The Company GlaxoSmithKline - Research Paper Example

Cultural Influence: GlaxoSmithKline (GSK) GlaxoSmithKline (GSK) is one of the world’s largest manufacturers of pharmaceutical products. The company is engaged through its various subsidiaries in the research, development, manufacture and marketing of drugs and other health related products. The company is listed primarily on the London Stock Exchange (LSE) and enjoys a market capitalization of £70 billion. CORE Analysis The study has utilized data from the company’s annual report for 2009 to compute the key financial rations which will be used for performing the necessary interpretations on the lines of the CORE Framework. From an overall perspective, certain operating and investor rations will be employed for this purpose and are elaborated below. Key operating ratios Return on capital employed (ROCE) Profit before taxation= £6.659 billion (7452 in 2007) (11% decline) Total assets = £42.862 billion (39393 in 2008) Current liabilities = £12.118 billion The return on capital employed therefore stands at 0.21. While the company has reduced its investments in plant and equipment through seconds sales, the overall quamtum of the non-current assets of the group have risen considerably in comparison to the figures for 2008, contributing to an increase in the value of the total assets by over £3.4 billion in a single year. The ROCE value of 21% implies that the group has succeeded in earning a healthy return for the total value of the capital employed minus its debt obligations and other liabilities. Operating return on equity (ROE) From the consolidated balance sheet, the shareholder equity has been valued at £10 billion. This results in a ROE value of 0.66 or 67%. In a market where anything in the range of 10 to 20% is considered a good performance, a return of over two-thirds of the shareholder equity is a sign of good performance although such high returns are mostly short lived and incidental. Net margin GlaxoSmithKline had a total net profit of £5.69 billion during 2009 along with revenue of £28.37 billion. The net margin is thus 0.2 or 20%. Such a high net margin ratio is uncommon for a company specializing in a conventional field such as pharmaceuticals where the average net margins range between 5-10%. In fact, the high profits are comparable to the performance of tech companies, which are traditionally renowned for such high returns. Profit during 2008 was £4.7 billion against revenues totalling £24.35 billion, putting the net margin at 19% for the year 2008. While the increase in net margin is not significant between 2008 and 2009, it is important to consider the 16% increase in revenue during this period against crumbling financial markets. Financial leverage Given the information from the preceding calculations, the degree of financial leverage (DFL) is relatively simple to determine and is calculated from the percentage changes in Earnings per Share (EPS) and Earnings before Interest and Tax (EBIT). % change in EPS = 2.8p/109.1p = 0.025. %change in EBIT = £4.016/£28.368 billion = 0.14 Degree of Financial leverage (DFL) = 0.178 The low DFL value signifies the limited power that the company enjoys in being able to increase the earnings per share through a corresponding increase in the revenues. In fact, this phenomenon is reflective of a resource intensive business such as pharmaceuticals where the profit margins are comparatively less and operating costs more in comparison with other industries. Asset turnover The ratio of revenue by assets for GlaxoSmithKline stands at 0.66 or 66% and is known as the Asset turnover. This estimate can be considered moderate in nature and is indicative of the company’s moderate profit margin. Part of the reason for this value can be attributed to the pricing strategy adopted by the company. Besides maintaining high sales in most of its operating markets which ensure greater returns, the company has also dedicated itself to offering subsidized medical supplies to poor nations (such as those in Africa) at lower prices, for which it has had to redirect some of its resources from its high-income markets. Asset turnover for 2008 was 61% which indicates a marked increase in turnover from assets by over 6% during 2009. Liquidity GlaxosmithKline has maintained a liquidity of 1.45 or 145% (Total current assets = £17.57 billion and Total current liabilities = £12.118 billion), which is typical of non-banking organizations. This measure is well below the industry accepted level of 2:1 or 200% as it suggests that the firm is in a slightly unfavourable position over meeting its short-term debt obligations for the next 12 months. Investor ratios Earnings per share (EPS) As of December 2009, the company declared earnings per share of 109.1 p, which is 20.5 % more than the earnings in 2008. This 23% increase in EPS is significant as it is the single most determining parameter for the stock price. However, it is important to calculate the corresponding EPS for the investment as it provides greater depth into understanding the level of equity required to generate these earnings. Dividend per share (DPS) The consolidated dividend per share for 2009 was 61 p (57 p in 2008) and is in tune with the gradual increase in the DPS declared by the company in recent years. The total dividend payable for 2009 is £3.09 billion and the number of shares outstanding was 1.09 billion. In the absence of any one time dividends during this period, the constantly rising DPS symbolizes the management’s belief that the growth can be sustained in the coming years. P/E ratio The market value of GlaxoSmithKline’s share is 1211 p, giving the P/E ratio as 11.09. This high P/E value is also in line with the increasing DPS on a year-by-year basis and suggests that investors are confident of the company’s growth and see higher earnings for their investments in the future. Dividend yield The dividend yield is the ratio of the DPS by the share price and is valued at 0.05 (0.045 in 2008 attributed to the drop in share price from £12.6 in 2008 to £12.2 in 2009). In fact, the dividend yield provides the further overview of the amount of cash flow achieved for every dollar invested and is the refinement mentioned under the ‘Earnings per share’ section. Total shareholder returns (TSR) The difference in share price for 2009 in the UK markets was 37p within the 52 week period. The TSR for an opening share price of £12.8 and a dividend of 61p is 0.078 or a return of 7.8% for investments in the company’s stock. Considering the global financial meltdown, the TSR for GlaxoSmithKline is a good indicator of a stable investment during difficult times in the stock market. GSK had without doubt felt an initial jolt of the financial crisis in 2008 albeit for a short period, which is evident from the smaller dividend and lesser return on investments (6.5%) during 2008. As of 2009, the company has been performing consistently registering a quarterly growth of 17% as of Dec. 2009. The company has also maintained a credible level of liquidity with cash reserves of £6.5 billion. In the backdrop of a global financial meltdown, the company succeeded in gaining an increase of 22.5% in its stock price during the 52-week period of 2009. However, while the company is in a good position to attend to its short term liabilities, the huge debt of £18 billion is an area that the company needs to focus upon and work towards reducing this key metric in the future. GlaxoSmithKline is currently second only to Pfizer as the largest pharmaceutical manufacturer. However, investors have traditionally favoured the latter given its high Earnings per share (£0.95) in comparison to GSK’s £0.65. The company also needs to do some restructuring given the high P/E ratio at 45.03, which is more than 3 times than the measure for its major competitors. If the company is serious about fulfilling its promise of cutting drug prices by 25% in the 50 poorest countries in the world, it needs to attract more investment by offering better returns and reduce its debt burden. Ealing Hospital NHS Trust A year-on-year comparison of the financial performance of the Ealing Hospital NHS Trust presents many interesting facts. The hospital has succeeded in enhancing its operating surplus by more than 50% during 2008/09 in comparison to the preceding year, despite substantial expenditure for upgradation of infrastructure in the various departments. The biggest strength of the hospital are its vast assts which stand at £87 million. Most of these assets are concentrated in the infrastructure and the equipment present in the hospital’s premises. A further detailed analysis of its financial performance is described below. Key operating ratios Return on capital employed Profit before Interest and Tax = £4.9 million Total Assets - Current liabilities = £94.49 million. The return on capital employed (RCE) is 0.05 or 5%. This implies that the hospital has had very little surplus earnings during 2009. Despite earning an income to the tune of £129 million during the year, the hospital has incurred huge operating expenses amounting to £124 million due to a number of ongoing works in upgrading existing infrastructure across existing departments. The Ealing Hospital is expected to earn better profits once these major works are completed by 2011. However, the RCE has improved during the year given that it was around 3% during 2008, signifying an increase of over 65%. Operating return on equity The issue with a public entity such as Ealing Hospital is that most of its capital is sourced from its assets. In fact, most of the infrastructure at Ealing hospital is worth more than £5000 each as per NHS (National Health Service) guidelines. Given the lack of any significant shareholder investments in the hospital’s operations, the Operating return on Equity is not a suitable measure in this scenario. Net margin The Ealing Hospital earned revenue of Operating return on equity £114. 82 from its activities and made an additional £15.08 million from other sources, bringing the total revenue to £129.9 million for 2009. The net margin is therefore 0.037 or 3.7%. The low net margin is again synonymous of a public service organization such as the Ealing hospital, which is dependent primarily on government funds through the NHS for its financial needs and does not operate like a traditional business organization for generating high profits through its operations. The total revenue during the preceding year was £121.8 million against a profit margin of £3.34 million, putting the net margin at 2.7%. From this, it can be inferred that the net margin has risen by a percent during 2009. Financial leverage The assets of Ealing Hospital are valued at £87 million (fixed) and it has a mere £7.4 million of debtor’s money to repay. This small percentage of external money other than government funds or through activities that needs to be repaid does not provide the hospital a great degree of financial leverage. The situation has been similar during 2008 when the hospital had £90 million in fexed assets and £7.8 million in debtor money, offering a minimal degree of financial leverage. Further, any increase or decrease of asset value would not allow the leverage to work for or against the hospital in this case. Asset turnover The asset turnover ratio is pretty straightforward from the figures obtained from the balance sheet and is estimated to be 1.37. The ratio indicates that the hospital has been able to generate more revenue by employing fewer assets on a value comparative basis. The explanation to this phenomenon can be attributed to the fact that much of the assets used in the hospital are in service for a number of years before being considered for upgradation or replacement. Thus, the same equipment is used constantly for generating revenue through activities without putting any further significant investments into the infrastructure. The asset turnover ratio for 2008 was 1.26, denoting a marginal increase in the revenue realized from the assets available during the year 2009. Liquidity Current assets = £14.19 million Current liabilities = £6.98 million The liquidity is 2.03 or 203%. This level of liquidity is even higher than compared to the business organization such as GlaxoSmithKline. This implies that Ealing Hospital is in a better position to meet its short term debt obligations for the next 12 months as it has less than half of its asset value for its consolidated immediate liabilities. Further, the hospital has cash worth £5.57 million at hand for use, which puts it in a strong position to meet any immediate cash requirements. Current assets during 2008 were £13.6 million and Current liabilities were £6.71, putting the liquidity ratio at 2.02. It implies that Ealing hospital has not achieved much in improving its liquidity position, which can also be attributed to the financial crisis during this period and falling real estate values. Investor ratios Earnings per share The hospital has paid a public dividend of £3.13 million for the financial year of 2009. In the absence of any other shareholders, this attribute will be considered as the sole representation for any equity in the hospital. In fact, the dividend payable is a return on the investment by the secretary of the state. The annual report further provides information that more than half of the investments came from the secretary of the state. The Ealing Hospital NHS trust has only a single investor which is a part of the government. In this situation, the earnings per share is not a useful statistic and cannot be used for any suitable inferences. Dividend per share In line with the preceding argument, a single public dividend of £3.13 million was paid to the secretary of the state. For assets valued at £94.49 million sans current liabilities, this is a good return on investment by the government on an annual basis. The dividend paid out during 2008 amounted to £2.58 million. P/E ratio The profit-to-earnings ratio is based on the stock price of a listed entity. The Ealing Hospital national trust is not a publicly traded organization on any stock exchanges. Thus, the return on the stock prices does not apply for this particular organization. Economy, Efficiency and effectiveness The three E’s approach is also being adopted to ascertain the value for money spent by the hospital as a government funded institution. In order to monitor and govern the economy, efficiency and effectiveness across the hospital, the hospital trust has put in a lot of effort into managing and overseeing a wide range of the hospital’s activities that can provide a broad appreciation to the effectiveness of the hospital along various grounds. Besides activities like strategic planning, financial performance and efficient budgeting, the Ealing hospital trust considers costing and pricing policies, procurement and capital initiatives as other key elements of the key performance indicators for the hospital. The performance of the hospital, measured against a number of targets and standards on a national scale, have termed the improvement factor as ‘good’ or ‘fair’ for quality of service under the annual assessment performed by the care quality commission annual health check. The trust further enforces many self-assessment tools that follow the development standards of the Healthcare Commission to track efficiency. Most importantly, the Ealing Hospital has succeeded in reducing the waiting times for both in and out patients well below the national average. In terms of the economy, Ealing hospital achieved an income and expenditure surplus increase of 90% over the preceding year (2008), which was mainly driven by a £8 million raise in income as well as a phenomenal £3.6 million in savings on energy bills. These gains have also offset the pay bill of the trust which have substantially increased during this one-year period by over 10%. To maintain performance and efficiency of service, this additional income has allowed the hospital to endure additional staffing needs to cater to the waiting times and other related activities. Importance of Accounting As the above discussions on both the private sector (GlaxoSmithKline) and public sector (Ealing Hospital) go on to show, profit is not a wholesome measure of a company’s performance due to the existence of several other parameters that are important from a financial and strategic perspective. In this context, profit merely represents a single element or determinant of growth within the accounting profession. In fact, the rules that govern accounting and financial analysis have to take into account other factors such as market, competition, region, religion and culture. Besides, the local regulation also plays a crucial role in the financial prospects of the firm while culture helps shape the strategic direction and thrust for the company. The importance of culture arises most prominently in the case of a global organization such as GlaxoSmithkline where the firm operates in several markets across the world, with each market representing a unique challenge in terms of local culture, religion, government regulations etc. Further, GSK is listed both in the UK and the US and trades in both the London Stock Exchange as well as the New York Stock Exchange, requiring different financial statements for these individual countries and related regulatory institutions. This variation in presenting the same information reflects on the added need for bringing in more attributed together with the accounting profit itself. Within the context of culture, Gray (1990) offers a number of accounting considerations that exist within corporate culture. Amongst these, the issue of statutory control, professionalism and transparency are found to be the most prominent and relevant attributes for both the companies in question. In the UK, the notion of free and fair business often attains the most significance where the level of professionalism is often regarded as high in terms of global standards. However, the goal over the years has moved on from ensuring sustainability and organic growth towards higher revenue margins. Firms auditing company accounts are often under pressure to overlook certain factors that may otherwise put the brakes on the firm’s intended pace of progress. In fact, the recent financial crisis borne out of financial greed and minimal regulatory oversight can be attributed directly to such corporate practices, which underscore the continued drive especially among private sector firms towards profit maximization. However, to ensure continued and sustained growth, the markets have clearly shown that today’s economy is evidently globalized and a multinational company such as GSK cannot weather any turmoil in the market without additional mechanisms in place. For instance, the freedom allowed among managers to make key decisions without compromising on ethical and fair practices must also be visible in the information that flows out from the company through periodical reports, which will further embolden it against any government scrutiny. In fact, transparency to the extent possible within the company’s accounting machine will enhance the confidence of the investors and maintain the stock price if not elevate it further in the long run. Public sector companies, as in the case of Ealing Hospital, maintain financial records and publish financial reports and statements although such institutions operate from government funds. For such institutions, the purpose of maintaining accounts is to maintain a tight oversight over spending and not look towards making profits. Further, most government institutions especially hospitals often operate on very tight and varying profits from year to year and are thus under constant pressure to ensure that the funds reach all quarters without causing patients any inconvenience. Financial reports further serve as straightforward documents for demonstrating to regulatory authorities such as the national health commission the assets owned by the hospital or the improvements initiated by the management to upgrade services and facilities at the hospitals. Financial statements thus do not consider profit an important attribute in this context where the primary focus is to ensure that the asset turnover or the utilization of assets for generating revenue is maximized through adequate and speedy services to the patients. The above discussions clearly show that accounting profit forms a subset of the complex equation that determines the performance of an organization in the modern world. In an environment where many individuals with variations in professional expertise, culture and attitudes come together, getting them to work together towards a common set of goals in the presence of targets, markets, competition and regulation brings in many other parameters that must be taken into account when determining the current position of the firm across all these functions. References 1. Gray (1990), Towards a Theory of Cultural Influence on the Development of Accounting Systems. New York: ABACUS. Read More