Singer Pakistan

Business Summary

Singer Pakistan Limited is principally engaged in the manufacturing, assembling and sale of sewing machines,

domestic consumer appliances and other light engineering products, and trading in other electric and domestic

consumer appliances. The Company offers a range of washing machines from automatic washing machines to twin

and single tub washing machine. It also operates as a retailer of several brands. Singer Pakistan Limited is a

subsidiary of Singer (Pakistan) B.V., which holds a 70.28% interest in the Company, and its ultimate parent

company is Retail Holdings N.V. During the year ended December 31, 2007, the Company launched a 32 inches

liquid crystal display (LCD) television in Pakistan. In addition, it introduced models of refrigerator with features,

such as Nano Silver Technology, Vitamin C- Fresh and stainless steel doors. In 2007, it also introduced a loyalty

card under the name Singer Plus for its repeat customers.

Singer has been operating in Pakistan since 1877, when the first Singer sewing machine went on sale. Today, Singer

Pakistan Limited is a large, diversified company with a presence throughout Pakistan. Singer has the largest retail

network in South Asia with over 750 stores.

Vision

“To be a respected and leading Family Company in Pakistan providing consumer durables”

Mission

“To improve the quality of life of people through the provision of consumer products and services at affordable

prices”

Product Range

LCD TV

Refrigerators / Deep Freezers

Washing Machines

Sewing Machines

Motorcycles

Water Geysers

Gas Heaters

Gas Stoves

Competitor Brands

Philips

Dawlance

LG

Haier

Honda Motorcycles

Super Asia

PEL

Singer Pakistan Ltd. 1

SWOT Analysis

Strengths:

Multiple brands under one roof Largest electronics and appliance retailer in

South Asia More than 750 retail appliance stores in

South Asia Multiple retail formats for different

consumer groups Nationwide service networks

Weaknesses:

Low market share Low economies of scale Availability of costlier funds

Opportunities:

Development and improved product mix Delivery of enhanced production

efficiencies Up gradation of facilities and systems Diversifying product portfolios Lowering operational costs

Threats:

Riskiness of the firm May face shortage of funds Questionable financial health


Michael Porter Model

I - Rivalry:

The market is attributed by low concentration. A low concentration indicates that the industry is characterized by many rivals. This type of market is said to be competitive. In pursuing an advantage over its rivals, Singer Pakistan has chosen from several competitive moves:

Improved Product Differentiation: the firm continuously strives to improve features, implementing innovations in the manufacturing processes and in the product itself like Singer refrigerator with Nano Silver Technology.

Creatively using channels of distribution: Singer Pakistan has practiced vertical integration and has more than 750 retail appliance stores in South Asia.

The intensity of rivalry is influenced by some characteristics of the industry like larger number of firms, low switching costs and low levels of product differentiations.

II - Threat of Substitutes:

The next is the threat of the substitutes where customer has more alternatives they have more options to buy what they want. In Singer’s case, there are lots of substitutes available to the customers like they can buy microwave of Dawlance, LG, Samsung, Haier etc. But mostly people buy the product on the brand name and company sells its geysers and sewing machine on its reliable brand name.

III - Buyer Power:

The power of buyers is the impact that customers have on producing industry. In the Pakistani industry, there is some asymmetry between a producing industry and buyers but most frequently, the buyers are considered to be weak. The following characteristics indicate weak buyer power in the industry:

Producers threaten forward integration – as Singer owns their own distribution / retailing networks. Buyers are fragmented (many, different) – that is no buyer has any particular influence on product or price.

IV - Supplier Power:

Also, the suppliers are weak as characterized by the followings:

Many competitive suppliers – that is the product is standardized: example is tire industry’s relationship to automobile manufacturers.

Credible backward integration threat by purchasers – like automobile manufacturers can buy the tire producing firm.

V - Barriers to Entry / Threat of Entry

It is not only incumbent rivals that pose a threat to firms in an industry; the possibility that new firms may enter the industry also effects competition. In the engineering industry of Pakistan, there found to be little barriers for entering of a new firm. It’s easy to enter in this industry because of the following:

Common technology Access to distribution channels Low scale threshold


Generic Strategies to Counter Five Forces:

Strategy can be formulated on three levels:

1. Corporate level2. Business unit level3. Functional or departmental level

The business unit level is the primary context of industry rivalry. Michael Porter identified three generic strategies (cost leadership, differentiation and focus) that can be implemented at the business unit level to create a competitive advantage.

Singer Pakistan adopts the differentiation strategy under which the firm the continuously striving to introduce improved, innovated and differentiated products to consumers.


SINGERBALANCE SHEET

Note (RUPEES IN THOUSAND)2007 2006 2005

ASSETS NON-CURRENT ASSETS Property, plant and equipment 156,915 110,312 99,248Intangible assets 4,666 822 560Investment 6,894 7,026 7,148Employee retirement benefits - prepayments 5,617 3,578 3,632Long term deposits 27,396 20,475 17,344Total Non - Current Assets 201,488 142,213 127,932

CURRENT ASSETS Stores and spares 5,433 3,083 4,047Stock-in-trade 393,286 305,452 229,383Trade debts 808,842 675,897 588,760Advances, deposits and prepayments 25,782 13,901 14,305Other receivables 7,036 2,301 3,289Taxation - net 21,346 21,264 12,962Cash and bank balances 99,413 72,534 61,307Total Current Assets 1,361,138 1,094,432 914,053

1,562,626 1,236,645 1,041,985

SINGERBALANCE SHEET


EQUITY AND LIABILITIESSHARE CAPITAL AND RESERVESAuthorised share capital25,000,000 (2006: 15,000,000) ordinary shares of Rs.10

250,000 150,000 150,000

Issued, subscribed and paid up share capital 245,038 133,173 113,339Capital Reserve 5,000 5,000 24,689Revenue Reserve 96,337 84,337 59,337Unappropriated Profit 42,961 32,986 25,840Total Equity 389,336 255,496 223,205

NON-CURRENT LIABILITIESDeferred Income 6,959 7,887 8,815Long Term Loans - Secured 186,459 134,000 125,305Liabilities against assets subject to finance lease 35,124 15,704 17,076Long term deposits 16,033 10,858 9,016Deferred tax liabilities 8,455 5,797 1,639Employee retirement benefits - obligation 1,962 2,193 1,956Total Non - Current Liabilities 254,992 176,439 163,807

CURRENT LIABILITIESTrade and other payables 349,072 312,600 239,693Mark-up accrued on short term running finances and long term loans

22,879 17,505 14,273

Short term running finances - secured 447,054 398,855 331,856Current portion of long term loans 88,167 68,944 63,615Current portion of liabilities against assets subject to finance leases

11,126 6,806 5,536

Total Current Liabilities 918,298 804,710 654,973

CONTINGENCIES AND COMMITMENTS 1,562,626 1,236,645 1,041,985

SINGERPROFIT & LOSS ACCOUNT


Sales 1,744,173 1,427,112 1,197,188Earned carrying charges 179,792 141,880 103,465Sales tax, commissions and discounts (340,267) (286,987) (236,025)Net Sales 1,583,698 1,282,005 1,064,628

Cost of Sales (1,225,362) (1,001,930) (849,750)Gross Profit 358,336 280,075 214,878

Marketing, selling and distribution costs (177,731) (137,175) (102,598)Administrative expenses (30,149) (25,500) (22,309)Other operating expenses (11,450) (8,028) (7,473)

(219,330) (170,703) (132,380)Profit from operations before finance costs 139,006 109,372 82,498

Finance costs (85,876) (70,915) (44,885)53,130 38,457 37,613

Other income 9,123 5,612 4,032Profit before taxation 62,253 44,069 41,645

Taxation (20,302) (11,178) (16,592)Profit after taxation 41,951 32,891 25,053

(Rupees)

Earning per share - basic and diluted 1.85 2.42 1.88

SINGERCOMMON SIZE BALANCE SHEET

(Percentage of Assets)2007 2006 2005

ASSETS NON-CURRENT ASSETS Property, plant and equipment 10.04 8.92 9.52Intangible assets 0.30 0.07 0.05Investment 0.44 0.57 0.69Employee retirement benefits - prepayments 0.36 0.29 0.35Long term deposits 1.75 1.66 1.66Total Non - Current Assets 12.89 11.50 12.28

CURRENT ASSETS Stores and spares 0.35 0.25 0.39Stock-in-trade 25.17 24.70 22.01Trade debts 51.76 54.66 56.50Advances, deposits and prepayments 1.65 1.12 1.37Other receivables 0.45 0.19 0.32Taxation - net 1.37 1.72 1.24Cash and bank balances 6.36 5.87 5.88Total Current Assets 87.11 88.50 87.72

100 100 100

SINGERCOMMON SIZE BALANCE SHEET

(Percentage of Assets)2007 2006 2005

EQUITY AND LIABILITIESSHARE CAPITAL AND RESERVESAuthorised share capital25,000,000 (2006: 15,000,000) ordinary shares of Rs.10

Issued, subscribed and paid up share capital 15.68 10.77 10.88Capital Reserve 0.32 0.40 2.37Revenue Reserve 6.17 6.82 5.69Unappropriated Profit 2.75 2.67 2.48Total Equity 24.92 20.66 21.42

NON-CURRENT LIABILITIESDeferred Income 0.45 0.64 0.85Long Term Loans - Secured 11.93 10.84 12.03Liabilities against assets subject to finance lease 2.25 1.27 1.64Long term deposits 1.03 0.88 0.87Deferred tax liabilities 0.54 0.47 0.16Employee retirement benefits - obligation 0.13 0.18 0.19Total Non - Current Liabilities 16.32 14.27 15.72

CURRENT LIABILITIESTrade and other payables 22.34 25.28 23.00Mark-up accrued on short term running finances and long term loans

1.46 1.42 1.37

Short term running finances - secured 28.61 32.25 31.85Current portion of long term loans 5.64 5.58 6.11Current portion of liabilities against assets subject to finance leases

0.71 0.55 0.53

Total Current Liabilities 58.77 65.07 62.86

CONTINGENCIES AND COMMITMENTS 100 100 100

SINGER

COMMON SIZE PROFIT & LOSS ACCOUNT

Note (Percentage of Sales)2007 2006 2005

SalesEarned carrying chargesSales tax, commissions and discountsNet Sales 100.00 100.00 100.00

Cost of Sales (77.37) (78.15) (79.82)Gross Profit 22.63 21.85 20.18

Marketing, selling and distribution costs (11.22) (10.70) (9.64)Administrative expenses (1.90) (1.99) (2.10)Other operating expenses (0.72) (0.63) (0.70)

(13.85) (13.32) (12.43)Profit from operations before finance costs 8.78 8.53 7.75

Finance costs (5.42) (5.53) (4.22)3.35 3.00 3.53

Other income 0.58 0.44 0.38Profit before taxation 3.93 3.44 3.91

Taxation (1.28) (0.87) (1.56)Profit after taxation 2.65 2.57 2.35

SINGERTREND BALANCE SHEET

2007-2006 2006-2005ASSETS NON-CURRENT ASSETS Property, plant and equipment 42.25% 11.15%Intangible assets 467.64% 46.79%Investment -1.88% -1.71%Employee retirement benefits - prepayments 56.99% -1.49%Long term deposits 33.80% 18.05%Total Non - Current Assets 41.68% 11.16%

CURRENT ASSETS Stores and spares 76.22% -23.82%Stock-in-trade 28.76% 33.16%Trade debts 19.67% 14.80%Advances, deposits and prepayments 85.47% -2.82%Other receivables 205.78% -30.04%Taxation - net 0.39% 64.05%Cash and bank balances 37.06% 18.31%Total Current Assets 24.37% 19.73%

26.36% 18.68%

SINGERTREND BALANCE SHEET

2007-2006 2006-2005EQUITY AND LIABILITIESSHARE CAPITAL AND RESERVESAuthorised share capital25,000,000 (2006: 15,000,000) ordinary shares of Rs.10

66.67% 0.00%

Issued, subscribed and paid up share capital 84.00% 17.50%Capital Reserve 0.00% -79.75%Revenue Reserve 14.23% 42.13%Unappropriated Profit 30.24% 27.65%Total Equity 52.38% 14.47%

NON-CURRENT LIABILITIESDeferred Income -11.77% -10.53%Long Term Loans - Secured 39.15% 6.94%Liabilities against assets subject to finance lease 123.66% -8.03%Long term deposits 47.66% 20.43%Deferred tax liabilities 45.85% 253.69%Employee retirement benefits - obligation -10.53% 12.12%Total Non - Current Liabilities 44.52% 7.71%

CURRENT LIABILITIESTrade and other payables 11.67% 30.42%Mark-up accrued on short term running finances and long term loans

30.70% 22.64%

Short term running finances - secured 12.08% 20.19%Current portion of long term loans 27.88% 8.38%Current portion of liabilities against assets subject to finance leases

63.47% 22.94%

Total Current Liabilities 14.12% 22.86%

CONTINGENCIES AND COMMITMENTS 26.36% 18.68%

SINGERTREND PROFIT & LOSS ACCOUNT

2007-2006 2006-2005

Sales 22.22% 19.21%Earned carrying charges 26.72% 37.13%Sales tax, commissions and discounts 18.57% 21.59%Net Sales 23.53% 20.42%

Cost of Sales 22.30% 17.91%Gross Profit 27.94% 30.34%

Marketing, selling and distribution costs 29.57% 33.70%Administrative expenses 18.23% 14.30%Other operating expenses 42.63% 7.43%

28.49% 28.95%Profit from operations before finance costs 27.09% 32.58%

Finance costs 21.10% 57.99%38.15% 2.24%

Other income 62.56% 39.19%Profit before taxation 41.26% 5.82%

Taxation 81.62% -32.63%Profit after taxation 27.55% 31.29%

(Rupees)

Earning per share - basic and diluted -23.55% 28.72%

SIGNIFICANT RATIOS 2007 2007-2006 2006 2006-2005 2005 INDUSTRY

Liquidity:

Current Ratio 1.48 8.99% 1.36 -2.55% 1.40 1.32Quick Ratio 1.02 6.32% 0.96 -5.70% 1.02 0.79

Profitability:

Gross Profit Margin 22.63 3.57% 21.85 8.24% 20.18 11.04Operating Profit Margin 8.78 2.88% 8.53 10.10% 7.75 9.42Net Profit Margin 2.65 3.25% 2.57 9.02% 2.35 5.58Return on Assets (ROI) 8.90 0.58% 8.84 11.71% 7.92 17.12Return on Equity (ROCE) 10.78 -16.30% 12.87 14.69% 11.22 28.06

Leverage:

Debt Ratio 75.08 -5.36% 79.34 0.97% 78.58 63.85Common Equity Ratio 24.92 20.60% 20.66 -3.55% 21.42 36.14Long Term Debt Ratio 11.93 10.12% 10.84 -9.89% 12.03 6.52Time Interest Earned 1.62 4.95% 1.54 -16.09% 1.84 8.62Fixed Charge Coverage Ratio 1.60 4.54% 1.53 -15.36% 1.80 1.71

Finance Cost 6.13 2.73% 5.97 10.56% 5.40 3.84

Activity:

Total Assets Turnover 1.01 -2.24% 1.04 1.46% 1.02 1.87Fixed Assets Turnover 10.09 -13.16% 11.62 8.34% 10.73 7.57 Inventory Turnover 3.47 -6.28% 3.70 1.57% 3.64 3.57Inventory Turnover in Days 105.34 6.70% 98.72 -1.54% 100.27 102.24 Debtor's Turnover 2.12 5.03% 2.02 12.25% 1.80 2.84Debtor's Turnover in Days 172.17 -4.79% 180.83 -10.91% 202.98 128.52 Creditor's Turnover 1.40 7.26% 1.30 35.43% 0.96 1.96

Creditor's Turnover in Days 260.80 -6.77% 279.74 -26.16% 378.85 186.22

Cash Conversion Cycle

Operating Cycle 277.51 -0.73% 279.54 -7.82% 303.25 230.76Cash Cycle 16.71 -8837.05% -0.19 -99.75% -75.61 44.54

Liquidity Ratios:

Liquidity ratios are used to indicate the ability of the subject firm to pay its bills on time. The first is the current ratio that is calculated as:

Current Ratio = Current Assets / Current Liabilities = 1.48 times (2007), 1.36 times (2006), 1.40 times (2005)

Current Ratio1.48

1.36

1.40

1.28

1.30

1.321.34

1.36

1.38

1.40

1.42

1.441.46

1.48

1.50

2007 2006 2005

Current ratio for the Singer Pakistan indicates that the firm improved its ability to pay its bills on time by over 6 percent from year 2005 to 2007. Firstly, the firm’s current ratio decreased by 2.5 percent in year 2006 as compared to 2005 but it regained its ability in 2007 by almost 9 percent. In Singer Pakistan’s case, the current ratio indicates that the firm has approximately one and a half times more current assets than it does current debt.

The increase in the firm’s ability to pay its bills on time from year 2005 to 2007 may be credited to following factors:

i. Increased current assetsii. Decreased current liabilities

iii. Impact of both

From trend analysis, we found that current assets of Singer Pakistan gained a growth by 19.5 percent in 2006 as compared to its current assets in year 2005 and further grew in 2007 by 24 percent. This increase in current assets resulted because of the increase in receivables, prepayments and cash and bank balances.

Another factor, which may have contributed towards increased current ratio, is the decreased current liabilities. From trend analysis, we found that the current liabilities of the Singer Pakistan grew by almost 23 percent in 2006 as compared to current liabilities in year 2005 but in 2007 they just grew by 14 percent. This indicates that the current liabilities of the firm are increasing at decreasing rate. The decrease in the current liabilities of the firm is subjected to the decrease in its short term running finances. The short term running finances of the firm lowered by 8 percent in 2007 as compared to short term borrowings in 2006.

At the same time, long-term loans of the firm grew by almost 40 percent from 2006 to 2007. That indicates that the management of the firm is now looking forward to finance its long term assets through long term borrowings instead of short term loans as practiced in earlier years.

Therefore, the increase in the ability of the firm to pay its bills on time (current ratio) is the impact of both, an increase in current assets and decrease in current liabilities. Furthermore, as compared to the industry average of 1.32, the firm’s current ratio of 1.48 in 2007 is a good measure.

The second measure of firm’s liquidity is the acid-test ratio or quick ratio, which is a modified version of the current ratio that is:

Quick Ratio = (Current Assets – Stock – Prepayments) / Current Liabilities = 1.02 times (2007), 0.95 times (2006), 1.01 times (2005)

Quick Ratio1.45

1.34

1.37

1.281.301.321.341.361.381.401.421.441.461.48

2007 2006 2005

Years

The removal of inventories from current assets provides a slightly more refined measure of firm’s liquidity, in that inventories are frequently the least liquid of the firm’s current assets. Further, prepayments or advance payments are subtracted from current assets because these are considered to be fictitious assets from which a firm cannot settle claims against it.

In Singer Pakistan’s case, the current ratio indicates that the firm has approximately one and a half times more current assets than it does current debt; however, when we eliminate inventories, the firm’s remaining current assets are approximately equal to its current liabilities. Of course, some of the firm’s inventories would be convertible into cash to help meet payment of the firm’s current liabilities, should such a dire circumstance arise. Thus, the fact that Singer Pakistan’s acid-test ratio is close to 1, whereas, the industry average is 0.79, is not necessarily cause for alarm.

Liquidity of Receivables:

To further inspect the suspected imbalances or problems in various components of the current assets, we want to examine these components separately in assessing liquidity. Receivables, for example, may be far from current. To regard all receivables as liquid, when in fact a sizable portion may be past due, overstates the liquidity of the firm. Receivables are liquid assets only insofar as they can be collected in reasonable amount of time.

Receivables Turnover = Annual Credit Sales / Average Receivables = 2.11 times (2007), 2.01 times (2006), 1.79 times (2005)

Average Collection Period = No. of Days in year / Receivables Turnover = 172 days (2007), 180 days (2006), 202 days (2005)

Debtors Turnover

2.12

2.02

1.80

1.60

1.70

1.80

1.90

2.00

2.10

2.20

2007 2006 2005

The average collection period for Singer Pakistan tells us the average number of days receivables are outstanding, that is, the average time it takes to convert them into cash. It also indicates the slowness of receivables. But, this ratio must be analyzed in relation to the billing terms given on sales. Although, the firm improved over years in converting its receivables into cash but still it’s lagging so far from the industry average of 2.84 times. This indicates that the firm exercises liberal credit policy.

On the other hand, it’s also clear that the firm’s average collection period has decreased by 15 percent, which indicates that the firm has improved its credit policy and buyer selection. Also, it has to further improve its credit policy to confirm to the industry average.

We can see here that the industry converts it’s receivables into cash in 128 days whereas Singer Pakistan converts the same in 172 days, thereby, short of funds by 44 days.

Duration of Payables:

Accounts payable is the average balance outstanding for the year and the numerator is the external purchases during the year. Payables Turnover = Annual Purchases / Average Account Payables

= 1.40 times (2007), 1.30 times (2006), 0.96 times (2005)

Average Payment Period = No. of Days in year / Payables Turnover = 260 days (2007), 280 days (2006), 378 days (2005)

Creditors Turnover

1.401.30

0.96

0.00

0.20

0.40

0.60

0.80

1.00

1.20

1.40

1.60

2007 2006 2005

The average payable period is valuable in evaluating the probability that a credit applicant will pay on time. The average payment period for Singer Pakistan decreased by over 30 percent in 2007 as compared to payment period in

2006. This indicates that the firm is moving towards confirming to the industry average of almost 2 times accounts payables turnover in a year.

Liquidity of Inventories:

We may compute the inventory turnover ratio as an indicator of the liquidity of inventory.

Inventory Turnover = Cost of Goods Sold / Average Inventory = 3.47 times (2007), 3.70 times (2006), 3.64 times (2005)

Inventory Turnover in days = No. of Days in the year / Inventory Turnover = 105 days (2007), 99 days (2006), 100 days (2005)

Inventory Turnover

3.47

3.70

3.64

3.30

3.35

3.40

3.45

3.50

3.55

3.60

3.65

3.70

3.75

2007 2006 2005

These ratios indicates the slow movement of inventory but for the reason, that Singer Pakistan is a manufacturing firm which manufactures seasonal products to be sold in next season, therefore, inventory turnover on the average of 100 days is a norm. Furthermore, industry average is 3.5 times in a year. This indicates that the firm is confirming to the industry average.

It’s also notable that the inventory turnover for the firm decreased by over 6 percent from 2006 to 2007. This decrease is credited to the increase in inventory and a slight decrease in its cost of goods sold due to better pricing policy.

Leverage Ratios:

Leverage ratios are used to indicate the extent to which a firm has financed its assets with non-owner sources of funds (i.e. has made use of financial leverage). We will discuss leverage ratios for Singer Pakistan in term of two categories: balance sheet based ratios and coverage ratios. Balance sheet based ratios simply portray the proportion of a firm’s assets financed by a particular source of funds (e.g. common equity or long term debt), while coverage ratios reflect the ability of the firm’s earnings to cover its fixed finance payments.

Balance Sheet Based Ratios:

The first balance sheet based ratio is debt ratio, which is as follows:

Debt ratio = Total liabilities / Total assets = 75.08 % (2007), 79.34 % (2006), 78.58 % (2005)

Debt Ratio

75.08

79.34

78.58

72.00

73.00

74.00

75.00

76.00

77.00

78.00

79.00

80.00

2007 2006 2005

Thus, it may be inferred here that Singer Pakistan has financed over three fourth of its assets by borrowing in these years. This may also be taken that Singer Pakistan is lowering financing in assets through outside borrowings from 2006 to 2007. The company has lowered financing assets by borrowings by almost 4.5% from year 2005 to 2007. The decrease in debt ratio is also credited to the increase in equity holdings of the firm.

A decrease in debt ratio may be caused by the following factors:

i. Decreased total liabilitiesii. Increased total assets

iii. Impact of both

Total liabilities of the firm decreased from 79 percent to 75 percent in 2007 whereas its total assets continued to grow at increasing pace. First, total assets grew by 18.5 percent in 2006 as compared to total assets in 2005 and then further grew by 26 percent. Therefore, a decrease in debt ratio is a result of the impact of both, a decrease in total liabilities of the firm and an increase in total assets.

Still, the firm is perceived to be risky because it has financed its assets by external borrowings. In framing a debt policy, a key concern is how risky Singer Pakistan may go. A higher financial leverages cause higher risks for the firm but at the same time it generates higher returns. There is a trade off between risk and returns a firm must carry and pursue in all environments. Singer Pakistan may be forced to seek external financing each year for a continued high level of capital expenditures. Capital spending is critical to Singer Pakistan’s future success because it is a key to minimizing the firm’s cost position and launching new products swiftly and efficiently. Since, capital spending is critical to maintaining and improving its competitive position, Singer Pakistan may be reluctant to reduce these expenditures considerably.

The firm has taken more borrowings as compared to the industry average. The industry average of debt ratio is found to be almost 64 percent indicating that Singer Pakistan has taken 11 percent more debt, thereby, placing itself more risky.

Also, a high debt policy generates higher projected earning per share, dividends per share and return on equity.

The next is the common equity ratio that is a slight refinement of the debt ratio in that it provides a measure of financial leverage that reflects the use of debt and preferred stock financing. The common equity ratio is calculated as follows:

Common Equity Ratio = Common equity / Total Assets = 25 % (2007), 21 % (2006), 21.5 % (2005)

Common Equity Ratio

24.92

20.66 21.42

0.00

5.00

10.00

15.00

20.00

25.00

30.00

2007 2006 2005

Years

In this particular case of Singer Pakistan, there was no preferred stock financing, so the debt ratio and the common equity ratios are ‘complements’. That is, the sum of these two leverage ratios is unity. However, should there have been preferred equity financing, the common equity ratio would have been less than 25% for the year 2007 and the debt ratio would have remained the same. The industry average for common equity ratio is 36 percent, so, Singer Pakistan should enforce measures to increase its common equity in order to confirm to the industry norms. Thus, the common equity ratio reflects the use both debt financing and preferred stock financing.

The final balance sheet based ratio we consider is the long-term debt ratio, which is calculated as:

Long term Debt Ratio = Long term debt / Total assets = 12 % (2007), 11 % (2006), 12 % (2005)

Long Term Debt Ratio

11.93

10.84

12.03

10.20

10.40

10.60

10.80

11.00

11.20

11.40

11.60

11.80

12.00

12.20

2007 2006 2005

Here we are interested in measuring the relative proportion of the firm’s assets ‘funded’ by long term or permanent debt. Notice that since Singer Pakistan has financed 75 percent of its assets by borrowings and just 12 percent by long-term debt, then it must have used 63 percent short term or current debt to finance its assets in year 2007. This practice is absolutely wrong since it carries its own shortcomings like re-pricing risk and generating a liability to retire another liability.

Whereas, by looking at industry average, it’s clear that it’s like a norm to finance assets by short term borrowings. The whole industry seems to finance its long term assets by short term borrowings by 57 percent.

Coverage Ratios:

We will use two coverage ratios: the times interest earned ratio and the fixed charge coverage ratio. The times interest earned ratio for Singer Pakistan is calculated as follows:

Times interest earned = EBIT / Interest expense = 1.62 times (2007), 1.54 times (2006), 1.84 times (2005)

Time Interest Earned

1.62

1.54

1.84

1.351.401.451.501.551.601.651.701.751.801.851.90

2007 2006 2005

This indicates that the company’s ability to cover its interest expense has decreased by 16 percent from 2005 to 2006. This is because the company introduced higher debt in 2006 and therefore has the highest debt ratio of 79.34 per cent in 2006 on which the firm had to pay the charge of debt among these years.

Eventually, the factors which can contribute towards lowering the times interest earned ratio are:

i. Decreased EBITii. Increased interest expense

iii. Impact of both

From trend analysis, we found that the firm’s earnings before interest and taxes increased by almost 32.5 percent from 2005 to 2006 and the same further increased by 27 percent in year 2007. This indicates a growth in the EBIT but at decreasing pace. This may be a favorable stance for the firm as an increase in EBIT can raise the ability of the firm to cover its interest expenses from it.

Secondly, it’s worth noting that the company’s interest expense has also continued to grow from year 2005 to 2007. The interest expense increased by almost 60 percent in 2006 as compared to interest expense in year 2005, whereas, the same expense further increased by 21 percent in 2007. An increasing interest expense ultimately resulted in lowering the times interest earned ratio of the firm. Thus, lowered times interest earned ratio is a result of the impact of an increased interest expense.

It’s already clear that the firm is seeking external borrowings for its capital expenditures on which it has to pay its charge. A raised interest expense indicates that the management may not be efficient to seek borrowings at lower charge or it has poor negotiation ability. Further, the firm may be taking costlier funds due to poor financing decisions of the management.

As compared to industry average, the times interest earned for Singer Pakistan is extremely poor.

The next coverage ratio is the fixed charge coverage ratio, which is actually a refined version of the times interest earned ratio and includes consideration for rental payments. The ratio is calculates as:

Fixed Charge Coverage Ratio = (EBIT + lease payments) / (Interest expense + lease payments) = 1.60 times (2007), 1.53 times (2006), 1.80 times (2005)

Fixed Charge Coverage Ratio

1.60

1.53

1.80

1.35

1.40

1.45

1.50

1.55

1.60

1.65

1.70

1.75

1.80

1.85

2007 2006 2005

Thus, after considering rental payments and interest expense, Singer Pakistan’s earnings for 2007 cover its fixed charge 1.6 times. The ability of the firm to pay its fixed charge decreased by 15 percent in 2006 as compared to 2005 and then grew by 4.5 percent in year 2007. Ultimately, the fixed charge coverage for the firm decreased by 11.5 percent. This decrease in the ability of the firm to pay its fixed charge resulted from the increase in interest expense and rental payments. Therefore, the management must notice the decrease and improve its financing decisions.

Profitability Ratios:

Profitability ratios serve as overall measures of the effectiveness of the firm’s management. These ratios can be conveniently segmented into two groups: profitability in relation to sales or “profit margin” ratios and profits in relation to investment.

Profit Margin Ratios:

The first profit margin ratio we consider is the gross profit margin, which for Singer Pakistan is calculated as follows:

Gross Profit Margin = Gross Profit / Net Sales = 22.6 % (2006), 21.8 % (2006), 20.18 % (2005)

Gross Profit Margin

22.63

21.85

20.18

18.50

19.00

19.50

20.00

20.50

21.00

21.50

22.00

22.50

23.00

2007 2006 2005

The gross profit margin of the firm grew by 30 percent from 2005 to 2006 and then grew by almost 28 percent from 2006 to 2007. Gross profit margin in year 2007 indicates that the 78 percent of Singer Pakistan’s sales revenues go toward paying for cost of goods sold. Further, it also indicates that the cost of goods sold for the firm decreased over these years. 79 percent and 80 percent of the firm’s sales revenues go toward paying for cost of goods sold in years 2006 and 2005 respectively.

The increase in GPM may be attributed to the following factors:

1. Increased gross profit2. Decreased net sales3. Impact of both

From common size analysis of profit and loss account, it is clear that the gross profit of Singer Pakistan has increased from 20 percent of sales to 22 percent of sales thus gaining a growth of almost 28 percent from year 2006 to 2007. We can also conclude that the net sales of the firm also increased at increasing rate. The net sales grew by 20.5 percent from year 2005 to 2006 and further grew by 23.5 percent from year 2006 to 2007. Thereby, denying the possibility of decreased net sales.

So, we can say that the increase in the gross profit margin is the result in the increase of gross profit.

The gross profit margin for the industry is 11 percent. This indicates that the cost of goods sold for Singer Pakistan is quite low due to its better pricing policy as compared to other players in the industry.

The next profit margin ratio is the operating income margin, which is calculated as follows:

Operating income margin = EBIT / Net Sales = 8.78 % (2007), 8.53 % (2006), 7.74 % (2005)

Operating Profit Margin

8.78

8.53

7.75

7.20

7.40

7.60

7.80

8.00

8.20

8.40

8.60

8.80

9.00

2007 2006 2005

Obviously operating expenses are a very significant part of Singer Pakistan’s expenses since the firm has 8.78 percent of its sales left after deduction of cost of goods sold (78 percent) and operating expenses (almost 14 percent).

An increased operating margin may be attributed to the following factors:

1. Increased net operating income2. Decreased net sales3. Impact of both

It’s already observed that the net sales of the Singer Pakistan increased at increasing rate. Therefore, the increase in operating profit margin may be a result of increase in EBIT. From trend analysis, we found that the net operating income of the firm continued to grow from 2005 to 2007. There is a growth of 32.5 percent in year 2006 in operating income as compared to the operating income of the firm in 2005. Further, the operating income for the firm grew by 27 percent in 2007.

Although, it is found that the operating expenses of the firm also continued to grow in these years. Operating expenses managed to grow by 28 percent each year. In year 2007, operating expenses were recorded to be almost 14 percent of sales as compared to 12 percent in year 2005.

The increase in net operating profit instead of continuous growth in operating expenses is a result of higher gross profit margin, which ultimately off settled the increase in operating expenses. However, operating expenses of Singer Pakistan are higher than the industry norms. Although the firm yielded higher gross profit margin than the industry, it ultimately yielded lower operating profit margin due to higher operating expenses.

The final profit margin we calculate is the net profit margin:

Net profit margin = Net income / sales= 2.64 % (2007), 2.51 % (2006), 2.35 % (2005)

Net Profit Margin

2.65

2.57

2.35

2.202.252.302.352.402.452.502.552.602.652.70

2007 2006 2005

Here we see that after all expenses are paid; including interest and taxes, the firm earns almost 2.5 percent of each sales rupee in profits. Whereas, the net profit margin for the industry is 5 percent. This indicates that the firm is paying higher interest charges which further lowered its net income.

Profitability in Relation to Investment Ratios:

The first profitability in relation to investment ratio we consider is the operating income return on investment or return on investment.

Return on Investment = Net Operating Income / Total Assets = 8.9 % (2007), 8.84 % (2006), 7.9 % (2005)

Return on Assets

8.90 8.84

7.92

7.40

7.60

7.80

8.00

8.20

8.40

8.60

8.80

9.00

2007 2006 2005

It indicates that on a before interest and tax basis, the management of Singer Pakistan produced 8.9 percent return on total investment of the firm in 2007. This number is the appropriate basis for assessing the effectiveness of the operating management of Singer Pakistan, since those managers do not have direct control over the method of financing selected by the firm. Thus, the relationship studied is independent of the way the firm is financed.

The asset utilization of the firm is questionable since the industry average is 17 percent. This means that the efficiency of operating management decisions is extremely low.

To assess the effectiveness of the management with respect to both its operating and financing decisions, we calculate the return on common equity.

Return on Common Equity = Net Income / Common Equity = 10.7 % (2007), 12.8 % (2006), 11.22 % (2005)

Return on Equity

10.78

12.87

11.22

9.50

10.00

10.50

11.00

11.50

12.00

12.50

13.00

13.50

2007 2006 2005

Thus, after all expenses, the firm’s management earned a return of 10.7 percent on the investment of the common shareholders during 2007. Although, in 2007, return on common equity had a negative growth of 16 percent whereas the same grew by 14.5 percent in 2006 as compared to return on common equity in 2005. The problem is that this number can also rise simply when the company takes on more debt, thereby, decreasing shareholder equity. It indicates that the company has more leverage, which could be a good thing, but it also indicates that the stock of the firm is more risky.

The sudden dip in the ROCE in year 2007 can be attributed towards the declining aggressive approach of Singer Pakistan. The firm had a relatively conservative approach in 20007 where it borrowed lesser than the earlier years. This resulted in the expansion of common equity, which ultimately lowered the return.

ROA Vs ROE:Here we only consider return on common equity and return on assets because they both measure a kind of return, at first glance; these two metrics seem pretty similar. Both gauge a company’s ability to generate earnings from its investments. But they don’t exactly represent the same thing. A closer look at these two ratios reveals some key differences. Together, however, they provide a clearer representation of company’s performance. Here we look at each ratio and what separates them.

The big factor that separates ROE and ROA is financial leverage or debt. The balance sheet’s fundamental equation shows how this is true: assets = liabilities + equity. This equation tells us that if a company carried no debt, its shareholder’s equity and its total assets would be the same. It follows then that their ROE and ROA would also be the same. But if the company took on financial leverage, ROE would rise above ROA. In other words, when debt increases, equity shrinks, and since equity is the ROE’s denominator, ROE, in turn, gets a boost. At the same time, when a company takes on debt, the total assets – the denominator of ROA – increase. So, the debt amplifies ROE in relation to ROA.

2007 2006 2005Return on Assets (ROI) 8.90 % 8.84 % 7.92 %Return on Equity (ROCE) 10.78 % 12.87 % 11.22 %

If we look again at the Singer Pakistan’s balance sheet, we see why the company’s ROE and ROA are so different in these three years. Singer Pakistan carried enormous amount debt in year 2006 – which kept its asset high while reducing shareholder’s equity. Whereas, in year 2007, the company lowered its borrowings which resulted in low ROCE and high ROA.

Because ROE weighs net income only against owner’s equity, it doesn’t say much about how well a company uses it’s financing from borrowings and bonds. ROA – because its denominator includes both debt and equity (assets = liabilities + equity) – help us see how well Singer Pakistan puts both these forms of financing to use.

Efficiency Ratios:

Efficiency ratios measure the effectiveness with which a firm is utilizing its assets to generate sales. A very efficient firm, then, is one that utilizes its investment in assets to generate the largest possible level of sales revenues. Here we will discuss two efficiency ratios that relate to aggregates of assets. The first is the fixed asset turnover ratio and the second is the total asset turnover ratio.

Singer Pakistan’s fixed asset turnover ratio is calculated as follows:

Fixed Asset Turnover = Net Sales / Fixed Assets = 10.09 times (2007), 11.62 times (2006), 10.72 times (2005)

Fixed Assets Turnover

10.09

11.62

10.73

9.00

9.50

10.00

10.50

11.00

11.50

12.00

2007 2006 2005

Singer Pakistan generates relatively high volume of sales from utilizing its fixed assets. Although, the fixed asset turnover decreased by over 13 percent from year 2006 to 2007, it indicates that the fixed assets of the firm increased by higher proportion than the increase in its net sales.

The total asset turnover ratio is calculated in a similar fashion, as follows:

Total Asset Turnover = Net Sales / Total Assets = 1.01 times (2007), 1.04 (2006), 1.02 times (2005)

Total Assets Turnover

1.01

1.04

1.02

1.00

1.01

1.01

1.02

1.02

1.03

1.03

1.04

1.04

2007 2006 2005

Thus, Singer Pakistan has a relatively high volume of sales relative to its total investment in assets. The fact that Singer Pakistan’s total asset turnover ratio is close to 1 is not necessarily cause for alarm but its still below the industry average which can be improved by utilizing the assets more efficiently to generate more sales.

Performance Analysis:

Performance Analysis is a very general tool for evaluating the overall performance of a firm. We are using performance analysis to further discover the problems in the two major areas: to assess the performance of the firm’s operating management and the assessment of the firm’s performance from the stockholder’s point of view. In both stances, we will seek to deconstruct the performance measure into meaningful components, which in turn can be used to evaluate the firm’s performance.

Analyzing Operating Effectiveness

A firm’s operating management is responsible for the efficient use of the firm’s assets. Therefore, when we evaluate the performance of the firm, we consider only those revenues and expenses that are directly attributable to investments that are under the control of the operating management. This means that we use EBIT for the firm’s operating management. Furthermore, since the operating management has the control over the total investment of the firm, we use total assets as our measure of total investment.

ROI = EBIT / Total Assets

To illustrate the use of ROI performance measure, we will compare the operating performance of Singer Pakistan and Pakistan Cables. In year 2007, Singer Pakistan yielded a return on assets equals to 8.9 percent whereas; Pakistan Cables yielded return on its total investments equals to 9.6 percent. To further understand the determinants of the ROI measure, and consequently the reasons that Singer Pakistan and Pakistan Cables’ ratios differ, we will “reformulate” the metric through some basic and algebraic rearrangements as follows:

First, multiplying ROI by the ratio Net Sales / Net Sales are rearranging terms produces the following result:

ROI = (EBIT / Net Sales) * (Net Sales / Assets) OPM TATO

Where OPM is the Operating Profit Margin and TATO is Total Asset Turnover. Further, noting that EBIT equals gross profit less operating expenses, we can further decompose ROI as follows:

ROI = [(GP / Net Sales) – (OE / Net Sales)] * (Net Sales / Assets) GPM OER TATO

We haven’t changed the definition of ROI at all, but we have deconstructed it into terms that will help us further evaluate a firm’s operating performance. Specifically, we see that one dimension of the firm’s operating

performance is related to how well it has controlled its cost of goods sold in combination with its pricing policies, which in turn determine the GPM. A second determinant of ROI is related to the level of operating expenses relative to sales (OER). Finally, ROI reflects the sheer size of the firm’s asset investment relative to the sales the firm generates, which in turn is reflected in TATO. Using the data of Singer Pakistan, these component ratios for the year 2007 appear as follows:

ROI = (0.22 – 0.13)(1.01) = .089

Similarly, comparable ratios for the Pakistan Cables are as follows:

ROI = (0.14- 0.044)(1.01) = .096

Comparing the components of ROI for Singer Pakistan and those of Pakistan Cables helps explain the difference in ROI we observed earlier. Specifically, Singer Pakistan had a higher gross profit margin, a higher operating expense ratio and an equal total asset turnover. Therefore, although Singer Pakistan had a substantially higher gross profit margin and an equal total asset turnover, its higher operating expense ratio offsets both those favorable factors and explains the difference in the two firms’ ROI.

Analyzing the Owner’s Return: (Three Step DuPont Analysis)

When we analyze the firm’s performance from the perspective of the common stockholders, we select as the focal point of our analysis an earnings figure that reflects the returns to the stockholders and then we select an investment base that reflects the investment of the common stockholders. In short, we use the return on common equity as the basis for our analysis, that is:

ROE = Net Income / Common Equity

ROCE is a closely watched number among knowledgeable investors. It is a strong measure of how well the management of a company creates value for its shareholders. This number can be misleading, however, as it is vulnerable to measures that increase its value while also making the stock more risky. Therefore, we break down the components of ROE so that inferences can be made whether the company is a good investment or not. Using the DuPont analysis shows the causes of shifts in the number.

ROCE = (Net Profit Margin) * (Asset Turnover) * (Equity Multiplier)

These components include:

Operating Efficiency – as measured by Net Profit Margin Asset Utilization Efficiency – as measured by Total Asset Turnover Financial Leverage – as measured by Equity Multiplier

DU PONT ANALYSIS

2007

ROENPM ATO EQ.M

0.02649 1.01348 4.0135710.78%

2006

ROENPM ATO EQ.M

0.02566 1.03668 4.8401712.87%

2005

ROENPM ATO EQ.M

0.02353 1.02173 4.6682911.22%

We now have ROCE broken down into net profit margin (how much profit the company gets out of its revenues), asset turnover (how effectively the company makes use of its assets), and equity multiplier (a measure of how much the company is leveraged). The usefulness should now be clear.

Here, it is clear that the firm’s ROCE increases in year 2006 due to the increase in equity multiplier. This is not good sign for the Singer Pakistan. Although, in the same year, two positive signs were also observed i.e. the increase in the net profit margin and asset turnover. Ultimately, the impact of these three factors collectively resulted in the growth of ROE by 14.5 percent from year 2005 to 2006. It indicates that the stock is yielding more return but at the same time getting more risky.

When we look at the sudden dip in the ROCE for year 2007, we observe that the net profit margin increased in 2007 by 3 percent as compared to net profit margin in year 2006. A negative sign also appeared in the same year. Total assets turnover decreased by 2 percent, which indicates that the management was unable to efficiently utilize its total investment. Another good aspect for the firm is that its stock is getting less risky as its equity multiplier decreased by over 17 percent. The decrease in the equity multiplier shows that the company is lowering its external borrowings. This decrease in the equity multiplier and total asset turnover resulted in the decrease in return on common equity, which also off settled the positive impact of the increase in the net profit margin (a sign of increasing operating efficiency).

Using Ratios to Predict Corporate Bankruptcy:

One of the important uses that can be made of financial ratios is the analysis of the likelihood that a firm will fail or become bankrupt. Beaver (1968) and Altman (1968) pioneered the use of modern statistical analysis of financial ratios in the prediction of the likelihood of corporate bankruptcy.

Altman (1968) provided the first “multivariate” analysis of bankruptcy utilizing financial ratios. He used a tool called multiple discriminant analysis, which allowed him to combine several financial ratios into a single predictive equation. The predictive equation looks like a multiple regression equation and produces a “Z-Score”. If the Z-Score of the firm is below 1.8, then the subject firm is considered a prime candidate for bankruptcy. Altman’s model appears as follows:

Z = 0.012 x1 + 0.014 x2 + 0.033 x3 + 0.006 x4 + 0.999 x5

Where: x1 = working capital / total assetsx2 = retained earnings / total assetsx3 = EBIT / total assetsx3 = market value of equity / book value of total debtx5 = Net Sales / total assets

For Altman’s model a Z-score less than 1.8 indicates a very high probability of failure, while a Z-score larger than 3 indicates a high probability of non failure, Z-scores between 1.8 and 3 fall in the “gray zone” where it is not possible to predict with confidence whether the firm will or will not fail.

To demonstrate the use of model, we will apply it to Singer Pakistan, using its 2007 financial statements as follows:

Z SIN = 0.012(0.41) + 0.014(0.24) + 0.033(0.08) + 0.006(2.13) +0.999(1.01) = 1.03

Now, interpreting Singer Pakistan’s Z-score, we find that it has a high probability of corporate bankruptcy. It indicates from this analysis that Singer Pakistan’s financial health is explicitly questionable.

Conclusion

The firm’s financial health is highly questionable although the firm’s liquidity is not a cause for alarm. But, the stock of Singer Pakistan is riskier in industry and it’s predicted that the firm is moving towards bankruptcy. The firm is investing in its long-term assets by taking costlier funds from supplier of funds, which has raised its interest charges. Also, the operating efficiency is deteriorating over years. Therefore, appropriate measures must be taken to soothe the financial crunch.

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Singer Pakistan