GlaxoSmithKline Plc and J Sainbury Plc: Accounting for Limited Companies - Coursework Example

?Introduction In order to compare two public companies a financial analyst must evaluate the financial results of each firm. There are thousands of companies listed in the London Stock Exchange. Due to the variety of investment alternatives available in the equity market the best way to determine which corporation is a better investment is by applying financial models and techniques that allow for a systematic evaluation of the financial results of a company. There a several techniques that can be used to evaluate the performance of a firm, but one of the most popular and effective techniques is the use of ratio analysis. Ratio analysis is relative simple to apply for any person if they know the formulas for the different financial ratios. The use of ratio analysis does have its limitations because it does not consider other qualitative factors that may affect the financial results of a company such as a pending lawsuit. This report is going to compare two public companies based in the United Kingdom. Ratio analysis is going to be the primary tool to compare the financial results of both companies. The two companies that are going to be compared are GlaxoSmithKline Plc and J Sainbury Plc. An inherent limitation of the use of ratio analysis to compare the results of these two companies is that the two companies participate in different industries. Different industries on many occasions have different expectations and industry standards, thus a ratio that might seem bad for a company might actually be good in comparison with the results of similar companies that participate in the same industry. Company Profile: GlaxoSmithKline Plc GlaxoSmithKline is a multinational organization dedicated to manufacturing pharmaceutical and healthcare products. The company’s headquarters is in the United Kingdom, but the firm has offices in over 100 countries across the world including major research centers in the United Kingdom, United States, Belgium, and China (Gsk). The firm is dedicated to helping the healthcare industry evidenced by the fact that the company is one of the few firms in the world that currently is developing both medicines and vaccines to battle the three diseases that the World Health Organization considers a top priority. These diseases are HIV/Aids, tuberculosis, and malaria. The scope of the medicines manufactured and developed by the company includes targeting treatment for diseases such as cancer. The company also develops medicines for diseases such as asthma, mental disorders, and cardiovascular conditions. The firm also makes a lot of money by selling a lot of branded over the counter drugs, skincare, nutritional drinks and hygiene products. Some of the leading brand products the firm manufactures include Sensodyne, Nicorette, and Panadol. The current value of the company’s common stock is $43.98 and the market capitalization of the company is $111.6 billion dollars (Yahoo). The firm is traded under the symbol GSK. During the past 52 weeks the lowest the price the common stock was traded is $34.85 and the highest price was $42.42. Company Profile: J Sainsbury Plc J Sainsbury Plc was founded in 1869. The company is located in the United Kingdom. The company operates one of the largest supermarket chains in the United Kingdom. The firm has 557 supermarkets, 337 convenience stores, a bank, and two property joint ventures (Sainsbury). The company’s market share in the UK supermarket industry is 16% evidenced by the fact the company serves 16 million customers weekly. Sainsbury is a very innovative company. One of its most innovative services is its online shopping service that is available to 93% of the UK households. The organization has over 150,000 employees. The common stock of the firm is traded in the open market under the symbol SBRY. The current market price of the common stock of Sainsbury is $312.40 and the market capitalization of the firm is $5.83 billion (Yahoo). During the past 52 weeks the lowest the SBRY common stocks have traded at was $307.20 and the highest price was $397. Four of the strategies used by the company include: Great food at fair prices Accelerating the growth of non food ranges and services Reaching more customers through additional channels Growing overall supermarket space Active Property Management (Sainsbury). Financial Analysis Including Ratio Analysis The most useful financial reports that analysts use to evaluate the financial performance of a firm are the financial statements. The four basic financial statements are the income statement, balance sheet, statement of retained earnings, and statement of cash flow. All public companies must release financial statements at least once a year. The financial statements of a company are published in the annual report of the firm. The income statement measures the profitability of a company during a period of time. The balance sheet reflects the financial position of a company in terms of assets, liabilities, and equity at a specific point in time. The financial statements serve as a source document that can be used to perform ratio analysis. Ratio analysis is a very effective and accurate financial technique that can be used to further examine the financial performance of a company. The five categories of financial ratios are liquidity, solvency, leverage, profitability, and operating (Kennon). A good way to determine if the result of a specific metric is good or bad is by comparing it to the industry standard. The different categories of ratios measure different aspects of the performance of a corporation. In fiscal year 2009 which ended December 31, 2009 GlaxoSmithKline generated total revenues of ?28,368 million (Annual Report: GlaxoSmithKline). The net income of the company during that period was ?6,283 million. The current ratio of GlaxoSmithKline was 1.45. The current ratio determines a company’s ability to pay off its short term debt. The general rule is that a good current ratio is above 1.0, thus the firm has a good metric result. The debt ratio of the company was 1.33. The debt ratio follows the same general rule of the metric being good if is above 1.0. GlaxoSmithKline is in a good position to pay off its short and long term debt. The gross margin of the firm was 74.99%. The gross margin is considered a broad measure of profitability. The company has a very good gross margin. High gross margins are a desirable outcome. The net margin of the enterprise was 22.99% The return on assets (ROA) of the firm was 14.66%. The return on assets measures how well assets have been employed by management. The higher the metric results the better the results are on this metric. The return on equity of the corporation was 52.49%. The return on equity metric measures the extent to which financial leverage is working for or against common stockholders. The earnings per share (EPS) of GlaxoSmithKline was ?109.2. The EPS results of the company were outstanding. “Since earnings form the basis for dividend payments, as well as the basis for future increases in the value of shares, investors are always interested in a company’s earnings per share (Garrison & Noreen, p.771). The inventory turnover ratio of the firm in 2009 was 1.75. The inventory turnover ratio measures how many times a company has sold its inventory during a year. In fiscal year 2010 which ended on March 21, 2010 J Sainsbury generated revenues of ?19,884 million. The net income the firm achieved during this accounting period was ?585 million. The current ratio of the firm was 0.64. The current ratio results are a little low since is below 1.0. The firm must pay close attention to the current ratio to ensure the company does not get into solvency problems. The debt ratio of Sainsbury was 1.84. The company has a very good debt ratio since the results are 84% above the 1.0 threshold. The firm is in a good position to pay off its long term debt. The gross margin and net margin of Sainsbury in fiscal year 2010 were 5.44% and 2.94%. Both figures at first glance seem a little low, but this is due to the nature of the industry. Profits are very thin in the supermarket industry. Since the company achieved positive instead of negative profitability the firm is doing fine. The return on assets of Sainsbury in 2010 was 5.39%. The return on equity of the company was 11.78%. The earnings per share of Sainsbury was ?32.10. Many financial analysts believe that the EPS influences the market price of a common stock. The inventory ratio of the company was 26.9. Generally speaking it is good for a company to turn its inventory over a lot of times during the year. The reason the metric was so high is because of the nature of the food business. Most food items are perishable and they have a limited shelf life, thus they must be sold within a few weeks. The ratio analysis that was performed can be used by an investor to choose the most attractive investment opportunity. The gross margin and net margin of GlaxoSmithKline were much better than J Sainsbury’s results. GSK operates in a risky industry and this implies that the firm has higher potential for bigger profits. The current ratio of GlaxoSmithKline was better than J Sainsbury by 0.81. These results imply that GSK is in a better position to pay off its short term debts than J Sainsbury. The debt ratio of J Sainsbury was better than GlaxoSmithKline by 0.51. J Sainsbury is in a better position to pay off its long term debt. Both the return on equity and return on equity of GlaxoSmithKline were superior to J Sainsbury by a wide margin. The EPS share of GlaxoSmithKline is more than three times better than J Sainsbury. The inventory turnover ratio of J Sainsbury was about 13 times higher than GlaxoSmithKline. The better inventory turnover of J Sainsbury is a positive factor. The overall results of the ratio analysis clearly indicate that GSK common stocks are a better investment than SBRY common stocks. Performance Factors GlaxoSmithKline is a successful firm in the pharmaceutical and healthcare industry. One of the factors that affect all pharmaceutical companies is the high capital requirements needed to develop a new drug. It cost approximately $868 million to develop a new drug and the range of costs varies from $500 million to $2 billion (Adams & Brantner). The reason it costs so much to develop a new drug is because for every successful drug that comes to the market hundreds fail due to the strict regulations of the Food and Drug Administration (FDA). Another fact that affects pharmaceutical companies such as GlaxoSmithKline is changes in the prescription coverage of medical plans. A factor that affected the company during fiscal year 2009 was the restructuring of program to improve the effectiveness and productivity of its operations (Annual Report: GlaxoSmithKline). A factor that negatively influenced the results of J Sainsbury during fiscal year 2010 was food inflation. Food inflation in the United Kingdom steadily rose during 2010 from 3% to 4% (Monaghan). When the prices of food items go up people spend less money grocery shopping. Fair Trade products are a factor that positively influenced the company during fiscal year 2009. J Sainsbury has become the number one seller of Fair Trade products in the world with annual sales in 2009 of ?218 million (Annual Report: Sainsbury). Conclusion The use of financial ratio analysis helped determine which company was a better investment. GlaxoSmithKline showed better overall profitability in all aspects including gross margin, net margin, return on equity, and return on assets. The investor regarded GlaxoSmithKline as a firm that has greater value evidenced by the ?109.2 EPS metric. GKS showed great solvency as well, J Sainsbury showed signs of problems in terms of its ability to pay its short term debt. A limitation of the analysis was that it did not consider the industry standards of each company. The food retail industry and the pharmaceutical industry are completely different. Understanding how to use, apply, and interpret financial ratios can be very beneficial for novice and institutionalized investors. Work Cited Page About.com. 2011. “The Five Categories of Financial Statements” 21 July 2011. < http://beginnersinvest.about.com/od/financialratio/a/ratiocategories.htm> Adams, C., Brantner, C. 2006. “Estimating the Cost of New Drug Development? Is it Really $802 Million” Health Affairs. 21 July 2011. Annual Report: GlaxoSmithKline. “GSK is Changing” December 31, 2009. 21 July 2011. Annual Report: J Sainsbury plc. 21 March 2010. 21 July 2011. Garrison, R., Noreen, E. 2003. Managerial Accounting (10th ed.). Boston: McGraw Hill. Gsk.com. 2011. “Our Company” 21 July 2011. Monoghan, A. 11 September 2010. “Fear over food prices despite inflation dip.” The Telegraph. 21 July 2011. < http://www.telegraph.co.uk/finance/newsbysector/retailandconsumer/7996556/Fear-over-food-prices-despite-inflation-dip.html Sainsbury.com 2011. “Company Overview” 21 July 2011. Sainsbury.com. 2011. “Our Strategy.” 21 July 2011. Yahoo.com. 2011. “GlaxoSmithKline plc (GSK).” 21 July 2011. < http://finance.yahoo.com/q?s=Gsk&ql=1> Yahoo.com. 2011. “J Sainsbury plc (SBRY.L).” 21 July 2011. < http://finance.yahoo.com/q?s=SBRY.L&ql=0 Appendix: Ratio Analysis comparison GlaxoSmithKline vs. J Sainsbury GSK SBRY current ratio 1.45 0.64 debt ratio 1.33 1.84 net margin 22.15% 2.94% gross margin 74.99% 5.44% return on assets 14.66% 5.39% return on equity 58.49% 11.78% EPS ?109.2 ?32.1 Inventory turnover 1.75 26.90 Read More