GSK Problems In Evaluating Financial Statements Accounting Essay

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This report summarises the financial performance of the Glaxo Smith Kline. I have analysed the change in share price of Glaxo Smith Kline in the recent years and pointed out the reasons for the change. Financial performance of the company has been analysed by calculating different relevant ratios such as Return on Capital Employed, Asset turnover ratio, etc. Cash Flow Statement has also been used to discuss the financial performance of Glaxo Smith Kline. This Report also shows the problems faced by the users while evaluating the financial statements of Glaxo Smith Kline in particular and the statements in general.


GLAXO SMITH KLINE was formed in the year 2000 when GLAXO WELLCOME LTD AND SMITH KLINE BEECHAMS LTD merged together. The history of the company goes to around 18th century. It is a major global healthcare group which is engaged in the creation and discovery, development, manufacture and marketing of pharmaceutical products including vaccines, over the counter medicines and health related consumer products. It is one of the leading healthcare groups in the world. The company has grown from strength to strength in past few years. Following report analyses the performance of Glaxo Smith Kline over the past few years. The report is all about the changes in the share price, discussion on financial performance and problems of analysing and evaluating the statements of the company.

Glaxo Smith Kline prepares its financial report on the basis of IFRS (International financial reporting standards) as adopted by the European Union and also with guidelines issued by IASB (International accounting standard board). The company's financial statement is drawn in sterling and according to IFRS ACCOUNTING presentation. It comprises of income statement, balance sheet, a cash flow statement, statement of recognised income and expense and notes to the financial statements.


Glaxo Smith Kline is a public listed company and it is listed on London stock exchange and New York stock exchange. The shares of the company are traded in the market. In the last few years, it has seen lots of ups and down in the price of the shares in the market. The graph below shows the movement in the price of the shares of GSK in the last three years.

The share price of Glaxo Smith Kline has been varying in the last few years. The share price is around £14 at start of the year 2006. Company earned a very good profit as compared to last year and paid rich dividends in 2006 which in turn increases the price of the share from £14 to £16 at the end of 2006. The share price falls at the start of the year 2007. This is because of their major restructuring programme. Due to this programme the company incurred lots of cost which brought the Gross Profit ratio down. But in mid 2007 the share price increases from £13 to £14.10. The price of the share was £14 at the start of the year 2008 which decreased drastically to £9.85 in the mid 2008. Also Gross profit of Glaxo Smith Kline has gone down which has resulted in fall of share price. The shareholders holding have also gone down from £1503m to £1415m in 2008 which is another reason fall in share price.


Glaxo Smith Kline has grown from strength to strength from its formation. The financial performance of Glaxo Smith Kline has always been good.  Financial performance has been analysed in accordance with IFRS as adopted by European Union and also IFRS issued by the International Accounting Standards Board. Efficiency and financial performance of the company is analysed by calculating different ratios. According to Alexander and Nobes, Ratios are techniques for expressing the earnings structure, profitability, liquidity and potential of business organisations".

Liquidity ratio is one of the most important ratios to judge the short term liquidity position of the firm. Liquidity ratio compares current assets to current liabilities which mean that how will firm meet its short term obligations. Liquidity ratio is dived into current ratio and quick ratio. Current ratio means current assets divided by current liabilities. The standard current ratio is 2:1. Glaxo Smith Kline has a current ratio of 1.68 in 2007 and 1.72 in 2008. An increase in current ratio shows improvement in the liquidity position of the company. This helps maintaining the reputation of the company. But Current assets are financed by the either borrowing or equity capital which includes a cost with it. Quick ratio means how quick the current assets convert into cash. Gsk's quick ratio was 1.2 in 2007 and 1.3 in 2008. The ratio is good as the idle is 1:1.

The most important ratio which shows the efficiency of the company is Return On Capital Employed. This ratio analyses the efficiency of business as a whole. In the context of Glaxo Smith Kline the return on capital employed ratio in 2008 was 73.1% which is very low as compared to years before. This is because of Glaxo Smith Kline has increased its long term borrowing from £7067m in 2007 to £15231m in 2008. Return on capital employed is affected by company's major restructuring programme which has led into a fall in the share price of the company. This programme has reduced company's overall profit and hence reduced return on capital employed.

Another ratio to be considered is the earning per share or PE ratio. EPS has fallen in 2008 as compared to last 2 years. The PE ratio is still high which means investors are backing the management. But a slight fall in PE ratio indicates a lack of confidence in the investors in the company. The shareholders investment depends on the earning per share.

Gross profit ratio indicates the profitability of the company. The gross profit ratio (73.65%) of Glaxo Smith Kline has decreased slightly in 2008. The decrease in the gross profit ratio has resulted in fall of share price in last couple of years. This is mainly because of major restructuring programme in the year 2007. In October 2007, Glaxo Smith Kline announced new Operational Excellence restructuring programme which was approved by the board for the implementation of detailed plan. A second formal plan was also approved by the board and was announced in February 2009. These plans include all the areas of GSK's business, including selling and manufacturing and R &D. But because of the major restructuring programme there has been many closure of manufacturing sites in UK, staff has been reduced and they have incurred a foreign exchange loss due to liquidation of the company. This reason has also brought a dip in the share price of the company.

Return on equity ratio is another important tool to judge the effectiveness of the company. It compares net income of the company with shareholders equity. The return on equity ratio was 54.29% in 2007 and 58% in 2008. This ratio is after including the restructuring cost. The increase in the ratio is a good indication for the company. The company share price has still fallen despite the increase in return on equity. There is a decrease in retained earnings in the year 2008 as compared to 2007 which has led to an increase in the return on equity. The share price down because the there is an increase in demand of the shares of the company.

Asset turnover ratio is another important ratio which can guide user to the financial performance of the company. Asset turnover ratio means sales divided by the capital employed. In 2007, the sales ratio was 0.73:1 which has fallen to 0.61:1 in 2008. No doubt the sales have increased in 2008 but the percentage increase of capital employed is more than sales which brings the ratio down.

One of the aims of Glaxo Smith Kline has been satisfying the needs of shareholders. The company despite of having some decrease in profit over last three years has been paying good amount of interest to its shareholders. In 2008 Glaxo Smith Kline paid £2929m dividend to shareholders as compared to a dividend of £2793 in the year 2007 which is more despite of a lesser profit. This shows the company's commitment towards achieving its one of the main goal.


According to Perks, Cash flow statements are a better indicator of financial performance of the company. A cash flow statement consists of cash from operating, investing and financing activities. Investors will be happy to see a positive operating activity and a negative investing activity in order to invest in the company. A company can generate enough profit but cannot back itself with the cash flows then it is a bad sign in the context of investors. In the case of Glaxo Smith Kline the company has a good profit along with a strong backing of its cash flows. The cash flow statement is good enough to attract the investors for the company. The cash balance is 2008 is almost three folds than in 2006.In 2008 the cash from operating activities was £7205m which is much higher than £4357m in the year 2006. This shows the firms stability and a good indicator of a financial performance.


Investors who are willing to invest in a company should have a proper knowledge and guidance of the financial statement and financial data of the company. This is the reason all the listed companies prepare an Annual Report which accounts for the company's stewardship of assets and also the information of the previous year. The Annual Report of the company consists of consolidated balance sheet, an income statement, the statement of recognised income and expenditure, the statement of cash flows and notes to financial statements.

Annual Report of a company is not easy to understand for users.  A user might face several problems in respect with analysis and evaluation of the financial statements. Following are the problems which a user should consider while evaluating the financial statements of GSK in particular and in general:

  • Political and economical context: In political context, Government measures could impact the sales of the company. In economic context, any change occurred in the accounting period such as costs affecting gross profit, receivables etc.
  • Investor in Glaxo Smith Kline doesn't necessary come from an accounting background which might create a problem in understanding the terms of accounting statements
  • Ratios should be interpreted by the user with help of notes to financial statement. For example in the report of Glaxo Smith Kline, there is note regarding the major restructuring programme which a user need to understand before calculating the gross profit ratio because the programme had incurred a lot of cost which affected it.
  • A user should be able to understand that does the report give a true and fair view of all the financial statements. Investors may take risk if any company has misrepresented its financial statements. There is also a risk of window dressing. The defective goods could be including in the sales by a company saying that they will return the goods next year.
  • The effect of depreciation is also an area of concern for the user. The net amount shown in the books of accounts is calculated by deducting accumulated depreciation from cost. This value is not an estimate of value of assets. The valuation of business on this basis becomes very difficult.
  • Some ratios might be distorted. It means the ratios will not provide a fair reflection of the business. This is generally related to inventory turnover ratio. For example, when I was calculating the Return on capital employed ratio, the ratio showed a lot of difference as compared to the ratio calculated by the company. This might create a problem in the minds of investor as it became confusion in my mind.
  • The statements in the report may vary across different companies. Companies have a different ways of presenting their financial statements. This might lead to confusion in the minds of the investors.
  • There is a difference in the accounting policies. For example, companies adopt different methods of depreciation such as reducing balance method or straight line method.
  • Some companies have branches in different countries. Glaxo Smith Kilne is spread all over the world. Exchange adjustments problems might arise which calculating the ratios.
  • Glaxo Smith Kline is a huge company and has different medical products. It becomes difficult for the user to understand each and every product and value the company.
  • Some companies increase their stock at the end of the year which increases the profits and current assets in the financial statement. Investors will value the company on the basis of that increased profit which could hamper their investment in future.
  • Calculation of EPS is a problem. The calculation of earning per share differ under IAS 33 and US SFAS 128.
  • Asset turnover ratio is important guide to know the financial performance of the company. But this ratio is sometimes misleading to users. In GSK the ratio has decreased despite an increase in sale and capital employed.

This report indicates a good financial performance of the company in context with the shareholders as they are receiving rich dividends from the company. Profitability ratios such as return on capital employed and gross profit ratio remains high but there is certain downfall in the ratios in 2008 as compared to other years. The major restructuring programme is the reason of decrease in the ratio and the share price of the company as the programme has incurred lots of cost. The sales of the company are increasing every year which is a good sign for the company. The share price is increasing after the credit crunch period which is another healthy sign for the company as the investors have trust for the company. One of the most important things in valuing the company is the cash. Company's cash flow is threefold in 2008 as compared to 2006. It is true that users might face many problems in understanding the financial statements of the company, but in the end the investors want to earn profit while selling the shares and receive dividend from the company.  Major restructuring programme has hampered the growth of the company to a certain extent. But when this programme falls in place the company will be ensured of a success in the productivity of its operations.