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Cloud of uncertainty

Investors need to be cautious as an increasing number of companies are reporting higher contingent liabilities

In all the dross number-crunching and ratio analysis done while analysing the financial performance of a company, one key aspect is often overlooked — that little entry in the books called contingent liabilities, which actually warrants a little more than just the cursory glance thrown in its direction. In fact, the quantum of contingent liabilities has grown in recent years as an increasing number of companies have taken to obfuscating their financial obligations under this accounting term. To put things in perspective, the cumulative contingent liability of the BSE 200 companies (excluding PSUs, banks and financials) has gone up from ₹178,789 crore in FY11 to ₹256,978 crore in FY14, an increase of 44% over a three-year period.

Need for closer scrutiny

About fifteen companies have a contingent liability that exceeds their market cap

A little more digging reveals that some companies have totted up liabilities in excess of their net worth and market capitalisation. On an average, these companies have contingent liabilities twice the size of their net worth and more than 100% of their market capitalisation (see: Need for closer scrutiny).

Not surprising, then, that market experts have advocated caution. Parag Parikh, founder, PPFAS, says, “Contingent liabilities are very important in assessing the investment-worthiness of a company, as it may erode the net worth of a firm and, in some cases, threaten its survival. It can create debts for a firm, turn a profit into a loss, change its capital structure and negatively impact a firm’s debt-to-equity ratio. The bigger risk is when companies do not provide for an event that could become a liability in the future.” 

Incidentally, it is mostly power and infrastructure companies that are sitting on huge contingent liabilities on account of large debt on their books. Companies such as GVK Power, HCC and Lanco Infra are among the few with the highest contingent liability.

Sitting ducks

In case of GVK Power, the contingent liability of ₹4,600 crore as of FY14 is nearly

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