Factors Affecting Profitability of Spinning Mills of Pakistan Muhammad Mushtaq M

angat Dr. M. Sarwar Rana Abdul- Rhim Wahab Abstract Spinning Industry of Pakista
n is one of the leading and major industries of Pakistan. Unfortunately, this in
dustry has been coping with overwhelmed crisis for the last few years. Mills hav
e to suffer from thrashing fatalities. Nearly 12 million spindles have been set
up in Pakistan and out of them 30% have closed down forever. What are the reason
s behind this collapse? The study has revealed various factors that had a substa
ntial relationship with the performance of the spinning mills and the conclusion
avers that net equity, non-current liabilities and sale volume have a positive
connection with the net profit of the mills. The study also finds a logical conn
ectivity between net profit (Earning Performance Share) and factors mentioned ab
ove. Nevertheless, other factors like, cost on raw material, electricity cost, w
ages and salaries have also parallel with profitability of mills but regarding s
tatistically importance the relation is not significant. Introduction
Textile is the backbone of Pakistani economy. It has 60% share in exports. In ea
rly 1960s, yarn and cotton were main contributors in exports but in 2007, clothi
ng (readymade garment, knitted garments, bed wears and towels) stepped forward a
nd surpassed. In 2007-8, the share of yarn and grey fabric in total textile expo
rts of the country was 30.1 % whereas, clothing sector had 59 % share. The cloth
ing is an increasing trend in
Pakistan as compare to yarn and grey fabric that is declining day by day. The da
ta related to the export reveals that there is a decline in yarn exports, meanin
g is that spinning industry is losing its share in international market (Table 1
). Spinning industryâ s share further plunged when in 2007-8; another 100 spinning mi
lls were forced to shut down, because of heavy losses. Spinning industry of Paki
stan is striving to survive and for this purpose, it is asking some concrete inc
entives and discounts to be given by the government of Pakistan. A big debate be
tween the government and industry continues. Chairman of All Pakistan Textile Mi
lls Association says in 2008 annual report that government is of the opinion tha
t the industry is not efficient, well organized and resourceful; it merely relie
s on old and obsolete technology. The report further says that the industry blam
es the government to be responsible for the downfall. But government views that
it is the fault of the wrong utilization of loans by the mills, consequently mil
ls are facing serious problems. The Industry feels that high interest rates, non
-availability of power and high rates of power, along with no incentives on expo
rt are the main reasons of these crises. In such a scenario, it becomes imperati
ve to conduct a research to find out the main reasons of the crises. For this pu
rpose, critical analysis of the financial reports published by the mills is the
one of the possible ways to make out insight of the issue. A large number of mil
ls are public limited companies and they publish their annual financial reports.
It is presumed that these reports are correct and we do not have any other sour
ce to know the financial health of the mills. Table 01
Share of Textile and Clothing in Exports of Pakistan
Product Description 2007-08 (Export 2006-07 Percentage Percentage in Net
Value in Million US (Export Value in $) TEXTILE & GARMENTS CATEGORY YARN FABRICS
SUB TOTAL READYMADE GARMENTS KNITWEAR MADE-UPS TOWELS SUB TOTAL 1,343,357.00 2,
004,310.00 3,347,667.00 1,498,499.00 1,831,178.00 2,423,723.00 615,415.00 6,368,
815.00 1,495,438.00 2,090,115.00 3,585,553.00 1,547,345.00 1,798,477.00 2,510,21
2.00 610,712.00 6,466,746.00 10,620,542.00 Million US $) 10,835,409.00
Change in Export Share in Total Textile Value -1.98 Exports
-10.17 -4.11 -6.63 -3.16 1.82 -3.45 0.77 -1.51
12.65 18.87 31.52 14.11 17.24 22.82 5.79 59.97
Background Spinning is a process in which fiber is converted into yarn and for t
his purpose, a number of machines have to function. A brief list of the process
is given as under: 1. Bale opening and fiber blending 2. Blow room to open and c
leaning of fibers 3. Carding for more orientation and removal of short fibers 4.
Drawing for more orientation and making of sliver 5. Simplex to convert sliver
into roving 6. Ring frame to convert roving into yarn 7. Winding to make big yar
n package This whole process needs labor, machinery and energy in order to run t
he machines. Spinning is a capital-intensive industry and needs less labor as co
mpared to other sectors like, clothing manufacturing. According to the financial
reports, the major expense of a spinning mill is cost of raw material, which is
between 65-75% of the total cost of production, depending upon the count which
company is producing. After that, electricity is a major expense and finally sal
ary and wages is the third expense. The above three factors have major share in
cost of goods sold (COGS). Financial strength of firms has also a considerable r
ole in profitability of the firms. Better resources definitely help to have late
st technology and low cost of input. During survey of the spinning mills, we fou
nd that the firms who had high current ratio (current assets divided by current
liability) were having input at low prices and of best quality e.g.
cotton, spare parts etc. it is because, high current ratio shows that company ha
s more working capital and can pay timely to vendors. The less cost of inputs he
lped in high EPS and it is the case with net equity that has to show firms are m
uch relying on their own resources rather than relying on banks and borrowing fr
om market, which is costly than banks even. Keeping all above discussion in view
, we have taken factors from both areas to check their affect on EPS. Research M
ethodology The annual financial reports of the mills are the main source for thi
s research. For this study we have collected and compiled data from the years 20
06-7 and 2007-8. The analysis has been made while using the software of SPSS. Th
e main reliance is on published annual financial reports by the spinning mills.
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 hav
e to opt opportunity sampling. For this purpose, we visited Lahore and Karachi S
tock 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 we
t processing) therefore, the data of such mills were not used due to different s
tructure from ordinary spinning mills. Reports of 55 mills were used for the stu
dy which is nearly 13% of the total mills.
Variable Selection Earnings Per Share (EPS) has been taken as dependent variable
while the following variables have taken as independent: 1. Share of raw materi
al cost in COGS 2. Share of salary and wages cost in COGS 3. Share of fuel cost
in COGS 4. Current Ratio 5. Net Equity 6. Net sale 7. Non-Current Liabilities
Discussion Seven different factors were selected in order to weigh up their impa
ct on EPS, which is ultimate target of the firm. We became convinced that there
were many more factors which can affect the performance of the mills but our lim
itation is due to the availability of data. We have calculated correlation betwe
en dependent and independent variables and finally we applied regression to deve
lop an equation, which could be used for prediction purpose of EPS.
Table 2
Correlation between Earnings Per Share (Pk. Rs.) and Seven Different Factors Pea
rson Correlation 0.087 Sig. (2Tailed) 0.401
Share % of Raw Material
Cost in COGS Share % of Salaries in COGS 0.-130 Share % of Fuel Cost in COGS Sal
e (Million Rs) Net Equity (Million Rs) Non Current Liabilities (Million Rs) Curr
ent Ratio -0.048
0.205 0.639
0.415 0.371 0.208
0.000 0.000 0.040
0.166
0.100
The above table shows there are three factors, which have a vital impact on EPS
these are: 1. Sales (P value: 000) 2. Net Equity (P value: 000) 3. Non Current L
iabilities (P value: 0.040) Result shows that sale has a positive effect on EPS.
Its practical impact is 0.415, which is quite high and can be considered as one
major factor. The table also throws light that more net equity has a direct and
positive contribution. Its practical contribution is 0.371. Lastly, non-current
liabilities have also a strong correlation and its practical impact is 0.208, w
hich is less than other factors.
Table 02, also explains that cost of raw material and current ratio have a posit
ive impact on EPS. Although, these factors are not statistically significant yet
we can infer from these figures that increase of raw material cost has not a bi
g impact. This means that in general, increase in fiber prices immediately affec
ts the yarn prices. People have a strong logic to increase the yarn price when t
here is an increase in fiber prices. In addition, current ratio, which indicates
the ratio of current liabilities to current assets, is an indicator of the comp
any to pay its current liabilities.
Regression Equation Regression analysis is one way to determine the relationship
and coefficient of relationship between dependent and independent variables. Fo
r this purpose following equation has been derived from the regression analysis:
EPS= -2.749 + 0.343 NS + 0.002 NE + 0.208 NCL Where: EPS= Earnings Performance
Share NS= Net sale in Million Pk Rs. NE= Net Equity in Million Ok Rs. NCL= Non C
urrent Liability in Million Pk Rs. Equation (1)
Adjusted R Square value of this model is 0.221 and p value is .000. Adjusted R S
quare value indicates that this model explains 22.1 % changes in the dependent v
ariables. In other words, we can say that any up to 22.1 % change in dependent v
ariable is due to
these three variables. The regression equation explains the importance of sale,
noncurrent liabilities and net equity for EPS of spinning mills.
Conclusion
The spinning mills of Pakistan can overcome all the crises if they improve their
sale and equity and more reliance on non-current liabilities rather borrowing s
hort term loans and goods on credit. For this purpose mills need loan on long te
rm basis. It is suggested that government should intervene and provide long term
facilities to decrease the current liabilities. So that mills may have better c
urrent ratio and finally they will have higher EPS. In addition to that there is
a need that mills should increase their sale volume by producing different type
s of yarn i.e. compact, core spun, slubs and sell their goods in markets other t
han the conventional markets. Nevertheless, cost of material, fuel and energy ha
ve also affect on the EPS but these factors are statistically not important. Thi
s study confirms that benefit of reduction in raw material prices directly refle
cts in the shape of reduction in price of yarn. However, increase in cost of fue
l and salary reduces the EPS but not significantly. If there is increase in cost
of fuel and salary it cannot be easily passed to customers, as it is done in ca
se of raw material cost, which is immediately passed to customers.