The pharmaceutical business has the potential to benefit more fromimproving the Return On Invested Capital (ROIC) compared to anelectric utility firm. The ROIC is an indicator of the financialstrategies an organization adopts. Unlike growth, the economicindicator requires businesses to direct necessary, but nonstrategicactivities towards an ecosystem of partners with the ability toprovide services on a consumption basis. Specifically, benefits fromimproving financial ratio emanate from the capacity to manage theoperating expenses of businesses (McKinsey & Company Inc. et al.,2015).
In contrast, capital expenditures are reserved to support the corecompetencies of the firm. Consequently, the use of ROIC would greatlybenefit the prescription business due to the extreme flexibility andagility associated with its operations. Medical drugs organizationscan enter and exit diverse markets and geographies upon depictingsigns of profitability. Besides, such businesses have the ability toshift their modes of businesses from retailers to wholesalers basedon the characteristics of the markets, and the position occupied inthe supply chain (McKinsey & Company Inc. et al., 2015).
In contrast, the utility company has to invest heavily in capitalassets to generate the same profits as newly formed businesses(McKinsey & Company Inc. et al., 2015). Unlike thepharmaceutical, the utility organization does not have the ability toventure quickly into diverse geographies, and the substantialinfrastructure denies the required flexibility and agility.Consequently, the service organization lacks to benefit fromincreased ROIC due to the high amount of money tied up in the assets(Wiehle et al., 2012).
The pharmaceutical firm can outperform the utility business on allkey value drivers such as growth and ROIC and deliver lower totalreturns to shareholders (TRS)(McKinsey & Company Inc. et al.,2015). The incidence occurs when the drug business maintains a highROIC and growth but fails to retain its revenue generation in tandemwith the growth of the market (Massari et al., 2016). The medicalbusiness also provides a lower total return to shareholders (TRS)when it concentrates on improving its growth at the cost of ROIC.When the pharmaceutical has a high ROIC, it can only generate highreturns to shareholders by raising revenues faster than the market ascompared to raising the financial ratio (McKinsey & Company Inc.et al., 2015). However, the relationship between high ROIC and TRSdoes not indicate that the organization can forego growth. Medicaldrugs entities are only required to maintain an above the averagemarket ROIC for them to invest in growth even when there is lowprofitability (Wiehle et al., 2012).
The change from First in First out (FIFO) to Last In First Out (LIFO)during inflationary periods results to an increase in revenues andcash flows of a business entity. During the increased price times,the market reacts by increasing the prices of inputs used byorganizations in the production of goods. Inflations are caused byeither the increase in prices or the upsurge in costs of goods. Theescalation in expenditures and rates emanates from increased demandthat is non-commensurate to the growth in supply (Massari et al.,2016).
The use of First in First Out (FIFO), indicates that the organizationutilizes the prices before the inflationary period to compute thecost of goods sold (McKinsey & Company Inc. et al., 2015). Sincethe expenditures before the inflationary period are low, the cost ofgoods sold results in higher taxable income. Consequently, theorganization pays more tax and remains with diminishing levels ofcash flows (Wiehle et al., 2012).
In contrast, the use of (LIFO) during price hike periods enables thefirms to compute a higher cost of goods sold by using the increasedvalue of inputs: labor, machinery, and raw materials (McKinsey &Company Inc. et al., 2015). The increased cost of goods sold, whendeducted from revenues, produces lower taxable income and lowers thetax payable by the business. Consequently, the organization remainswith larger amounts of cash flows (Massari et al., 2016).
Massari, M.,Gianfrate, G., & Zanetti, L. (2016). Wiley financecorporate valuation. Hoboken: John Wiley.
McKinsey & Company Inc, Koller, T., Goedhart, M., &Wessels,D. (2015). Valuation: measuring and managing the value ofcompanies (6th Ed). New Jersey, NY. John Wiley & Sons, Inc
Wiehle, U., Diegelmann, M., Deter, H., Schömig, P. N., & Rolf,M. (2012). Corporate valuation methods, exemplarycalculations, pros and cons. Wiesbaden: Cometis.