The financial repercussion of cost, revenue and profit: an extension in

Applied Financial Economics, 2005, 15, 259–271

The financial repercussion of cost, revenue and profit: an extension in the BEP and CVP analysis Ayub Mehar Institute of Business and Technology – BIZTEK, Karachi, Pakistan E-mail: [email protected]

The study measures the impacts of the profitability factors on the capital structure of a firm. A simulation analysis has been applied in the study and the impacts of Cost, Revenue, Profit, Tax Liability and Dividend have been tested. It has been found that capital growth of a firm does not depend on the profitability factors. However, the factors of the profitability are important in determination of the liquidity position of a firm. It is interesting that a large number of studies have measured the effects of capital structure on the profitability, but the present study measured the effect of the profits’ factors on the capital structure of a firm.

I. Introduction The ‘Break Even Analysis’ and the ‘Cost-VolumeProfit Analysis’ are the two famous techniques in the management accounting literature. The techniques are applied to quantify the effects of the production and sales volume on the profitability of a firm. From the profits’ analysis point of view, the techniques are good and valid, but they do not measure the financial repercussion of the profitability factors. No doubt, profitability depends on the revenue and cost factors. However, it is more important to analyse the impact of those factors on the pattern of financing. Now, it is accepted in the finance literature that revenue, cost and profits’ factors can affect the financial structure of a firm (McCabe, 1979; Anthonyson and Cooper, 1982; Peterson and Bennett, 1983; Myers, 1984; Chadwick, 1987; Jensen and Zorn, 1988; Bandt and Pascal, 1992; Welch, 1994; Williamson, 1987). This study is important from the growth and stability point of view, because it measures the impacts of the present business activities on the

long-term capital structure of a firm. In other words, this study quantifies the effects of the structure of income statement on the structure of a balance sheet. It is interesting that a large number of studies have measured the effects of capital structure on the profitability, while the present study measures the effects of profitability on the capital structure of a firm. It is concluded in the various studies that corporate investment, dividend and the financial policies are interrelated and the debt and equity are alternative ‘Financial Structures’ (Modigliani and Miller, 1958, 1963; McCabe, 1979; Peterson and Bennett, 1983; Myers, 1984; Chadwick, 1987; Jensen and Zorn, 1988; Gearald et al., 1992). But, relatively less attention has been paid on the relations between the factors of profitability and the investment patterns. An econometric approach was adopted in this study, however, it is useful to recall the main insight of financial accounting on which most of the corporate finances’ models are based. The accounting and the economic approaches in the literature differed fundamentally. The accounting studies focus attention on the preparation of the flow of funds (where

Applied Financial Economics ISSN 0960–3107 print/ISSN 1466–4305 online # 2005 Taylor & Francis Group Ltd http://www.tandf.co.uk/journals DOI: 10.1080/0960310042000314205

259

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260 Table 1. Description of the variables Variable

Description

ACMDEP ACMDEP(t1) BNSSHR CAPITAL CAPITAL(t1) CFLOW CHCAP CLSTOCK CSTPRD CURLIBL D2 D6 D7 DEBTRS DEPRCT DIVIDEN EQUITY FASSTC LASST LASST(t1) LTDEBT

Accumulated depreciation fund One year lagged accumulated depreciation fund Bonus shares issued by the company during the year Equities plus fixed (Long-term) liabilities One year lagged employed capital Cash flow as per cash flow statement Change in capital Value of merchandizing inventories at closing date Cost of production Current liabilities Dummy variable equal to one if company belong to chemical/pharmaceutical industry Dummy variable equal to one if company belong to cement industry Dummy variable equal to one if company belong to fuel and energysector Accounts receivables including bills/ notes receivables and pre paid expenses Annual depreciation on fixed assets Amount of dividend declared Shareholders’ equity Fixed assets at cost Balance of petty cash plus bank accounts (liquid assets) One year lagged liquid assets Long-term debt including loan from financial institutions, preference share capital, bonds, debentures and other fixed liabilities Net current assets Net profit after tax Net profit before tax Ordinary shares (paid up) capital One year lagged paid-up capital A part of reserve funds represents money raised by premium on shares issued by the company New issues in the form of right shares Retention/Retained earnings Net sales revenue Number of shares held by the management (Board of Directors) Outstanding balance of retained earnings (surplus and reserves funds) One year lagged reserves and surplus account Total current assets Time (trend) variable equal to one for 1981–1982 and so on Total assets and properties (footing of balance sheet) Total equity and liabilities (footing of balance sheet) Provision for income tax

NCRASST NPAFTX NPBFTX OSCAP OSCAP(t1) PRUM RIGHT RTNTN SALES SHNMBR SURPLUS SURPLUS(t1) TCRASST TIME TOTASST TOTLIBL TXPROV

funds come from and where they go). While attention in the economic theories are paid on the behaviour of investors and managers; why funds come and why they go. Consequently, those studies on answering various questions that are not addressed by the accounting literature. The Generally Accepted Accounting Principles have been followed in the study and the standard accounting definitions have been adopted for the transformation of the data. Various companies have different accounting policies. Particularly in Depreciation Accounting, Inventories Valuation and Bad Debts Estimates, policies may be significantly differed. A methodology was adopted where effects of accounting policies could be minimized. Moreover, all the accounts were converted into a Uniform Accounting System (AICPA, 1986; IASC, various issues).

II. The Model To test the effects of profitability factors, on capital structure, a simulation analysis was exercised. For this purpose a simulation model was estimated in the context of the listed companies of the Karachi Stock Exchange (Mehar, 1994). To estimate the model, the pooled data of 225 companies was applied for the period of 15 years, since 1981. The data have been extracted from the annual accounts of the companies listed on the Karachi Stock Exchange (Karachi Stock Exchange, various issues; State Bank of Pakistan, various issues). The structural equations were estimated by a ThreeStage Least Square (3SLS) technique. The model consists of 20 equations, six of which are stochastic. So, one has 20 endogenous variables of which six are

Cost, revenue and profit

261

Table 2. The model in functional form structure of corporate finance Behavioural equations 1 2 3 4 5 6 7 8 9 10 11 Accounting identities 12 13 14 15 16 17 18 19 20 21 22 23 24 25 Exogenous variables 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43

LASST ¼ f (CONST, FASSTC, NPATX, RTNTN, D6, D7) DBTRS ¼ f (CONST, LASST, CURLIBL, SURPLUS, DEPRCT, SALES, CSTPRD) CLSTOCK ¼ f (CONST, DBTRS, SALES, TIME) 4. FASSTC ¼ f ( CONST, CURLIBL, SURPLUS, OSCAP, NPATX, TCRASST) CURLIBL ¼ f (CONST, LASST, DBTRS, CLSTOCK, FASSTC, SURPLUS, OSCAP, ACMDEP, CFLOW, NPBTX) DIVEDN ¼ f (CONST, NPATX, NCRASST, BNSHR, TXPROV, SHRNBR, D2) CFLOW ¼ LASST LASST(T1) TCRASST ¼ LASST þ DBTRS þ CLSTOCK NCRASST ¼ TCRASST CURLIBL TOTASST ¼ TCRASST þ FASSTC TOTLIBL ¼ TOTASST NPATX ¼ NPBTX TXPROV RTNTN ¼ NPATX DIVEDN SURPLUS ¼ SURPLUS(T 1) þ RTNTN þ PRUM CAPITAL ¼ TOTLIBL CURLIBL EQUITY ¼ CAPITAL LTDBT OSCAP ¼ EQUITY SURPLUS RIGHT ¼ OSCAP OSCAP(T 1) BNSHR CHCAP ¼ CAPITAL CAPITAL(T 1) ACMDEP ¼ ACMDEP(T 1) þ DEPRCT DEPRCT ¼ DEPRCT SALES ¼ SALES CSTPRD ¼ CSTPRD LTDBT ¼ LTDBT NPBTX ¼ NPBTX TXPROV ¼ TXPROV BNSHR ¼ BNSHR SHNMBR ¼ SHNMBR PRUM ¼ PRUM LASST(T 1) ¼ LASST(T 1) ACMDEP(T 1) ¼ ACMDEP(T 1) SURPLUS(T 1) ¼ SURPLUS(T 1) OSCAP(T 1) ¼ OSCAP(T 1) CAPITAL(T 1) ¼ CAPITAL(T 1) TIME ¼ TIME D2 ¼ D2 D6 ¼ D6 D7 ¼ D7

Where, ‘CONST’ is used for the constant term/intercept of the equation.

explained by stochastic equations and the remaining defined by the accounting identities, which close the model. The model is thus mathematically complete having 18 predetermined variables. All the lagged variables, e.g. last year’s Liquid Assets (LASST t1), last year’s Depreciation Fund (ACMDEP t1), last year’s paid up capital (OSCAP t1), last year’s Reserves and Surplus (SURPLUS t1), and trend variable (TIME) are treated as exogenous variables. An econometric model of financial planning is often a mixture of accounting framework and economic theories. Financial economists provided theoretical

background for the model in the various studies. The various functional approaches have merged within a complete simulation model, which finds its statistical base in an accounting framework as presented in Table 2. The specifications of the individual equations are briefly discussed as follows: Liquid assets (LASSTS) The first equation of the model explains the volume of Liquid Assets (LASSTS) in a Balance Sheet. Petty

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262 Cash, Short-term Investment and Bank Balance are the components of the Liquid Assets (LASSTS). The following three major determinants of Liquid Assets (LASSTS) have been identified: 1. A higher value of fixed assets (FASSTC) always requires a higher value of Liquid Assets (LASSTS). Bandt and Pascal (1992) found a positive correlation between Capital and Cash Flow. To capture the effects of Investment in Fixed Asset, they have been included in the model. 2. Retained Earnings (RTNTN) also determine the Liquid Assets (LASSTS). It is commonly observed that higher retention leads to increase in the Cash Balance with a credit balance in Surplus and Reserve Fund (SURPLUS). 3. Net Profit after Tax (NPAT) also plays an important role in the determination of Liquid Assets (LASSTS) of a company. It is generally thought that profit and liquidity have a significant positive correlation. Besides those three explanatory variables, two dummy variables have also been incorporated to capture the impacts of the Cash Flow patterns of the Cement (D6) and Energy sectors (D7). Accounts and notes receivables (DBTRS) It has been hypothesized that Reserves Fund and Surplus (SURPLUS), Short-term Liabilities (CURLIBL), Liquid Assets (LASST) and Sales Revenue (SALES) have direct relationship with the Receivables from Debtors (DBTRS). All of those variables lead the improvement in liquidity position of a firm; while, a good liquidity position leads a soft policy for sales on credit. Shehzad and Smith (1982) included Sales Revenue (SALES) in the equation of the Receivables from Debtors (DBTRS) as a proxy of market power. It is also commonly intuitive that addition in the Cost of Production (CSTPRD) and Depreciation Expenditures (DEPRCT) leads the lower sales on credit. So, they also have been taken as independent variables. Closing inventories (CLSTOCK) Traditional studies in cost accounting recommend Economic Order Quantity (EOQ) and Buffer Stock techniques. Such techniques are based on the assumption that sales volume is equal to the production volume. So, it is hypothesized that Closing Inventories (CLSTOCK) depend on Sale Volume (SALES) largely. A higher amount of sales (SALES) implies a higher volume of Closing Inventories (CLSTOCK). It is also hypothesized that the

Receivable from Debtors (DBTRS) is a substitute of Closing Inventories (CLSTOCK). So, in the presence of a higher amount of Receivables (DBTRS) the volume of Closing Inventories (CLSTOCK) should be lower. Moreover, time (TIME) is the most important factor of the Closing Inventories (CLSTOCK). Time indicates the addition in the value of Inventories (CLSTOCK) over the years. This also incorporates the effects of the improvement in Inventory Management, Storage Facilities, Buffer Stock Estimation and Economic Order Quantity (EOQ) levels. Fixed assets at historical cost (FASSTC) The explanatory variables of the Fixed Assets (FASSTC) are Paid up Capital (OSCAP), Reserves and Surplus Fund (SURPLUS), Total Current Assets (TCRASST), Net Profit after Tax (NPAT) and Current Liabilities (CURLIBL). Equities (OSCAP plus SURPLUS) are obviously one of the most influential factors of the acquisition of Fixed Assets. So, its inclusion in the model is obvious. A higher magnitude of Current Assets (TCRASST) may be a cause of lower investment in Fixed Assets (FASSTC), because total financial resources are distributed between the two categories of assets. Short term liabilities (CURLIBL) It is hypothesized that Short-term Financing depends on the equity capital of a firm (EQUITY). The equity financing is higher, the short-term financing will be lower. The payments of Staff Salaries, Utility Bills, Outstanding dues of the vendors and the suppliers of the raw material, etc. will not be delayed if a firm has a higher equity. However, to isolate the effects of Paid up Capital (OSCAP) and Reserves and Surplus Fund (SURPLUS), both the variables have been included individually. Depreciation Fund (ACMDEP) is also a source of financing. So, it may be a substitute of the Short-term Financing (CURLIBL). The components of the Current Assets – Liquid Assets (LASSTS), Receivables from Debtors (DBTRS) and Closing Inventories (CLSTOCK) – may also be a cause of the change in the Current Liabilities (CURLIBL), because of management decision to maintain the Current Ratio or Working Capital level. If, a firm want to maintain a higher value of Liquid Assets (LASSTS) the Current Liabilities (CURLIBL) may also be increased. Moreover, a positive relation between the Current Liabilities (CURLIBL) and Receivables from Debtors (DBTRS) is commonly viewed; Similarly, Cash Flow (CFLOW) is a phenomenon of Liquidity Position. If Cash Flow (CFLOW)

Cost, revenue and profit increases, the Current Liabilities (CURLIBL) will decrease. It is also hypothesized that Fixed Assets (FASSTC) will lead to increase in Short-term Financing (CURLIBL). Net Profit before Tax (NPBT) is also an indicator of the availability of funds; so, in the presence of higher profits the Shortterm Financing (CURLIBL) may decrease. It is notable that one is incorporating Profit before Tax (NPBT), because the payments of Short-term Liabilities are made before the payment of taxes. Equity (EQUITY) and long term financing (LTDBT) It is obvious that all the assets and Current Liabilities (CURLIBL) depend on some explanatory variables. So, either Equity (EQUITY) or Long-term Debt (LTDBT) must be residual (balancing amount) in credit side of a balance sheet. However, because of the dependency of debts on external factors – like availability of external funds, rate of interest, credit rating and status of a company, etc. – Long-term Debt (LTDBT) is considered as an exogenous variable (Mehar, 1994).

263 Board of Directors (SHNMBR) was also included as an explanatory variable. In the previous studies, insider ownership (SHNMBR) has been assumed to be an exogenous factor. According to Jensen et al. (1992) Insider Ownership (SHNMBR) choice are endogenous outcomes of value-maximizing behaviour. However, due to the limitation of the study, it is considered as an exogenous variable. The complete structure of the model has been shown in Table 2, while the statistical estimations are presented in Table 3. The list of variables has been shown in Table 1, while Fig. 1 shows a complete picture of the interrelations among the financial variables. The estimated t-ratios, F-statistics and the adjusted coefficient of determination (R2) are also listed in Table 3. All the equations have good fits. The high values of F-statistics confirm the validity of the results. The t-ratios are also highly significant, reflecting that the explanatory variables are the significant determinants of the dependent variables.

III. The Simulation Analysis Dividends pay out (DIVEDN) For any of the financial indicators wherein financial planners and managers are interested, the forecaster will identify and select those factors which are contributing to or explaining most of the indicators’ behaviour or trend. Empirical investigations tell us that Net Profit after Tax (NPAT), Working Capital (NCRASST) and Insider shares in equity (SHNMBR) affect the firm’s decision regarding dividend pay-out (DIVEDN). Brittain (1966) verified a positive relationship between dividend (DIVEDN) and Net Profit after Tax (NPAT). So, those variables were also included in the model. Working capital (NCRASST) is included in the equation as an indicator of the probability of Cash Dividend. Provision for Tax (TXPROV) is a below the line head of account. So, it has been included in the equation of dividend (DIVEDN). Bonus shares may be a substitute of Dividend; so, this variable is also included in the dividend’s equation. Companies in chemical and pharmaceutical sectors belong to the large multinational groups. They do not emphasize Retained Earnings. Because, their investment depends on their Initial Equity (Parent companies’ investment). So, they have higher pay out ratio. Therefore, a dummy variable (D2) has been introduced in the equation to capture the phenomenon. It is also observed that a high percentage of shares held by management (Board of Directors) lead the high dividend. So, the number of shares held by the

This section will discuss the impacts of the Cost of Production, Sales Revenue, Profits and Dividend on the pattern of investment and finance. To reach the conclusion, the model was simulated under various scenarios. The results of simulations have been presented in Tables 4 to 9. The analysis is based on the following assumptions: 1. Firm is a going concern. 2. Business has been commenced. 3. Long term debt is an exogenous factor, and it will remain constant. 4. Paid up capital will be the residual amount of financing. Firm arranges the required additional capital through the right or bonus issues. The following simuations are based on the econometrice model discussed in Section II. The simulation results have found some interesting observations. For the year 1995, the simulated results have been presented in the following tables. The ex-post simulation results are based on the actual magnitudes of exogenous variables. To test the impacts of the factors of profitability on capital structure, the magnitudes of the Cost of Production, Sales Revenue, Net Profits, Tax Provisions and Dividends were exogenized and changed. Then the estimated values of the Current Assets, Fixed Assets, Current Liabilities, and Equities were compared with their base values. The effects of the Sales revenue, the Cost of Production, the Tax

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264 Table 3. Estimated results (3SLS) Equation number

Dependent variable

Independent variables

Coefficient

T-Statistics

R-square

1.

LASST

0.9823

11536.19

3.

CLSTOCK

0.9215

4846.30

4.

FASSTC

0.9148

3544.37

5.

CURLIBL

0.9536

3770.99

6.

DIVEDN

1.12 18.11 9.80 4.37 2.92 6.48 5.38 16.85 62.27 9.15 7.90 12.71 6.06 8.51 135.86 50.46 3.93 3.83 18.80 77.96 21.83 4.79 22.90 5.89 3.34 27.52 22.31 24.496 4.88 4 .18 18.77 103.58 103.91 5.96 12.85 19.35 26.51 25.10 2.17 2.48

394.08

DBTRS

0.779 0.069 0.614 0.348 13.548 23.142 7.635 0.266 0.275 0.424 0.788 0.051 0.024 50.422 0.982 0.290 3.435 26.948 3.294 3.288 2.306 1.595 2.469 7.232 0.424 0.442 1.055 0.174 0.283 0.316 0.164 0.938 0.908 1.022 0.035 0.155 0.627 0.297 0.103 1.319

0.5435

2.

CONST FAASTC NPATX RTNTN D6 D7 CONST SURPLUS CURLIBL LASST DEPRCT SALES CSTPRD CONST DBTRS SALES TIME CONST OSCAP SURPLUS TCRASST NPATX CURLIBL CONST OSCAP SURPLUS LASST FASSTC NPBTX CFLOW ACMDEP DBTRS CLSTOCK CONST NCRASST NPATX SHNMBR TXPROV BNSHR D2

0.8305

1114.52

Provision in profit and loss appropriation accounts, the Net Profit, and the Dividends have been quantified. The impacts of change in sales revenue On basis of the simulations, the following changes were observed in the capital structure by a 100% increase in sales revenue. 1. The current liabilities will be increased by 86%. 2. The current assets will be increased by 82%. 3. The footing of the balance sheet will be increased by 28%. 4. The share capital will be increased only by 6%. Sales revenue will affect the current assets by means of the addition in Closing Inventories and

F-Statistics

Receivables. The Receivables will be raised by 5% of additional Sales Revenue. But, a decline in the Inventories equal to 92% of the incremental Receivables will be a cause of lesser addition in total Current Assets. However, Inventories also increased by 29% of additional Sales Revenue. Sales Revenue does not have any direct affect on Current Liabilities. However, by an increase in Current Assets, Current Liabilities will also increase as an alternative source of additional financing. The increase in the footing of balance sheet would be done by the change in Current Assets and in Current Liabilities. Through the simulation analysis, it can be concluded that Sales Revenue would not affect the Employed Capital. The investment in Fixed


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Table 4. Simulation analysis impacts of sales revenue on financing Effects on

No discretionary change in sales revenue

Sales revenue raised by 20%



Fixed assets at cost Current assets Total assets and properties Paid up capital Reserve funds Debt financing Current liabilities

351 182 534 215 35 125 158

351 212 564 217 35 125 186

351 257 609 221 35 125 227

351 332 684 228 35 125 295

976 969 944 252 356 501 835

976 913 889 850 356 501 182

976 830 806 746 356 501 203

976 691 667 239 356 501 570

Table 5. Simulation analysis impacts of the cost of production on financing Effects on

No discretionary change in cost of production

Cost of production raised by 20%




351 182 534 215 35 125 158

351 182 534 215 35 125 158

351 182 534 215 35 125 158

351 182 534 215 35 125 158

976 969 944 252 356 501 835

976 929 904 316 356 501 732

976 868 844 411 356 501 576

976 767 743 569 356 501 317

Table 6. Simulation analysis impacts of net profit on financing Effects on

No change in net profit

Net profit raised by 20%




351 182 534 215 35 125 158

351 183 535 214 37 125 158

351 184 536 213 40 125 157

351 186 538 211 44 125 156

976 969 944 252 356 501 835

976 492 467 690 258 501 018

976 578 553 371 113 501 568

976 388 364 172 870 501 820

Table 7. Simulation analysis impacts of dividend pay out on financing Effects on

No discretionary change in dividend

Dividend raised by 20%




351 182 534 215 35 125 158

351 183 535 216 33 125 159

351 184 536 218 31 125 160

351 185 537 220 27 125 163

976 969 944 252 356 501 835

Assets is not dependent on Sales Revenue. Investment decisions are determined by other causes. However, Working Capital of a firm will be affected by the change in Sales Revenue. So, increase in Sale Revenue is a solution for the liquidity problem.

976 290 265 582 822 501 359

976 073 048 101 523 501 923

976 378 354 633 690 501 530

The Sales Revenue is not proven as a factor of the equilibrium in the Assets and Liabilities. The structure of Fixed Assets and Employed Capital will be affected by the other variables. Therefore, investment and financing decisions are independent from Sales Revenue. Sales Revenues

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266

Current assets

Fixed assets

Current liabilities Liquid assets

Depreciation funds Reserves and surplus

Accounts receivables

Share’s capital Retained earnings

Inventories Cash flow

Net profit after tax

Net profit before tax Depreciation

Cost of production Sales revenue Time/trend

Fig. 1. Determination of assets

are the requirement of the continuation and flow of business. While, the Fixed Assets and the Employed Capital are required for the existence and expansion in the business. The results do not confirm the hypothesis that the expansion and development of a company is directly linked with the Sales Revenue.

The impacts of change in the cost of production On the base of the simulation analysis, the following changes were observed in the capital structure of a firm by a 100% increase in the Cost of Production: 1. The current liabilities would be decreased by 0.33%.


267 Tax liabilities

Net profit (-)

Liquid assets (++)

Receivables (-)

Dividend (+,+)

Fixed assets (-)

Current liabilities (+,+)

Reserves and surplus funds (-)

Equities (-)

Fig. 2. The impacts of tax liabilities (first three rounds effects)

Table 8. Simulation analysis impacts of tax liability on financing Effects on

No change in tax liability

Tax liability raised by 20%




351 182 534 215 35 125 158

351 182 534 216 33 125 158

351 182 534 217 31 125 159

351 181 533 219 28 125 160

976 969 944 252 356 501 835

976 490 466 307 920 501 738

976 075 051 413 767 501 369

976 382 358 257 179 501 421

Table 9. Impacts of the profitability actors on investment and financing pattern (a bird’s eye view) Sources and application of funds

Sales revenue

Cost of production

Taxes

Net profit after tax

Dividends

Paid-up capital Reserves and surplus funds Long-term debts Current liabilities Total assets Fixed assets Total current assets

To be increased No effect No effect To be increased To be increased No effect To be increased

To be increased No effect No effect To be decreased To be decreased No effect To be decreased

To be increased No effect No effect U-shaped To be decreased No effect To be decreased

To be decreased To be increased No effect To be decreased To be increased No effect To be increased

To be increased To be decreased No effect To be increased To be increased No effect To be increased

2. The current assets would be decreased by 0.11%. 3. The Footing of balance sheet would also be decreased by 0.03% only. 4. The share capital would be increased only by 0.15%. So to say, the Cost of Production has a little effect on the pattern of financing and investment. It is shown

by the econometric estimation that if Cost of Production increases, Sales on Credit would not be offered or less offered. As a result, Accounts (or Notes) Receivables would decrease. This decrease in Receivables (Current Assets) would be a cause of the decrease in the Current Liabilities. But, decrease in Current Liabilities would be less than the decrease in Current Assets. In fact, the decline in Current Liabilities is a second round affect. The Current

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268 Liabilities are decrease only by the decrease in Current Assets. The impacts of the change in net profit It is observed that the following components of the balance sheet would be changed by a 100% increase in the net profit after tax. 1. 2. 3. 4.

The The The The

Reserve Funds would increase by 27%. Current Liabilities would decrease by 1%. Current Assets would increase by 2%. share capital would decrease by only 2%.

In the absence of tax liability, the effects of net profit on equities are highly positive. The results indicate that Marginal Propensity of Dividend with respect to profit is only 15.5%. It means, 84.5% incremental profit will go to Retained Earnings. The impacts of the change in dividend The following changes were observed in the capital structure of a firm by a 100% increase in the Dividend Pay out. 1. 2. 3. 4.

The The The The

Reserves Funds would decrease by 22% Current Liabilities would increase by 3%. Current Assets would increase by 1%. Share Capital will be raised only by 2.5%.

It is understandable that the Reserves and Surplus Funds are largely affected by the Cash Dividend. The results indicate that decrease in retention will be a cause of increase in liquid assets. So, at the second round Current Assets would increase, but an increase in Current Liabilities due to a decrease in Reserve Funds would be greater than the increase in Current Assets. Its mean dividend payments will deteriorate the liquidity position of a firm. The impacts of change in tax liabilities The following effects of a 100% increase in the tax liabilities of a firm, have been observed. 1. The Reserve Funds will decrease by 20%. 2. The Current Assets will decrease by 0.87%. 3. The Share Capital will increase only by 2%. Figure 2 shows the impacts of tax liabilities on the financial position of a firm. The Dividend Pay out has a direct relation with the Tax Liabilities. It is interesting that taxpayer companies usually declare dividend, so their retention would be lower. A decrease in the Net Profit after Tax would be a cause of decrease in Liquid Assets. It is also

concluded that in the presence of Tax Liabilities, the Sale on Credit would increase.

IV. Conclusion It is the major conclusion of the study that sources and distribution of profit do not affect Fixed Assets. By and large, Paid up Capital is one of the least affected variables. The interesting conclusion is that the Working Capital is affected by the change in the sources and distribution of profits. It means liquidity position of a firm has direct relations with the income and its distribution. The profit is also important for internal financing. But, Paid up Capital or leverage position does not depend on the profit. The important conclusions can be classified in the following four points: 1. It is important from the lenders’ point of view that borrowing (or leverage) is not related with the profitability. 2. A higher profit does not necessarily mean that firm would expand its business. 3. The Cost, Revenue, Profit, and Dividend are the important factors of the liquidity position of a firm, in the short term. 4. The capital growth of a firm is independent from the profit. The profit is a desirable objective from the operational point of view. But, the growth in Revenue (or Profit) is not directly correlated with the growth in Capital.

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equations framework, University of Nebraska, Department of Finance, Working Paper. Karachi Stock Exchange (various issues) Annual Reports of the Companies, Karachi. McCabe, G. M. (1979) The empirical relationship between investment and financing: a new look, Journal of Financial and Quantitative Analysis, 14, 119–35. Mehar, M. (1994) A simulation model of corporate finances: a study of companies listed on the Karachi Stock Exchange, Karachi, PhD Dissertation. Modigliani, F. and Miller, M. (1958) Some estimates of the cost of capital to the electric utility industry 1954–57, American Economic Review, 13, 261–97. Modigliani, F. and Miller, M. H. (1963) Corporate income taxes and the cost of capital: a correction, American Economic Review, 433–43. Myers, S. C. (1984) The capital structure puzzle, Journal of Finance, 39, 575–92. Peterson, P. P. and Bennett, G. A. (1983) A reexamination of the empirical relationship between investment and financing decision, Journal of Financial and Quantitative Analysis, 429–53. Shehzad, M. L. and Smith, C. W. (1972) Account receivable management policy: theory and evidence, The Journal of Finance, 7(1), 169–200. Smith, K. (1980) Readings on the Management of Working Capital, West Publishing Company, Eagan, MN. State Bank of Pakistan (various issues) Balance Sheet Analysi, The State Bank of Pakistan, Karachi. Welch, I. (1994) The cross-sectional determinants of corporate capital expenditures: a multinational comparison, UCLA Working Papers. Williamson, G. H. (1987) An approach to modeling in business and industry via simulation, The Newsletter of the Chartered Association of Certified Accountants, November, 23–9.

Appendix: list of companies Serial number

Company

Textile group Private sector 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19

Adamjee Industries Ahmed Spinning Mills Ali Asghar Textile Mills Allawasaya Textile and Finishing Annoor Textile Anwar Textile Ayesha Textile Babri Cotton Bahawalpur Textile Burewala Textile Central Cotton Chaudhry Textile Chenab Textile Colony Sarhad Colony Thal Crescent Textile D.M. Textile Dawood Cotton Dewan Textile

Serial number 20 21 22 23 24 25 26 27 28 29 30 31 32 33 34 35 36 37 38 39 40 41 42 43 44 45 46 47 48 49 50 51 52 53 54 55 56 57 58 59 60 61 62 63 64 65 66 67 68 69 70 71 72 73 74 75 76 77 78 79 80 81

Company Dost Muhammad Cotton Elahi Cotton Elite Textile Fateh Textile Fazal Cloth Fazal Textile F.P. Textile Ghafur Textile Globe Textile (OE) Globe Textile Gul Ahmed Textile Gulistan Textile Hafiz Textile Hamraz Industries Hussein Industries Indus Dyeing and Manufacturing Island Textile Jubilee Spinning and Weaving Junaid Cotton Karim Cotton Khalid Textile Khyber Textile Kohat Textile Kohinoor Industries Kohinoor Spinning Kohinoor Textile Kotri Textile M.F.M.Y. Industries Mahmood Textile Modern Textile Muhammad Farooq Mushtaq Textile Nafees Cotton Nakshbandi Aindustries Naveed Tex Nishat Mills Noon Textile Olympia Spinning and Weaving Quetta Textile Rasihid Textile Sadiqabad Textile Sally Textile Sapphire Textile Service Industries Shafiq Textile Shahyar Textile Shaheen Cotton Shams Textile Sind Fine Texitle Star Textile Sunshine Cotton Universal Textile Usman Textile Yousuf Textile Zaman Textile Bengal Fibre Colony Woollen Dilon Ltd Karim Silk Lawrencepur Wollen and Textile Liberty Mills Moonlite (Pak) (continued)

A. Mehar

270 Serial number 82 83 84 85 86 Public sector 88 89

Company Nilom Nylon Noor Silk Polypropylene Products United Carpets Valika Art Fabrics Harnai Woollen Ravi Rayon

Chemical and pharmaceutical group Private sector 90 Abbott Laboratories 91 Bawany Oxygen 92 Berger Paints 93 Chemicals Ltd 94 Cyanamid (Pak) Ltd 95 Dawood Hercules Chemicals 96 Exxon Chemicals Pakistan 97 Ferozsons Laboratories 98 Glaxo Laboratories 99 Hoechst (Pak) Ltd 100 I.C.I. (Pak) Ltd 101 P.Leiner and Sons Chemicals and Feeds 102 Pakistan Gum and Chemical 103 Pakistan Industrial Gases 104 Pakistan Oxygen 105 Reckitt and Colman 106 Sandoz Pakistan 107 Wellcome Pakistan 108 Pakistan P.V.C. Ltd 109 Sind Alkalies Engineering group Private sector 110 Allwin Engineering Industries 111 Aslo Electrical Industries 112 Atlas Autos 113 Climax Engineering 114 Johnson and Philips 115 K.S.B. Pumps 116 Nowshera Engineering 117 Pakistan Cables 118 Philips Electrical Industries 119 Punjab Lamp Eorks 120 R.C.D. Ball Bearings 121 Regnis Pakistan 122 Saif Nadeem Kawasaki 123 Saifee Development Corporation 124 Shaigon Electrical and Engineering 125 Siemens Engineering (pak) Public sector 126 127 128 129 130 131 132 133

Bela Engineers Karachi Pipe Mack Trucks of Pakistan Metropolitan Steel Corporation Millat Tractors National Motors Pakistan Engineering Quality Steel

Serial number

Company

Sugar and allied group Private sector 134 135 136 137 138 139 140 141 142 143 144 145 146 147 148 149

Al-Noor Sugar Bawany Sugar Charsadda Sugar Crescent Sugar Facto Sugar Frontier Sugar Habib Arkady Husein Sugar Kohinoor Sugar Mehran Sugar Mirpurkhas Sugar Noon Sugar Premier Sugar Shahtaj Sugar Shakarganj Mils United Sugar

Public sector 150

Thal Industries Corportation

Paper board and allied group Private sector 151 Adamjee Paper and Board 152 Baluchistan Partical Board 153 Chilya Corrugated Board 154 Crescent Board 155 Orient Straw Board and Paper 156 Packages Limited (Pvt) 157 Pakistan Paper Corporation 158 Pakistan Paper Products 159 Pakistan Paper Sack Corporation Public sector 160

Security Papers

Cement group Private sector 161

Asbestos Cement Industries

Public sector 162 163 164 165

Gharibwal Cement Javedan Cement Mustehkham Cement Industries Zeal Pak Cement Factory

Fuel and energy group Private sector 166 167 168 169 170

Atlas Battery Burshan ( Pak) Ltd Haroon Oil Ltd Pakistan Burmah Shell Pakistan Refinery

Public sector 171 172 173 174 175 176 177

Attock Refinery Karachi Electric Supply Corp National Refinery Pakistan Oil Fields Pakistan State Oil Sui Gas Transmission Co Sui Northern Gas Pipelines (continued)

Cost, revenue and profit Serial number The ‘Miscellaneous’ group Private sector 178 179 180 181 182 183 184 185 186 187 188 189 190 191 192 193 194 195 196 197 198 199 200 201

271 Company

Amin Fabrics Crescent Jute Production Indus Jute Latif Jute Mehran Jute Pakistan Jute and Synthetics Thal Jute Exteaction Pakistan Lever Brothers Pakistan Arpak International Bari Rice Bata Pakistan U.D.L Industries Benz Industries Brooke Bond Pakistan Dadabhoy Padube General Tyer and Rubber Haji Dossa Hashimi Can Company Hilal Flour and General Karachi Can Companyt Lipton Pakistan Milk Pak Noon Pakistan

Serial number 201 203 204 205 206 207 208 209 210 211 215 213 214 Public sector 215 216 217 218 219 220 221 222 223 224 225

Company Pakistan Fisheries Pakistan House International Pakistan Services Prince Glass Security Safe Deposit Co Service Industries ( Shoes) Shabbir Tiles and Ceramics Spencers and Co. Pakiistan Syed Match Co Taj Mahal Hotels Trans-Pak Corporation Treet Corporation Universal Leather and Footwear Industries Associated Industries Burma Oil Mills Fazal Vegetable Ghee Kakakhel Industries Kohinoor Oil Maqbool Company Maorafco Industreis Sh.Fazal Rehman and Sons Suraj Ghee Industries Universal Oil Vegetable Ghee Wazir Ali Industries