This study examines the impact of operating expenseson net profit margin of cement

Transcription

1 IMPACT OF OPERATING EXPENSES ON NET PROFIT MARGIN IN CEMENT SECTOR OF PAKISTAN Ahmed Muneeb Mehta Lecturer, Hailey College of Banking & Finance, University of the Punjab, Lahore, Pakistan Ali Irshad Independent Researcher Imran Hashmi Independent Researcher Abstract This study examines the impact of operating expenseson net profit margin of cement sector of Pakistan.The purpose of this study is to find out the relationship between operating expenses and profitability of cement sectors. The effect of operating expenses, net sale on profit margin was analyzed for the year 2007 to 2010 for 15 companies of cement sector which are listed in stock exchange. For this purpose Fixed effect model is used for analysis this relationship. Results shows the relationship of operating expenses and net profit margin was found to be negative. In cement sector operation expenses are more as compared to sale that s why profitability is going to decrease. The cement sectors of Pakistan need to be improving quality and proper utilization of all resources for maximizing the profit margin. Keywords :Operating expenses, Net profit margin, Net sale Introduction A cost received in undertaking a corporation's day-to-day activities, but not immediately associated with development. These costs are usually divided into selling costs and management and general costs. In the accounting world, there are three overall groups of expenses: cost of goods sold, operating expenses, and extraordinary expenses.a task confronted by an organization's management is to figure out how much operating cost can be reduced without considerably impacting the organization's ability to contest COPY RIGHT 2014 Institute of Interdisciplinary Business Research 284

2 with its competitors. This study uses data from the financial statements to study the relation between operating expenses and net profit margin for a sample of Pakistani cement companies. Operating expenses are a major element in the determination of gross premiums. Many decisions made by manager s result in expenditures on some combination of salaries, commissions, equipment, office supplies, and other operating expenses (Myers, 1998) An organization's most important goal is to generate income and keep it, which is determined by assets and performance. Because these features figure out an organization's ability to pay dividend, earnings is demonstrated in stock price. As such, Investor should know how to evaluate various aspects of earnings, such as how properly a company uses its sources and how much income it produces from operations. When a corporation has a higher revenue edge, it commonly means that it also has one or more benefits over its competitors. Organizations with great income have a larger support to secure themselves during the difficulty. Organizations with low income can get damaged in a recession. And firms with income showing a aggressive advantage are able to increase their business during the difficulty - making them even better located when things increase again. The Business capacity to control operating cost immediately effect the owner equity through its effect on net earnings. The greater the operating expenses, the reduced the net earnings. The reduced the operating expenses, the greater the net earnings. There are four stages of profit or profit margins in an income statement - gross profit, operating profit, profit before tax and net profit. Profit margin study uses the COPY RIGHT 2014 Institute of Interdisciplinary Business Research 285

3 amount computation to provide a complete evaluate of a organization's income on a past base (3-5 years) and in evaluation to peer organization and market standards. The objective of margin analysis is to find reliability or positive/negative movements in an organization's earnings. Management has good control over managing costs than its cost of sales. Thus, traders need to analyze the operating profit margin carefully. Positive and negative trend in this rate are, for the most part, immediately as a result of management choices. Hypothesis H0: There is no significant relationship of operating expense and the net profit margin. H1: There is significant relationshipbetween operating expense and the net profit margin. Literature Review To Find out which activities will sell margins and decrease operating cost, supervisors need to understand design of source intake at the small level, where the activity is really developing. Managers might then determine improperly that operating cost were indeed set and not varying. The costs were set, however, only because supervisors did not take the activities required to make them varying. The proportion of operating expenses has a direct effect on sale which leads to profitability for the organization(kaplan, 1991). When company faces the crisis in the period of depression then company should revise the operating expenses for maintaining its profitability. Copeland (1921) looking at the business cycle broadly, one of its prominent features is the revision and readjustment of operating expenses that it necessitates. The three basic measures of managing COPY RIGHT 2014 Institute of Interdisciplinary Business Research 286

4 efficiency are the rate of return on a assets (ROA) and its disaggregated elements, profit margin (PM) and asset turnover. (Paul R. Brown, 1994) The generalizations were drawn that operating expenses tended to vary with gross earnings as in other lines of business and that a downward trend(bodfish, 1996). In Pakistan cement sector depend on different factors of cost, including Administrative cost, selling cost and financial cost. Operating expense and cost of goods sold collectively called as operating cost. In addition Government policies, Inflation and also other factors influence the cost of any commodity. The merchant will realize that he must recapture replacement cost plus expenses on the upswing and will increase sales prices more rapidly. Someconcern will have a gross profit of such size and expenses so low that their profit and loss statement will show a profit large enough to cover replacement costs and expenses.(mccowen, 1987). Allocation of cost is also very useful to determine the profitability for the organization. Proper allocation of resources and cost is the indicator of efficient and effective use of resources which helps to generate revenues for the organization. According to Pavia ( 1995) If the expenditures have by the company are not quickly tracked to a particular result (for example, the utility expenses for a distributed developing plant), the expenditures must be designated. The need for a given result is believed to be a operate of the price. Hence, the price allowance program that is chosen will impact both the price and the need for the output. Multiproduct firms generally have set costs which are difficult to feature to the of a particular result but operating cost is the varying price which concerns the production.this is a difficult problem for firms that use production costs to establish COPY RIGHT 2014 Institute of Interdisciplinary Business Research 287

5 prices because if prices are increases then sale will be affected so operating expenses need to consider seriously for setting the prices because operating expenses are not only associated with the net profit margin but also many other factors like price, competition, quality of the product etc. Variation in operating profits over the lowest level should depend more or less on changes in input prices. The unexplained part of the profit differential may be attributed to productivity or efficiency in the use of inputs, pressure of demand, capacity utilization and the primacy of particular objectives from the management point of view.there is a fairly high positive correlation between changes in profits and administrative expenses. Theory Building Operating expense includes administrative and selling expenses which may have positive or negative impact on profitability of an organization because when management increases their operating expenses then there are possibilities of increase in revenues. Operating expenses plays very important role for achieving the maximum revenue because through proper use of resources and expenses firm get huge sale which also generate greater net profit for the organization.a high positive correlation between profits and administrative expenses and a similar (even higher) coefficient of multiple correlation between profits, cost of goods sold, and administrative expenses. (Ghosh, 1973) Methodology In this article, time series data is used by taking 10 cement sectors of Pakistan. Numerical and financial data were collected to test the hypothesis. For this purpose COPY RIGHT 2014 Institute of Interdisciplinary Business Research 288

6 financial statements of these companies were used and the researcher check the impact of operating expenses on net sale, net profit and net profit margin.the original data on operating expenses of cement sectors were taken from financial reports of individual companies which gave the expenses incurred per annumand the main source of this data is Karachi stock exchange. Limitations This study used the data of listed companies for 5 year ( ) therefore future researchers can conduct study with same variables for more than 5 year. And this study is limited to cement sector of Pakistan. OPERATING EExpenses in Millions YEAR Al Abaas Attock Berger Bestway D.G.K Dandot Fauji Flying Poineer Maple Net profit YEAR Al Abaas Attock Berger Bestway D.G.K Dandot Fauji Fecto Flying Lucky Maple Poineer COPY RIGHT 2014 Institute of Interdisciplinary Business Research 289

7 Net Profit Margin YEAR Al Abaas Attock Berger Bestway D.G.K Fauji Flying Poineer Lucky Maple Source: KSE Results Dependent Variable: PROFITMARGIN Method: Panel Least Squares Date: 05/15/12 Time: 12:49 Sample: Periods included: 5 Cross-sections included: 10 Total panel (balanced) observations: 50 Coefficient Std. Error t-statistic Prob. C OPERATING EXP COPY RIGHT 2014 Institute of Interdisciplinary Business Research 290

8 Effects Specification Cross-section fixed (dummy variables) Period fixed (dummy variables) R-squared Mean dependent var Adjusted R-squared S.D. dependent var S.E. of regression Akaike info criterion Sum squared resid Schwarz criterion Log likelihood Hannan-Quinn criter F-statistic Durbin-Watson stat Prob(F-statistic) Regression line Net profit margin = Operating expenses Interpretation The results show that if one unit increases in operating expenses then there are0.345 decreases in net profit margin. The mostly cement sectors of Pakistan in continuously suffering a net loss from last 5 years. The constant value is it means that many other factors affecting the net profit margin which is not taking in this study.. R 2 value is which shows 74 % variation in the net profit margin variable by the operating expenses. The Durban Watson value is 2.6 which shows the problem of hetroscedasticity is not exist in the data. A Fixed effects model is used in this data that reveals the noticed amounts with regards to independent factors that are managed as if the quantities were COPY RIGHT 2014 Institute of Interdisciplinary Business Research 291

9 non-random.. The significance value is which shows high confidence level on results and it is less than 0.05 so we reject the null hypothesis and accept the alternative hypothesis which shows there is there is impact of operating expense on net profit margin. Conclusions This study conclude that operating expenses are part of operating cost and operating cost need to be minimum as compared to sale but in the cement sector of Pakistan it is not applicable and the Relation of operating expenses and net profit margin was found to be negative. In cement sector operation expenses are more as compared to sale (operating expenses / net sale) that s why profitability is going to decrease. The cement sectors of Pakistan need to be improving quality and proper utilization of all resources for maximizing the profit margin. This study also concludes that many other factors are affecting on net profit margin which is not taken and this is also the limitation of this study. Operating expenses involves administrative and selling expenses if company utilizes these effectively and efficiently then profitability or net profit margin can be increase. COPY RIGHT 2014 Institute of Interdisciplinary Business Research 292

10 References Bodfish, J. H. (1996). Operating Expense Ratios in Building and Loan Associations. The Journal of Land & Public Utility Economics, Copeland, M. T. (1921). The Readjustment of Operating Expenses. The Review of Economics and Statistics, Ghosh, P. K. (1973). Cost-Profit Relation in Industry. Indian Journal of Industrial Relations, Kaplan, R. C. (1991). Profit Priorities from Aotivity-Based Costing. HARVARD BUSINESS REVIEW. McCowen, G. B. (1987). Replacement Cost of Goods Sold. The Accounting Review, Myers, S. T. (1980). Changes in Life Insurer Operating Expenses during Inflation. The Journal of Risk and Insurance, Paul R. Brown, V. E. (1994). Comparing U.S. and Japanese Corporate-Level Operating Performance Using Financial Data. Strategic Management Journal, Pavia, T. M. (1995). Profit Maximizing Cost Allocation for Firms Using Cost-Based Pricing. Management Science, COPY RIGHT 2014 Institute of Interdisciplinary Business Research 293