Paper Example on Financial Ratios for Pharmaceutical Industry

Introduction

Financial statements contain essential financial data that can be analyzed using financial ratios to interpret an organization's financial statements better. The financial ratios of one organization can then be compared with ratios from similar organizations within the same industry to determine the performance levels, efficiency, profitability, and financial health compared to competitors. Financial analysis using financial ratios can thus provide important information to an organization's management on their current profitability, solvency, and efficiency and provide relevant advice to increase efficiency. Potential investors can also use information from financial ratios to determine if a given organization is a worthy investment and the potential returns on such an investment. The pharmaceutical industry differs significantly with other industries regarding business processes that are core to the business. One important element or core process in the pharmaceutical industry is research and development that determines the value of the pharmaceutical company and its products. The most critical financial ratios for the pharmaceutical industry include return on research capital ratio, profitability ratios, and liquidity ratios.

As previously stated in the last paragraph, research and development is a crucial process for a pharmaceutical firm. The industry spends a considerable amount of expenditure on researching new products that can be first in the market and thus generate enormous profits for the company if well utilized. The return on research capital ratio is an important financial ratio that calculates the amount of financial gain a pharmaceutical company recoups from the expenditure spent on research and development. The return on research capital ratio RORC is used to indicate the gross profit realized by the company from every dollar spent in research and development. To calculate return on research capital ratio, the current gross profit of the organization for the year is divided by the research and development expenditure recorded for the previous year. This ratio is important as it helps the investors in the pharmaceutical company to determine how efficient the company is in managing the research and development expenditures for the previous year into the current fiscal year revenues.

RORC=Gross profit/R & D Expenditure

A pharmaceutical company just like other businesses is created to generate profits for its investors and shareholders. It is thus critical for pharmaceutical companies to also calculate profitability ratios. The selected profitability ratio to be measured for the pharmaceutical industry is the net profit margin. This ratio also referred to as profit margin is used to calculate the percentage profit that an organization produces from its total revenue. Below is the formula expressed as a percentage.

Net profit margin= Net income/ Total revenue

The third financial ratio critical is the liquidity and debt coverage ratios. Liquidity ratios are used to determine the level of liquidity of a firm or its ability to repay its debts in the short-term. Pharmaceutical companies are capital intensive since they require huge expenditures to cover research and development. It is thus critical for such firms to record their liquidity positions in order to enable them to effectively manage the huge debts required by the firm. The liquidity ratio to be applied for the organization is the current ratio. The current ratio is a ratio that measures an organization's ability to pay its short-term debt obligations. In order to calculate the current ratio, an analysis of the total current assets of the company are considered. The current assets considered include cash, market securities, inventory, and accounts receivable. The current ratio is an important tool to measure the financial health of the organization and the operational efficiency of an organization.

Current ratio= Current assets/Current liabilities

Provide a 3 to 5 year time, trend, series analysis of the ratios discussed in question 1. Please include graphs.

Return on research capital RORC=Gross profit/R & D Expenditure 2017 2016 2015 172,436.1/41,640.9=4.14 166,469.2/38,441.4=4.33 158,236.5/36,631.6=4.32

The company's ability to optimize its research and development capital to maximize revenue has consistently dropped from 2015 to the final year 2017.

Net profit margin Net profit margin= Net income/ Total revenue

2016 2015 65593.4/240,981.3=0.27 or 27% 60452.6/230,808.1=0.26 or 26% 55489.3/217,800.7=0.25 or 25%

A company with a high net profit margin means that the company can control its costs and provide its products at a price high above its expenses. The Pharmaceutical Company has thus been increasing its net profit margin for the last three years, and therefore it is improving its efficiency in cost control.

Current ratio Quick ratio= Current assets/Current liabilities

2016 2015 46,518.2/161,459.1=0.29 42,001.1/147,909.2=0.28 40,347.4/131,510.5=0.31

A current ratio of less than 1 indicates that a company has greater liabilities than its assets. Such a company would be unable to pay for its short-term obligations at the given point in time. The current ratio was highest in 2015 and has been fluctuating by dropping in 2016 and then rising in 2017.