Financial ratio analysis and interpretation

Financial Analysis

Understanding how a company operates within any industry is dependent upon comprehension of many financial properties. Assessing the financial stability of a company is essential in determining the company's strengths and weaknesses as well as ultimately assessing its profitability. Financial ratios should be considered a useful tool when examining the profitability and efficiency of any company. Some companies are certainly more successful and profitable than others, and pharmaceutical companies in particular seem to have a distinct advantage when measuring financial ratios.

When assessing any organization, for terms of this paper are as follows: Johnson & Johnson, Pfizer and Merck it is important to consider the profitability and efficiency of the company. This is among the first information investors will explore before "investing" in a company. Ratio analysis is a critical analysis of the financial structure of an organization. There are four categories of ratios that need to be examined: leverage, liquidity, efficiency and profitability. These ratios are also referred to as "DuPont" ratios (MBA, 681). There are many other ratios that may be considered when evaluating a company, but for financial purposes, and for evaluating the above mentioned pharmaceutical companies the four listed ratios are most important in comparing the companies success in the market compared to other companies in the industry.

Liquidity ratios indicate how well an organization is able to basically "pay its bills" without undue hardship. A high liquidity can be a good sign, but too high of a ratio may signify that the firm is actually not efficiently operating. This will be discussed further as the pharmaceutical companies measured above are analyzed.

Leverage ratios measure the ability of an organization over several years to meet its obligations, such as making payments on loans and interest. When considering leverage ratio's it is important to note that a successful company typically has an average ratio, not too high or too low. Too high of a ratio could indicate financial distress, similar to the imbalance created by too high of a liquidity ratio.

Efficiency and profitability are extremely important ratios to consider. Efficiency ratios measure the companies ability to generate sales and invest in assets "efficiently," assessing in essence whether a firm is maximizing utilization of assets. Profitability ratios are most often utilized when comparing companies in the same industry. A profitability ratio assesses whether a company is capable of generating revenue. Control of expenses, proper use of assets and the ability to manage A/P are all reflected in the profitability ratio.

In examining pharmaceutical companies such as Johnson & Johnson, Pfizer and Merck, this paper will analyze the following:

What are the historical costs and market values of each pharmaceutical company?

What are some examples of benchmark analysis of similar companies?

How do each of these companies compare in terms of financial ratios among each other as well as among other companies in the industry?

What are the financial long-term prospects of each of these companies based on evaluation of the four financial ratios?

How profitable are each of the companies, based on their ability to control expenses?

Of course also to be considered are how well assets are utilized and expenses accounted for each of the companies.

When considering other industries and other related organizations as compared to the pharmaceutical companies mentioned in this paper, the following will be noted:

Trends in ratios and Dun and Bradstreet reports.

CONCLUSION:

Historically pharmaceutical companies such as Johnson & Johnson, Pfizer and Merck have managed to sustain relatively average or good financial ratios in the areas of leverage, liquidity, efficiency and profitability. Part of the reason for this, in a volatile market when the dynamics of population interest and buying habits frequently vary, the need for pharmaceutical products and new and improved products is always increasing. Part of this is driven by customer demand, which over time has proven to increase and always demand the best when related to pharmaceuticals, or the health of the population.

Even though the current state of the economy is in a slump, the pattern of valuation for Johnson and Johnson over time has shown overall improvement. For example, according to statistics the valuation ratio's for J & J. had improved steadily from 1996-2000, growing from a book value of $4.07/share to $6.07/share (JNJ, 2003). Net profit margin for this company grew approximately 3% during the same time frame, indicating an overall "successful" financial gain for the company (JNJ, 2003). The leverage ratio for the company maintained an average between 1.7-1.9, and compared to other companies in the industry the "Price to Earnings Ratio" varied from 100.9% to 78%.

Not bad given the current poor state of economic affairs.