Assignment On Pro forma Income Statement, Balance-Sheet, Important Ratios and Dupoint Analysis of Square Pharmaceuticals Ltd

Chapter: 01

Introduction

We  will study the 2009-2010 financial statements of Square Pharmaceuticals Ltd and calculate the proforma income statement , balance-sheet, important ratios and Dupoint analysis and make decisions based on the calculated outcome in overall assignment.  

Scope of the study

• ·         The basic introduction of “Square Pharmaceuticals Ltd” as a leading pharmaceuticals private company
• ·         The inspection of company’s economic and financial condition and set out the prerequisite attempts to do well in future
• ·         Get the ideas about company’s capital structure , liquidity , capital structure , other performance measurement tool
• ·         Showing the ways of making appraisal decision making and forecasting future outcomes.

Methodology

We have used the concept of the course, information of the Assignment.

Sources of Data

Here the secondary sources of information were used. The secondary sources are:

Ø  Books.

Ø  Web site.

Ø  Annual report

Limitation of the study

While conducting the report on “Square Pharmaceuticals Ltd”, some limitations have been yet present there:

• Ø  Because of time shortage many related areas can’t be focused in depth
• Ø  Political violence
• Ø  Lack of enough information to make it the best
• Ø  Poor group co-ordination
• Ø  Inefficiency in writing , proofreading , aggregation and presentation
• Ø  Absence of up to date input to generate up to date output
• Ø   We cannot assure our analysis is fully correct but we try our best to get a probable scenario. 
  

Chapter: 02

Introduction of Square Pharmaceuticals Ltd

Square

SQUARE today symbolizes a name – a state of mind. But its journey to the growth and prosperity has been no bed of roses. From the inception in 1958, it has today burgeoned into one of the top line conglomerates in Bangladesh. Square Pharmaceuticals Ltd., the flagship company, is holding stronger leadership position in the pharmaceutical industry of Bangladesh since 1985 and is now on its way to becoming a high performance global player.

SQUARE today is more than just an organization, it is an institute. In a career spanning across four and a half decades it has pioneered the development of the local business in fields as diverse as Pharmaceuticals, Toiletries, Garments, Textile, Information Technology, Health Products, Food Products, Hospital, etc. With an average Annual turnover of over US$ 200 million and a workforce of about 3500 the SQUARE Group is a true icon of the Bangladesh business sector.

Chapter: 02

Proforma Income statement and balance -sheet analysis

Square pharmaceutical Ltd balance sheet of 2009 and 2010

Year	2009	2010
Asset
Cash	$86,400	$78,000
Accounts Receivable	$526,800	$603.00
Inventory	$1,072.80	$1,254.00
Total Current Assets	$1,686,000	$1,935,000
Fixed Assets	$736,500	$790,500
Less: Accumulated Dep.	$219,300	$249,300
Net Fixed Assets	$517,200	$541,200
Total Assets	$2,203,200	$2,476,200
Liabilities
Accounts Payable	$218,400	$262,800
Notes Payable	$300,000	$337,500
Accruals	$204,000	$210,000
Total Current Liabilities	$722,400	$810,300
Long Term Debt	$485,148	$636,918
Equity
Common Stock	$690,000	$690,000
Retained Earnings	$305.65	$338,982
Total Equity	$995,652	$1,028,982
Total Liabilities and Equity	$2,203,200	$2,476,200

Square pharmaceutical Ltd Comparative Income Statements

Year	2009	2010
Sales	$5,260,255	$5,782,000
Cost of Goods Sold	$4,296,000	$4,875,000
Gross Profit	$964,255	$907,000
Selling, General & Admin Expenses	$610,000	$645,450
Depreciation	$28,350	$30,000
Operating Profit (EBIT)	$325,905	$231,550
Interest Expense	$93,750	$114,000
EBT	$232,155	$117,550
Tax (@40%)	$92,862	$47,020
Net Income	$139,293	$70,530
Dividend Payment		$37,200

Pro-forma income statement of Square Pharmaceutical Ltd For the year end of 2011

Particulars	Amount
Sale	6360200                    1.1*5782000
Cost of goods sold	5362500                     1.1*$4,875,000
Gross profit	997700
Selling and administrative expenses	709995                       1.1*645450
Depreciation	33000                        1.1*30000
Operating profit	254705
Interest expense	114,000
EBT	140705
Tax @40%	56282
Net income	84423
Dividend	44528                         .53*84423

Pro-forma balance sheet of Square Pharmaceutical Ltd For the year end of 2011

Particulars	Amount
Asset
Cash	85800                      78000*1.1
Account receivable	663300                     603000*1.1
Inventory	1379400                   1,254,000*1.1
Current asset	2128500
Fixed asset	869550                    790,500*1.1
Accumulated depreciation	282300                    249,300+33000
Total  asset	2715750
Liabilities
Account payable	289080                    262800*1.1
Note payable	337,500 +AFN =152375
Accrual	231000                     210000*1.1
Total current liabilities	857580
Total long term liabilities	636,918
Equity
Common stock	690000
Retained earning	378877             (338982+84423-44528)
Total equity	1068877
Total equity and liabilities	2715750

 

·   Current ratio for the company in 2010 = ($1,935,000/$810,300) = 2.39 which slightly lower than industry average ratio 2.8. That indicated that company has sufficient current asset to meet up with current liabilities.

Quick ratio:

·         An indicator of a company’s short-term liquidity. The quick ratio measures a company’s ability to meet its short-term obligations with its most liquid assets. For this reason, the ratio excludes inventories from current assets, and is calculated as follows:

·  Quick ratio = (current assets – inventories) / current liabilities or  (cash and equivalents + marketable securities + accounts receivable) / current liabilities

·  Quick ration in 2010= ($1,935,000-$1,254,000)/ $810,300 = $0.84 which is very poor in cooperative to Industrial average $1.1. The $.84 indicates that company has liquid asset $.84 to meet $1 liability 

  

Inventory turnover:

·         The formula for the inventory turnover ratio measures how well a company is turning their inventory into sales.

·         A high inventory ratio means that the company is efficiently managing and selling its inventory. The faster the inventory sells the fewer funds the company has tied up.

·         Inventory turnover in 2010 = ($5,782,000 / $1,254,000) = 4.61

·         Interpretation: inventory turnover ratio in 2010 is 4.61, which is relatively less than industry average 7.2.That means the company is not managing its inventory efficiently and effectively thus less sale and high stock of inventory occurs.

Fixed asset turnover ratio

·         Fixed asset turnover ratio = (net sale / net fixed asset)

·         Fixed asset turnover ratio in 2010 = ( $5782000 / $541,200) = 10.6

·         Interpretation: Since current FAT = 10.6; which is fair than industry average 10.5; the company is efficient in managing fixed asset.

 Total asset turnover:

·         Total asset turnover = ( net Sale / Total asset)

·         TAT in 2010 = ($5782000 / $2,476,200) = 2.34

·         Interpretation: Sight decrease in current TAT in comparison to industry average 2.6. That means the company will is not maintaining asset management policy properly.

·

Chapter: 05 
Dupoint Analysis and Vital Decision Making
The DuPont ratio can be used as a compass in this process by directing the analyst toward significant areas of strength and weakness evident in the financial statements. The DuPont ratio is calculated as follows:

ROE = (Net Income/Sales) X (Sales/Average Assets) X (Average Assets/Avenge Equity)         (1)The ratio provides measures in three of the four key areas of analysis, each representing a compass bearing, pointing the way to the next stage of the investigation.
The DuPont Ratio DecompositionThe DuPont ratio is a good place to begin a financial statement analysis because it measures the return on equity (ROE). A tor-profit business exists to create wealth for its owner(s). ROE is, therefore, arguably the most important of the key ratios, since it indicates the rate at which owner wealth is increasing. While the DuPont analysis is not an adequate replacement for detailed financial analysis, it provides an excellent snapshot and starting point, as will be seen below.
The three components of the DuPont ratio, as represented in equation (1), cover the areas of profitability, operating efficiency and leverage (liquidity analysis needs to be conducted separately). In the following paragraphs, we examine the meaning of each of these components by calculating and comparing the DuPont ratio using the financial statements and industry standards for square pharmaceutical Ltd.

Profitability: Net Profit Margin (NPM: Net Income/Sales)Profitability ratios measure the rate at which either sales or capital is converted into profits at different levels of the operation. The most common are gross, operating and net profitability, which describe performance at different activity levels. Of the three, net profitability is the most comprehensive since it uses the bottom line net income in its measure.The net profitability for square pharmaceutical ltd in 2010 is:Net Profit Margin = Net Income/Sales = $70,530/$5,782,000 = 1.22.        (2)A proper analysis of this ratio would include at least three to five years of trend and cross-sectional data.              
Square pharmaceutical Ltd (Exhibit 1) Comparative Balance Sheets


Year 20 09 2010 Asset

Cash   $86,400 $78,000 Accounts Receivable                $526,800 $603.00 Inventory   $1,072.80 $1,254.00 Total Current Assets          $1,686,000 $1,935,000 Fixed Assets $736,500 $790,500 Less: Accumulated Dep.          $219,300 $249,300 Net Fixed Assets $517,200 $541,200 Total Assets                        $2,203,200 $2,476,200


Liabilities

Accounts Payable $218,400 $262,800 Notes Payable  $300,000 $337,500 Accruals   $204,000 $210,000 Total Current Liabilities                $722,400 $810,300  Long Term Debt $485,148 $636,918 Equity

Common Stock        $690,000 $690,000 Retained Earnings $305.65 $338,982 Total Equity $995,652 $1,028,982 Total Liabilities and Equity $2,203,200 $2,476,200 Exhibit 2: Square pharmaceutical Ltd Comparative Income Statements Year 2009 2010 Sales $5,260,255 $5,782,000 Cost of Goods Sold             $4,296,000 $4,875,000 Gross Profit        $964,255 $907,000 Selling, General & Admin Expenses $610,000 $645,450 Depreciation  $28,350 $30,000 Operating Profit (EBIT)      $325,905 $231,550 Interest Expense               $93,750 $114,000 EBT   $232,155 $117,550 Tax (@40%)      $92,862 $47,020 Net Income              $139,293 $70,530 Dividend Payment
$37,200








Operating Sufficiency or Asset Utilization: Total Asset Turnover (TAT:           Sales/Average Assets
The total asset turnover (TAT) ratio measures the degree to which a firm generates sales with its total asset base. As in the case of net profitability, the most comprehensive measure of performance in this particular area is being employed in the DuPont ratio (other measures being fixed asset turnover, working capital turnover, and inventory and receivables turnover). It is important to use average assets in the denominator to eliminate bias in the ratio calculation. Financial ratio bias is commonly present when combining items from both the balance sheet and income statement. For example, TAT uses income statement sales in its numerator and balance sheet assets in the denominator. Income statement items are flow variables measured over a time interval, while balance sheet items are measured at a fixed point in time. In cases where the firm has been involved in major change, such as an expansion project, balance sheet measures taken at the end of the year may misrepresent the amount of assets available and/or in use over the course of the year. Taking a simple average for balance sheet items (i.e., ((beginning + ending) /2)) will control for at least some of this bias and provide a more accurate and meaningful ratio. The limiting assumption is that the change in the balance sheet occurred evenly over the course of the year, which may not always be the case. The measure of total asset turnover for Square pharmaceutical is:

TAT = Sales/Average Assets= $5,782,000/ (($2,203,200+$2,476,200)/2) = 2.47. (3)

In this case, total assets did not substantially change over the course of the year, and therefore, potential bias caused by using the ending asset amount would not be substantial.

     

Leverage: The Leverage Multiplier (Average Assets/Average Equity)

Leverage ratios measure the extent to which a company relies on debt financing in its capital structure. Debt is both beneficial and costly to a firm. The cost of debt is lower than the cost of equity, an effect which is enhanced by the tax deductibility of interest payments in contrast to taxable dividend payments and stock repurchases. If debt proceeds are invested in projects which return more than the cost of debt, owners keep the residual, and hence, the return on equity is "leveraged up." The debt sword, however, cuts both ways. Adding debt creates a fixed payment required of the firm whether or not it is earning an operating profit, and therefore, payments may cut into the equity base. Further, the risk of the equity position is increased by the presence of debt holders having a superior claim to the assets of the firm.

The leverage multiplier employed in the DuPont ratio is directly related to the proportion of debt in the firm's capital structure. The measure, which divides average assets by average equity, can be restated in two ways, as follows:

Average Assets/Average Equity = 1/ (1 - (Average Debt/Average Assets))   (4) or

Average Assets/Average Equity = 1 + (Average Debt/Average Equity).  (5)

Equation (4) employs a simple debt/asset ratio, while equation (5) uses the well known debt/equity ratio. Once again, averages are used to control for potential bias caused by the end-of-year values. The leverage multiplier for square pharmaceutical Ltd is:

Average Assets/Average Equity = $2,339,700/ (($995,652+$1,025,982)/2) = 2.31. (6)

Combination and Analysis of the Results

Once the three components have been calculated, they can be combined to form the ROE, as follows:

(Net Income/Sales)X (Sales/Average Assets) X (Average Assets/Average Equity) = ROE1.22 X 2.47 X 2.31 = 6.96. (7)

While additional measures for prior years would provide the basis for a necessary trend analysis, this result is not meaningful until it is compared to an industry or best practices benchmark. The DuPont ratio/or the industry (Exhibit 4) is:

3.60 X 2.60 X 2.00 = 18.72    (8)

As can be seen, problems in square pharmaceutical ltd are immediately evident in the comparison of equations (7) and (8). The company appears to have significant weaknesses in profitability, while total asset turnover and leverage seem to be roughly in line with the industry. The analyst can now focus on the company's profitability. A quick analysis of profitability yields the following result:

  

It is plain to see that square pharmaceutical ltd gross margin is well below the industry average. While the operating margin is also below the standard, the difference is explained by the low gross margin. This can be illustrated by the fact that me company's operating expenses are 11.6% of sales (i.e., gross - operating margin = 15.6 - 4.0 = 11.6%), while the industry average is 12.6%. Low gross margins are usually related to inventory problems, such as:

1.)   Poor inventory quality/inventory not moving at target market prices,

2.)   Poor purchasing policies/not getting best purchase price for inventory,

3.) Location or other problem attracting customers/need lower prices to attra

ct them.

This leads the analyst to examine the inventory turnover for square pharmaceutical ltd relative to the industry. The results are:

As can be seen, the inventory turnover is significantly lower than the industry average, which means that the problem is more likely due to poor location or inventory quality rather than the inventory management processes. The next step in the analysis would most likely be a qualitative study of the composition of the inventory as well as the retail facility itself.

Remarks

Sound financial statement analysis is an integral part of the management process for any organization. The DuPont ratio, while not the end in itself, is an excellent way to get a quick snapshot view of the overall performance of a firm in three of the four critical areas of ratio analysis, profitability, operating efficiency and leverage. By identifying strengths and/or weaknesses in any of the three areas, the DuPont analysis enables the analyst to quickly focus his or her detailed study on a particular spot, making the subsequent inquiry both easier and more meaningfu

The DuPont ratio consists of very general measures, drawing from the broadest values on the balance sheets and income statements. A DuPont study is not a replacement for detailed, comprehensive analysis. Further, there may be problems that the DuPont decomposition does not readily identify. For example, an average outcome for net profitability may mask the existence of a low gross margin combined with an abnormally high operating margin. Without looking at the two detailed measures, understanding of the true performance of the firm would be lost. The DuPont ratio can also be broken into mLookingponents, depending upon the needs of the analyst .In any case, the DuPont can add value to understand and solving a broad variety of business problems.

References

       Annual Report of Square Pharmaceuticals Ltd from (2009-2010)

      http://www.squarepharma.com.bd/