It is the prerogative of a company due to business or other considerations as to how it will carry out its business operations. It may prefer to carry out its business as a single legal entity or through various separate entities. These separate entities may be subsidiary companies, associate companies and/or joint ventures. In India, companies have resorted to complex structures while entering new markets, new geographical territories and so on. Many acquisitions have taken place through special purpose vehicles as well. In case the main company carries out its operations through various separate entities, the mode of operation and the business synergy may be varied. These entities may be in the same line of business as the parent in or few of them may be in the similar line of business with strong/limited operational synergy or without any synergy. Even if the subsidiary companies/associate companies/joint venture entities are having operational synergy among themselves and with the parent company, each entity’s strategic importance in the group and standing & stature may be different.
This paper contains the modality & approach of Infomerics in evaluating an entity’s financial profile, after taking due cognisance of the aforesaid factors. At the outset, Infomerics analyses the financials of the entity on a standalone basis to get a perspective of the financial risk profile of the entity concerned. Thereafter, it may be necessary to analyse the consolidated financials together with the standalone financials to take a holistic approach. Consolidated approach is generally undertaken in the case of specific request from the Issuer for the same and when this meets the criteria for consolidation noted in this section hereafter. There are instances where a company prefers to isolate its cash flows from those of the new venture and does ring fencing. As there is no sufficient clarity about the obligation of the parent company and there may be possibilities of implications of inter-company transactions on parent company’s financials, it becomes necessary to take an overall view. At times, the parent company acts as a holding company only and the company being rated may be the major company of the group. In such a case, the evaluation of the consolidated financials do not bring much on the table; but even then the evaluation needs to be done. The evaluation of consolidated financials assumes strong significance where there are inter-group transactions for operational linkages or otherwise because the consolidated financials present an overall financial position of the parent and all its group companies as a single economic entity. Infomerics also considers the potential business synergy and the expected fund flows within the group. So what Infomerics considers important is the underlying business & operational linkages which may not always be substantiated through the percentage of equity holding and the entire financial analysis rests on that. Given the above, many a times the rating decisions are based on consolidated financials, among others; while sometime the consolidated financials throw lights over the overall financial position. Needless to make a mention here that the consolidated financials portray a meaningful picture of the overall operation & financials such as profitability, debt level & debt mix, resource pattern and asset base of the group. Therefore, in the evaluation process, depending on the significance, approach followed is that of rating the parent as a single economic unit with all subsidiaries, associates and JVs being its various departments.
For the purpose of consolidation, there are three prevalent methods such as, Pooling of Interest Method, Equity Method and Purchase Method, being used depending on the purpose of consolidation and the appropriateness. Infomerics follows Pooling of Interests method to assess the overall financial risk profile of the group and analyse the implications thereof on the company being rated. The Pooling of Interest method cancels out all inter-company assets, liabilities, investments, equity, revenue and expenses for the purpose of consolidation. Under this method, the overall picture of the economic resources under the control of the parent company, its overall obligations and profitability are seen. Infomerics, in line with the IND AS 110, considers control as the basis for consolidation. For this purpose, an investor has control when it has rights to variable returns from its involvement with the investee, and has the ability to affect the returns, and must present consolidated financial statements, in which assets, liabilities, equity, income, expenses, and cash flow of the parent and subsidiaries are presented as those of a single economic entity. Infomerics believes that the necessity or willingness of one group entity to extend support to another is triggered by the business linkage. Even in a situation where the company being rated is having no major equity stake in a group company, the consolidation is highly necessary if there are inter-group transactions involving cash flow implications. In a situation where the parent company has a significant equity holding in a group company, but there is no business linkage, the necessity of consolidation is inferred from the possibility & extent of cash flow transactions.
Infomerics consolidates all subsidiaries except where the subsidiary does not operate in the same business or sector as the parent and where the activity of the subsidiary is clearly insulated & ring-fenced and where there is no possible/potential cash flow support to the subsidiary. If the subsidiary and parent operate in different sectors, a capital allocation approach is used to determine the rating. In case of a finance subsidiary of a manufacturing parent or an insurance subsidiary of a bank, Infomerics may notch up the rating of the unconsolidated subsidiary on account of a stronger parent. Under this approach, some capital assessed for the level of parent support envisaged is deducted from the parent company’s networth and is allocated to the unconsolidated subsidiary. In this process, the rating of the subsidiary company gets improved. The obvious implication for the same for the purpose of rating of parent company gets captured through deduction from its networth as mentioned above.
The relationship between the parent entity and the group company is evaluated mainly on the basis of the extent and likelihood of support from the parent to the group companies. This evaluation depends on many factors like
Infomerics evaluates the impact of group companies on the business and financial risk profile of the parent company being rated. It generally consolidates all subsidiaries of the rated entity through the pooling of interests method for a clear representation of the parent’s operations and liabilities. If a subsidiary company operates in a different sector than the parent or if its operations are explicitly separated and ring-fenced, Infomerics prefers not to consolidate the business and financial risk profiles. However, potential support from the parent to the group company may be considered depending on the extent of linkages.
In analysis, while taking a consolidated view, Infomerics mentions the name of all the companies/entities (including associates, joint ventures, if any) consolidated and the extent & rationale of consolidation in the Rating Report under Financial Analysis chapter. Extent of consolidation shall be candid as to whether the consolidation is 100% or proportionate to stake holding or otherwise. If the detailed consolidation is not possible, then the consolidated key parameters like Revenues from operations, EBIDTA, PBT, PAT, Net worth, Total Debt are considered. A synopsis of the above is also mentioned in the Press Release under the Analytical Approach.
*Revised Criteria on Consolidation of Companies is approved in the BM dated 26.11.2021.