Assessing financial flexibility of Indian software industry

Abstract

Business cycles have affected businesses in the past and will continue to do so in the future. Given the prolonged expansion of the 1990's the Indian Software Services Industry had its first encounter with a downturn in 2001 and 2002. We have looked at the factors that can affect the Indian Software Services Industry in times of downturn, the actual impact during the recent downturn, the available cushion to fall back on, and the cost of such financial flexibility. Top ranking publicly traded Indian Software Service Industry companies were studied, using financial statement and annual report data. We found that there is a natural hedge that buffers the impact of a downturn in target markets of the Indian Software Services Industry. From the perspective of controlling cost, we find that employee salaries constitute a large portion of the expenses. This expense is difficult to control in the short term under conditions of sharp downturn. However, it can be managed over the long term. A regression analysis of expenses classified as employee costs, non-employee costs, selling general & administrative, repairs and maintenance, and indirect taxes indicates that there is no fixed component to these costs. Cash flow analysis shows that operating cash flows remained positive during the downturn period and account receivables days did not change significantly. Capital structure of the industry has increasingly become equity oriented over the years with free cash flows being used to repay long-term debt. The industry has also accumulated large amounts of financial assets. We estimated a cash buffer (liquid assets) size that would allow companies to tide over downturn periods. We found that the industry has excessive financial assets as compared to the estimated cash buffer required. We have estimated a median cost of this financial flexibility (forgone returns) to be 7.33%, which is borne by investors in this industry. We conclude that the Indian software services industry is not in need of financial flexibility and its associated cost is high.