An empirical study on the profitability and its influencing factors of the pharmaceutical industry

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1 Available online Journal of Chemical and Pharmaceutical Research, 2014, 6(6): Research Article ISSN : CODEN(USA) : JCPRC5 An empirical study on the profitability and its influencing factors of the pharmaceutical industry Shi Yuqian and Gu Wenlin School of Business, HOHAI University, Nan Jing, China ABSTRACT The pharmaceutical industry is an important part of our national economy, combined with traditional industries and modern industries. However, China's pharmaceutical industry profitability has declined in recent years. There is a certain gap compared with other manufacturing industry. This paper selected 129 listed companies in the pharmaceutical industry as the research object. Establish the multiple linear regression models based on the factors that affect profitability. These factors include research and development ability (R&D ability), development capacity, solvency, operational capacity, marketing capabilities, cost Management, capital structure, cash flow management and level of risk. According to the models, analyze the current development of China's pharmaceutical industry and put forward some advices. Key words: pharmaceutical industry; profitability; influencing factors; correlations INTRODUCTION The profitability of the company is influenced by various factors. In the performance evaluation system of company, profitability is not only a core index, but also affects other aspects of performance evaluation. Companies engage in business activities, the most important goal is to maximize corporate profits and remain stable development. Profitability indicators are able to measure them. In addition, it is an important manifestation of managers operating performance and focused by all corporate stakeholders. Therefore, it is very important to analyze the corporate profitability [1]. In this paper, the reason for the pharmaceutical industry as sample is that the analysis of domestic profitability rarely involves a particular industry; the profitability of pharmaceutical industry has declined in recent years. So it is very worth studying. What s more, the pharmaceutical industry is one of the high-tech industry groups integrated by multidisciplinary advanced technologies and tools, involved in national health, social stability and economic development. 2. Literature Review Foreign scholars researched on the corporate profitability and its evaluation system long ago. MM capital structure theory is one of them. It is established by Modigliani and Miller. There are two conclusion of this theory. One is that capital structure affects the total value of the company; another is that debt management will bring the effect of tax saving. This theory provides a useful starting point and analytical framework for researching the problems about capital Structure. American scholar Alexander Wall once evaluated the profitability of companies based on five indexes. These indexes are net profit margin of assets, net profit margin on sales, return on stockholders' equity, accounts receivable turnover ratio and inventory turnover. Chinese scholars also have many related researches. However, domestic researches were less involved in the profitability of a particular industry. This article may make up for a little bit about the gap [2]. 1191

2 3. Process of Empirical Research 3.1 Introductions of Research Methods and Models This paper chooses panel data analysis. Panel data refers to taking multiple sections in time sequence, in order to analyze the sample data in three dimensions (time, individuals and indicators), that is analyzing the differences between individuals with taking the time factor into account. Panel data analysis can not only overcome the multicollinearity problems troubled by time series, but also provide more degrees of freedom and greater estimate efficiency. In addition, it could reflect some combined effects of the ignored factors of time and individual differences. Therefore, this article established four fixed effects models based on four different dependent variables on behalf of the corporate profitability. 3.2, Selection of Variables What the sample selected is twenty-two financial indicators of listed companies in China's pharmaceutical industry from 2011 to Among the indicators, Earning Per Share (EPS), Rate of Return on Total Assets (ROA), Rate of Return on Common Stockholders Equity (ROE) and Operating Profit Ratio are as dependent variables to measure the profitability of the pharmaceutical industry. It covers the aspects of benefits, profits, application of fund comprehensively. The remaining indexes are as independent variables, including nine aspects. They are research and development ability (R&D ability), development capacity, solvency, operational capacity, marketing capabilities, cost management, capital structure, cash flow management and level of risk. R&D ability is very important for the pharmaceutical industry, because the pharmaceutical industry needs to develop new medicine, as well as a large number of scientists and huge capital investment. However, R & D spending of the pharmaceutical industry could not be fully achieved, so R & D capability is represented by intangible assets ratio. Then, it will list a table linking the indexes with the influencing factors. Factors R&D ability Solvency Operational Capacity Marketing Capabilities Cost Management Capital Structure Cash Flow Management Level of Risk Indexes Intangible Assets Ratio Total Assets Growth Rate; Capital Preservation Increment Rate Current Ratio; Acid-test Ratio Accounts Receivable Turnover Ratio; Inventory Turnover Ratio; Current Assets Turnover Ratio; Total Assets Turnover Ratio Ratio of Expenses to Sales; Net Profit Margin on Sales; Management Expense Ratio; Financial Expense Ratio Debt Asset Ratio; Current Liabilities Ratio Operating Income Cash Ratio; Ratio of Capital Expenditures and Depreciation and Amortization Comprehensive Leverage 3.3 To Establish Models This paper uses econometric software Eviews to analyze samples by panel data and selects four fixed effects models by F test and Hausman test. The results of tests are in the following tables. Model One The dependent variable: Earning Per Share R&D ability Intangible Assets Ratio Total Assets Growth Rate Capital Preservation Increment Rate Solvency Current Ratio Acid-test Ratio Operational Capacity Accounts Receivable Turnover Ratio Inventory Turnover Ratio Current Assets Turnover Ratio Total Assets Turnover Ratio Marketing Capabilities Ratio of Expenses to Sales Net Profit Margin on Sales Cost Management Management Expense Ratio Financial Expense Ratio Capital Structure Debt Asset Ratio Current Liabilities Ratio Cash Flow Management Operating Income Cash Ratio Ratio of Capital Expenditures and Depreciation and Amortization Level of Risk Comprehensive Leverage c

3 Model Two The dependent variable: Rate of Return on Total Assets R&D ability Intangible Assets Ratio Total Assets Growth Rate Capital Preservation Increment Rate Solvency Current Ratio Acid-test Ratio Operational Capacity Accounts Receivable Turnover Ratio Inventory Turnover Ratio Current Assets Turnover Ratio Total Assets Turnover Ratio Marketing Capabilities Ratio of Expenses to Sales Net Profit Margin on Sales Cost Management Management Expense Ratio Financial Expense Ratio Capital Structure Debt Asset Ratio Current Liabilities Ratio Cash Flow Management Operating Income Cash Ratio Ratio of Capital Expenditures and Depreciation and Amortization Level of Risk Comprehensive Leverage c Model Three The dependent variable: Rate of Return on Common Stockholders Equity R&D ability Intangible Assets Ratio Total Assets Growth Rate Capital Preservation Increment Rate Solvency Current Ratio Acid-test Ratio Operational Capacity Accounts Receivable Turnover Ratio Inventory Turnover Ratio Current Assets Turnover Ratio Total Assets Turnover Ratio Marketing Capabilities Ratio of Expenses to Sales Net Profit Margin on Sales Cost Management Management Expense Ratio Financial Expense Ratio Capital Structure Debt Asset Ratio Current Liabilities Ratio Cash Flow Management Operating Income Cash Ratio Ratio of Capital Expenditures and Depreciation and Amortization Level of Risk Comprehensive Leverage c Model Four The dependent variable: Operating Profit Ratio R&D ability Intangible Assets Ratio Total Assets Growth Rate Capital Preservation Increment Rate Solvency Current Ratio Acid-test Ratio Operational Capacity Accounts Receivable Turnover Ratio Inventory Turnover Ratio Current Assets Turnover Ratio Total Assets Turnover Ratio Marketing Capabilities Ratio of Expenses to Sales Net Profit Margin on Sales Cost Management Management Expense Ratio Financial Expense Ratio Capital Structure Debt Asset Ratio Current Liabilities Ratio Cash Flow Management Operating Income Cash Ratio Ratio of Capital Expenditures and Depreciation and Amortization Level of Risk Comprehensive Leverage c

4 4. Analysis of the Empirical Results When P value is greater than 0.5, it indicates that there is almost no correlation between dependent variable and explanatory variables. Therefore, we should exclude the explanatory variables whose P value is greater than 0.5, when researching. Excluding irrelevant variables, Intangible Assets Ratio representing R&D ability is positively correlated with EPS and Operating Profit Ratio, which explains that the increasing Intangible assets would bring the EPS and Operating Profit Ratio growth in the companies. Nevertheless, in the second and third model, the Intangible Assets Ratio is negative correlated with ROA and ROE, which seems contrary to common sense. The reason may be that pharmaceutical manufacturing companies invest its assets to the land use rights vested in intangible assets in order to obtain GMP certification in recent years. Then, intangible assets don t achieve the practical effect on the economic, although the proportion of intangible assets of enterprises is increasing continuously. In the second, third and forth model, Current Ratio representing short-term solvency is negative correlated with ROA, ROE and Operating Profit Ratio, while Acid-test Ratio is positively correlated. In addition, Ratio of Expenses to Sales representing is negative correlated with ROA, ROE and Operating Profit Ratio, which shows that the increasing selling expenses leads to a decline in profitability. What the same in the four models is that Inventory Turnover Ratio representing Operational Capacity is negative correlated with the four dependent variables; Net Profit Margin on Sales representing Marketing Capabilities is positively correlated; Current Liabilities Ratio representing Capital Structure is negative correlated. Those relationships could typically illustrate the three factors have effects on profitability. Among these, liquidity and funds occupied of the inventory are not reasonable in the Pharmaceutical Industry. The stronger the marketing ability, the stronger the profitability. 5. Advices Currently, the entire pharmaceutical industry has entered a stage of full competition. Continuous price reduction of the policy drugs as well as the foreign pharmaceutical enterprises further into the domestic, which bring great challenges to the survival and development of Chinese pharmaceutical companies. So there are some advices to meet those challenges. 1. Improve the disclosure of intangible assets in accounting standards Accounting standards require a clear definition of intangible assets, to expand the scope of intangible assets. The "controllability", "measurable" intangible assets should be confirmed and revealed appropriately, making the carrying value of intangible assets reflect its true value better. It needs to increase the disclosure of intangible assets in financial statements; the specific constituent name and total amount of intangible assets need disclosure in the notes. In addition, it needs to strengthen the behaviors of disclosure of intangible assets of listed companies, making the names of the specific items of intangible assets to be unified. 2. Improve innovation capabilities and R & D capabilities The pharmaceutical industry is an innovative industry, which needs enough high-tech medical personnel. The biggest problem in China is that it is difficult to find new medicines for medical personnel. However, it is the most profitable part. Therefore, pharmaceutical industry should improve innovation capabilities and R & D capabilities in order to survive and profit in the market. 3. Expand sales channels and strengthen cash flow management The pharmaceutical industry should promote featured products with well-known brands. Currently, the number of companies in the pharmaceutical industry is large; products repeat and are low-tech. Therefore, companies must increase investment of the marketing aspects; increase marketing efforts; strive to expand the market; establish brand effect to improve the main business income. At the same time, the companies should control management costs and improve management efficiency. In order to realize the maximization of shareholders' benefit value, the companies of pharmaceutical industry must manage the cash flow efficiently to balance the financial leverage. Acknowledgements Thanks to the guidance of my teacher! REFERENCES [1] Lu Zhengfei; Xin Yu; J. Accounting Research, 1998, 8, [2] Wang Honghong; J. Finance and Economy, 2005, 5,

5 [3] Modigliani; F & M. H. Miller; J. The American Economic Review, 1963, 6, [4] Shleifer A and Vishny R. J. Journal of Political Economy, 1997, [5] Hall,L.A.; Bagchi-Sen; J.Technovation, 2007, [6] Thornhill; Journal of Business Venturing, 2006, [7] Porter; M. E; Harvard Business Review, 1979, [8] B.A.Gloy; L.W.Tauer; W.Knoblauch. Journal of Dairy Science, 2002,

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