Over the last several years, accounting standards and the budgetary process of multinational corporations has been increasingly brought to the forefront. This is because the recent recession and lingering financial challenges, have illustrated how many firms were often over reporting their earnings. As they are using standards that give them more latitude in determining how revenues and expenses are recorded (.i.e. pro-forma). This is when earnings projections and growth, are based upon future revenues the firm will receive. The problem begins, when economic activity is slow and many of the expected orders are canceled. This is the point that the firm will have to restate their earnings to account for these changes. Once this happens, is when the price of the stock will more than likely go into a free fall based upon these issues. ("Pro Forma")
This is problematic for many multinational corporations, based on the underlying challenges they are dealing with. In the case of Johnson and Johnson (J&J), the company was able to protect itself against the impact of declining consumer spending. To fully understand what is happening, requires looking at the company itself and the kind of budget that should be utilized by the firm. Together, these elements will offer the greatest insights as to the strengths of J&J's business model and the way they can adjust for new challenges in the future.
An Evaluation of Johnson & Johnson
J & J. was founded in 1887. The company is currently involved in various segments that are focused on: consumers, pharmaceuticals and medical devices. The Consumer division is concentrating on products that are sold over the counter. A few of the different areas that they are concentrating on include: baby / skin / oral care, wellness and OTC merchandise. ("Johnson and Johnson Form 10K")
The Pharmaceuticals segment is providing a host of prescription drugs to consumers. The different products they are selling include: anti-infective, antipsychotic, contraceptive, dermatology, gastrointestinal, hematology, immunology, neurology, oncology, pain management and virolog. This area helps to address issues that are impacting customers by providing them with medication to treat specific conditions. ("Johnson and Johnson Form 10K")
The Medical Devices division is involved in those products that are sold directly to health care providers with an emphasis on improving treatment options. Some of the different merchandise that they are marketing include: Biosense Webster's electrophysiology products, Cordis' circulatory disease management products, DePuy's orthopaedic joint reconstruction / spinal care / neurological / sports medicine products, Ethicon's surgical care / aesthetics / women's health products, Ethicon Endo-Surgery's minimally invasive surgical products / advanced sterilization products, LifeScan's blood glucose monitoring / insulin delivery products, Ortho-Clinical Diagnostics' professional diagnostic products and Vistakon's disposable contact lenses. ("Johnson and Johnson Form 10K") These areas are showing how J&J, is focused on addressing specific needs of consumers and health care providers.
As a result, this focus has allowed the company to deliver more stable earnings (considering the stagnant recovery over the last year). Evidence of this can be seen with the earnings per share for the firm during this time (which is illustrated in the below table).
2011 Earnings per Share for J&J
("Johnson and Johnson")
These figures are showing how the business model and the bookkeeping procedures have protected the profit margins of the firm against sudden changes.
What types of budgets would you recommend for the company? Why?
However, the above table is also illustrating how the earnings for J&J have been very unstable over the past year. This is troubling, because it is showing that the firm is facing a number of challenges with their budgetary procedures. As a result, the company needs to modify their strategy to deal with these difficulties. The best way that this can take place is to create a budget that will focus on different areas to include: revenues and capital expenditures. ("Budgets") ("Johnson and Johnson Form 10K") ("Johnson and Johnson")
Revenues are when managers will make some kind of forecast about future earnings and profit margins of the firm. The problem is that executives have been too optimistic in the guidance they are providing. Once this takes place, is when the analysts will begin reducing their estimates for earnings (which increases the amounts of volatility in the stock). To deal with these challenges, there needs to be a change in the projections that are provided. ("Budgets")
The best way to do this is managers should use the traditional format and then subtract 15% from these numbers. In the event that there is some kind of pricing pressure from: inflation or sudden shocks to the economy these areas will serve as a buffer zone. This will ensure that the management is always providing everyone with the most reliable numbers by taking into account the worst case scenarios. In the future, this will provide more stability to earnings (resulting in better performance for the stock). ("Budgets")
The reason why this was recommended is because J&J is having trouble providing consistent bottom line numbers. This is despite the fact that demand for health care products are increasing exponentially. If the firm can provide more conservative revenue figures, they will be able to improve the confidence of shareholders. This is when the company can improve upon the favorable image that it has built over the years. ("Budgets")
The capital expenditures are when the company is investing aggressively in new plants and equipment to maintain competitiveness. Currently, J&J has 139 manufacturing plants that occupy 21.8 million square feet of floor space. In general, this is providing the company with the ability to keep up with customer demand for the products they are delivering. The problem is that some of the firm's prescription drugs are losing their patent protection. ("Budgets") ("Johnson and Johnson Form 10K") ("Johnson and Johnson")
A good example of this occurred when the company lost its patent protection for Topamax and Levaquin. In both cases, the firm realized a decrease in sales of 53.3% and 57.9% (once this was no longer in place). To address these issues, J&J has been increasing capital spending from $6.8 billion for 2008 to $7.6 billion for 2011. These factors are showing how the company will have to dramatically increase the investments in these areas to account for the loss of patent protection on certain drugs. ("Johnson and Johnson Form 10K") ("Johnson and Johnson")
As a result, this is causing the company's earnings to become more unstable. This is one main reason, why the earnings and revenues have been declining over the past year. To deal with these kinds of issues, executives need to transform the budgeting process. This means that there must be more long-term planning for expiring patents.
One possible strategy for dealing with these challenges is to increase capital spending on new drugs gradually. This will occur with small increases allocated for those drugs that have received FDA approval and can begin selling. As the patent expiration date becomes closer, is when this amount will increase. If this kind of approach is taken, it will gradually introduce new products that can replace medication which can be sold generically. The reason why this was selected is because there has been a decrease in the earnings on a year over year basis. Unless drastic action is taken, the company could see more reductions in earnings. As a result, there needs to be a constant focus on introducing new products. ("Johnson and Johnson Form 10K") ("Johnson and Johnson")
Clearly, the biggest strength of J&J's business model is the GAAP standards they are following. This is allowing the firm to report more accurate numbers to shareholders. However, the problem is: this approach is ignoring the fact that executives can over project future sales and they are not considering…