1

Financial Outlook of Spinning Industry of Pakistan: 2006-2008

1
Muhammad Mushtaq Mangat
2
Abdul Raheem Wahab

Introduction
Spinning industry of Pakistan is one of the oldest and well organized manufacturing industries of
Pakistan. At the time of Partition, there were two big mills in Pakistan. However, in 2009, there are
more than 450 spinning mills and nearly 12 million spindles are installed in Pakistan. These mills
are providing yarn to local industry and have a significant share in international yarn trade.
Furthermore, this sector has contributed a lot for the promotion of textile education and training in
Pakistan. Government of Pakistan imposed education tax on the mills for National Textile
University, formally National College of Textile Engineering Faisal Abad. In addition, All Pakistan
Textile Mills Association (APTMA) made a generous contribution to establish Textile Institute
Pakistan in Karachi (APTMA 2008).

Spinning industry is capital intensive in nature and needs a huge investment to put a mill into
function. Furthermore, there is a need of continuous support of banks for the regular supply of
fibers. APTMA annul report of 2008 depicts that spinning industry is in crises. Nearly 20% mills
have been closed down their functions and are facing crises. It is a serious matter since this sector is
one of the sectors who have a significant share in employment, GDP and capitalization. If
something happens wrong with this sector, it would be absurd for the economy of Pakistan.

Financial Ratios and Spinning Mills of Pakistan

One can have a deep idea about the future of firms from its financial ratios. These ratios are derived
from the financial statements provided by the firms. This report is an effort to have an idea about
the current problems and financial health of the mills. Considering these ratios, one can develop an
idea about the future of this sector. We did not find any combined report on the financial position of
mills. This is an effort to give a comprehensive view of this sector.

Significance and Implication of Financial Ratios: A Literature Review

Financial Ratios are derived from financial reports of the firms. There is certain objectivity behind
calculating the ratios. These ratios indicate financial health and strength of the firms. There is a long

1 Assistant Professor University of Management and Technology Lahore

2 Textile Graduate from University of Management and Technology Lahore
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list of financial ratios. Sometimes, such long list can create some sort of confusion. The user needs
to array all available ratios and then has to group them under various heads. Such exercise can help
user to earmark the useful ratios (Gombola and Edward, 1983). There is a logical connectivity
among these groups since they are derived from the same source. Classification and selection of
useful ratios depends upon the objectives as well as the business dynamics. This classification is
based on the natural and instinct nature of the ratios. Gombola and Edward (1983) have grouped
ratios into seven following classes:

1. Return on investment
2. Capital intenseness
3. Inventory intensiveness
4. Financial leverage
5. Receivable intensiveness
6. Short term liquify
7. Cash position

Chen and Shimerda (1981) have discussed the significance of financial ratios in evaluating the
performance and financial position of the firms. They concluded that such ratios also helped people
to predict the bankruptcy of firms up to 90%. It shows that ratios demonstrate picture of the firm
and one can anticipate the future of the firms. Rapid changes in business has forced business world
to develop functional and practical financial ratios of the organization. There are many usages of
these ratio but primarily these ratios are used for prediction purpose (Gupta and Huffier 1972).

Beaver (1966) points out that ratio analysis is in use since the beginning of the nineteenth century
and initially current ratio was common. This ratio was used primarily for the evaluation of
creditworthiness. However by the end of the century there are numerous ratios commonly under
use. Beaver further states that useful of ratios is mainly linked with the objectivity if the study.

Ratios are widely used in real business world and people rely on these ratios. These ratios are quite
important for investor, lenders etc. On the other hand, academic world is moving away from this
traditional concept and demands to develop a multivariate discriminatory model. Particularly, to
predict the bankruptcy. Altman (1968) writing about this idea developed a model which has given
95 % accurate results. Above debate is quite valid and needs a serious discussion. This debate
reveals that there is a serious difference of opinion between academic world and real business
world. Nevertheless, one thing is common that both agree that the ratios are quite useful for the
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prediction of future. The main difference is how one uses these ratios. This paper is an effort to
assess the current financial health of a sector, which is very much important for the economy of
Pakistan. We prefer to apply traditional method to measure financial ratios. However we believe
that for prediction of solvency, such limited knowledge is quite meager and needs in depth
information to have a reliable result.

There are certain issues while selecting and comparing the ratios. Literature is full of such
discussions that selection of ratios needs a careful consideration keeping in mind the objectivity of
the study. Chen and Shimerda (1981) discussed the issue regarding selection of useful ratios. They
have tried to help people in selecting the useful by analyzing the empirical studies. Their
conclusion tells that there is no constant and set rule which may be useful in selecting the ratios. In
our view such selection is of subjective nature and biased towards the nature and objectivity of the
researchers.

Financial ratios are derived for certain application. There is an emerging trend in transforming these
ratios into a meaningful predicting model by using advance statistical techniques. Application of
statistical techniques are providing useful results but accuracy and usefulness of these results are
under question (Deakin 1976). Application of statistical techniques depends upon some
assumptions. As described by Deakin, it is not possible in all cases that such techniques can be used
to predict the future of the firms. Statistics in its nature relies on the assumptions and it provides the
probability of the outcome. Keeping this limitation Deakin does not support to use advance
statistical tools rather prefers traditional use of ratios to assess financial health of the firms.

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.
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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
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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.
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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.
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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
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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

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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.
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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

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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
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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.
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Financial Ratios of Spinning Industry of Pakistan

2006-7 2007-8

Mean Percentiles Mean Percentiles

25 50 75 25 50 75
Liquidity Current Ratio
Measurement
Ratios 0.87 0.69 0.9 1.02 0.82 0.73 0.84 1
Return on
Assets
-2.07% -4.00% 0.00% 2.00% -1.73% -5.00% -1.00% 1.00%
Gross Profit
Margin
6.53% 4.00% 9.00% 13.00% 6.21% 2.25% 8.00% 13.00%
Operating
Margin 1.82% 0.50% 5.00% 10.00% -0.58% -3.00% 4.00% 8.00%
Profit Margin
-1.74% -2.25% 0.00% 2.00% -6.25% -4.00% -2.00% 1.00%
Return on
Equity 0.71% -11.25% 2.00% 11.25%-10.74% -23.50% -2.00% 8.00%
Earnings Per
Share (Pk. Rs)
Profitability
Indicator
Ratios 0.4 -3 0 2 -2.37 -3 -1 2
Debit Ratio
Debit Ratios 78.95% 57.00% 71.00% 88.50% 81.97% 64.00% 73.00% 89.00%
Operating Total Asset
Performance Turnover
Ratios 0.98 0.62 0.86 1.12 0.95 0.55 0.82 1.2
Fixed Asset
Turnover
1.45 0.86 1.17 1.95 1.56 0.9 1.28 1.91
Current Asset
Turnover
3 1.69 2.46 3.56 2.65 1.46 2.13 3.09
Salaries to
Total Cost
8.12% 6.00% 7.50% 9.00% 7.78% 6.00% 7.00% 9.00%
Energy to Total 10.50% 9.00% 10.00% 12.00% 9.90% 8.00% 10.00% 11.75%
Cost
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Financial Ratios of Spinning Industry of Pakistan

Raw Material to
Total Cost 68.76% 64.00% 70.00% 73.00% 70.48% 68.00% 72.50% 76.00%

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.

References
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Bankruptcy. The Journal of Finance, Vol. 23, No. 4 (September, 1968), pp. 589-609

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