Altman-Z Score of Pharma Industry

A Report
Submitted in Partial Fulfilment of the
Requirements for Award of the Degree of
B.B.A
by
Ridhtang Duggal M22BBAU0045
Shantanu Singh M22BBAU0484

School Of Management
Bennett University
Greater Noida, Uttar Pradesh, India

Month (11) YEAR (2024)

Table of Content

1. Understanding Altman –Z SCORE and Importance

2. Selected Industry Analysis
3. A deeper way to look
4. Recommendations

Understanding Altman –Z SCORE and Importance

The Altman Z-score is a financial model developed by Professor Edward Altman in
1968 to predict the likelihood of a company's bankruptcy. It combines five key financial
ratios, each capturing a different aspect of the company’s financial health, to create a
single score. This score can be particularly useful for investors, financial analysts, and
managers in evaluating the financial stability of a company and the risks of potential
bankruptcy.

1. Components of the Altman Z-score

2. Working Capital / Total Assets (WC/TA)
This ratio measures liquidity, assessing a company's short-term financial health
by determining how much of its assets are financed by working capital. Higher
values typically indicate that a company has adequate assets to meet short-term
liabilities.
3. Retained Earnings / Total Assets (RE/TA)
This component gauges the company’s profitability over time, reflecting
accumulated earnings. A higher ratio suggests that a company has strong
historical profitability, which reduces the risk of insolvency.
4. Earnings Before Interest and Taxes / Total Assets (EBIT/TA)
Known as the “return on assets,” this ratio examines a company’s operational
efficiency, evaluating how well it uses its assets to generate earnings. Higher
values point toward robust profitability.
5. Market Value of Equity / Total Liabilities (MVE/TL)
This component assesses leverage, comparing a company's market value against
its liabilities. A higher ratio implies that the company’s equity is significantly
higher than its debt, indicating lower financial risk.
6. Sales / Total Assets (S/TA)
Known as the asset turnover ratio, this measures how efficiently the company
uses its assets to generate revenue. High values suggest effective asset
utilization, contributing to stability.
7. Formula and Interpretation

The Altman Z-score formula is:

The resulting Z-score can be interpreted as follows:

 Z > 2.99: Safe zone – indicates a low risk of bankruptcy.

 1.81 < Z < 2.99: Grey zone – some risk of financial distress, warranting closer
examination.
 Z < 1.81: Distress zone – high risk of bankruptcy, a red flag for investors and
creditors.

8. Importance of the Altman Z-score

 The Altman Z-score is valuable because it consolidates multiple financial health
indicators into a single, comprehensive metric. Here’s why it’s crucial in financial
analysis:

1. Early Warning Signal

It provides an early warning for financial distress, allowing companies to take
corrective actions, and enabling investors and creditors to avoid potential losses.
2. Investment Decision-Making
The score aids investors in evaluating a company’s financial stability, helping
them avoid investing in companies with high bankruptcy risk.
3. Comparative Analysis
The Z-score enables analysts to compare companies within the same industry,
even with different sizes, using a standardized approach.
4. Credit Risk Assessment
Creditors can use the Z-score as a part of their due diligence to gauge a
company’s ability to meet debt obligations, thus influencing lending decisions.
5. Financial Monitoring
For company management, monitoring the Z-score can inform strategic
decisions, particularly in identifying weaknesses in liquidity, profitability, or
asset management.

Over View of SBL Pvt LTD

Altman's ZScore
Dec-15 Dec-16 Dec-17 Dec-18 Dec-19 Dec-20
Final Score 0.651359641 0.654004271 0.734245261 0.815984284 1.811046794 2.648595399
Financial Stability Distressed Distressed Distressed Distressed GreyZone GreyZone
 Overall Altman Z-score Trend
Pre-Merger (Dec 2015 - Dec 2017): The Altman Z-score remains within the Distressed
zone, reflecting high financial risk with scores between 0.65 and 0.73.
Post-Merger (Dec 2018 - Dec 2020): The score shows a marked improvement, moving to
the Grey Zone by Dec 2019 (1.81) and further increasing in Dec 2020 to 2.65. While the
company is not yet in the Safe Zone, this upward trend indicates reduced financial distress
and suggests that the merger may have contributed positively to financial stability.
Key Ratio Analysis
Breaking down the components helps explain the score changes over time:
Working Capital / Total Assets (Liquidity)
Pre-Merger: Negative values in Dec 2015 and Dec 2016 indicate a weak liquidity
position, with working capital well below total assets.
Post-Merger: Significant improvement, moving into positive territory and rising to
0.31 by Dec 2020. This boost in liquidity likely contributed to the overall Z-score
increase.
Retained Earnings / Total Assets (Profitability and Retained Earnings)
Pre- and Post-Merger: The ratio remains stable at 0.13 throughout the period,
indicating consistent retained earnings relative to total assets. While not a driver of
the Z-score improvement, stability here supports financial health.
EBIT / Total Assets (Operational Efficiency)
Pre-Merger: Ratios between 0.11 and 0.15, indicating moderate operational
efficiency.
Post-Merger: Significant increase to 0.62 by Dec 2020, suggesting improved
efficiency in asset utilization and profitability. This may be an effect of merger
synergies, contributing to higher operational income relative to assets.
Market Cap / Long-Term Liabilities (Leverage)
Pre-Merger: Decline from 0.10 to 0.07, indicating increasing leverage.
Post-Merger: The ratio stabilizes around 0.07, showing that while leverage
remained high, it did not worsen, possibly due to post-merger financial
restructuring.
Sales / Total Assets (Asset Turnover)
Pre-Merger: Decrease from 0.56 to 0.37, suggesting reduced efficiency in
generating revenue from assets.
Post-Merger: Increase to 0.88 in Dec 2020, indicating improved sales efficiency
and asset utilization. This ratio's improvement aligns with overall operational gains
post-merger, enhancing the Z-score.
3. Financial Stability Evaluation
Pre-Merger: Persistent Distressed scores show SBL Pvt Ltd faced considerable financial
challenges.
Post-Merger: Improved Z-score progression toward the Grey Zone suggests enhanced
financial stability. This shift likely results from strengthened liquidity, operational
efficiency, and sales performance, indicating the merger's positive impact on SBL Pvt Ltd’s
financial health
Strategic Roadmap to the Safe Zone
 Short-Term (1-2 Years): Focus on liquidity improvements and immediate cost
reductions to generate a stronger working capital position and improve profitability.
 Medium-Term (2-4 Years): Increase retained earnings by maintaining a disciplined
dividend policy, and expand sales through targeted growth initiatives. Optimize asset
usage for better turnover ratios.
 Long-Term (4+ Years): Focus on reducing debt gradually, improving leverage ratios,
and seeking sustained profitability and sales efficiency to secure a position in the Safe
Zone.
1. Enhance Liquidity (Working Capital / Total Assets)
Recommendation: Increase working capital by managing current assets and liabilities more
effectively. This could involve:
Reducing accounts receivables through stricter credit policies and timely
collections.
Decreasing inventory levels via inventory optimization techniques, such as just-in-
time (JIT) management.
Extending payment terms with suppliers to preserve cash while meeting short-term
obligations.
Expected Outcome: A higher working capital-to-total-assets ratio will improve liquidity,
which boosts the Z-score and reduces short-term financial stress.
2. Increase Retained Earnings (Retained Earnings / Total Assets)
Recommendation: Retain a larger portion of earnings by reinvesting profits rather than
distributing them as dividends. Additionally, focus on increasing profitability through cost-
cutting measures and efficiency improvements.
Implement lean operational strategies to minimize waste and reduce production
costs.
Pursue high-margin product lines or services that generate greater returns,
improving profitability.
Reinforce cash reserves from profits rather than taking on new debt to maintain
financial independence.
Expected Outcome: Higher retained earnings contribute to a stronger Z-score and build
resilience against downturns.
3. Boost Profitability (EBIT / Total Assets)
Recommendation: Improve the EBIT-to-total-assets ratio by maximizing revenue-
generating activities and minimizing costs.
Revenue Growth: Expand into new markets or product lines with strong demand,
or adopt a focused sales strategy to increase market share in high-growth regions.
Cost Management: Optimize production and administrative expenses. Implement
technology-driven efficiencies like automation or AI-driven analytics to streamline
operations.
Expected Outcome: Enhanced profitability will directly impact the Z-score and indicate
stronger operational health.
4. Optimize Capital Structure (Market Value of Equity / Total Liabilities)
Recommendation: Reduce reliance on debt to improve leverage, as a higher equity-to-
liabilities ratio contributes to a higher Z-score.
Debt Reduction: Consider using excess cash flow to pay down high-interest debt.
 Equity Infusion: If feasible, issue equity to raise funds and reduce the debt-to-
equity ratio, strengthening the capital structure.
Financial Restructuring: Look into refinancing options to lower interest costs and
extend debt maturities, reducing the immediate financial burden.
Expected Outcome: Improving this ratio will decrease financial risk and enhance SBL Pvt
Ltd’s attractiveness to investors, as well as positively impact the Z-score.
5. Increase Sales Efficiency (Sales / Total Assets)
Recommendation: Focus on increasing revenue without proportionally increasing assets to
raise the asset turnover ratio.
Market Expansion: Enter new geographic markets or customer segments to
increase sales.
Product Differentiation: Develop or improve products to drive customer demand,
which will allow for pricing power and increased revenue.
Asset Optimization: Improve asset utilization by selling underperforming assets or
renting out idle facilities, converting non-revenue-generating assets into cash.
Expected Outcome: Higher asset turnover reflects efficient use of assets, improving the Z-
score and indicating better financial management.
 Covalent Laboratories Pvt. Ltd.
Altman's ZScore
Dec-10 Dec-11 Dec-12 Dec-13 Dec-14
Final Score 0.671168027 0.884083001 0.856702269 2.301224264 2.475889679
Financial Stability Distressed Distressed Distressed GreyZone GreyZone

1. Analysis of Pre-Merger (Dec 2010 - Dec 2012)

2. Altman Z-Score:
From 2010 to 2012, Covalent Lab Pvt Ltd’s Altman Z-score ranged between
0.67 and 0.86, indicating a "Distressed" financial status. These scores suggest a
high risk of financial distress and potential bankruptcy, as the company remains
well below the "Grey Zone" threshold.
3. Component Analysis:
Working Capital to Total Assets (A): Decreased from 14.8% to 10.4%,
indicating a reduction in the company’s liquidity and working capital
efficiency.
Retained Earnings to Total Assets (B): Constant at 0.13 across the years,
suggesting stable earnings retention relative to assets but insufficient to improve
the Z-score significantly.
EBIT to Total Assets (C): Increased notably from 8.8% in 2010 to 16.6% in
2012, reflecting improved profitability and operational efficiency pre-merger.
Market Cap to Long-Term Liabilities (D): This ratio decreased, signifying a
reduction in market valuation relative to liabilities. Lower market cap relative to
debt is a negative signal, showing investor uncertainty.
Sales to Total Assets (E): Fell sharply from 1.34 in 2010 to 0.11 in 2012,
indicating declining sales relative to the asset base, which could be due to
operational inefficiencies or reduced demand.
4. Summary (Pre-Merger):
Despite an improvement in EBIT-to-Total Assets, the decline in liquidity,
market valuation, and asset efficiency contributed to the company’s distressed
status.
5. Analysis of Post-Merger (Dec 2013 - Dec 2014)
1. Altman Z-Score:
Post-merger, the Z-score increased to the "Grey Zone," reaching 2.30 in 2013
and 2.48 in 2014. This improvement suggests that the merger had a positive
impact on financial stability, bringing the company closer to a more stable
financial state.
2. Component Analysis:
Working Capital to Total Assets (A): Dropped to 7.8% in 2013, then rose to
9.6% in 2014. Although improved, this still indicates lower liquidity and cash
flow efficiency.
Retained Earnings to Total Assets (B): Maintained at 0.13, indicating steady
but insufficient retained earnings relative to assets.
EBIT to Total Assets (C): Increased significantly to 61.3% in 2013 and further
to 65.9% in 2014. This shows a remarkable post-merger improvement in
operating profitability, which is the primary driver for the Z-score rise.
 Market Cap to Long-Term Liabilities (D): Continued to decline, suggesting
persistent concerns about market valuation versus debt.
Sales to Total Assets (E): Stabilized but remained low at 0.16 and 0.09,
implying inefficiency in generating revenue from assets.
3. Summary (Post-Merger):
The merger boosted profitability and overall financial stability, moving the
company into the "Grey Zone." However, issues like low liquidity and market
valuation relative to debt remain, preventing a transition to the "Safe Zone."
6. Recommendations for Moving to the Safe Zone
1. Enhance Liquidity and Working Capital Management:
Improve working capital efficiency to ensure better liquidity, allowing more
flexibility in meeting obligations.
2. Increase Revenue Generation from Assets:
Focus on optimizing asset utilization to improve the Sales-to-Total Assets ratio.
This could involve operational enhancements, asset divestiture, or expansion
into new revenue streams.
3. Strengthen Market Perception:
Improve the company’s market cap relative to liabilities by addressing investor
concerns, perhaps through transparent financial communication or strategic
partnerships to bolster confidence.
4. Focus on Debt Reduction:
Reducing long-term liabilities would improve the Market Cap to Long-Term
Liabilities ratio, enhancing financial stability.

Recommendations for Covalent Lab Pvt Ltd in the Context of the Indian Pharma
Industry

 Enhance Operational Efficiency: Focus on optimizing the manufacturing process to

reduce costs and improve EBIT margins. Consider adopting lean manufacturing or
automation technologies to improve cost-effectiveness.
 Increase R&D Investment: Covalent Lab should invest in high-margin, innovative
products (such as biosimilars or new chemical entities) to diversify its product portfolio
and reduce dependency on generics, which face increasing price pressure.
 Strengthen Cash Flow Management: Improved working capital management is
crucial. Covalent Lab should focus on better inventory management and faster
receivables turnover to improve liquidity.
 Debt Management: While the company’s Z-score improved post-merger, reducing
long-term liabilities and improving the market perception of the company’s ability to
handle debt could help move the company into the "Safe Zone."
 Leverage Exports: Expand the export business, particularly to regulated markets (e.g.,
the US, Europe), where price control pressures are lower, and there is greater demand
for quality generic products.
 GS Pharmbutor Pvt.Ltd
Altman's ZScore
Dec-13 Dec-14 Dec-15 Dec-16 Dec-17 Dec-18
Final Score 0.850666421 0.763368637 0.640292247 0.673000195 0.802203832 0.71490311
Financial Stability Distressed Distressed Distressed Distressed Distressed Distressed

1. Improve Liquidity and Working Capital Management:

 Optimize Working Capital: The company should focus on improving working

capital management by shortening the cash conversion cycle. This could involve
improving inventory management, streamlining receivables, and extending
payables where possible, without harming relationships with suppliers.
 Cash Flow Monitoring: Regular cash flow forecasting and monitoring can help
anticipate liquidity issues and ensure that the company maintains sufficient cash
reserves to meet short-term obligations.
 Diversify Funding Sources: Reducing dependence on external financing (i.e.,
debt and equity) and relying more on internal sources like retained earnings
could provide more flexibility in managing liquidity.

2. Focus on Operational Efficiency:

  Asset Utilization: The declining sales to total assets ratio suggests inefficiencies
in asset utilization. GS Pharma should review its asset base, especially non-
performing or underutilized assets, and consider selling or repurposing them to
improve efficiency.
 Cost Reduction Strategies: Identifying areas for cost-cutting without affecting
product quality (e.g., renegotiating supplier contracts, improving operational
processes) could improve profitability and better utilize assets to generate higher
sales.
 Product Diversification and Market Expansion: Given the challenges in sales
growth, GS Pharma should consider expanding its product offerings or entering
new markets to increase revenue. This could also help reduce dependency on
existing products and markets.

3. Enhance Profitability:

 Increase Revenue Streams: The company should explore additional revenue

streams, such as partnerships, new market opportunities, or vertical integration,
to boost revenue without significantly increasing its asset base.
 Price Optimization: Conduct a detailed pricing strategy review to ensure the
company is maximizing revenue from its existing products while staying
competitive in the market.
 Focus on High-Margin Products: Shifting focus to higher-margin products or
services, particularly those that utilize existing assets, could help improve
profitability.

4. Improve Debt Management and Financial Structure:

 Debt Restructuring: Given the declining ratio of market cap to long-term

liabilities, GS Pharma should consider renegotiating its debt or refinancing to
obtain more favorable terms, such as lower interest rates or extended repayment
schedules, which would reduce financial pressure.
 Equity Financing: If liquidity issues persist, the company might need to
consider raising additional equity capital to reduce the debt burden and
strengthen its balance sheet. However, it should weigh the potential dilution of
ownership.
 Optimize Capital Structure: A balanced mix of debt and equity financing
would reduce financial risk. GS Pharma could analyze its capital structure and
explore ways to optimize it to reduce interest costs and improve financial
flexibility.

5. Focus on Financial Health and Risk Mitigation:

 Improve the Altman Z-Score: With the Z-score indicating financial distress,
GS Pharma should take steps to improve its score. This could involve reducing
debt, increasing retained earnings (through improved profitability), and
optimizing asset management.
 Risk Management Framework: Implement a comprehensive risk management
framework to assess and mitigate risks related to market fluctuations,
competition, regulatory changes, and operational inefficiencies.
6. Strengthen Market Perception and Investor Confidence:

 Investor Relations: Improving communication with investors and clearly

outlining strategies for addressing financial difficulties can help boost investor
confidence. Transparency about ongoing efforts to address liquidity and
profitability issues is key.
 Strategic Alliances: Forming alliances with stronger financial partners or large
pharmaceutical companies could improve market confidence and provide access
to additional resources for growth.

7. Strategic Focus on Mergers and Acquisitions:

 Evaluate Merger Synergies: Since the company recently underwent a merger,

it’s important to evaluate the synergies from this merger to ensure that the
combined entity is operating efficiently. A detailed post-merger integration plan
could help realize cost savings and operational efficiencies.
 Future M&A Opportunities: GS Pharma should explore potential acquisitions
of smaller, profitable firms or assets that complement its operations, which could
help diversify its business and reduce dependence on a few markets or product
lines.

8. Address Financial Distress Indicators:

 Financial Restructuring: If financial distress indicators (such as the low

Altman Z-score) persist, the company should consider engaging with financial
advisors for restructuring options, potentially including a debt-to-equity swap or
other corporate restructuring initiatives to alleviate financial pressure.
 Short-term Financial Support: In case of short-term liquidity issues, GS
Pharma might seek temporary financial support, like lines of credit or bridging
loans, to cover working capital needs.

9. Invest in Digital Transformation:

 Digitize Operations: Investing in digital technologies for manufacturing, sales,

and finance can improve efficiency, reduce operational costs, and provide real-
time data for better decision-making.
 E-commerce and Online Channels: Expanding digital sales channels and
leveraging e-commerce platforms can help grow revenue without significantly
increasing asset base.
 Halcyon Labs Private Limited
Altman's ZScore
Dec-16 Dec-17 Dec-18 Dec-19 Dec-20 Dec-21
Final Score 1.116414662 0.635898072 1.010817939 1.445730506 2.483289071 3.034536493
Financial Stability Distressed Distressed Distressed Distressed GreyZone Strong

 Financial Position Pre- and Post-Merger: The company was in a distressed state from
Dec-16 through Dec-19. However, the Z-score improved significantly in Dec-20,
reaching the grey zone, and ultimately achieving a strong financial position by Dec-21.
 Key Ratios:
o Working Capital / Total Assets: A rising trend in working capital relative to
total assets indicates improved liquidity.
o Retained Earnings / Total Assets: Decreased over time, reflecting limited
retained earnings growth.
o EBIT / Total Assets: Improved significantly, particularly in Dec-20 and Dec-
21, indicating enhanced profitability.
o Market Cap / Long-Term Liabilities: Low values show a high debt relative to
market cap, though other improvements have offset this weakness.
o Sales / Total Assets: Strong performance, though sales fell slightly in Dec-20
and Dec-21.
 Recommendations:
To maintain and strengthen Halcyon Labs’ strong financial position:
1. Maintain Efficient Working Capital Management: Sustaining a high working capital
ratio relative to total assets will help ensure liquidity remains strong, particularly as
business expands.
2. Increase Retained Earnings: Focus on retaining more earnings to support growth and
reduce dependency on external financing. This can be achieved through cost
optimization, efficient operations, and prudent capital allocation.
3. Optimize Debt Levels: Reduce long-term liabilities where possible to enhance the
Market Cap/Long-term Liabilities ratio. Refinancing high-cost debt or targeting
strategic debt reduction can strengthen financial stability further.
4. Sustain Profit Margins: Given the significant improvement in EBIT/Total Assets, it's
essential to continue focusing on profitability through efficient operations and strategic
cost management. Investment in high-margin products or markets may also contribute
positively.
5. Focus on Sales Growth: Although profitability is strong, sales growth should be
revived, especially as it declined slightly in Dec-20 and Dec-21. Diversifying revenue
streams or expanding into new markets can help.
Multivariate Discriminant Analysis
Multivariate Discriminant analysis is one of the best distinguishing analysis methods for two
or more groups with similar number of members from each other with derivation of index
score (Balcaen & Ooghe, 2006). This analysis is used for classification of observations
depending on the characteristics of the observations into one for several a priori groupings.
This model can be described as below as a linear combination of discriminatory variables
(See Equation (4));
Z value stands for the dependent variable score (value) to assess the classification
of the group it belongs to, β values are the coefficients of the discriminant, X values
are the discriminatory independent variables. In this study's case the Z score is the
multivariate discriminant score of a firm which gets value attribute value of for a
firm (Balcaen & Ooghe, 2006).
In the application of the MDA analysis there are some assumptions described for the
model;
● Variables are independent to each other.
● The groups are mutually exclusive.
● Number of the independent variables is not supposed to be more than two less of
the sample size.
● In the significance testing, multivariate normal distribution has to be followed by
independent variables.
● Errors have to be randomly distributed.
● Variance-covariance structure of the independent variables is similar within each
group of the dependent variable.