Factors Affecting Profitability of Spinning Mills of Pakistan

Muhammad Mushtaq Mangat

Dr. M. Sarwar Rana
Abdul- Rhim Wahab
Abstract

Spinning Industry of Pakistan is one of the leading and major industries of Pakistan.

Unfortunately, this industry has been coping with overwhelmed crisis for the last few

years. Mills have to suffer from thrashing fatalities. Nearly 12 million spindles have been

set up in Pakistan and out of them 30% have closed down forever. What are the reasons

behind this collapse? The study has revealed various factors that had a substantial

relationship with the performance of the spinning mills and the conclusion avers that net

equity, non-current liabilities and sale volume have a positive connection with the net

profit of the mills. The study also finds a logical connectivity between net profit (Earning

Performance Share) and factors mentioned above. Nevertheless, other factors like, cost

on raw material, electricity cost, wages and salaries have also parallel with profitability of

mills but regarding statistically importance the relation is not significant.

Introduction

Textile is the backbone of Pakistani economy. It has 60% share in exports. In early 1960s,

yarn and cotton were main contributors in exports but in 2007, clothing (readymade

garment, knitted garments, bed wears and towels) stepped forward and surpassed. In

2007-8, the share of yarn and grey fabric in total textile exports of the country was 30.1

% whereas, clothing sector had 59 % share. The clothing is an increasing trend in

Pakistan as compare to yarn and grey fabric that is declining day by day. The data related

to the export reveals that there is a decline in yarn exports, meaning is that spinning

industry is losing its share in international market (Table 1). Spinning industry’s share

further plunged when in 2007-8; another 100 spinning mills were forced to shut down,

because of heavy losses. Spinning industry of Pakistan is striving to survive and for this

purpose, it is asking some concrete incentives and discounts to be given by the

government of Pakistan. A big debate between the government and industry continues.

Chairman of All Pakistan Textile Mills Association says in 2008 annual report that

government is of the opinion that the industry is not efficient, well organized and

resourceful; it merely relies on old and obsolete technology. The report further says that

the industry blames the government to be responsible for the downfall. But government

views that it is the fault of the wrong utilization of loans by the mills, consequently mills

are facing serious problems.

The Industry feels that high interest rates, non-availability of power and high rates of

power, along with no incentives on export are the main reasons of these crises. In such a

scenario, it becomes imperative to conduct a research to find out the main reasons of the

crises. For this purpose, critical analysis of the financial reports published by the mills is

the one of the possible ways to make out insight of the issue.

A large number of mills are public limited companies and they publish their annual

financial reports. It is presumed that these reports are correct and we do not have any

other source to know the financial health of the mills.

Table 01
Share of Textile and Clothing in Exports of Pakistan

Product Description 2007-08 (Export 2006-07 Percentage Percentage in Net

Value in Million US (Export Value in Change in Export Share in Total Textile

$) Value Exports
Million US $)
TEXTILE & 10,620,542.00 10,835,409.00 -1.98

GARMENTS

CATEGORY
YARN 1,343,357.00 1,495,438.00 -10.17 12.65
FABRICS 2,004,310.00 2,090,115.00 -4.11 18.87
SUB TOTAL 3,347,667.00 3,585,553.00 -6.63 31.52
READYMADE 1,498,499.00 1,547,345.00 -3.16 14.11

GARMENTS
KNITWEAR 1,831,178.00 1,798,477.00 1.82 17.24
MADE-UPS 2,423,723.00 2,510,212.00 -3.45 22.82
TOWELS 615,415.00 610,712.00 0.77 5.79
SUB TOTAL 6,368,815.00 6,466,746.00 -1.51 59.97
Background

Spinning is a process in which fiber is converted into yarn and for this purpose, a number

of machines have to function. A brief list of the process is given as under:

1. Bale opening and fiber blending

2. Blow room to open and cleaning of fibers

3. Carding for more orientation and removal of short fibers

4. Drawing for more orientation and making of sliver

5. Simplex to convert sliver into roving

6. Ring frame to convert roving into yarn

7. Winding to make big yarn package

This whole process needs labor, machinery and energy in order to run the machines.

Spinning is a capital-intensive industry and needs less labor as compared to other sectors

like, clothing manufacturing. According to the financial reports, the major expense of a

spinning mill is cost of raw material, which is between 65-75% of the total cost of

production, depending upon the count which company is producing. After that, electricity

is a major expense and finally salary and wages is the third expense. The above three

factors have major share in cost of goods sold (COGS).

Financial strength of firms has also a considerable role in profitability of the firms. Better

resources definitely help to have latest technology and low cost of input. During survey

of the spinning mills, we found that the firms who had high current ratio (current assets

divided by current liability) were having input at low prices and of best quality e.g.
cotton, spare parts etc. it is because, high current ratio shows that company has more

working capital and can pay timely to vendors. The less cost of inputs helped in high EPS

and it is the case with net equity that has to show firms are much relying on their own

resources rather than relying on banks and borrowing from market, which is costly than

banks even.

Keeping all above discussion in view, we have taken factors from both areas to check

their affect on EPS.

Research Methodology

The annual financial reports of the mills are the main source for this research. For this

study we have collected and compiled data from the years 2006-7 and 2007-8. The

analysis has been made while using the software of SPSS. The main reliance is on

published annual financial reports by the spinning mills.

Sampling

We tried our level best to have financial reports of all spinning mills but due to

unavailability of reports in stock exchanges and on internet, we have to opt opportunity

sampling. For this purpose, we visited Lahore and Karachi Stock exchanges. Letters were

written to all spinning mills but total 62 reports could be collected. As a few mills are

composite units (spinning, weaving and wet processing) therefore, the data of such mills

were not used due to different structure from ordinary spinning mills. Reports of 55 mills

were used for the study which is nearly 13% of the total mills.
Variable Selection

Earnings Per Share (EPS) has been taken as dependent variable while the following

variables have taken as independent:

1. Share of raw material cost in COGS

2. Share of salary and wages cost in COGS

3. Share of fuel cost in COGS

4. Current Ratio

5. Net Equity

6. Net sale

7. Non-Current Liabilities

Discussion

Seven different factors were selected in order to weigh up their impact on EPS, which is

ultimate target of the firm. We became convinced that there were many more factors

which can affect the performance of the mills but our limitation is due to the availability

of data. We have calculated correlation between dependent and independent variables and

finally we applied regression to develop an equation, which could be used for prediction

purpose of EPS.

Table 2
 Correlation between Earnings Per Share (Pk. Rs.) and Seven Different Factors
Pearson Sig. (2-

Correlation Tailed)
Share % of Raw Material 0.087 0.401

Cost in COGS
Share % of Salaries in COGS 0.-130 0.205
Share % of Fuel Cost in -0.048 0.639

COGS
Sale (Million Rs) 0.415 0.000
Net Equity (Million Rs) 0.371 0.000
Non Current Liabilities 0.208 0.040

(Million Rs)
Current Ratio 0.166 0.100

The above table shows there are three factors, which have a vital impact on EPS these

are:

1. Sales (P value: 000)

2. Net Equity (P value: 000)

3. Non Current Liabilities (P value: 0.040)

Result shows that sale has a positive effect on EPS. Its practical impact is 0.415, which is

quite high and can be considered as one major factor. The table also throws light that

more net equity has a direct and positive contribution. Its practical contribution is 0.371.

Lastly, non-current liabilities have also a strong correlation and its practical impact is

0.208, which is less than other factors.

Table 02, also explains that cost of raw material and current ratio have a positive impact

on EPS. Although, these factors are not statistically significant yet we can infer from

these figures that increase of raw material cost has not a big impact. This means that in

general, increase in fiber prices immediately affects the yarn prices. People have a strong

logic to increase the yarn price when there is an increase in fiber prices. In addition,

current ratio, which indicates the ratio of current liabilities to current assets, is an

indicator of the company to pay its current liabilities.

Regression Equation

Regression analysis is one way to determine the relationship and coefficient of

relationship between dependent and independent variables. For this purpose following

equation has been derived from the regression analysis:

EPS= -2.749 + 0.343 NS + 0.002 NE + 0.208 NCL Equation (1)

Where:

EPS= Earnings Performance Share

NS= Net sale in Million Pk Rs.
NE= Net Equity in Million Ok Rs.
NCL= Non Current Liability in Million Pk Rs.

Adjusted R Square value of this model is 0.221 and p value is .000. Adjusted R Square

value indicates that this model explains 22.1 % changes in the dependent variables. In

other words, we can say that any up to 22.1 % change in dependent variable is due to
these three variables. The regression equation explains the importance of sale, non-

current liabilities and net equity for EPS of spinning mills.

Conclusion

The spinning mills of Pakistan can overcome all the crises if they improve their sale and

equity and more reliance on non-current liabilities rather borrowing short term loans and

goods on credit. For this purpose mills need loan on long term basis. It is suggested that

government should intervene and provide long term facilities to decrease the current

liabilities. So that mills may have better current ratio and finally they will have higher

EPS. In addition to that there is a need that mills should increase their sale volume by

producing different types of yarn i.e. compact, core spun, slubs and sell their goods in

markets other than the conventional markets. Nevertheless, cost of material, fuel and

energy have also affect on the EPS but these factors are statistically not important. This

study confirms that benefit of reduction in raw material prices directly reflects in the

shape of reduction in price of yarn. However, increase in cost of fuel and salary reduces

the EPS but not significantly. If there is increase in cost of fuel and salary it cannot be

easily passed to customers, as it is done in case of raw material cost, which is

immediately passed to customers.