Introduction
Financial reporting entails the preparation of financial statements, which are communication documents to companies’ stakeholders. The financial statements are mainly the income statement, the balance sheet, and the statement of cash flows.
However, in their current form, the financial statements do not provide sufficient information for decision-making purposes. Analysis of such financial information is thus necessary to enable the company’s stakeholders to make decisions regarding their future engagements with the company. Ratio analysis is one such form of analysis that is done using the financial statement items (Cornett, Adair, & Nofsinger, 2011). The trends in these ratios from one financial year to another are indicators of the possible levels of performance in the future and give decision-makers a ground on which to base their decisions.
This essay shall analyze some financial ratios for Johnson and Johnson pharmaceutical companies for the last three financial years. The trends in those ratios shall be studied and recommendations given regarding possible steps to improve or maintain the current level of financial success.
Financial Ratios
Financial ratios are classified into several categories that include liquidity, gearing, activity, profitability, and investor ratios (Gibson, 2009). Each category of ratios is of interest to a specific category of stakeholders of the company. This essay shall discuss and compute six ratios for Johnson and Johnson pharmaceutical company for the three financial years ended 31st December 2011, 2012, and 2013. The ratios are the profit margin, debt to asset ratio, price-earnings ratio, inventory turnover, current ratio, and the time’s interest earned ratio.
Profit margin expresses the net profit as a percentage of sales (Gibson, 2009). The higher the profit margin, the better it is for the company. The debt to asset ratio is an indicator of the amount of borrowed resources expressed as a fraction of total assets. A higher debt to asset ratio indicates that the company is highly geared, which is not desirable for the company. The price-earnings ratio indicates an investor’s confidence in the performance of the company in the future.
A high price-earnings ratio suggests that investors are confident that the company shall perform well in the future. Inventory turnover shows the number of times stock was replenished in the company. A high inventory turnover is a sign of the efficiency of the company is selling its products (Gibson, 2009). The current ratio shows the number of dollars available to repay each dollar of current liabilities. A current ratio of over +1 is desirable, and it shows the company’s ability to repay its debts on time. The time’s interest earned ratio shows the number of times the net profit can be used to cover interest expenses in the future (Gibson, 2009). A higher times interest earned ratio is better for the company. The above ratios for Johnson and Johnson Company are summarized in the table below:
Financial Trends
The financial ratios for Johnson and Johnson Company show a generally positive trend. The profit margin increased over the three years. The debt to asset ratio decreased over the three years, which is an improvement in the company’s gearing position. The price-earnings ratio of Johnson and Johnson Company increased from 2011 to 2012 but later declined in the year 2013 (Stock Analysis on Net, 2014). The rate of stock turnover decreased over the years but seems to revolve around 3 or 4 times. The current ratio decreased in the year 2012 but increased again in the year 2013, but the ratio was above the threshold over the years. Times interest earned ratio has been increasing consistently over the three years.
From the analysis, it is evident that Johnson and Johnson Company is in no financial difficulties. The company shows a consistent profitability record, which is likely to raise confidence among the investors about the future profitability potential of the company. Therefore, the company is likely to be operational over the next five years.
Major steps to financial success
If I were the manager of Johnson and Johnson Company, maintaining or improving this profitability record would be my goal. First, I would invest in research and development to ensure that the company enjoys more patent rights.
This would further improve the reputation of the company, thus increasing the sales potential as well as the market price of the shares of the company. Cost leadership would also be my strategy to ensure that the cost of sales is minimized and the gross profit margin increased. Secondly, I would embark on a global strategy by opening more branches and subsidiary companies in countries where the company has no presence. That would be possible because it is easy to obtain external funding as the company’s gearing ratio is low. The strategy would further increase sales, hence profits.
Conclusion
The preparation of financial statements is not sufficient in itself to make decisions. Ratio analysis thus becomes inevitable. Different ratios can be classified as liquidity, profitability, gearing, activity, and investor ratios. The financial ratios are compared from one year to another to identify a trend that makes stakeholders make sound decisions regarding their future engagements with the company. A positive trend is an indicator that the company is likely to be operational soon.
References
Cornett, M. M., Adair, T. A., & Nofsinger, J. R. (2011). Finance: applications & theory. New York: McGraw-Hill/Irwin.
Gibson, C. H. (2009). Financial reporting & analysis: using financial accounting information. Mason: South-Western Cengage Learning.
Stock Analysis on Net. (2014). Johnson & Johnson (JNJ): Common Stock Valuation Ratios (Price Multiples). Web.
Appendices
Johnson and Johnson income statements for the three years ended 31st December 2011, 2012 and 2013
(Dollars and shares are in millions except per share amounts)
Johnson and Johnson’s Balance sheets as of 31st December 2011, 2013 and 2013
(Amounts in millions of dollars)