indicates the lack of diversification of financial resources for the company between liabilities and equity. In addition, cash represents about 50% of the current assets, this means that there is poor cash management resulting in keeping of this cash rather than using it to improve the company’s assets. Moreover, the company borrows more finance to acquire assets rather than utilizing the surplus cash in their disposal. On the other hand, current ratio is almost equal to quick asset ratio because there is almost no inventory in the company. 2.4 Market Performance Analysis: Figure 2 The earning per share has increased from 16.29 in 2003 to 22.4 in 2004 and then decreased to 17.73 in 2006; this is because the company divided the number of shares. Then, the EPS improved in 2008 reaching a high of 25.24. 3. Analysis after the books cooked up: Available information in internet and the letter from the company’s chairperson - Ramalinga Raju (see appendix 1), indicates that there are four concerns in the financial statements in the past few years: 1. Inflated (non-existent) cash of Rs.5, 040 crore 2. An accrued interest of Rs.376 crore; which is nonexistent 3. An understated liability of Rs.1, 230 crore 4. An over stated debt position of Rs.490 crore Based on this information, the analysis has effect: 3.1 Profitability: Since ROA is one of the main ratios of profitability, we have seen that ROA was on the range of 25% for the last 5 years. However, total assets were not correct since the cash, which was represents about 60% of the total assets; accrued interests and part of debtors were not existent. In addition, the EBIT was not correct because Raju said that the actual operating margin is 3% not 24% as reported in the books, which means that the EBIT was also overstated. On the other hand, since the company increased the revenue, they did the same with the cash, accrued interest and debtors to balance the balance sheet and to reach to a logical ROA. In addition, the company try to diversify the inflation in the revenue between the cash, accrued interest and debtors. As a result, the ROA does not reflect the actual position of the company and in the profitability. On the other side, ROE will decrease because the EAT was inflated as the revenue inflated. Consequently, the company has cheated investors by believing that the company has a higher ROE. 3.2 Capital Structure: Debt to equity ratio as appeared in the analysis shows that the company depends more on their equity to fund their assets while the actual debt to equity ratio is very different. The difference comes from the understated liability, which lead to decrease in debt to equity ratio. As a result, the actual debt to equity ratio shows that the company depends more on their liability than the unreal debt to equity ratio. On the other side, the debt ratio over the past 5 years was between 11% - 21%, which indicate that the company relies more on their equity to fund their assets. However, the company understated their liabilities and overstated their assets, which mean that liabilities were used to facilitate the business. As a result, this will put the company in a dangerous situation because they are relying on other sources to fund their assets. In addition, according to Raju letter, he stated that the revenue reported in the books was Rs. 2,700 crore where the actual revenue is Rs. 2,112 crore. This means that the net profit, which is one of the main components of calculating the total equity, was highly estimated and makes the total equity overstated. Consequently, this is a red flag because the company rely more on liabilities to fund the total assets. 3.3 Market Performance: Earnings per share for the past five years give an indication of the current and prospective investors that the company is in good financial situation. However, the company inflates revenue and reduce expenses to give that impression. As a result, the real earning per share is much lower. 4. Future prediction of the company: Based on the annual reports of the last five years and the current information regarding the company, it shows that the company will face financial crisis. These will affect the future of the company in several ways: 4.1 Financial effects: The future sales for the company will decline dramatically in the next years since the clients for the company will not deal with them. Harichandan Arakali said that, “Satyam Computer Services Ltd. has lost outsourcing contracts from about 46 customers to rivals such as International Business Machines Corp., Tata Consultancy Services Ltd”. In addition, the company will find difficulties to take loans form any bank since they have bad reputation and financial statements, which do not reflect true position of the company. As known, loans are one of the important sources to finance assets and to enlarge the growth of the company. On the other hand, the inflation that happened in the financial statements will put the company in dangerous position with their shareholders in fulfilling their obligations. 4.2 Market effects: Hence, because of the fraud that has happened in Satyam Company, will negatively affect their reputation and the company will lose its market share and their competitors will have an advantage. Heather Timmons and Bettina Wassener said that, “a lot of clients for Satyam will move to other competitors like Infosys, TCS and Wipro”. Nevertheless, the company will also lose their employees to competitors. 4.3 Stock market effects: Figure 3 The market price for the company has sharply decreased in Indian stock Exchange and New York Stock Exchange. For example, between 8 and 9 January, the company lost 75% of their market price. In addition, if the market price of the company goes below the book value of the company, this may put the company into a tricky position for future investments. As a result, the future for Satyam Company is not bright and the company has to work hard to solve these problems. In addition, there is an uncertain situation in the ability of the company to continue expansion in the future due to the changes in the fictitious assets. Currently, the prospective investor must wait for more clear pictures about the future of the company and see if there are any corrective actions. For example, re-issued the financial statements for the last years in order to reflect the real financial position of the company or change the current board of directors and the external auditor. Conclusion: The company has lost its reputation and market share because of fraud and because of their deceptive nature towards their investors and clients. Although the company started to solve these problems by changing board of directors and the external auditor, the company has to work hard to give a positive reputation of the company instead of the bad reputation that has been built. Working hard includes hiring professional managers and changing strategies and polices. In addition, clarity and transparency are the most important instruments to deal with users of financial statements. In conclusion, even though swindling and fraud may treat problems in short term, will never solve any problem in the long term. Therefore, any employee has to make their ethics, integrity and clarity in first priority. Read More