Introduction
The paper takes a financial analysis of Shire plc and AstraZeneca plc; both companies have their main operating base in the United Kingdom. Both companies are listed in the countries stock exchange. They are in the pharmaceutical industry.
Brief information about the Companies
Shire plc commonly referred to as SHP, is an international pharmaceutical company with its head quarters in the United Kingdom. It was registered in London stock exchange in 1996. Though the company has an Irish origin, its main operational base is in the United Kingdom. The company specializes in different pharmaceutical and medical areas however, its major base is in gastrointestinal (GI) diseases hyperactivity disorder (ADHD), and human genetic therapies (HGT); its accounts are audited by Deloitte, London (Shire plc. Corporate website, 2010).
AstraZeneca plc is ranked seventh largest pharmaceutical and medical products provider in revenue generation in the world; the company operates in more than 100 countries and forms FTSE 100 Index, in London Stock Exchange (LSE). Other than LSE, the company is listed in New York stock exchange. Its leading role in the industry is facilitated by innovativeness and strategic decision that the company have undertaken (AstraZeneca plc corporate website, 2010).
Performance Assessment
Performance ratios
Gross profit ratio
Gross profit ratio = Gross profit/Revenue x 100
Operating Profit Percentage
Net Profit Percentage
Net profit percentage = Profit after taxes/Revenue x 100
Return on Equity ROE
Return on Equity ROE = Profit After taxes / Equity x 100
Return on capital employed
It is calculated as follows: = EBIT / Total Assets – Current Liabilities
Performance Comparison
For the three years, AstraZeneca has had increasing gross profit percentage, operating profit percentages and net profit percentage, ROE and ROCE. The increase follows the same range with the assets of the company; this is an indication of a company that have adopted an on-going concept where it improves its current operations as it lays a foundation for future business. The increase is a show of better management and strategies to cope with global financial crisis, which the world is currently facing. Such a move shows a company with experienced and dedicated management staff (AstraZeneca plc corporate website, 2010).
SHP’s gross profit percentage, operating profit percentages and net profit percentage, ROE and ROCE is on the increase, the company use of resources is improving with time although in 2007, the company made a loss. In 2007, the world experienced a global financial crisis that can explain the poor performance of the company. The same was the case in operating profit ratio and gross profit ratio. The loss made the company work-hard and reverses the trend in 2008 although its assets were reducing. This shows a company whose management has realized the need for an effective management of resources. The fact that when assets are reducing profits are increasing is a clear indication that inefficiency and those assets not bringing benefit to the company are being faced out. Better combination of resources may have been implemented.
Comparing the two companies, clear that AstraZeneca plc has a better operating base than its counterpart SHP does. It has better management who are focused to see the company a success. AstraZeneca plc has a better utility of available resources. An investor is interest in this ratio to gauge the level of efficiency of management. It is important to compare this rate with the rate of the industry to gauge the strength of current company.
Liquidity & Working Capital Assessment
Liquidity ratios
Current Ratio
Quick Ratio
Quick Ratio = Current assets – inventory (stock) / Current liabilities
Inventory Holding Period
Average Inventory Period = (inventory x 365 days) / cost of sales.
Receivables Payment Periods
Receivable Payment rate = Net sales/account receivable
Payables Payment Period
Payment Period = Cost of goods sold/accounts payable
Asset Turnover
Asset turnover = Net sales revenue / average total assets
The company has a reduced efficiency as far as asset utilisation is concerned.
Working Capital Cycle
Working capital = current assets – current Liabilities
Liquidity Comparison
AstraZeneca plc, had its current ratio and quick ratio less than the standard two, however the available current assets could meet short-term financial needs when they fall due. On the other hand, the company is having increasing current liabilities, with such current ratio then it is likely to develop unpleasant relationship with its creditors. The results show a company that makes long-term financial promises for those operations that are current in nature like paying of suppliers. If the ratio continues to be so, then in the future the company will have problems trading. To reverse the trend and likely to have a better operating situation, then the company should devise internal mechanisms in this effect. Such mechanisms include have better dept collection methods, reduce short-term creditors and if possible restructure current short-term liabilities. Increasing its profitability and having a higher allocation to working capital should be embarked on (AstraZeneca plc corporate website, 2010).
SHP current ratio for 2007 and 2008 shows a company that has sound financial standing. It shows a company that can meet its short-term financial obligation when they fall due. In 2009, the company is facing a working capital deficit, where the strength that has been experience in the previous two years seems to be fading. It is also important to note that the trend of current ratio is decreasing. The company thus seems to be having an increasing current liability that is not proportional to the increase in current assets. The indication and the trend is alarming and need to be addressed fast; to cure the deficit, the company should put in place stringent collection methods and reduce its burrowing rate. From the information, current assets are reducing yearly; the company should invest in short term assets. The liabilities are also noted to be increasing, there is need to check on the trend.
The trend adopted by AstraZeneca plc is the better trend as it has an element of going on concern that the trend adopted by SHP, however both the companies have a lot to do. Working capital in a company is the operating finances that a company can use at one particular point to take advantage of prevailing condition. It assists in smooth operation of business and provides money to finance current opportunities brought about by the market. The higher the working capital the better for a company however, it should be well managed to ensure that money is not embezzled. A company with positive working capital has enough money to finance its operation whereas a Company with negative operating company does not have such funds. Negative working capital leads to difficulties in conducting business and can lead a company to be bankrupt.
Likely Causes and Effects of the Changes in the Liquidity Ratios over the Period of Two Years
The trend taken by the companies’ ratios is different where AstraZeneca plc is increasing whereas that of SHP is decreasing. The world is recovering from global financial crisis that affected businesses in different angles. How well a company operated and strategized during the period determined how well the company is performing. From the analysis, AstraZeneca plc, developed better terms of coping with the crisis that include diversifying to different countries and innovating products to attain a larger market. Alternatively, according to directors’ report, the company had embarked on massive debt collection procedure to ensure it has sound financial standings. It also avoided borrowing during the time. It did not sit back to absorb the shocks of the crisis but it aimed at improving its operations through various strategic decisions.
During the crisis, different government implemented strategies to solve the crisis with one f them being making lending available. It seems SHP took the advantage and increased its borrowed capital which was not a strategic decision considering the time that it came. Alternatively, the company might have disposed some of its short-term assets. Some of these decisions injured its operations although there is hope that the company will do better in the future.
Capital Structure Analysis
Gearing Ratio
It is calculated as follows:
Gearing Ratio = Sum of Borrowings / (sum Borrowings + sum Equity) * 100 = long term borrowing (debt) / equty + long term borrowing (debt) x 100
Interest Cover
It is an analysis of how best a company can pay its depts. interests; it is calculated as follows: Interest Coverage Ratio – EBIT / Interest Expense
Compare the Capital Structure of Both Companies
Shire is highly geared although the trend that it has taken to reduce the gearing ratio is good. It seems the company has embarked on massive loan clearance. This is a positive move especially noted that it is equally reducing its current liabilities. It shows a company that is financially sound. The company is getting from bad to worse, it is highly geared and the rate of borrowing is on the increase. The situation is even made worse by the increase in current liabilities and decrease in current working capital (current ratio decrease). It finances over half of its operations by borrowed capital. It is a high time that management devise mechanisms to finance its projects internally and ensure there is minimal borrowing. If the trend continues, the future of the business is doomed. Another approach that the company can employ is to restructure the loan facilities it is holding to have a longer payment period so as it can have some money left for operation. Save for 2007, when the company registered a loss, the company has been able to finance its interest appropriately.
AstraZeneca Plc has a reducing gearing rate; the rate is improving form a rate of above 50% of its operations being financed from borrowed capital in 2007 and 2008, to a rate lower than 50% in 2009. This shows a company that is committed for clear its outstanding dept and look for finance from other sources other than borrowing. For the last three threes, the company has been able to cover its interest expense appropriately.
Comparing the two companies, they have a common philosophy that aims at improving their financing rate through internal financing relative to borrowed capital. The rate adopted by Shire is higher, if the rate continues; the company will have its processes financed internally. Both companies earn credit for sound dept management.
Investment Analysis
Earnings Per Share (EPS)
Earnings Per Sharc = Profit / Weighted Average Common Shares
Dividend Payout Ratio
Dividend Payout Ratio: = Yearly Dividend per Share / Earnings per Share or equivalently: = Dividends / Net Income
Dividend Yield
Dividend Yield = Annual Dividends per Share / Price per Share
The company dividend yield is high and encouraging to investors.
Price Earnings Ratio (P/E)
Price Earnings Ratio (P/E) = Market Value per Share / Earnings per Share (EPS)
Comparison of Return to Shareholders Rate
According to the analysis, AstraZeneca plc in a better position to offer better returns to its shareholders than the case of Shire. The company has been able to offer divided to its shareholders despite difficulties in the world financial crisis period. The growth of expectation is expected to lead to an increase in share price in the market resulting from forces of demand and supply. P/E is an element of profit made by a company and thus in the case of AstraZeneca plc, there is better future as it is likely to enjoy an increased share capital than the case of Shire.
Comparing the two results, AstraZeneca plc has a better financial standing and can attract investors than the case of SHP. Existing investors are more satisfied with the returns of the company. Rational investors prefer a company that has sound financial standing and can look at their welfare, AstraZeneca plc is better positioned to attract more investors and look into the welfare of existing ones.
Capital Structure the Companies and Their Past Implications
Both companies are listed in London Stock Exchange; they thus offer shares to the public. AstraZeneca has a policy that gives rights to employees to own shares in the company as a motivational measure. Shares are issued at a premium to the public and to employees under the employee ownership policy. The company also has borrowed capital to finance different programs both long-term and short-term borrowings. It also leases some assets.
SHP offers share to the public through London Stock exchange. It has a staff company ownership where it sells shares to staffs at subsidised rates. A large portion of the company’s capital is borrowed capital mostly form financial institutions; it also leases some assets (Helfert, 1997).
Implications of Investment Ratios to Existing and Potential Investors
Investment ratios are the most used tools to gauge financial strength and used as investment decision-making tools. Both existing and potential investors, use them when making decisions regarding a certain company.
For existing investors, the ratios assist them in gauging the efficiency of management and rate the how well their resources are being utilized; different financial ratios give different reflections for various decisions in the firm. Other than current operations, investment ratios tracks individual firm performance over time, so as this information can be used to gauge future operation. Investors in a company need to have a well-documented structure and performance rate of their company so as they can learn whether it is becoming strong or weakening over time. A trend analysis offers a good chance to compare what the company had promised to offer and what it has actually offered. Historical operation of a company is important, as owners will learn the future their company has from the operation. To have a trend analysis, investors consider individual ratios for a certain period and then compare them over certain duration. Some industries have an expected rate in the industry that every well-managed business should be able to attain; it is given in ratios thus computing a company’s ratio assists existing investors to gauge their company.
Investors have different options to invest in; they use investment ratios for comparative judgments regarding a firm performance among others in the same industry or same market. Existing owners will realize their company’s management operational efficiency and its share in the market.
Potential investors are rational and would like to invest in a business whose future is promising; investment ratios like profitability ratio, equity ratio’s, and gearing ratios assist a potential investor to make informed decision on the right company to invest in. Potential investors will be interested in those companies that will give high returns to their investments. To gauge the potential they will consider ratios like asset utilization ratios, EPS, and other investment ratios. Gearing ratios and working capital ratios are also major considerations when making an investment decisions since they reflect the likelihood of future operation in a company. They give an implication whether the company will be a going on concern; this is crucial for both existing and potential investors.
The operation and demand for a company’s share capital will of great important to speculators both exist as company owners and potential ones. Price/earnings ratios give a reflection of the strength that a company will have in the near future thus assists in making investment decisions (Weygand, Kimmel and Kieso, 2010).
Problems Faced By Users of Published Accounts
Although existing and potential investor gauge company operations using published financial statements, users are faced with some problems. They may be problems on their part or on the company’s part.
Not all users of financial statement can make sense out of disclosures and ratios in the statements. Some people do not understand what a certain ratio implies; the assistance that can be derived from such ration is limited. Alternatively, some investors and other users of financial accounts may be ignorant of the ratios or use a certain class of ratios and ignore others.
Different users have different needs thus; they may tend to focus on a certain area of ratios and published statements while ignoring others. This may results to misleading information through based on published accounts. For example, investors are more likely to use profitability ratios and ignore liquidity ratios; this can misguide them. Another example of a different users are creditors, they may get involved in liquidity ratios and ignore profitability ratios. This may have an unforeseen effect on the creditor.
Sometimes investment published accounts analysis tools lacks consistency; some implications may be made form an analysis of one set of analytic tools but a very different implication is gotten from another set. For example, it is likely for a company to have strong liquidity ratio but have weak profitability ratios. When the two sets of ratios are analysed, a potential ratio user is left at close road on which set to rely on.
Although international accounting practice calls for ethical code of conduct in businesses, some companies with the corrosion of their auditors have been reported to manipulate their accounts to reflect some strength. These results to misleading information thus investors making their decisions based on such manipulated results are likely to suffer. Manipulation may be a misrepresentation of facts or high-tech accounts manipulations. For example, a company may have obsolete assets of a high value to another company; when making financial statements and calculating ratios, they may delay the sale or transfer of such assets to reflect a strong asset base or alternatively they may transfer ownership but when calculating asset utilization ratios, they consider only the existing assets. Such a move show high level of asset efficiency, which is not the case.
Finally, published reports do not have full information of a company; some information that affects the operation of a company but is not reflected in published reports. Such information includes a company’s brand name. Although these are criminal operations, they happen and can be misleading to an existing or potential investor (Fridson and Fernando, 2002).
References
AstraZeneca plc corporate website., 2010. Health in Real World. Web.
Fridson, M. and Fernando A., 2002. Financial Statement Analysis: A Practitioner’s Guide.New York: John Wiley.
Helfert, A., 1997. Techniques of Financial Analysis: A Modern Approach. Chicago: Richard D. Irwin, Inc.
Shire plc. Corporate website., 2010. A Story of continuing transformation. Web.
Weygand, J., Kimmel, P. and Kieso, A., 2010. Financial Accounting: IFRS. Illinois: Northern Illinois University.