INTERPRETATION Square Cephalosporins

Square Cephalosporins initiated in 2006 and in the period 2006- 2007 the output; cost and expense level could not reach optimum level as yet. The operating result however reached profitable level during the next two periods, 2007- 2008 and 2008- 2009. The pharmaceutical plant has further plans for upgrading its technological processes, research and training, creating possibilities of investments. The analysis of the financial statements reflected a growing pharmaceutical company. The study of the financial statements of Square Cephalosporins proposed three trend movements in the company. The trends are: 1. growing liquidity 2. decreasing financial leverage 3. increasing efficiency of asset utilization 4. rising profitability

Growing liquidity
The company has shown an upward trend in liquidity. The trend path is shown in the chart below:

Figure: chart showing trends of liquidity

From 2007 to 2008 the current ratio increased from 0.34 to 0.63. This occurred due to a significant increase in closing inventories of raw and
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packing materials. The increase was also caused by the occurrence of trade debtors through export sales. The ratio also increased as, almost half of the accrued expenses were paid off during the period. In 2009, the ratio increased by 0.7 times. In 2009, receivables of 2008 were collected and no new export sales were made. But, the cash balance increased 20 times this year than last year. It was a result of greater cash flow from operation and a lower interest payment during the year. Inventories in 2007 represented 91% of the current asset, most of which were the finished goods. This was because operation just started in November 2006, and sales could not reach the optimum level. In 2008, inventory was 89%, and that of 2009 was 88% of current asset. Due to high expenditure (interest and salaries) from the sales receipts, the net cash flow from operation was quite low in 2007 and 2008. As a result there was no residual cash at hand in 2007 and that of 2008 was a negligible part of the current liabilities. However in 2009, the company financed itself through short term borrowings and had a good flow of cash through reduced cash outflow to suppliers, employee and lenders (most of the short term loans were paid in the past years).The increased cash ratio of 2009(0 to 0.05) shows the companys improving cash standing.

Decreasing Financial Leverage

The use of debt by the company has decreased. The total debt ratio showed a regular downward trend (from 1.03 to 0.69) in the three accounting periods. Also the long term debt ratio decreased from 1.05 to 0.62 in these periods. Initially short and long term bank loans were taken to fund the implementation of the plant. After initiation, the cash inflow in the business was in the form of short term borrowings and receipts from customers. The inflow was used to finance purchase of fixed asset and operational expenses especially in the period 2006-2007 when the company made a net loss. By 2009, however, most of the retained earnings from operational activities were used to pay off substantial portions of the liabilities, which included the full payment of the long term bank loans. The suppliers of raw materials, packing materials and promotional supplies had been paid on a regular basis. Due to progressive functioning of the pharmaceutical unit, its retained earnings followed an upward trend which resulted in a rising shareholders equity. No additional shares were issued in the operating period of 2006-2009. Assets values decreased due to depreciation.
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Therefore, the decreasing liabilities (short and long), decreasing asset values and increasing equity have resulted in the decreasing trend of financial leverage of the company.
The companys adoption of the practice of quick repayments of creditors is reinforced by the trend of interest payment. The financial expenses of the company includes: interest on cash credit, short and long term loans , overdraft and lease, of which interest on short and long term loans constitutes a greater portion.

Figure: chart showing trends of Financial Leverage The cash coverage ratio followed an overall increasing trend starting from- 7.81 in 2007 to 2.94 in 2008 and ending to 5.56 in 2009. In the period 2006-2007, the company had an outflow of income (negative EBIT) and the interest expense was 7.81 times more than the loss. The cash coverage ratio of 2008 is lower than that of 2009 since in 2007-2008 period higher interest expenses were incurred. This is because in 2008- 2009 period, the company had no long term loan which resulted in lower interest payment. In 2009 the cash coverage ratio is higher as the interest expenses are lower and the retained earnings are higher than any of the other two periods. The decreasing trend of interest payment shows that the liabilities are paid off thus eliminating future interest expenses. This shows the debt management policy of Square Cephalosporins which involves quick repayments and prevalence of internal funding through retained earnings.

Increasing Efficiency of Asset Utilization

Square Celphasporins efficiency has increased in the three periods in terms of using its assets intensively to create sales. At the beginning it had a slow start with an inventory turnover of 1.09, but by 2009 the plant became efficient and sold off its inventory 2.31 times. Also now inventory sat for 158 days compared to that of 2006-2007 periods 335 days.
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The company had working 15 Inventory capital deficit in the periods 10 NW C 2007-2008 and 2006-2007. 5 Although with time, net Fixed asst. 0 working capital (NWC) Total asst. -5 2007 2008 2009 management of -10 Cephalosporins improved and by 2009 it achieved operating efficiency. This happened due to managing inventory, accounts payable and cash well. The suppliers were paid in advance in order to have an uninterrupted supply of raw and packaging materials. This minimized reordering cost thus saving up cash. Moreover, the current liabilities especially the short term borrowings and accrued expenses decreased over the three periods and current assets increased due to increased cash balance ( in 2007 there was no cash balance). These changes caused the NWC to move towards a positive scale and by 2009 it became positive. Therefore the trend is moving towards an efficient employment of NWC to generate sales as well as sufficient fund to satisfy maturing short term debts and upcoming operating expenses. Figure:
chart showing trends of Asset Utilization

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Rising profitability
The profitability of the business increased over the accounting periods. Although there was a net loss in 2006-2007, the company recovered itself and till 31 March 2009 generated 14.86% of sales as profit. This occurred as new fixed assets including improved technological equipments were purchased which increased production capacity thus meeting more local sales demand consequently increasing the net income for the succeeding periods. In 2008 interest expense was quite high (8% of sales) due to the interest on long term loans. However in 2009 the interest expense decreased to 5% as the long term loan had been paid fully. This gave rise to a higher net income in 2009. DU-PONT ANALYSIS The return on equity (ROE) can be broken down to see the operating efficiency, asset use efficiency and financial leverage of the company. ROE = Equity Multiplier x profit margin x total asset turnover = Equity Multiplier * ROA [ROA: return on asset]

The ROE states how much the shareholders have in return to their investments. The ROA tells us what is the return from the assets purchased
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by those investments and the equity multiplier signifies how much the return from asset is multiplied to act as the return for the shareholders. Due to net loss in 2007, there was no return on equity. In 2008, ROE was 141.35% and that in 2009 was 75.66%. This decrease in ROE was because in 2008 the retained earnings was negative which resulted in a smaller equity, whereas in 2009 the retained earnings was large and positive which resulted a larger equity. Moreover, the value of total assets decreased due to decrease in fixed asset by depreciation. These two changes caused the ROE of 2009 to decrease, though reasoning shows that it has happened for positive causes. The company has turned to be more profitable for shareholders as its earnings per share and net asset per share has been rising in the last three periods.

APPENDIX 1
(Extra questions)

What is the Dividend payout trend of the company?

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Square Cephalosporinss Ltd. has not yet proposed any dividend. They did not do so as it started operation in 2006 and in the period 2006-2007, the company made a net loss. It had to still upgrade its technological processes by purchasing fixed assets such as electrochemical equipment and laboratory equipments and pay its short term loans. With below optimal sales in 2007 and 2008, it could not generate enough cash to result a positive retained earnings balance at the period end. Since cash was inevitably needed for further operation paying dividend was not logical. Moreover the company may plan to take another series of long term bank loan in 2010 for more up gradation for which it preferred to repay its previous long term bank loans. These practices resulted in the no dividend trend but, the companys growing operating efficiency promises future dividend payment.

Illustrate an operating cost analysis; depicting which criteria is expensed more? The particulars of the operating expenses are not given. However, since the parent company and the subsidiary produces similar kinds of products the expensing trend of the parent company (Square Pharmaceuticals Ltd.) can be considered. Raw materials
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consumption generally covers most of the cost of goods sold. This may be due to the importing of some portion of raw materials as addition of import duty increases the cost. The selling and distribution expenses mostly consist of field staff allowance, marketing and promotional expenses and special discount. In administrative expenses, repair and maintenance, salaries and travelling costs are the major contributors. What is the constitution of inventory?
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Inventory constitutes of raw materials, packaging materials, finished goods and promotional materials. The raw and packaging materials compose most of the inventory. There are 843 items of raw materials amongst which certain portion is imported. Import duty is also said to be paid by the company but, the specifications of the percentage of imported raw materials and its relevant import duty are not given.

How does the company plan to finance its expansion/growth?

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The company has a policy to finance for its purchase of fixed asset and other investments mostly from internal fund. It tries to keep long term bank loan as a small portion of the financial mix. In 2008, long term loan represented 3.9% of the total liabilities and equity. In the projection of the financial statements of 2010, long term bank loan has been considered to be 4% of the total liabilities and equity (following 2008s trend).