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4 things that link economy with corporate profits
Companies are affected by the environment they work in. After a sluggish economic growth, a new government in power is widely expected to benefit the economy. Benchmark indices have jumped to record-high levels in anticipation of better profits next year.
Here are four ways macro-economic conditions affect corporate profits:
Consider the overall economy as a big pond. If the water in the pond gets dirty, the organisms living in it will be affected. Exactly the same way, the overall growth of the economy is important. Not only does it affect business sentiment, it also has a direct bearing on company financials. As India witnessed a sharp slow down in the economic growth over the past five years, it hurt corporate earnings. During 2012-13, quarterly growth in revenues fell to a mere 5% from around 20%, according to credit ratings agency CRISIL. Moreover, when an economy slows, it creates fewer jobs. This slows demand for goods and services. Sales and profit growth slows as a result.
India has been battling against persistent high inflation for years. In the last few years, inflation rose to two-digit figures. This has a direct impact on companies - especially those in the consumer goods sector. Firstly, a rise in prices increases input costs for companies. Secondly, persistent inflation affects demand. As prices rise, people tighten their purse string and spend less. This affects sales and total revenue. Demand in India has taken a huge beating in the last few years. As a result, the consumer goods industry saw a fall in sales volume in the September 2014 quarter, according to a market study by Nielson, an agency.
When inflation rises, the Reserve Bank of India (RBI) hikes interest rates. This makes borrowing costly and thus discourages extra spending. A RBI survey highlighted that net profits as a percentage of sales for non-finance companies fell to 6.1% in 2012-13 from over 8% in 2010-11. This data highlights the pressure on profits businesses are facing as a result of persistent high interest rates. Companies have resorted to utilising existing cash or divesting non-core assets to raise money instead of borrowing. As a result, interest payments by companies fell 5% in the April-June 2014 quarter and another 1% in the September 2014 quarter from the previous year, according to Hindu Business Line, a newspaper. This decrease in cost helped companies post an 18% rise in net profits even though sales growth fell to 6%.
India is an import-dependent economy. A lot of goods, required for manufacturing of products and services, are imported from other countries. As the rupee appreciates or falls against the dollar, the total cost of the goods too falls or rises. This means companies directly get affected by any change in the rupee's exchange rate. Companies dependent on imports thus see costs rise when the rupee depreciates. For companies that mainly export goods and services, a depreciating rupee increases income. This is because they earn in foreign exchange. In FY13-14, IT remained the only sector to see an improvement in sales growth. All other manufacturing and services sectors saw a fall in sales growth, according to RBI data.
The rise or fall in global prices of key commodities also affects Indian companies. Crude oil prices fell in the July-September quarter. As a result, prices of raw materials too trended lower. Raw material costs amounted to nearly half of the total revenue or 47% in the July-September quarter last year. This fell to 45% this year.