Managerial Finance: Financial Ratios and Investment Appraisal Methods

This document provides a comparative analysis of Glaxo Smith Kline plc and Reckitt Benckiser Group plc by calculating and evaluating various financial ratios. It also discusses major investment appraisal methods used in managerial finance.

Managerial Finance

Table of Contents
INTRODUCTION...........................................................................................................................1
TASK ..............................................................................................................................................1
PORTFOLIO 1.................................................................................................................................1
(a) Calculation of different financial ratios for two years (2017 – 2018):..................................1
c. Recommendation in order to improve the poorly performing business..................................4
d. Limitation of financial ratios...................................................................................................5
PORTFOLIO 2.................................................................................................................................6
(a). Calculation of financial ratios for two years (2017 – 2018):................................................6
Payback Period:...........................................................................................................................6
b. Limitation of using investment appraisal technique.............................................................10
CONCLUSION..............................................................................................................................11
REFERENCES .............................................................................................................................12

INTRODUCTION
Managerial finance related to finance division that is dealing with fiscal tactics '
managerial importance. Instead of methodology, it depends on interpretation (Carbo‐Valverde,
Rodriguez‐Fernandez and Udell, 2016). Management finance deals with the responsibilities of
the fiscal manager who functions in a company. This study involves comparative analysis of
corporations named Glaxo Smith Kline plc and Reckitt Benckiser Group plc by computation
and critical evaluation of 10 significant financial ratios. It further discuss about several major
investment appraisal methods which assist managers and investors in taking financial and
investment decisions.
TASK
PORTFOLIO 1
(a) Calculation of different financial ratios for two years (2017 – 2018):
1. Current ratio = Current assets / Current liabilities
All data in £
million except
current ratio
Glaxo Smith Kline plc Reckitt Benckiser Group plc
2017 2018 2017 2018
Current assets 15907 16927 5424 4952
Current liabilities 26569 22491 6576 7614
Calculation 15907/26569 16927/22491 5424/6576 4952/7614
Current ratio 0.60 times 0.75 times 0.82 times 0.65 times
2. Quick ratio = Quick assets / Current liabilities
All data in £
million except
Quick ratio
Glaxo Smith Kline plc Reckitt Benckiser Group plc
2017 2018 2017 2018
Quick assets 10042 11121 4223 3676
Current liabilities 26569 22491 6576 7614
Calculation 10042/26569 11121/22491 4223/6576 3676/7614
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Quick ratio 0.38times 0.49 times 0.64 times 0.48 times
3. Net profit margin = Net profit / net sales x 100
All data in £
million except net
profit margin
Glaxo Smith Kline plc Reckitt Benckiser Group plc
2017 2018 2017 2018
Net profit 1532 3623 6172 2161
Net sales 30186 30821 11512 12597
Calculation 1532/30186*100 3623/30821*100 6172/11512*100 2161/12597*100
Net profit margin 5.07% 11.75% 53.61% 17.15%
4. Gross profit margin = Gross profit / Net sales x 100
All data in £
million except
gross profit
margin
Glaxo Smith Kline plc Reckitt Benckiser Group plc
2017 2018 2017 2018
Gross profit 19844 20580 6870 7635
Net sales 30186 30821 11512 12597
Calculation 19844/30186*100 20580/30821*100 6870/11512*100 7635/12597*100
Gross profit
margin
65.74% 66.77% 59.68% 60.61%
5. Gearing ratio = Total Debt / Equity
All data in £
million except
Gearing Ratio Glaxo Smith Kline plc Reckitt Benckiser Group plc
2017 2018 2017 2018
Total Debt 56449 53706 23480 22908
Equity -68 4360 13533 14742
Calculation 56449 / -68 53706 / 4360 23480 / 13533 22908 / 14742
2

Gearing Ratio -830.13 12.32 1.74 1.55
6. Price earning ratio = Market Price Per Share / Earning Per Share
All data in £
million Glaxo Smith Kline plc Reckitt Benckiser Group plc
2017 2018 2017 2018
Market Price Per
Share 1361 1491.2 6841 5964
Earning Price Per
Share 0.3152 0.7455 8.3859 2.9361
Calculation 1361 / .3152 1491.2 / .7455 6841 / 8.3859 5964 / 2.9361
Price Earning Ratio 4317.89 2000.27 815.77 2031.26
7. Earning per share = Net Profit / Ordinary Numbers of Shares
All data in £ Glaxo Smith Kline plc Reckitt Benckiser Group plc
2017 2018 2017 2018
Net Profit 1532 3623 6172 2161
Ordinary Numbers
of Shares 4860 4860 736 736
Calculation 1532/4860 3623/4860 6172/736 2161/736
EPS 0.3152 0.7455 8.3859 2.9361
8. Return on capital employed = Operating profit (EBIT) / Capital employed *100
All data in £
million except
Return on capital
employed ratio
Glaxo Smith Kline plc Reckitt Benckiser Group plc
2017 2018 2017 2018
EBIT 6061 7064 2963 3280
Capital employed 29812 35575 30437 30036
3

Calculation 6061/29812*100 7064/35575*100 2963/30437*100 3280/30036*100
ROCE 20.33% 19.86% 9.73% 10.92%
Working Note:
Capital employed = Total assets – Current liabilities
9. Average inventory turn over period = Average stock / Cost of goods sold * 365 days
All data in £
million except
Average
inventory turn
over period
Glaxo Smith Kline plc Reckitt Benckiser Group plc
2017 2018 2017 2018
Average stock 5557 5476 1201 1276
Cost of goods
sold
10342 10241 4642 4962
Calculation 5557/10342*365 5476/10241*365 1201/4642*365 1276/4962*365
Average
inventory turn
over days
196 days 195 days 94 days 93.86 or 94 days
10. Dividend payout ratio = Total debts / total equities
All data in £
million except
Dividend payout
ratio
Glaxo Smith Kline plc Reckitt Benckiser Group plc
2017 2018 2017 2018
Total debts 56449 53706 23480 22908
Total equities -68 4360 13533 14742
Calculation 56449/-68 53706/4360 23480/13533 22908/14742
4

Dividend payout
ratio
-830.13 12.31 1.73 1.55
(b) Evaluation of performance, financial position and investment potential.
1. Current ratio
2017 (in times) 2018 (in times)
0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9
0.6
0.75
0.82 0.85
Glaxo Smith Kline plc
Reckitt Benckiser Group plc
Interpretation: Current ratio clearly reflects a corporation's short-term liquidation status.
Generally current ratio 2 or exceeding 2 is considered as most appropriate. This is most
significant proportion between current assets and short-term liabilities or current liabilities over a
specified time-period. RBG Plc and GSK Plc stated current ratio of 0.6 and 0.82 in year 2017,
and 0.75 and 0.85 in year 2018 (About Glaxo Smith Kline plc, 2019). RBG has reported an
increase in current ratio and also much better than other company GSK. This shows RBG is
effectively more capable to repay all its current liabilities as compare to GSK.
2. Quick Ratio
2017 (in times) 2018 (in times)
0
0.1
0.2
0.3
0.4
0.5
0.6
0.7
0.38
0.49
0.64
0.48
Glaxo Smith Kline plc
Reckitt Benckiser Group plc
Interpretation:
3. Net Profit Margin Ratio
5

2017 (in %) 2018 (in %)
0
10
20
30
40
50
60
5.07
11.75
53.61
17.15
Glaxo Smith Kline plc
Reckitt Benckiser Group plc
Interpretation: This ratio indicates how efficiently company is satisfy net profitability
criteria. It clearly states a corporation's net profitability status during particular financial period.
In 2017 net profit margin of companies RBG Plc and GSK Plc were respectively 53.61 percent
and 5.07 percent while in year 2018 this level have been changed to 17.15 percent and 11.75
percent respectively (About Reckitt Benckiser Group plc, 2019). Here higher net profit ratio in
comparison is of RBG Plc but there is also a decrease in net profit. While GSK Plc's ratio has
been shown a upward trend.
4. Gross Profit margin ratio
2017 (in %) 2018 (in %)
56
58
60
62
64
66
68
65.74 66.67
59.68 60.61 Glaxo Smith Kline plc
Reckitt Benckiser Group plc
Interpretation: This is more specifically shows company's profit generation capacity
through their core trade operations. Here in gross profitability ratio GSK's ratio are more better
as in comparison to RBG. In year 2018, GP ratio of RBG and GSK are 60.61 percent and 66.67
percent whereas in 2017, GP ratio of respective corporation are 59.68 percent and 66.74 percent.
In both corporations, GP ratio has been increased but GSK's GP ratio is higher then another
company which shows that company has more capability to generate gross profit.
5. Gearing Ratio
6

2017 2018
0
2
4
6
8
10
12
14
0
12.32
1.74 1.55
Glaxo Smith Kline plc
Reckitt Benckiser Group plc
Interpretation: This ratio shows how effectively company is leveraged and effectiveness of
company's capital structure. It relates debts level of company with equity employed (Gitman,
Juchau and Flanagan, 2015). In RBG and GSK plc gearing ratios are 1.74 and nil (– 803.13) in
year 2017, here negative gearing ratio represents excessive debts in organisation. While in 2018,
Gearing ratios in year 2018, are 1.55 and 12.32 respectively in both corporations. GSK has
improved their gearing ratio in 2018 so company comparatively has more improved leveraged
position.
6. P/E Ratio
2017 2018
0
500
1000
1500
2000
2500
3000
3500
4000
4500
5000
4317.89
2000.27
815.77
2031.36 Glaxo Smith Kline plc
Reckitt Benckiser Group plc
Interpretation: In 2017 companies RBG and GSK have PE ratio of 815.77 and 4317.89
respectively, whereas in year 2018, respective companies PE ratio are 2031.36 and 2000.27
respectively. RBG has improved their PE ratio in 2018 which is also higher than PE ratio of
GSK. A lower figure of PE Ratio is indicator that share of corporation are undervalued and
having lower earning growth. Thus RBG's share are overvalued and indicating earning growth in
shares.
7

7. Earning Per share:
2017 2018
0
1
2
3
4
5
6
7
8
9
0.31 0.74
8.38
2.93
Glaxo Smith Kline plc
Reckitt Benckiser Group plc
Interpretation: Increased earnings per share is almost always preferable than just a
weaker ratio because that implies the corporation is more sustainable as well as the company has
much more income to distribute it to its stakeholders. RBG and GSK have EPS in year 2017
amounting 8.38 and 0.31 while in 2018, EPS of respective companies are 2.93 and 0.74
respectively. This points out that RBG is providing more earning on its share comparatively,
however there is decline in EPS but company is more efficient.
8. Return on capital Employed
2017 (in %) 2018 (in %)
0
5
10
15
20
25
20.33 19.86
9.73 10.92 Glaxo Smith Kline plc
Reckitt Benckiser Group plc
Interpretation: This percentage proportion shows how much company can provide
return on invested fund (Lee and Isa, 2015). In this ratio comparison, GSK with higher ratio is
more capable to generate returns on employed funds while RBG's capital employed has been
improved over period 2017-2018. Also there is a decline in ROCE of GSK but overall analysis
suggest that in comparison company is more profitable.
9. Average inventories turn over period
8

2017 (in days) 2018 (in days)
0
50
100
150
200
250
196 195
94 93.86 Glaxo Smith Kline plc
Reckitt Benckiser Group plc
Interpretation: It demonstrates that by keeping non-saleable stock, the organization does
not over-spend by purchasing too much inventory and wasting resources. It also demonstrates the
company's ability to successfully market its stock. RBG with lower ratio is more efficacious in
converting stocks into sales. In 2018, RBG and GSK have reported Inventories-turnover of 94
days and 196 days respectively. While in year 2017 in respective organisations are 93.86 days
and 195 days.
10. Dividend payout ratio
2017 2018
0
0.5
1
1.5
2
2.5
3
2.55
1.08
0.18
0.55
Glaxo Smith Kline plc
Reckitt Benckiser Group plc
Interpretation: This is ratio which shows how much dividend company is paying on
each of its share. In 2017, RBG has reported dividend payout ratio of 0.18 which has been
increased to 0.55 in year 2018. While in other company GSK, dividend payout ratio in year 2018
is 1.08 and in year 2017 is 2.55, there is decline in payout but comparatively company is paying
more dividend to its shareholders.
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c. Recommendation in order to improve the poorly performing business.
In the end of above calculation of different significant ratios it has been identified that the
overall financial stability and efficiency of GSK is weak as compared to RGB. The analysis
shows that Reckitt Benckiser Group plc have better performance of net profit ratio, current and
quick ratio are better as well as the earning per share and ROCE are also higher (Osterhoff and
Kaserer, 2016). It is also observed that after Brexit deal in 2018 there have been decrease on the
financial strength of RGB but the overall financial status, solvency and liquidity are far better
than other company. This is because of higher sales and significant control on additional
expenses. There are several measures that can be followed by the management to improve the
overall capital base of the GSK. Such as:
 In terms of raising cash flow rates, GSK directors can pay careful attention on increasing
financial assets, which will facilitate short-term business activity to be carried out
productively and reach the desired outcome in much less time.
 Through useful, efficient strategies and tactics like increasing sales and reducing the costs
that enhance overall income per unit.
 The average inventory period of the organization is quite high so it is necessary for
managers to find ways to cut the time length. Directors should create new strategies such
as setting suitable re order level, regular stock audit etc. to improve their financial results
in a year (Van Essen, Otten and Carberry, 2015).
It is advised that RBG company monitor the practices which are increasing at the current
amount of profit and raise it in order to maintain market penetration in specific business. In terms
of improving their profits, the company must compete throughout the growing market. In
general, the liquidity condition needs to be controlled and long-term measures should be taken
for meeting the short-term debts requirements. It is primarily improvement in the context of the
ROCE so that better step must be taken for equal distribution.
d. Limitation of financial ratios.
Ratio analysis is an useful technique, particularly for an external credit analyst lender or
stock analyst in order to make favourable decision (Xiang and Worthington, 2015). It mainly
show the scale of a company's financial consequences and condition from the annual financial
reports. Nonetheless, a variety of ratio analysis drawbacks are recognized which are discussed
below:
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 Historical Information: The evidence used in the study were based on the findings from
the history that the organization reports. Ratio analyses do not accurately reflect potential
business performance.
 Changes in accounting policies: The financial statements can have a major impact if the
organization has modified its financial policies and practices. All the changes are
basically recorded in the notes section of financial statement. In this situation, the major
financial parameters used in the ratios study will be changed as well as the financial
results obtained after the adjustment will not be equivalent to those reported before the
adjustment. Until the end of the fiscal current period, adjustments in the actual
accounting reports are made in all companies and no clear accurate informations are
needed for investors on these figures.
 Manipulation of financial statements: The information in balance sheet can be
manipulated by the person preparing reports in order to make better outcome. Therefore,
the ratio calculation can not properly portray a company's real nature, since a basic
analysis does not detect a false representation of facts (Throsby, 2016).
 Aggregations: It is observed that the information in financial statements are being
aggregated in the past to make calculation easy for Audit. Thus, the ratio analysis do not
include the specific information within whole trend period which can impact the results.
 Point in time: It is observed that ratio take information form balance sheet which is
prepared at the last of the reporting year. In case if there are an unseen decline or increase
in the balance of the last time then the results are going to be different which impact the
overall analysis (Uchide and Imanishi, 2016).
PORTFOLIO 2
(a). Calculation of financial ratios for two years (2017 – 2018):
It is observed that to make a better and worthy investment manager uses various kind of
investment appraisal techniques so that higher return are received (Alkaraan, 2015). These
methods are NPV, Payback period which consider accounting rate of return in order to determine
the most suitable funding option. In the present report, Harris Pvt Ltd. Is planning to buy a new
machine in order make best possible outcome that support to grow overall profitability.
11

Company have two different option for investment, thus manager uses different techniques to
determine the most appropriate.
Provided information:
 Initial investment = 110 (For both the projects)
 Salvage value = Project A (0), Project B (8)
Payback Period:
Formula: Completed years + [(Initial investment – CCA of completed year) / Cash inflow
of next year]
12

Working note:
Pay back period for Project A = 2 + (110 – 90) /45
= 2 + (20 / 45)
= 2 + 0.44
= 2.44
Pay back period for Project B = 4 + (110 – 105) / 65
= 4 + (5 / 65)
= 4 + 0.07
= 4.07
In the above calculation, it has been determined that the payback time of machine A is
less than machine B, so Harris Pvt Ltd must choose option A for future use and stability.
Net Present value:
Formula: Discounted cash inflow – Initial investment
13

Working note:
NPV for Project A = 147.31 – 110
= 37.31
NPV for project B = 120.92 – 110
= 10.92
From the above computation it is determined that Machine B have lower NPV in
comparison to option A which means that company must select the higher NPV machine to make
profitable results.
14

15

From above computation, it is observed that ARR for Machine A is slightly higher than
other machine and it would more advantageous to Harris Pvt Ltd.
Recommendation: It have been recommended that respective company must invest to
purchase machine A as it will be a better option resulting in higher profitable outcome in specific
time period. The total investment would be recovered in 2.44 year with 36.4% ARR and the net
present value of machine A is 37.32 which is higher than other option.
b. Limitation of using investment appraisal technique.
There have been various types of methods applicable to analyse the usefulness of every
proposal or project by an organization (Yarram and Dollery, 2015). There are some major
disadvantage of these techniques which are elaborated underneath:
 The time-value of money is among the major drawbacks of this technique. Projects
obtained prematurely in comparison with subsequent cash flow obtained by the end of
years have value. There are two programs of the same time offer off span, but it has been
found that one plan produces additional cash flows in the preceding year.
 This comprises of various applications depending on the cost of estimation and analysis,
which decreases cash flow. Depending on theories, the work is performed on premises,
which challenge consequences and use this method to make successful decisions.
 This approach is not implemented in conjunction with the circumstance where
expenditure into a specific project is needed and the results of business operations are at
greater risk (Harris, 2017).
CONCLUSION
In the conclusion it is founded that the process of managing and controlling different kind
of management and financing activity within an organisation is known as managerial finance.
There are different type of ratio which are analysed for determining the actual profitability of
company in an accounting year. Investment appraisal techniques are very much effective in
identifying the most beneficial proposal that give higher results. There are certain limitation of
ratio analysis that must be consider by investor while obtaining the actual financial status of
company. Similarly each investment technique have some disadvantage and due to which results
can be negative in many situation.
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REFERENCES
Books and Journals:
Carbo‐Valverde, S., Rodriguez‐Fernandez, F. and Udell, G. F., 2016. Trade credit, the financial
crisis, and SME access to finance. Journal of Money, Credit and Banking. 48(1).
pp.113-143.
Gitman, L. J., Juchau, R. and Flanagan, J., 2015. Principles of managerial finance. Pearson
Higher Education AU.
Lee, S. P. and Isa, M., 2015. Directors’ remuneration, governance and performance: the case of
Malaysian banks. Managerial Finance. 41(1). pp.26-44.
Osterhoff, F. and Kaserer, C., 2016. Determinants of tracking error in German ETFs–the role of
market liquidity. Managerial Finance. 42(5). pp.417-437.
Van Essen, M., Otten, J. and Carberry, E. J., 2015. Assessing managerial power theory: A meta-
analytic approach to understanding the determinants of CEO compensation. Journal of
Management. 41(1). pp.164-202.
Xiang, D. and Worthington, A., 2015. Finance-seeking behaviour and outcomes for small-and
medium-sized enterprises. International Journal of Managerial Finance. 11(4). pp.513-
530.
Yarram, S. R. and Dollery, B., 2015. Corporate governance and financial policies: influence of
board characteristics on the dividend policy of Australian firms. Managerial Finance.
41(3). pp.267-285.
Uchide, T. and Imanishi, K., 2016. Small earthquakes deviate from the omega‐square model as
revealed by multiple spectral ratio analysis. Bulletin of the Seismological Society of
America. 106(3). pp.1357-1363.
Suzuki, D., Esaka, F., Miyamoto, Y. and Magara, M., 2015. Direct isotope ratio analysis of
individual uranium–plutonium mixed particles with various U/Pu ratios by thermal
ionization mass spectrometry. Applied Radiation and Isotopes. 96. pp.52-56.
Harris, E., 2017. Strategic project risk appraisal and management. Routledge.
Alkaraan, F., 2015. Strategic investment decision-making perspectives. In Advances in mergers
and acquisitions (pp. 53-66). Emerald Group Publishing Limited.
Throsby, D., 2016. Investment in urban heritage conservation in developing countries: Concepts,
methods and data. City, Culture and Society. 7(2). pp.81-86.
Online:
About Glaxo Smith Kline plc, 2019. [Online] available through:
<https://www.gsk.com/>
About Reckitt Benckiser Group plc, 2019. [Online] available through:
<https://www.rb.com/>
17