We have attempted to understand the nature of the Indian IT industry through a financial analysis of a sample of listed companies. This section of provides a brief overview of the current and past financial performance of these listed IT companies.

The sample selected for this analysis comprised of listed IT firms with sales turnover of over Rs 100 mn. The chosen analysis set accounts for close to 60% of total Indian IT Industry sales turnover as given by NASSCOM, hence is fairly representative.

The graph below depicts the cumulative contribution of the top companies of our sample to the total IT industry sales turnover.

Source: CMIE Prowess Database, NASSCOM, D&B Research

The graph reveals that the top 50 firms in our sample contribute over 50% of the total Indian IT Industry turnover.

The IT industry has been logically divided into 3 categories based on the net sales turnover.

• Large size firms (> Rs 20,000 mn)

• Medium size firms (Rs 2,000 – 20,000 mn)

• Small size firms (< Rs 2,000 mn)

A brief profile of the three categories, with respect to our sample is shown below:

Source: CMIE Prowess Database, D&B Research

68% of our sample comprises of small size firms, which account for 7% of the total sample sales turnover. A quarter of our sample is medium size firms, which also account for a quarter of the sample sales. Large size firms contribute close to 70% of the sample turnover.

Sales Growth: As per NASSCOM, IT Industry (IT Services and hardware) grew by 27% in 2005 and by 28% in 2006. As can be seen all IT companies in our sample set enjoyed sales growth in excess of the industry average with the exception of medium sized companies in 2005 and small sized companies in 2006.

Source: CMIE Prowess Database, D&B Research

Net Profit Growth: The Profit after Tax (PAT) of the IT companies has registered strong growth with the small IT companies registering the highest growth. Our sample as whole registered a growth of 65% in 2005 and 39% in 2006.

Source: CMIE Prowess Database, D&B Research

The asset base of the sample set grew by about 30% annually from 2004 to 2006. Large and medium firms contributed 60% and 25% respectively to asset growth.

Source: CMIE Prowess Database, D&B Research

Cost Structure & Profitability

Source: CMIE Prowess Database, D&B Research

A significant portion of the overall costs for large firms is in the form of personnel expenses that accounts of 42.5% of the net sales. This has grown from 38% in 2004. However other expenses have come down from 19.5% in 2004 to 15.8% in 2006. PBIT PBT and PAT as a percentage of sales have remained stable at around 25%, 22% and 18% respectively from 2004 to 2006.

Source: CMIE Prowess Database, D&B Research

For medium sized firms the share of personnel cost as a percentage of sales is lower than large sized firms. Wage cost has increased from 35% in 2004 to 38% in 2006. Sales general and administrative (SGA) expenses have gone down from 38% in 2004 to around 15% in 2006. SGA expense ratio is still higher compared to larger IT firms by about 300 - 400 basis points. PBIT, PBT and PAT margins for medium sized firms are lower than large sized firms by about 800 – 1000 basis points.

Source: CMIE Prowess Database, D&B Research

For smaller firms personnel expenses drops further. SGA expenses as a percentage of sales is much lower compared to medium sized and large sized firms. This can be attributed to the small, concentrated group of customers that these firms cater to whereby the client servicing costs are lower. A significant cost component is by way of other operating expenses and depreciation expense that accounts for greater than 45% of sales. The PBIT, PBT and PAT margins for FY06 are comparable to medium sized firms. The differential in net profit margin between small sized and medium sized firms has narrowed from 8% in 2004 to about 1% in 2006.

Return Measures

a. Return on Networth:

Source: CMIE Prowess Database, D&B Research

Return on net worth (RONW) measures the return on the shareholders equity. Large and small IT companies have shown increasing return on net worth over 3 years with the large companies showing the largest return. The medium sized companies have shown a marginal decline over the three years.

b. Return on Capital Employed (ROCE):

Source: CMIE Prowess Database, D&B Research

Return on Capital Employed (ROCE) is used as a measure of the returns that a company is realizing from its capital employed. ROCE is defined as the ratio of Profit before Interest and Taxes (PBIT) to capital employed. Capital employed is calculated as Total Assets less Current Liabilities.

The large companies seem to be deploying capital much more efficiently than the medium and smaller sized companies. ROCE for large sized has grown consistently over the past three years. Small firms have shown a rising ROCE trend implying that these firms are also improving their capital utilization efficiency. Medium sized firms have shown a marginal drop in capital deployment efficiency during the same period.

Capital Structure

In the IT industry, borrowing seems to play a relatively small part in the total funds deployed for operating purposes and for capital expenditure. Most of the operations are funded through internal accruals. The larger the company size, the higher the share of internal accruals in the total liabilities. At no point in any year does the share of internal accruals to total liabilities fall below 60% for medium and large companies. For the smaller companies financing internal and external growth out of their relatively small earnings is difficult. Therefore these companies have a higher proportion of debt.

Source: CMIE Prowess Database, D&B Research

Source: CMIE Prowess Database, D&B Research