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Estimate the five operating expenses for each of the past three fiscal years, and evaluate what operating leverage, if any, was applied each year - Essay Example

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The objective of analyzing operating expenses and evaluating whether an operating leverage was applied in a company is to assess the "impact of any change in revenue on profit or cash flow" (Buccino and Mc Kinley 1997). The understanding is important since it assist the company by providing guidance on the company's cash position as well as future strategies for managing working capital…
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Estimate the five operating expenses for each of the past three fiscal years, and evaluate what operating leverage, if any, was applied each year
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Extract of sample "Estimate the five operating expenses for each of the past three fiscal years, and evaluate what operating leverage, if any, was applied each year"

Download file to see previous pages According to both financial statements the five costs are Cost of Revenue, Research and Development, Selling General and Administrative Expenses, Non-Recurring and Others. For the sake of simplicity, Cost of Revenue and Selling, General and Administration Expenses would be regarded as Variable Cost and the other expenditure as Fixed Cost.
From the Income Statement Extract for 2003 (Fig 2), it is clear that PFIZER operated with a higher degree of operating leverage than GlaxoSmithKline. This is evident in the company's fixed cost percentage as PFIZER's fixed cost position is 2% higher that its competitor. The fact that PFIZER has a substantial amounts of capital tied up in its fixed assets and in particular in Research and Development Expenditure, would account for its higher operating leverage. It should be of no surprise therefore, that PFIZER's Research and Development accounts for over 50% of its total fixed cost. GlaxoSmithKline may have been a little more conservative since its Research and Development Expenditure spans only 5% of its total fixed cost.
The strategy therefore would be for PFIZER to reduce its fixed cost percentage and thus enable itself to manage its risks. It has successfully done so in December 2004 (Fig 3) and as a result its operations have expanded by 13%. GlaxoSmithKline, on the other hand, operating income expanded by only 3% despite the reduction of its operating leverage. This is owing to the fact that its revenue of $39 Billion only increased by 3%.


Fig 4


According to Fig 4, the Operating Income of GlaxoSmithKline has improved by an additional 4% where as PFIZER fell by 5%. PFIZER operating leverage has increased again and hence would account for the fall in Operating Income by $3 Billion. It was clear that GlaxoSmithKline managed its operating leverage better and hence reduces its risk.

Conclusion

The question, which may arise, is whether PFIZER is in a better situation than GlaxoSmithKline The truth is "leverage is neither good or bad"(Schmedt May 1998). Each company must assess the amount of risk it is willing to take while striving to achieve its corporate objectives. It is important to understand the company's cost structure to enable management to make effective decisions so that it can compete effectively and achieve the competitive advantage it so desires.




References

Fred Schmedts, The concept of Operating Leverage : The Samuel Roberts Noble Foundation
http://www.noble.org/Ag/Economics/OperatingLeverage/index.html



Glaxosmithkline PLC Financial Statements December 2003 to December 2005 - Yahoo Finance
http://finance.yahoo.com/q/iss=GSK&annual



PFIZER Inc Financial Statements December 2003 to December 2005 - Yahoo Finance
http://finance.yahoo.com/q/iss=PFE&annual



Buccino, Gerald P. and Kraig S. McKinley, "The Importance of Operating Leverage in a Turnaround," Secure Lender (September / October 1997), ...Download file to see next pagesRead More
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