Gupta and Huffier elaborate two main problems related to study of the ratios when these are used at macro level or for a cluster. One is related to data validity and second selection of standards which can be used as benchmark. Without having any standard it would be highly difficult to comment on the number derived through financial analysis. Furthermore, current nature of business world requires to develop standards on a continuous basis to accommodate the rapid changes. We believe that there is also a third problem associated with these ratios and that is the acceptability of these standards. It is not like the measuring unit of a length or volume which is acceptable throughout the world.
Data structure and evaluation of data is another source of ambiguity about the results. For better results there is always a need of required and useful data. In most of the cases required data is not available and consequently, researchers have to rely on the limited data and this kind of situation may lead to an unexpected outcome (Gupta and Huffier 1972). Working with a limited data would not allow to make certain absolute statements. Rather, results may be classified into broad categories. In this study we are also facing this dilemma and we are unable to put forward any absolute statement. However, we will be able to give mean, minimum and maximum values. These values will provide a broader view about the spinning industry of Pakistan.
Osteryoung et al (1992) have compared financial ratio of small, medium, and large firms and concluded that there is a significant difference among the ratios. However, there are few ratios which show consistency. Their study explores that ratios cannot be used with same mindset. In previous lines we have discussed the validity of ratios and standards for comparison. Here we have come across another issue and that is the size of the firms. Along with size, business type is also a matter of concern. Ratios of retail business naturally will be different from the manufacturing business. This is the issue which we are facing in this research. It defies common sense if we compare ratios of spinning industry of Pakistan with any manufacturing sector. We need to have ratios from the same sector, which apparently seems difficult.
Lev (1969) had tried to solve this issue and explained that traditionally firms compare their ratios with average of the sector. Lev studied and found that generally firms adjust their targets according to the mean of the said sector. Nevertheless, there are also predetermined standards available in the literature but their application is quite different. This difference may be due to size or due to the nature of the business. In our view this difference may be cyclic in nature.
Rees (1995) has also discussed this issue. According to Rees, Data is informative when related to a point of comparison. Benchmarking is misleading when applied to different industries.
Benchmarking can be achieved through a time series comparison with examined firms or by using cross sectional perspective by using industry average. Firm’s performance should always be judged
keeping in view the overall performance of the sector. If there is a general decline or rise, it means nothing is special with any particular firm. However rate of change must be compared with other players. For ratio selection Rees states that it is always difficult to select most appropriate ratio. However, too many ratios may become cause of a subset of ratios. Keeping all constraints in view we will compare the ratios with generally acceptable ratios and this study will also provide a benchmark for future studies.
All above discussion is to give a summary about the description of financial ratios, implication attached with selection and application. It is obvious from the literature review that financial ratios are under use since centuries. However, acceptance of these ratios as a separate filed is linked with industrial revolution and in current era its significance has been fortified due to rapid transaction and turmoil business situation. In our view stock exchange activities have also given a boost to these ratios. Since these ratios are highly useful for shareholders. Banking area is also relying a lot on these ratios since they are also one of the stakeholders.
Comparison and benchmarking for financial ratios is one of the major issues. Above discussion summarizes that there is no international benchmarking for these ratios. Ratios should be compared within same sector and keeping in view the context. This study also gives the average values of the sector and individual firms can compare their ratios with the average of the sector. This study will also be useful for future reference.
Research Objective
This search aims to know the real financial health of this sector. Main objective of all this effort is to explore the financial position of the spinning mills. It is believed that one can predict the future of the firms after having a deep look on the financial reports of the firms.
Research Methods
To assess the financial outlook of the sector, we collected annual financial reports of the mills and compiled the detail. The annual financial reports of the mills are the main and only source for this research. For this study we have collected and compiled data from the years 2006-7 and 2007-8.
Sampling
We tried our level best to have financial reports of all spinning mills but due to unavailability of reports in stock exchanges and on internet, we have to opt for opportunity sampling. For this purpose, we visited Lahore and Karachi Stock exchanges. Letters were written to all spinning mills but total 62 reports could be collected. As a few mills are composite units (spinning, weaving and wet processing) therefore, the data of such mills was not used due to different structure from ordinary spinning mills. Reports of 55 mills were used for the study which is nearly 13% of the total mills.
Results and Discussion
We have derived 14 different ratios from the available data and grouped into main four categories. In the following lines, we will discuss the results.
Current Ratio
Current Ratio is an indicator of the capability of the firms to pay its current liability by converting current assets. It is also known as "liquidity ratio" or "cash asset ratio", also "cash ratio. It is calculated by dividing current assets with current liabilities.
Current Assets
Current Ratio= ----------------------
Current Liabilities
High figures mean that company has the capacity to pay its current liability. Acceptable figures vary, depending upon the type of business. Generally, more than one is acceptable. Smaller value shows that company has not enough current assets to discharge its current liabilities. One means that the current assets are equal to current liabilities. Less than one means that company has more current liabilities and less current assets, which is a sign of concern in many cases.
We have compiled current ratio of spinning mills of Pakistan and found the mean of current ratio is less than 1.00 in both years. It is alarming. Mean of current ratio in 2006-7 was 0.87 and 0.82 in 2007-8. As discussed above, less than one means that company is less likely the capabilities to pay its current liabilities. Ratio table depicts that there is no improvement in 2207-8 and if it continues, there is a probability that in coming year’s situation of the sector as a whole will not be better. However, firms can check their position by comparing with the average of the sector. Table further tells that only 25% firms have current ratio more than 1.00. It means that there are certain firms which have more current assets than current liabilities.
Return on Assets
Return on Assets (ROA) is an indicator which tells about the efficiency of firm in using the assets. It is calculated by dividing the annual earning of the company with total assets. It displays in percentage. It is also called return on assets.
Net Earning
Return on Assets= ---------------------- *100
Total Assets
It further tells that how many dollars company is earning against each dollar invested. There is an understood variation in the number since it is highly related to capital investment. Spinning mills are capital intensive sectors and there is a need that these figures should be compared with another capital intensive sector. Ratio table tells that mean of the return on asset is-2.07 and -1.73%, which is quite alarming. One can assume that if this situation prevails in coming years, then many mills will not able to survive.
Gross Profit Margin
Profit maximization is one of the core functions of commercial firms. It may have many sources like, income for investment etc. There is a need to know the output of firms from its core activities. For this purpose, gross profit margin is calculated.
Gross profit is a difference of net sale and COGS. It shows how well the operation is generating revenue.
Gross Profit
Gross Profit Margin =---------------------- * 100
Net Sale
Ratio table shows that spinning industry of Pakistan could have only 6.53% and 6.21% gross profit margin in 2006-7 and 2007-8 respectively. Apparently it shows that firms earned profit from operation. Nevertheless, percentage was too small, and all profits earned were consumed to bear the other expenses and ultimately firms went into loss. One thing is sure that majority of the firms did not make any loss in operations.
Operating Profit Margin
Operating Profit Margin (OPM) is also called operating margin, operating income margin or return on sales (ROS). It is calculated by dividing operating profit with net sale usually presented in percentage. It shows the efficiency of the firm in generating profits from its operations. Difference between gross profit and operating profit provides information about the over head expenses in total cost.
Operating Profit
Operating Profit Margin= ---------------------- *100
Net Sale
Ratio table depicts that in 2006-7, its mean value is 1.82%. In 2007-8, this has decreased a lot and gone to -0.58%. It shows that as a whole, spinning mills of Pakistan have borne loss. Furthermore, it is also obvious from the table that 25% firms have -3% loss, however, data tells that more than 50% firms have positive figure.
Net Profit
Net Profit Margin= ---------------------- *100
Net Sale
In 2006-7, spinning mills of Pakistan have -1.76 % and in 2007-8, situation became worst and it is -6.25%. Furthermore, data also tells that in both years 50 % firms had faced a loss, which is quite alarming.
Return on Equity
Equity is the money invested by the shareholders for profit. This ratio indicates the firm’s ability to earn against the investment. It is also called return on average common equity, return on net worth, return on ordinary shareholders' funds.
Net Income after tax
Return on Equity= ---------------------- *100
Net equity
Spinning mills of Pakistan have only 0.71% ROE in 2006-7 and situation became worst in 2007-8. In 2007-8, it has -10.74%. It shows a pictures which tells that former year is worst than the previous year. Net loss of the firms will lead them to a serious position and this position may not allow them to survive and ultimately there are more chances that many firms will be bankrupt.
Earning Per Share
Earning per Share (EPS) is an indicator of the firm performance. It depends upon the profitability of the firms. It is calculated after closing the previous year’s books.
It is the portion of the firm’s profit which is allocated to each outstanding share of investors. In other words, it is a valid and reliable tool to measure the profitability of the companies. It is calculated as:
Net income-Dividends on Preferred Stocks
EPS= ----------------------
Avg. Outstanding Shares
In this study we have used EPS, which is considered as the single most significant variable in determining a share's price in stock exchange. This variable also tells price-to-earnings valuation ratio.
Table tells about the EPS situation of spinning mills of Pakistan. It is obvious that in 2006-7, the mean value of EPS is Rs. -0.39, whereas, it has gone to Rs. --2.37 in 2007-8, almost three times greater than previous years. It shows that spinning industry of Pakistan is facing big loss. If this trend remains continue in future, it will lead to a disaster, which can instigate many other losses. Data also provides information that more than 50% mills in 2007-8 have faced loss, whereas, in 2006-7, more than 50% mills earned profit.
Debit Ratio
Debt ratio is one the fundamental ratios used to determine the financial health of the firms. It tells that what is the level of total liabilities and assets of the firms.
Total Liabilities
Debit Ratio= ---------------------- *100
Total Assets
Spinning mills of Pakistan have 78.95 % and 64.00 % debt ratio in 2006-7 and 2007-8. It means that liabilities are more than the assets. In other words, there is a serious shortfall. More important is that in former year this ratio has gown down further, which means that with the passage of time the difference between liabilities and assets is increasing.
Total Asset Turnover
Total Asset Turnover (TAT) is a ratio which deals with net sale and total assets. This ratio measures how well a firm is using its assets to generate revenue.
Net Sales
Total Asset Turnover (TAT) = ----------------------
Average Total Assets
Table shows that in 2006-7, TAT mean value is 0.98 and in 2007-8 it is 0.95. Both figures tell that as a whole spinning industry could not generate revenue equal to the total asset. As discussed earlier that spinning sector is a capital intensive sector, we cannot compare results with any retail business. Apparently it looks that sale of the industry is significantly less than the total assets employed. This table also depicts that 25% firms succeeded to have sale more than capital invested (1.12 and 1.20 in 2006-7 and 2007-8 respectively).
Fixed Asset Turnover
Spinning mills have to invest in fixed assets to generate revenue. It may be in shape of land, machinery etc. Ratio of fixed and capital assets depends upon the type of industry.
Net Sales
Fixed Asset Turnover (FAT) = ----------------------*100
Average Fixed Assets
Spinning industry demands more fixed asset as compare to a stitching mill. This ratio simply deals with the ability of the firm to generate revenue from fixed assets. Naturally higher the figure means that firm is generating more revenue from the fixed assets. Table shows that in 2006-7, this ratio is 1.45, whereas, in 2007-8 it has gone to 1.56. It shows that spinning industry as a whole generates more revenue by using fixed assets in 2007-8 as compared to previous year.
It is obvious from the table that average of 25% firms is 1.95 and 1.91 for 2006-7 and 2007-8 respectively. It is nearly twice to the fixed assets.
Current Asset Turnover
Current Asset Turnover (CAT) is an indicator how the firm is using its current assets to revenue. Figure shows that how many times, firm has generated revenue as compared to its current assets.
Net Sale
Current Asset Turnover= -------------------
Average Current Assets
Ratio table shows that mean value on this ration in 2006-7 is 3.00, which has gone down to 2.65 in 2007-8. We have seen already that spinning industry of Pakistan failed to have turnover equal to their total assets. Nevertheless, spinning industry could manage to have revenue nearly three times to their current assets.
Salaries to Total Cost
Wages and salaries are a part of COGS. It varies depending upon many factors i.e. Type of firm, size of firm etc. Apparently it is difficult to comment on value. However, it is possible that we may compare this value among different mills belonging to same sector. As discussed in previous pages firms are compared with the average of the sector.
Total Wages and Salary
Salary to Cost Ratio = -------------------------------- *100
COGS
Ratio table tells that salary cost is 8% of the COGS in both years. Nevertheless, range is too wide. It starts from 3% and goes to 18%. Furthermore, data speaks that in both years 50% firms have 10% share of salary and wages in COGS.
Energy to Total COGS
Cost of fuel or energy is the second major cost of spinning mills. Data shows that its range is from 6 to 22 percent of the total cost of production. It is very useful to note that there are mills where share of fuel cost is too low. The mean value of energy to COGS is 11 and 10% in 2006-7 and 2007-8 respectively. There is a slight decline in the share of energy. It may be reflection of increase in cost of raw material which has pushed down the energy share or might be due to better use of energy. There is another possibility that this decline may be due to shift of many mills on in house generation of electricity by using natural gas, which is cheaper than the electricity provided by the government.
Total cot of energy
Energy to COGS =--------------------------- *100
COGS
It may be due to efficient system or use of natural gas to produce electricity. Table provides information that there is minor reduction in the average share of fuel cost. It may be due to many reasons; efficient use of electricity, modern technology or switching to gas based generators of electricity.
Raw Material to COGS
Table shows that raw material, which is mainly fiber, has 68.76% and 70.00% share in COGS in 2006-7 and 2007-8 respectively. It is major cost of any spinning mill. Main raw material of spinning mill is fiber. It may be cotton, polyester or any other fiber. Data shows that it has a wide range.
Total cot of raw material
Raw Material to COGS =--------------------------- *100
COGS
Cost of raw material covers nearly 3/4 of COGS. Any minor change in this cost can create a big problem for the spinning industry. Pakistan is a major producer of cotton and at the same time major user of cotton. Cotton is natural product and its production depends upon many factors and climate is one of them. Naturally, there is a cyclic price trend. It was observed during survey that firms having better current assets prefer to buy cotton at cheap rates and ultimately, it gives them advantages and increase profit margin of such firms.
Conclusion
From all above discussion it is much clear that more than 50% mills have shown losses in 2007-8, current ratio of more than 60% mills is less than one. Return on assets is quite low, rather many industries have shown a negative figure. All this discussion gives a proof that financial situation is quite worse and if it keeps on going in coming years, there is a chance that many share holders will lose their all investment and banks will not be able to take their loans back.
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Assistant Professor University of Management and Technology Lahore
Textile Graduate from University of Management and Technology Lahore
