5_IJS_MAY2012

INTRODUCTION 4. Acquiring new long term debt increases working

The success of any business is largely depends on its capital, total liabilities and total assets.

effective financial management practices which starts with 5. Depreciation and amortization expense is already

procurement of funds and ends with effective utilization of included in the earnings but it will increase working

funds. Therefore continuous financial analysis of financial capital as noncash items previously deducted.

position and results is required to take corrective measures 6. Capital Expenditures decrease working capital as cash

to meet the short-term and long-term requirements is used to pay for them.

adequately.

The Z-Score is also a critical business tool which COMPANY PROFILE

CIPLA Pharmaceutical incorporated in 1934 by Dr K A utilizes to inform how to improve the financial health of

Hamied and set ups "The Chemical, Industrial and the business. Z Score factors that contribute to under-

Pharmaceutical Laboratories Ltd." in a rented bungalow, at performance; working capital, earnings retention,

Bombay Central. Now it has Nine facilitating division in profitability and leverage can be isolated. This enables

different places and ranks Ist in India. Established in 1984, managers to initiate actions to improve the score of these

Dr. Reddy's Laboratories Ltd. is an integrated global factors contributing to financial unhealthiness. Focus areas

pharmaceutical company, committed to providing for managers to improve Z Score are on earnings/ (losses),

affordable and innovative medicines for healthier lives. capital expenditures, equity and debt transactions. It

Through its three businesses - Pharmaceutical Services and includes:

Active Ingredients, Global Generics and Proprietary 1. Earnings increases working capital and equity.

Products - Dr. Reddy's offers a portfolio of products and 2. Adjust EBIT by adding back interest expense.

services including Active Pharmaceutical Ingredients 3. Adjust EBIT by adding back income tax expense.

INTERNATIONAL JOURNAL OF SOCIAL SCIENCES

& INTERDISCIPLINARY RESEARCH

Vol.1 No. 5, May 2012, ISSN 2277 3630

Online Available at indianresearchjournals.com

*S.CHRISTINA SHEELA, **DR. K. KARTHIKEYAN

*Indra Ganesan College Of Engg, Associate Professor, Management Studies, M-793, Anna Nagar, Trichy-620 026, Tamil Nadu.

**Saranathan College Of Engg,Associate Professor, Management Studies, Trichy-620 026, Tamil Nadu

ABSTRACT

Most of the internal users as well external users like shareholders, government, bankers, creditors, financial institutions

etc. focus on the success and solvency position of the company with whom they are dealing. The absolute figures

presented in financial statements and accounts do not serve this object. As there are many accounting tools like ratio

analysis, decision theory etc. used for analysis but again they shows absolute result through which the present position

can be judged not the future. Edward I Altman, Professor of Finance at New York University was the first person who

developed a new model popularly known as "Z-score Model" to predict the financial health of the business concerns. He

considered five ratios and assigned a weight for each ratio and produced a single number which indicates the financial

health of the business concerns. In the present research paper an attempt is made to predict the financial health of

PHARMACEUTICAL INDUSTRY with special reference to Cipla, Dr.Reddy's laboratories and Ranbaxy

Laboratories Ltd from 2001-2002 to 2010-2011 for 10 years using Altman's Z-Score model. It is found out that Cipla

and Dr. Reddy's are in too healthy Zone where it is successful in its financial performance and not to fall bankrupt. But

Ranbaxy is in healthy zone where its financial viability is considered healthy and the failure in the situation is uncertain

to predict.

KEY WORDS: Financial Health, Cipla, Dr.reddy's Laboratories, Ranbaxy Pharmaceutical, Z-score Model, Financial

Performance

EVALUATING FINANCIAL HEALTH OF PHARMACEUTICAL

INDUSTRY IN INDIA THROUGH 'Z' SCORE MODEL

25

(APIs), Custom Pharmaceutical Services (CPS), generics, debt to total assets (iv) networking capital to total assets

bio-similar, differentiated formulations and News and (v) current assets to current liabilities" as expected,

Chemical Entities (NCEs). "Ranbaxy Laboratories Ltd failed firms had more debt and lower return on assets. They

was incorporated in 1961 and which is renowned as India's had less cash but more receivables as well as low current

largest pharmaceutical company and producing a wide ratios. They also had fewer inventories". It was observed

range of quality, affordable generic medicines. Its present that cash flow to total debt had maximum prediction

MD is Arun Sawhney. It is ranked amongst the top ten power among different ratios in the study.

generic companies worldwide. Ranbaxy has expanding Prof. Adward I. Altman (1968)2 selected five ratios of

international portfolios of affiliates, JVs and representative twenty two initially considered. He took 33 successful

offices across the globe with a presence in 23 of the top 25 firms and 33 bankrupt firms and developed a model

pharmaceutical markets of the world. Ranbaxy is one of the popularly known as 'Altman's Z- Score mode'. The model

largest pharmaceutical companies in India, with significant comprises the five ratios viz;

focus on the generics markets of the US and Europe. It is (i) Networking capital to total assets (X1)

the only Indian company listed in the top 100 (ii) Retained earnings to total assets (X2)

pharmaceutical companies of the world. (iii) Earnings before interest and tax to total assets (X3)

(iv) Market value of equity to book value of debt (X4) and

OBJECTIVES OF THE STUDY (v) Sales to total assets (X5)

1. To evaluate the efficiency of selected Indian The ratios were given weight aged and combined to

pharmaceutical companies. produce a single number which was termed as Z score

2. To examine the overall financial performance of 3

selected Indian pharmaceutical companies. Johah Aiyabei (2002) applied Z score model examine the

3. To forecast the financial health and viability of the financial performance of small business firms based in

selected Indian pharmaceutical companies. Kenya and discussed the theoretical aspect of a financially

distressed firm based on a cyclical concept. Mansur A.

RESEARCH METHODOLOGY4

The present study is concerned with the analysis of Mulla (2002) conducted a study to evaluate financial

financial health of Cipla, Dr.Reddy's laboratories and health of textile mills by using Z score model.

Ranbaxy Laboratories Ltd. The entire study is based on 5

Ben Mc Clure (2004) suggested invetors to check Z secondary data. The data has been collected from websites

score of their companies regularly.of the companies. The period of study is 2001-02 to 2010-

11. Altman's model has been adopted to analyze the 6

V.Dheenadhyalan (2008) adopted Z score to predict the financial health of Cipla, Dr.Reddy's laboratories and

corporate failure of steel authority of Indian Limited. The Ranbaxy Laboratories Ltd.

Z score of SAIL showed a rising trend through the study

LIMITATIONS OF THE STUDY period and it was concluded that the financial health of the

SAIL was good.1. The study is confined to only selected three Indian

pharmaceutical companies7

In the Indian context, L.C.Gupta (1979) attempted a 2. The present study covers only a period of ten years

refinement of Beaver's method with the objective of 3. The collected data for the present study is secondary

building a forewarning system of corporate sickness. A data.

simple non-parametric test for measuring the relative

REVIEW OF LITERATURE differentiating power of the various financial ratios was

used. The test is based on taking a sample of sick and non-William H. Beaver (1967)1 selected five ratios out of thirty

sick arraying them by the magnitude of each ratio to be financial ratios to study the financial health of 79 successful

tested, selecting a cut of point which will devide the array units and 79 unsuccessful units. The ratios were (i) cash

into two classed with a minimum possible number of flow to total debt (ii) net income to total assets (iii) total

S.CHRISTINA SHEELA, DR. K. KARTHIKEYAN

26

misclassification and then computing the percentage

THEORY FRAMEWORKclassification error.

The first attempt to, perhaps, suggest a more effective way 8

Selvam, M. and others (2004) of diagnosing corporate insolvency was made in the works made a study to predict

the financial health and viability of India Cement Ltd. they of Altman (1983) in which he used the discriminate

concluded that the cement company under the study was analysis technique to calculate bankruptcy ratio. This ratio

just on the range of financial collapse. which uses the Z value to represent overall index of

corporate fiscal health, is used mostly by stockholders to 9

Krishna Chaitanya (2005) measured the financial determine if the company is a good investment. The

distress of IDBI with the help of Altman's Z score to formula for the ratio is

predict that IDBI is not in the health zone and is likely to be

insolvent in the near future. Z= 1.2 X + 1.4 X + 3.3 X + 0.6 X + 1.0 X1 2 3 4 5

The Z score of the SAIL showed a rising trend throughout Where

the study period and it was concluded that the financial X = Working capital divided by total assets1

health of the SAIL was good. Dr.K Venkat Janardhan X = Retained earnings divided by total assets2

10

Rao and M.Durga Prasad (2009) examined the X = Earnings before interest and taxes divided by total 3

financial performance of Eicher Motors Ltd is better than assets

M M. According to K.R.Sharma, different models like X = Market value of equity divided by the book value of 4

R . A . Ya d a v a n d S . S . S r i v a s t a v a m o d e l , total of total debt.

Prof,C.D.Bhattacharya model and Prof..K.B.Mehta's X = Sales divided by total assets.5

model have been used to measure financial health.

Altman Guidelines For Financial Healthy Zone

DATA ANALYSIS

TABLE NO: 1 VARIOUS DATAS OF SELECTED PHARMACEUTICLE COMPANY

EVALUATING FINANCIAL HEALTH OF PHARMACEUTICAL INDUSTRY IN INDIA THROUGH 'Z' SCORE MODEL

27


28

FINDINGS laboratories. It indicates that during 2002 to 2011

NET WORKING CAPITAL TO TOTAL ASSETS Dr.Reddy's Laboratories had very high level of investment

(X1) (aggressive) in current assets and which shows that too

Working capital is the excess of total current assets. The much of its current funds are blocked in the form of current

ratio of working capital to total assets shows liquidity assets instead of investing them in the potential

position of relative to total capitalization. "Consistent investments. Cipla is having the moderate investment. And

operating losses will cause current assets to shrink relative the RANBAXY had very low level (conservative) of

to total assets. A negative ratio, resulting from negative investments in current assets which shows the poor

working capital, is a serious problem". The ratio of working capital management of the company.

working capital to total assets shows the liquidity position This analysis will help all the companies in maintaining the

of the company. appropriate working capital i.e. neither low nor high level

The ratios of working capital to total assets are calculated in of investments in current assets without disturbing the

table-2. It is observed from the table that the ratio ranges basic liquidity position of the companies.

between 0.32 to 0.42 for Cipla, 0.21 to 0.59 for

Dr.Reddy's Laboratories and 0.02 to 0.34 for Ranboxy

TABLE NO: 2 CALCULATIONS FOR VARIOUS RATIOS USED

IN Z-SCORE MODEL FOR SELECTED PHARMACEUTICAL COMPANY

TABLE NO: 3 STATEMENTS SHOWING THE Z-SCORE HEALTH

ZONE FOR THE SELECTED PHARMACEUTICAL COMPANY

Z SCORE MODEL FINANCIAL HEALTH = 1.2*X1 + 1.4*X2 + 3.3*X3 + 0.6*X4 + 1.0*X5


29

RETAINED EARNINGS TO TOTAL ASSETS (X2) equity portion of Cipla is 0.08 to 0.34, Dr.Reddys is 0.04

The ratio of retained earnings to total assets indicates that to 0.24 and Ranbaxy is 0.05 to 0.20 in comparison to debt

how much portion of total assets has been financed by portion in the capital structure during the study period.

retained earnings. Higher the ratio greater the financial The highest equity portion of total capital of Dr.Reddys

stability of the company at times of low profitability and the lowest portion of equity is Ranbaxy. On the basis of

periods. And also it depicts that the company utilizing its the analysis pertaining to this ratio, it may be conclude that

own earnings as cheaper source of finance rather than debt the financial health of the Dr. Reddys is quite good when

finance. compare to others and it provides a margin of safety to its

The percentages of retained earnings of all the three creditors in times of bankruptcy.

companies are furnished in the table 2 about here. From the

table 2 it is observed that on an average 0.62 to 1.02 of total SALES TO TOTAL ASSETS (X5)

Sales revenue plays a pivotal role in overall performance of assets of Cipla, 0.05 to 1.41 of Dr. Reddy's Laboratories

the companies because all the operations are more or less and 0.52 to 0.87 of Ranboxy are financed by its retained

depend on the sales revenue. Sales to total assets ratio earnings during the study period.

measure the power of the asset in generating the sales. This study shows that these companies have been utilizing

Higher ratio indicates the better performance and while more debt rather than retained earnings. The decreasing

poor ratio indicates the poor financial management of the trend of retained earnings during the study period indicates

companies in the optimum utilization of its assets in that the unsustainable growth of the Dr. Reddy's

generating the sales revenue. The ratio varies from one Laboratories, Cipla and Ranbaxy Laboratories Ltd. And

company to another. The relevant information of the two this situation may compel both the companies in the

selected sample pharmacy companies is furnished in the bankruptcy at low profitable times.

table 2 about here.

EARNING BEFORE INTEREST AND TAX TO From the table 2 it is observed that the average ratios

TOTAL ASSETS (X3) of sales to total assets of the selected sample pharmacy

This ratio expresses operating performance and companies are cipla Pharmacy ranges from 0.66 to 0.94,

productivity of the assets which is mentioned in table-2. Dr. Reddy's 0.50 to 0.88 while it was 0.42 to 1.06 for

This ratio varies from 0.16 to 0.25 for Cipla, 0.05 to 0.36 Ranbaxy Laboratories Ltd during the study period. While

for Dr. Reddy's Laboratories and -0.11 to 0.87 for comparing the performance of all three companies, the

Ranbaxy. During selected period the operating efficiency performance of Cipla is best, Dr. Reddy's is better and

of the company is very low for Ranboxy followed by Cipla Ranbaxy is the lowest.

and Dr. Reddys. Company is unable to operate the fixed Based on the information from table 2 it was crystal

assets properly. clear that the companies still had an opportunity to

improve its sales capacity but had been totally failure to

BOOK VALUE OF EQUITY TO BOOK VALUE OF utilize their assets optimally in generating the sales

TOTAL DEBTS (X4) revenue. It will have an adverse effect on its performance. It

This ratio is used to ascertain the soundness of the long- is suggested that the companies have to take appropriate

term financial policies. The company having 1:1 equity- steps in the optimum utilization of its assets in generating

debt mix is considered as quite good. Excessive debt tends more and more sales revenue.

to cause insolvency. Fixed interest paid on debt where as

variable dividend is paid on equity. If debt is more than the CONCLUSION

equity it will reduce the profit of the company, despite The Z score of Cipla Pharmaceutical, Dr. Reddy's

increases the profitability of the share holders. It will be a Laboratories and Ranbaxy laboratories Ltd based on the

curse in times of bad performing. The relevant information Altman's model is 3.076952622, 3.379786405 and

of the two selected sample pharmacy companies in the 2.34756 during the study period (i.e 2001-02 to 2010-

pharmacy industry is furnished in the table 2 about here. 11). It is observed from the table 3 that the companies are

From the table 2 it is observed that the on an average in grey area or healthy zone. In this situation Cipla and Dr.


30

Reddy's are in too healthy Zone where it is successful in its Management Accountant,Aug.,pp.608-610.

financial performance and not to fall bankrupt. But 12. K.R.Sharma (2008), Business Research

Ranbaxy is in healthy zone where its financial viability is 13. Pandey,I.M. (2000), " Financial Management" Vikas

considered healthy and the failure in the situation is Publishing House Pvt.Ltd., New Delhi), Eigth

uncertain to predict. Finally it can be concluded that the Edition,p.185.

overall financial health of Cipla and Dr. Reddy's are very 14. http://www.aurobindopharma.com

good and Ranbaxy is uncertain to predict. This study will 15. http://www.aurobindopharma.com

be useful for all the stakeholders of pharmaceutical 16. Brealey,R.A. and Myers S.C. (1991), "Principles of

industry. Corporation Finance" Tata Mc-raw-Hill Publishing

Co. Ltd;New Delhi,p.754 quoted by Sahu, R.K.

REFERENCES (2002), A simplified model for liquidity analysis of

1. William H. Beaver (1967) paper companies in "The Management Accountant",

2. Altman (1968), "Financial ratio, discriminant analysis Nov., vol.37,No.11,p.806.

and the prediction of corporate bankrupcy", Journal of 17. Pandey, I.M (2000), op.cit. p.184.

Finance, 23(4): 589-609.

3. Jonah Aiyabei (2002), "Financial Distress: Theory,

Measurement and Consequence". The Eastern Africa

Journal of Humanities and Sciences,vol.1 no.1 quoted

by M. Kannadhasan (2007), "Measuring Financial

Health of A Public Limited company using 'Z' Score

Model - A case study" in The Management

Accountant, June, p.470.

4. Mansur A. Mulla (2002), "Use of Z score Analysis for

evaluation of Financial Health of Textile Mills-A case

Study", Abhigyan, Jan-March Vol.XIX, No.4 pp. 37-

41.

5. Ben Mc Clure, (2004), "Z marks the Eng"

Feb.11.www.investopedia.com

6. Gupta L.C., "Financial Ratios as Forewarning

indicators of Corporate sickness" Bombay ICICI

1979 quoted by Pandey I.M.op.cit, p.184.

7. Selvam M. Vanitha S. and Babu M. (2004), "A study

on financial health of cement industry - "Z" score

analysis", The Management Accountant, July, Vol.39,

No.7, pp.591-593.

8. Krishna Chaitanya V. (2005), "Measuring Financial

Distress of IDBI using Altman Z score model", The

ICFAI journal of Bank Management, August, Vol.IV,

No.3, pp.7-17.

9. M.Kannadhasan, op.cit., pp.469-473 and p.479.

10. V.Dheenadhyalan (2008), "Financial Health of Steel

Authority of India Limited: A Z-score Approach",

I n d i a n J o u r n a l o f A c c o u n t i n g , D e c . ,

Vol.XXXVI(I),pp.48-52.

11. Dr.K.V.J.Rao and M.Durga Prasad (2009),"Z score

analysis-A tool to predict Financial Health", The


31

Page 1Page 2Page 3Page 4Page 5Page 6Page 7

Documents

5_IJS_MAY2012