Balance sheet review
These companies disclose the several components in the stockholder’s equity. The first component disclosed by Merck & Co. Inc. is common stock. The second component is paid in capital for the company. The third component for Merck & Co. Inc. is retained earnings which are valued at $ 39,985,000. The first item for Novartis International AG is comprehensive income of $ 8,624,000. The other items are equity based compensation, dividends and changes in non-controlling interests (Walter, 2012). These companies have preferred stock. The special feature for Merck & Co. preferred stock is that it is convertible to ordinary stock. Novartis International AG has preferred stock that is redeemable. However, redeeming is allowed once in two years. The only company that holds treasury stock is Merck. In 2012, Merck reacquired treasury stock amounting to $ 1,593,000. The reason for the reacquisition was to finance its operating needs and capital expenditures.
Income statement review
The basic EPS for Novartis International was $ 3.93 while the diluted EPS was $ 3.89. Merck Incorporation had a basic EPS of $ 2.03 and a diluted EPS of $ 2.00. The only discontinued operations for the companies are medical studies. Novartis discontinued the study of NIC002 while Merck discontinued operations of MK0524B. This discontinuation has not had a substantial financial impact on the companies (Mongiello, 2009). Both of these companies report stock based compensation plans. This reporting is conducted by use of fair value method. The Black- Scholes model is applied by both companies. Historical and any current market data are applied in the model. The compensation expense by Novartis International amounted to $ 856,000 while that for Merck Incorporation was $ 521,000.
In this analysis, there are three profitability ratios that are to be analyzed. Based on the gross profit margin, Novartis International is more profitable than Merck & Co. since its ratio is higher than that of Merck. However, Merck turns out to be more profitable than Novartis basing analysis on net profit margin. This implies that Novartis had higher operating costs than Merck in 2012. Stockholders of Merck had a return of over 30% while those of Novartis had a return of 14%. The analyst’s story based on these profitability ratios is that Merck is the best company to commit investments (Cengage Learning, 2011).
In computing the quick ratio, inventory for each of these companies will be subtracted from current assets. This figure will be divided by current liabilities. Since inventory for Novartis International amounted to $ 6,744,000, its quick ratio will be ($ 28,004,000 - $ 6,744,000)/ $ 24,051,000 = 0.88. The figure for Merck will be ($ 34,857,000 - $ 6,535,000)/ $ 18,348,000 = 1.54. To compute inventory turnover for these two companies, cost of goods sold will be divided by average inventory (Drake, 2011). Average inventory for Novartis was ($ 5,930,000 + $ 6,744,000)/ 2 = $ 6,337,000. The Average inventory for Merck amounted to ($ 6,535,000 + $ 6,254,000)/ 2 = $ 6,394,500. The inventory turnover for Novartis was $ 18,756,000/$ 6,337,000 = 2.96. Merck had an inventory turnover of $ 38,528,000/ $ 6,394,000 = 6.03.
Based on liquidity ratios, Merck is more liquid than Novartis since it has recorded higher liquidity ratios, across all categories, than Novartis. A current ratio of 1.9 for Merck implies that its ability to pay current obligations is 1.9 times higher than the obligations themselves. This is higher than that of Novartis, which is 1.6. The quick ratio for Novartis is 0.88. Its ability to meet its current obligations after deducting inventory is less than the current obligations (Mongiello, 2009). However, Merck has a quick ratio of 1.54, implying that it has a higher ability to pay its current obligations than Novartis. The inventory turnover for Merck is more than double that of Novartis. It is an implication that Merck has a higher ability to obtain sales from its inventory than Novartis (Mongiello, 2009).
For leverage ratios, Merck recorded a debt to asset ratio, which was higher than that for Novartis. This implies that nearly half of its assets were financed by debt. For Novartis, only 44% of its assets were financed by debt. 91% of Merck’s equity was financed by debt while only 79% of Novartis equity was debt financed. These two ratios indicate that Merck is more burdened by debt than Novartis. The times covered ratio of above 12 for Novartis implies that its ability to pay for its interest expense is 12 times its revenues. For Merck, this ability is low since its times covered ratio is 3.58.
Information in footnotes
In the footnotes of these two companies, there is information on accounting policies. This information has been grouped under many categories including inventory and revenue recognition (SEC, 2007). Changes in executive compensation have been included in these footnotes. The other information regards debt maturities and legal cases involving Merck and Novartis.
Comment on ratio analysis
The balance sheet, ratios and income statement, are informative since they provide investors with crucial information on this company. Financial performance has been evaluated from these statements by use of ratios. Advantages of ratio analysis are that they are easy to compute and understand. They also provide a subjective company analysis (Walter, 2012). Disadvantages are embedded in their inconsistency. A company may perform well in liquidity and poorly in profitability hence confusing investors. They may not be effective in comparison across industries due to inherent industrial characteristics, for instance high capitalization (Walter, 2012).
Cengage Learning. (2011, November 15). Business Resources for Students: The Role of Financial Analysis. Retrieved from http://college.cengage.com/business/resources/casestudies/students/financial.htm: http://college.cengage.com
Drake, P. (2011). Liquidity Ratios . Financial Ratio Analysis, 53-54.
Mongiello, M. (2009). International Financial Reporting. New York: Perseus Publishers.
SEC. (2007). Disclosure in Financial Footnotes. Beginners' Guide to Financial Statements., 32.
Walter, I. (2012). Principles of Accounting. Massachusetts: Jones and Bartlett Publishers.