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Interglobe Aviation, which owns India’s only consistently profitable airline IndiGo, caused a bit of a stir during its initial public offer early last month. Reason: Despite making a profit of ₹640 crore during the June quarter, the company reported negative networth to the tune of ₹139 crore as on its last balance sheet date. This was largely on account of a ₹1,103-crore dividend that the promoters decided to pay themselves ahead of the offer.
What is it?
In accounting terms, networth is the total owner’s capital invested in a company. Networth consists of both initial share capital raised from promoters and others, and the company’s profits accumulated over the years. Accumulated profits are also termed as reserves and surpluses. A company with negative networth is presumed to be on a weak footing because it usually shows that the business is loss-making and has hardly any own capital left to fund future expansion.
In Interglobe’s case, though, the airline was quite profitable, the liberal dividends paid out ahead of the offer drained its networth and took it (briefly) into negative territory.
Under normal circumstances, a company’s networth can change due to two factors — infusion of capital and the profits or losses from operations. Any addition to capital by way of a fresh share issue will result in an increase in networth. Likewise, if the company has surplus profit available after paying dividend to its shareholders, this will be transferred to its reserves and surplus, and increase its networth. If an enterprise reels under losses, that will lead to a depletion in the networth.
Besides all this, of course, if a firm decides to pay dividend far higher than the outstanding balance in its reserves and surplus account, it may lead to a negative or deficit networth.
Why is it important?
While the Interglobe case was an exception, it is usually chronically loss-making companies that carry negative networth in their balance sheet. A company’s networth is a key indicator of its financial health. For one, it indicates the extent of owner’s capital that the firm has to meet its future expansion and capital needs. Networth per share, which is also called book value per share, is used to gauge the intrinsic value of a company’s business as well.
This is why even the statutory auditors examining a company’s books of accounts are required to make a special mention to shareholders in their report, if they find that the company has run up a negative networth in any accounting period. A negative networth is normally a warning that the company needs a quick infusion of fresh equity.
Why should I care?
If you are an equity investor, it is pertinent to keep a tab on your company’s networth. It will tell you if there are any assets left for you as a shareholder, should the company’s operations become unviable and warrant closure. If the company’s networth is negative or deficit and the entity makes losses, it may be a warning signal for you as an investor to exit your investment.
The bottomline
The IndiGo case showed that you cannot judge a company by its networth alone. But when you are making your market debut, appearances do matter. The firm’s negative networth may have weighed against it, at least with retail investors.
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