LIQUIDITY AND PROFITABILITY PERFORMANCE ANALYSIS OF SELECT PHARMACEUTICAL COMPANIES Mohmad Mushtaq Khan1, Dr. Syed Khaja Safiuddin2 1Research Scholar, 2Sr. Asst. Professor, Department of Management Studies MANUU, Hyderabad

ABSTRACT Indian pharmaceutical market (IPM) is one of the fastest growing pharmaceutical markets, highly fragmented with about 24000 players out of which 330 belong to organized sector. There are approximately 250 large units and 8000 small scale units, which form the core of the pharmaceutical industry in India. The market is dominated by the branded generics, as we see the top ten companies make up for more than 3/4th of the market, that means nearly 70% to 80% of the market. As far as the reputation and rank of the IPM is concerned, it tops amongst the India’s science based industries; is 3rd largest in terms of its volume, and 13th largest as per its value in the world pharmaceutical market. Indian pharmaceutical market is expected to expand at a CAGR of 23.9 % to reach US$ 55 billion by 2020. Indian pharmaceutical companies receive a large sum of from the exports besides the domestic market, as some of them focus on the generics market in US, Europe and semi regulated markets; and some of them focus on custom manufacturing for innovator companies. We know that a company’s operating performance depends upon some key factors like turnover, profit, utilization, etc. and the variables which are found in profit and loss account and of a company. Henceforth, considering the growth and prosperity of pharmaceutical market, the study aims to analyze the financial performance of selected pharmaceutical companies, by establishing a close relationship between the variables in terms of liquidity and profitability. The study through empirical approach, may use ratios and indicators to measure the performance and identify the financial health status of the companies operating under one of the most dynamic sector in Indian economy.

Keywords: Liquidity, Profitability, Financial Performance.

I. INTRODUCTION

Financial ratios are useful indicators to measure a company’s performance and financialsituation. The present study aims to analyze the liquidity and profitability performance of selected Indian pharmaceutical companies (Cipla and Dr Reddy’s Labs). The term 'Liquidity' refers to the ability of a firm to meet its short-term maturing obligations within one year. The Liquidity resources of a firm may be kept in various forms: in hand and cash at in current assets, reserve drawing power under a cash or overdraft arrangement and short term deposits. Cash balances in current account provide the highest degree of liquidity. A firm can maintain liquidity if it holds assets that could be shifted or sold quickly with minimum transaction cost and loss in value. 167 | P a g e

The test of liquidity is the ability of the firm to meet its cash obligations when they are due and to exploit sudden opportunities in the market. Whenever one speaks of a firm's liquidity, one tries to measure firm's ability to meet expected and unexpected cash requirements, expand its assets, reduce its liabilities or cover any operating losses. According to Shapiro (2006) financial management is usually divided in two main separated functions: acquisition and investment of funds. Thus it is part of the financial management decisions and the attributions to obtain the necessary resources and apply them in order to achieve the profit maximization or the maximum value for shareholders. The management of is the part of the financial management responsible for the control of the gross current assets, which includes the firm’s cash, account receivables and inventories (Beranek, 1966). According to Assaf Neto (2003), the liquid assets are usually less profitable than the fixed assets. Investments in working capital do not generate production or sales. According to Eljelly (2004) the management of working capital becomes even more important during crises periods, “liquidity management is important in good times andit takes further importance in troubled times.” Also according to him, the efficient management of the liquidity levels of a company is of extreme relevance for the firm’s profitability and well-being.

II. LITERATURE REVIEW

A non-systematic literature review was undertaken to identify the financial ratios included in articles in peer- reviewed journals, industry publications, and articles in magazines and newspaper. To identify ratios in peer-reviewed articles, searches of academic databases using keywords such as “financial management”, “profitability and liquidity” and “ratio analysis” were undertaken Singh and Pandey (2008) In their research suggested that, for the successful working of any business organization, fixed and current assets play a vital role, and that the management of working capital is essential as it has a direct impact on profitability and liquidity. They studied the working capital components and found a significant impact of working capital management on profitability for Hindalco Industries Limited. Chakraborty and Bandopadhyay (2007) In their research studied strategic working capital management, and its role in corporate strategy development, ultimately ensuring the survival of the firm. They also highlight how strategic current decisions and strategic current liabilities decisions had multi-dimensional impact on the performance of a company. Raheman and Nasr (2007) In their study made an attempt to show the effect of different variables of working capital management including average collection period, inventory turnover in days, average payment period, cash conversion cycle, and current ratio on the net operating profitability of Pakistani firms. They selected a sample of 94 Pakistani firms listed on Karachi Stock Exchange for a period of six years from 1999 - 2004 and found a strong negative relationship between variables of working capital management and profitability of the firm. They found that as the cash conversion cycle increases, it leads to decreasing profitability of the firm and managers can create a positive value for the shareholders by reducing the cash conversion cycle to a possible minimum level. Lazaridis and Tryfonidis (2006) They conducted a cross sectional study by using a sample of 131 firms listed on the Athens Stock Exchange for the period of 2001 - 2004 and found statistically significant relationship between profitability, measured through gross operating profit, and the cash conversion cycle and its components 168 | P a g e

(accounts receivables, accounts payables, and inventory). Based on the results analysis of annual data by using correlation and regression tests, they suggest that managers can create profits for their companies by correctly handling the cash conversion cycle and by keeping each component of the conversion cycle (accounts receivables, accounts payables, and inventory) at an optimal level. Eljelly (2004) In his study empirically examined the relationship between profitability and liquidity, as measured by current ratio and cash gap (cash conversion cycle) on a sample of 929 joint stock companies in Saudi Arabia. Using correlation and regression analysis, Eljelly found significant negative relationship between the firm's profitability and its liquidity level, as measured by current ratio. This relationship is more pronounced for firms with high current ratios and long cash conversion cycles. At the industry level, however, he found that the cash conversion cycle or the cash gap is of more importance as a measure of liquidity than current ratio that affects profitability. The firm size variable was also found to have significant effect on profitability at the industry level. Ghosh and Maji, (2003) The study made an attempt to examine the efficiency of working capital management of the Indian cement companies during 1992 – 1993 to 2001 – 2002. For measuring the efficiency of working capital management, performance, utilization, and overall efficiency indices were calculated instead of using some common working capital management ratios. Setting industry norms as target-efficiency levels of the individual firms, this paper also tested the speed of achieving that target level of efficiency by an individual firm during the period of study. Findings of the study indicated that the Indian Cement Industry as a whole did not perform remarkably well during this period.

2.1. Liquidity Liquidity management is very important for every organization that means to pay current obligations on business, the payment obligations include operating and financial that are short term but maturing long term debt. According to Shim and Siegel (2000) liquidity is the company’s capacity to liquidate maturing short- term debt (within one year). Maintaining adequate liquidity is much more than a corporate goal and is a condition without which it could not reach the continuity of a business. Functions leading to liquidity In seeking sufficient liquidity to carry out the firm’s activities, following functions have to be carried out: 1) Forecasting cash flows: Successful day-to-day operations require the firm to be able to pay its bills promptly. This is largely a matter of matching cash inflows against outflows. The firm must be able to forecast the sources and timing of inflows from customers and use them to pay creditors and suppliers. 2) Raising funds: The firm receives financing from a variety of sources. At different times some sources will be more desirable than others. A possible source may not; at a given point of time have sufficient funds available to meet the firm’s needs. So the financial manager must identify the amount of funds available from each source and the periods when they will be needed. 3) Managing the flow of internal funds: A large firm has a number of different bank accounts for various operating divisions or for special purposes. The money that flows among these internal accounts should be carefully monitored.

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2.2. Profitability Profitability can be defined as the final measure of economic success achieved by a company in relation to the capital invested in it. This economic success is determined by the magnitude of the net profit accounting (Pimentel et al, 2005). Profitability may be measured in many different ways Lazaridis and Tryfonidis (2006) found statistically significant relationship between profitability, measured through gross operating profit, and the cash conversion cycle and its components (accounts receivables, accounts payables, and inventory). Functions leading to Profitability In seeking profits for firm, the financial manager can be a full member of the corporate management structure. In this role the manager provides specific input into decision making process, based on financial training and actions. With respect to profitability, some of his specific functions are as: 1) Cost control: Most large corporations have detailed systems to monitor expenditures in the operational areas of the firm. Because of supervising the accounting and reporting functions, the financial manager is in a position to monitor and measure the amounts of money spent or committed be the company. 2) Pricing: Some of the most important decisions made by a firm involve the prices established for products, product lines, and services. The philosophy and approach to pricing policy are critical elements in the company’s marketing effort, image, and sales level. Determination of the appropriate price is the joint decision of marketing and finance. 3) Forecasting profits: The financial manager is usually responsible for gathering and analyzing the relevant data and making forecasts of profit levels. 4) Measuring required return: Every time a firm invests its capital, it must make the risk-return decision. The required return is the rate of return that must be expect from a proposal before it can be accepted.

2.3. Need for the study Liquidity and profitability play a significant role in any organization that means to meet current obligations and maintain a healthy profitability from business operations. The purpose of this study is to measure the liquidity and profitability performance of the selected pharmaceutical companies. Every stakeholder has interest in the liquidity position of a company. Suppliers of goods will check the liquidity of the company before selling goods on credit. Employees should also be concerned about the company’s liquidity to know whether the company can meet its employee related obligations–salary, pension, provident fund, etc. Thus, a company needs to maintain adequate liquidity so that liquidity greatly affects profits of which some portion that will be divided to shareholders. Analysis of profit is of vital concern to stockholders since they derive in the form of dividends. Profits are also important to creditors because profits are one source of funds for debt coverage. Furthermore, Management uses profit as a performance measure.Liquidity ratios measure the ability of a firm to meet its short-term obligations. The ability to pay short-term debt is of concern to anyone who interacts with the company. If a company cannot maintain a short-term debt-paying ability, it will not be able to maintain a long- term debt-paying ability, nor will it be able to satisfy its stockholders. The liquidity ratios look at aspects of the company's assets and their relationship to current liabilities.

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2.4. Indian Pharmaceutical Sector Indian pharmaceutical sector has come a long way, being a small sector 1970 to a vital supplier of healthcare products, serving almost 95 per cent of the countries pharmaceutical needs. It ranks third in the world in terms of production volume and 13th in domestic consumption volume. Indian pharmaceutical industry grew at 15.7 per cent during December 2011. The Indian pharmaceutical industry is estimated to grow at 20 per cent compound annual growth rate (CAGR) over the next five years. India is now among the top five pharmaceutical emerging markets. There will be new drug launches, new drug filings, and phase II clinic trials throughout the year. On back of increasing sales of generic medicines, continued growth in chronic therapies and a greater penetration in the rural markets, the domestic pharma market will grow at 10-12 percent in FY15 as compared to 9 percent in FY14. Factors involved in the growth and challenges faced by Indian pharmaceutical market India is known today for producing high quality generic medicines that are sold globally. The following factors have fueled the growth of drugs and pharmaceutical sector. 1) The growing population over a billion. 2) Growing Indian economy with increasing income. 3) Changing disease profile. 4) A huge patient base. 5) Improving healthcare infrastructure. The following challenges faced by global pharmaceutical industry also open up a number of opportunities for the Indian pharmaceutical industry. 1) High healthcare cost. 2) Competition from generics. 3) Patent expiries of blockbuster drugs. 4) Poor all round infrastructure is a major challenge. 5) Stringent price controls. 6) Lack of data protection. Many Indian pharmaceutical firms are major market players in Indian and global market and these include Cipla, Ranbaxy, Dr Reddy’s Labs, Sun Pharma etc. The above are some of the key variables along with them high research and development expenditures, continuous innovation expenditures, modification expenditures etc., thrashes the solvency and profitability of the pharmaceutical companies. Therefore, application of adequate financial management is must to manage and control the flow of funds efficiently which helps the organizations to improve their solvency and profitability performance.

III. HYPOTHESES OF THE STUDY

H0: to ratio is uniform in the selected companies. H1: Current asset to current liability ratio is not uniform in the selected companies. H0: Quick ratio is uniform in the selected companies. H1: Quick ratio is not uniform in the selected companies. 171 | P a g e

H0: Return on assets is uniform in the selected companies. H1: Return on assets is not uniform in the selected companies. H0: Return on is uniform in the selected companies. H1: Return on equity is not uniform in the selected companies.

3.1. Objectives The main objective of the study is to analyze the liquidity and profitability of selected companies and more specifically it seeks: 1) To study the liquidity performance of select companies. 2) To study the profitability performance of select companies. 3) To compare the liquidity and profitability performance of selected companies.

3.2. Scope The concern of this study liquidity and profitability performance of selected Indian pharmaceutical companies. The pharmaceutical sector has been chosen for this study because it is one of the important and fastest growing sector in Indian economy and data from a reasonable number of companies would be easy to find. Current ratio and quick ratio is vital to analyze the liquidity position of the firm. Return on Assets (ROA) and Return on Equity (ROE) will also be used to calculate profitability of the firms in this study. The past five years (05) annual financial reports of the firms from 2010 to 2014 will be used in this study. The sample was selected picking up the largest pharmaceutical companies in India. And Cipla being the largest in terms of revenue and Dr. Redd’s labs the third largest pharmaceutical company in India. In consequence of the time limitation to finish the work it is decided to pick a sample of only 2 companies, however this number is good enough for the statistical procedures.

IV. METHODOLOGY

Financial management theories provide various indexes for measuring a company’s performance. One of them is accounting ratios. The uses of the financial ratios are quite common in the literature. Company regulators, for example, use financial ratios to help evaluate a company’s performance. Data Set: The data used in the present study was acquired from the annual reports of the selected companies. The analysis is based on financial statements of the two pharmaceutical companies of our economy. Variables: The present study carries out the issue of recognizing key variables that influence financial performance. All the variables stated below have been used to test the hypotheses of study. Liquidity ratios Static measurement of liquidity determines the relation between current assets and short-term liabilities. The ratios based on this relation are the relationship of various ranges of current assets with different liquidity levels to short-term liabilities. They reflect, thus, various degrees of financial liquidity of an enterprise. There are two basic ratios of financial liquidity.

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Current ratio (CR) – III-degree liquidity ratio CR = CA/CL where: CR – current ratio CA – current assets CL – Current liabilities The current ratio is the most frequently used one. It offers a general view of the company liquidity and is a starting point of its analysis. It defines to what degree current assets cover short-term liabilities. It determines then potential ability of an enterprise to pay all its current liabilities through liquidizing possessed resources of current assets. The higher the value of the ratio, the higher this ability is. Quick Ratio (QR) – II-degree liquidity ratio QR = CA – I/CL where: QR – quick ratio I – inventory The least liquid element of current assets is inventory. To obtain the liquidity measure on the basis of a group of assets which are easier to sell, we separate them from the current ratio. The quick ratio shows to what degree short-term liabilities are covered with the most liquid current assets. Profitability measurement Assets profitability ratios are the relation of income net to total assets involved in company activities. They show what amount of financial result is generated by a cash unit of the assets. Return on assets (ROA) R O A = NI/TA × 100 where: ROA – return on assets NI – net income TA – total assets Return on assets ratio is a basic measure of the profitability of all assets and reflects its earning power. The ratios of own equity profitability constitute a relation of the financial result to own equity, showing what amount of profit (loss) is generated by its monetary unit. Return on equity (ROE) R O E = NI/E × 100 where: ROE – return on equity E – equity The return on equity ratio is a key ratio in evaluating profitability. The difference between this ratio and the return on assets ratio in a rough approximation expresses the level of financial leverage.

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4.1 Data Analysis After concluding steps of the data collection statistical analysis of the data has been done by using mean. Liquidity ratios: CR = CA/CL Test of Hypotheses - I Year Cipla Dr. Reddy’s labs

2010 3.13 1.46

2011 2.6 1.1

2012 3.6 1.5

2013 3.0 1.5

2014 2.20 1.8

Mean 2.90 1.47

Sources www.moneycontrol.com&www.equitymaster.com The above table shows that over the course of five financial periods of study the mean of Current Ratio in Cipla is higher than Dr. Reddy’s labs. This shows that Cipla have sufficient current assets to meet short term operating needs, but even though we can’t claim it as on good position as current ratio of 2.9 times is much more than the standardized degree and leads to increase in the volume of dormant or non performing funds. Interpretation: calculated mean value of current ratios is not same. So H0 Hypothesis is rejected. QR = CA – I/CL (Quick Ratio) Test of Hypotheses - II Year Cipla Dr. Reddy’s labs 2010 2.0 1.18 2011 1.96 1.28 2012 1.56 1.58 2013 1.64 1.60 2014 1.38 1.76 Mean 1.70 1.48 Sources www.moneycontrol.com&www.equitymaster.com

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The mean values of quick ratios are not same for the selected companies. The quick ratio shows to what degree short-term liabilities are covered with the most liquid current assets. From the table we can see Cipla has higher quick ratio than Dr. Reddy’s labs. Interpretation: calculated mean value of quick ratios is not same. So H0 Hypothesis is rejected. Means there is significant difference between the performance of pharmaceutical companies on the basis of Quick Ratio. Profitability measurement R O A = NI/TA × 100 (Return on assets) Test of Hypotheses - IV Year Cipla (%) Dr. Reddy’s labs (%)

2010 15.28 1.32 2011 11.8 11.6 2012 12.6 12.6 2013 13.5 12.1 2014 11.4 13.0 Mean 14.50 9.85 Sources www.moneycontrol.com&www.equitymaster.com Return on assets as a basic measure of the profitability, we can see the performance of Cipla is better than that of Dr. Reddy’s labs in terms of profitability. Interpretation: calculated mean value of return on assets is not same. So H0 Hypothesis is rejected. R O E = NI/E × 100 (Return on equity) Test of Hypotheses - V Year Cipla (%) Dr. Reddy’s labs (%)

2010 18.32 21.4 2011 14.8 24.8 2012 15.0 26.1 2013 17.1 24.0 2014 13.8 25.0 Mean 15.8 24.26 Sources www.moneycontrol.com&www.equitymaster.com Being the key ratio in evaluating profitability, we can see the performance of Dr. Reddy’s labs has improved and it has performed better than Cipla in terms of return on equity. Interpretation: calculated mean value of return on is not same. So H0 Hypothesis is rejected.

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V. FINDINGS AND CONCLUSION

1. From the analysis it is found that over the course of five financial periods of study the mean of Current Ratio in Cipla is higher than Dr. Reddy’s labs. This shows that Cipla has sufficient current assets to meet short term operating needs. 2. From the study it is also found that the mean values of quick ratios are not same for the selected companies. The quick ratio shows to what degree short-term liabilities are covered with the most liquid current assets.Means there is significant difference between the performance of pharmaceutical companies on the basis of Quick Ratio. 3. From the analysis it is also found that the performance of Cipla is better than that of Dr. Reddy’s labs in terms of profitability. 4. In terms of return on equity in evaluating profitability, we can see the performance of Dr. Reddy’s labs has

improved and it has performed better than Cipla in terms of return on equity. Financial management has great importance in making management decisions. The financial soundness of a company can be achieved maintaining liquidity and profitability of the company. The purpose of this study was to measure the liquidity and profitability of the selected pharmaceutical companies. So now to conclude the current ratio of Cipla is better than Dr. Reddy’s labs show that Cipla has performed better in terms of liquidity and Cipla has also performed better than Dr. Reddy’s Labs in terms of quick ratios. The profitability ratios show that return on assets is higher in Cipla than that of Dr. Reddy’s labs which means it has higher rate of profits than Dr. Reddy’s Labs. But in terms of return on equity Dr. Reddy’s labs has performed far better than Cipla. Which shows that Cipla is having more liquid funds than the required (CR. 2.90) which in turn might have decreased its profits. But there are various other reasons for the decrease in profits. To conclude there is a vast difference in the performance of selected pharmaceutical companies in terms of liquidity and profitability.

REFERENCES Books [1]. Shapiro, A. C. Multinational Financial Management. 8th edition. Boston: Wiley, John & Sons. (2006). [2]. Beranek, William. Working Capital Management. Belmont, Calif.: Wadsworth Pub., 1966. Print. [3]. Assaf Neto, A. Finanças Corporativas e Valor. São Paulo: Atlas 2003. [4]. C R Kothari, Gaurav Garg, Research Methodology- 3rd edition. New Age International Publishers 2014. [5]. John J. Hampton, Financial Decision Making- 4th edition. Prentice-Hall India 2004. [6]. Pandey, I. M Financial Management-eight edition. 1995. terature, Lund. 2007. Articles [1]. Eljelly, A. (2004). “Liquidity – profitability tradeoff: an empirical investigation in an emerging market”. IJCM, 14 (2) [2]. Pimentel, R. C., Braga, R., & Casa Nova, S. P. C. (2005). “Interação entre rentabilidade e liquidez: um estudo exploratório. Revista de Contabilidade do Mestrado em CiênciasContábeis da” UERJ, Rio de Janeiro – 10 (2), PP. 83-98. 176 | P a g e

Journals [1]. Singh, J.P. and Pandey, S. (2008), “Impact of Working Capital Management in the Profitability of Hindalco Industries Limited,” The Icfai University Journal of FinancialEconomics [2]. Chakraborty, P.K. and Bandopadhyay, K. (2007), “Strategic Working Capital Management: Case of a Turnaround Company,” ICFAI Reader [3]. Raheman A, Nasr M, 2007. Working capital management and profitability – case of Pakistani firms. International Review of Business Research Papers [4]. Lazaridis, Ioannis and Tryfonidis, Dimitrios, “Relationship Between Working Capital Management and Profitability of Listed Companies in the Athens Stock Exchange. Journal of Financial Management and Analysis”, Vol. 19, No. 1, January-June 2006. Available at SSRN: http://ssrn.com/abstract=931591 [5]. Ghosh, S. K. and Maji, S. G. 2003. “Working Capital Management Efficiency: A study on the Indian Cement Industry”,The Institute of Cost and Works of India. [6]. Shim, Jae K., Joel G. Siegel, and Allison I. Shim. "Budgeting Basics and Beyond." (2000). Print.

Websites www.moneycontrol.com www.equitymaster.com www.ibef.org/industry/pharmaceutical-india.aspx

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