Altman Z score and RBI Kamath committee ratios.

 Edward Altman published the Z score formula for predicting bankruptcy way back in 1968. He said this formula can be judiciously used to find whether any company may go into bankruptcy within the next two years. It is a quick find formula to gauge the financial health for publicly held companies by using the P&L values and Balance sheet values through a mix of business ratios.

In simple terms Z =1.2X1+1.4X2+3.3X3+0.6X4+1.0X5, where

X1= Working capital/Total assets.i.e the ratio of liquid assets in relation to the total assets or size of the Co.

X2=Retained earnings/Total assets i.e the ratio of retained profit in relation to the total assets of the Co.

X3=EBIT/Total Assets i.e the ratio of efficiency of the operations without the impact of leveraging, in relation to the assets deployed in the Co.also signifying the importance of operating earnings for the long term financial health of the Co.

X4=market capitalisation/book value of total liabilities i.e the ratio of market price in relation to the total liabilities incl. borrowings are  considered as a reflection financial health;

X5= Total sales/ Total assets i.e the ratio of assets turnover indicating how well the assets are utilised to generate the sales.

There are some variations for privately held companies and for service cos.

What is the necessity for delving into this formula of bankruptcy now? RBI appointed KV Kamath Committee has come out with similar ratios for the use of banks in identifying distress among the Indian business companies with various ratio values depending on the kind of business the cos concerned are in.

The Committee came out with the following ratios, that were selected based on their relevance for Resolution Plan for the distressed cos. when their loans are put to restructuring by the banks. 

1)Total outside liabilities(TOL)/Adjusted Tangible Networth(ATNW)i.e Adjusted Net of investments;

2)Total Debt/EBIDTA ;

3)Current Ratio;

4)Debt Service Coverage Ratio (DSCR);i.e the ratio of the addition of the net cash accruals with interest and finance charges divided by the addition of the current portion of the long-term debt with interest and finance charges.

5) Average Debt Service Coverage Ratio (ADSCR) i.e average over the loan period.

All these ratios are highly relevant with a well-defined threshold for various industries of the domestic economy including that of services, for those looking at the financial health of the Companies. Many Credit Rating Agencies also use many of these ratios. Perhaps, the Altman Z score may also be included for evaluating the preponderance to bankruptcy among the Co.s  under the distressed category seeking their bank loans to be restructured.

Law of Averages,Regression to the Mean and the Walk down the Dalal Street!

 Sir Francis Galton, a British polymath, did pioneering work on Regression or Reversion to the Mean in Statistical Research in the late 19th Century. According to his analysis of human characteristics, he applied statistical methods to the study of human differences and inheritance of intelligence and pioneered the work on Eugenics. He also contributed to the field of psychology by founding psychometrics with personality mapping.

He was a versatile genius and being the half-cousin to Charles Darwin, his works in many ways drew sufficient inspiration from Darwin's studies. But his most outstanding contribution is Regression to the Mean in Statistical analysis. He is also considered to have developed a central limit theorem showing that with sufficient sample size the binomial distribution approximates a Normal Distribution and the practical demonstration of it is called Galton Board or Quincunx or Bean machine

Regression to the Mean is in simple terms that if there is volatility observed over the mean, over a while the values will show Regression to the Mean/Average and Francis Galton termed it as Regression to the Mediocrity in terms of inherited human characteristics. This led to modern statistical modeling based on linear regression analysis.

Regression to the Mean is also important to understand the stock market behaviour. Stock market behaviour is considered to be a Random walk and the financial world which considers a normal world will always look for stable returns. Jeremy Siegel said that "return to the mean" may show that returns may be unstable in the short term but stable in the long run. In such a situation the returns can be easily quantified and not a Random walk. But the stock market exhibits typical Random Walk characteristics. A Random Walk is one in which future steps or directions cannot be predicted based on past actions or performance. But Dalal street would hate to call its three-piece suit executives , who carry an air of super cat financial strategists,  as "Random Walkers"!!(link). The central hypothesis of Random walk is that one cannot consistently outperform the market averages. In other words, even the best of financial strategies would eventually start regressing to the mean.

The law of averages which is a law of large numbers gives false belief and therefore it is called "Gamblers' fallacy". It leads to the misconception that the probability of an outcome occurs with a small number of consecutive experiments so they will have to "average out" sooner rather than later. This is the fallacy that rules the mind of every gambler and that is why it is called "gambler's fallacy". Stock market ups and downs can also lead to this kind of fallacy in the short term.

Dalal Street is a minefield for the uninitiated and a good playground for those who have an appetite for a long walk or for those lethargists who buy indexed bonds, sleepover them and don't go for a walk!!

India, its agriculture lending a helping hand during the pandemic!

 India's agriculture has hit a new high when the entire country is under lockdown and the industry has hit the rock bottom.Kharif sowing as on 5th Sep20 has reached 1095 lakh hectares which is 6% more than what was the sown area in kharif season 19-20.The acreage of paddy has grown by 8% to 396 lac hec.over previous year.The acreage under Oilseeds has grown by 12% to 195 LH; Pulses by 5%  to 137 LH; Cotton by 3% to 129 LH and Coarse cereals by 2% to 179 LH.This has been facilitated by 9% increase in rainfall during June-Sep 20 to 795mm.

All five summer grown Oilseeds has seen higher than anticipated increase in their respective MSPs  and better procurement during the initial months of Covid pandemic phase.The increase in Minimum Support Prices including that of Paddy announced at the beginning of Kharif season in june 20 has really helped in increasing the sowing area and in augmenting the revenue of the farmer.

That apart, India has witnessed a 23% increase in farm exports dominated by Rice and Sugar, in the Q1 of Fy 20-21. These are all heartening news from the agri sector.

However the worrying patches, in the otherwise bright outlook,are the outstanding dues of over Rs.14.2K Cr. of Sugar Mills in UP to the cane growers. The State Govt has raised the FRP(Fair & Remunerative Price) by Rs.10 on an average as a policy measure during this cane crushing season, starting Oct 1.Sugar Mills have approached the Govt for a subsidy to pay the farmers in order to tide over the Covid induced difficulties.

Modi Govt has also constituted a Agri Infra Fund of Rs.1 lac cr. The Infra Fund is for catalysing the Agri-infra development and help build pivotal infrastructures like warehouses, cold storage, and nurture farm assets. This will bring about a increase in Agri share of GDP in the economy from 15% approx and thus improve the livelihood of those dependant on agriculture.(link GDP).

Modi Govt has promised doubling of farmers' income  by 2022 which is a daunting task ahead and Govt. is well focussed on this with far reaching structural changes made in the last few months by amending Essential Commodities Act and by liberalising farm trade , land leasing for agriculture across the country.

Now the country is looking forward to the Rabi season.