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LIQUIDITY and PROFITABILITY PERFORMANCE ANALYSIS of SELECT PHARMACEUTICAL COMPANIES Mohmad Mushtaq Khan1, Dr

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LIQUIDITY and PROFITABILITY PERFORMANCE ANALYSIS of SELECT PHARMACEUTICAL COMPANIES Mohmad Mushtaq Khan1, Dr 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 revenues 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, assets utilization, etc. and the variables which are found in profit and loss account and balance sheet 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: cash in hand and cash at bank in current assets, reserve drawing power under a cash credit 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 working capital 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 asset 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 expenses that are short term but maturing long term debt. According to Shim and Siegel (2000) accounting 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. 169 | P a g e 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.
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