Commented [u1]:

BE882-7: ACCOUNTING
AND FINANCE

SUBMITTED BY

MRIDHA, SRIJAN 2213410

Executive Summary
Novartis AG is a Swiss multinational pharmaceutical corporation based in Basel, Switzerland
which ranked in the global top five in terms of revenue (Wikipedia, 2023). In this report we have
analyzed the present situation of the company through ratio analysis and then tried to project the
income statement, cash flow and financial statement to understand the present valuation of the
company and based on that we can see expansion can create a significant value to the shareholder
as valuation is much more higher in case of expansion. Further we have explained the limitation
of the methods we used for projections and valuations.

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 Index
Executive Summary ................................................................................................................... 1

1. Novartis Business Dynamics ................................................................................................. 3

2. Ratio Analysis ........................................................................................................................ 4

2.1 Profitability Ratio .................................................................................................................. 4

2.2 Liquidity Ratio ...................................................................................................................... 5
2.3 Efficiency Ratio..................................................................................................................... 6
2.4 Solvency Ratio ...................................................................................................................... 7
3. Impact of Specific Accounting Practices ............................................................................... 8

4. Forecasted Financial Statement ............................................................................................. 9

5. Projected Fundamentals Based Valuation ........................................................................... 11

5.1 With Expansion Plan ........................................................................................................... 12

5.2 Without Expansion Plan ...................................................................................................... 12
6. Underlying Assumptions & Limitations .............................................................................. 13

7. Closing Thoughts ................................................................................................................. 15

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1. Novartis Business Dynamics
Novartis is a specialized medicine company that strives to provide high-value drugs to ease
society's biggest diseases through technological leadership in the field of research and
development, world-class commercialization, global accessibility, and data science. Novartis has
developed a new, specialized strategy anchored by eight multi-billion-dollar potential high-sales
brands, and the company has a large pipeline (Novartis, n.d.). It is now a "pure-play" Innovative
medicine business that focuses on five key therapeutic fields (cardiovascular and immunology,
neuroscience, cancer, and the field of hematology) that have significant market and pipeline
products in all of these areas, which target a high burden of diseases and offer significant growth
potential (Novartis, n.d.). Novartis has a strong financial position and is expected to see future
growth that allows it to launch $15 billion in share buybacks with the same level of liquidity
(Novartis, n.d.).
Novartis has seen solid revenue and profit growth due to its key growth brands, including
Cosentyx, Entresto, Zolgensma, and Kisqali. Novartis' key launch programs, such as Kesimpta,
Leqvio, Scemblix, and Pluvicto, have been gaining momentum (Novartis, n.d.). Novartis continues
to be a disciplined company and is focused on shareholders with its capital allocation to be sure
that it is balancing its investment in its company through organic investments as well as valuable
bolt-ons while also returning capital to shareholders through its increasing annual dividend as well
as the purchase of shares (Novartis, n.d.).
Novartis is implementing a modern organizational system that is designed to encourage expansion,
innovation, and efficiency, which is progressing well. Novartis provides a unified overview of the
risks that affect the entire company. This is known as the Novartis Risk Compass. Novartis Risk
Compass It highlights the four major risks. The business's Sandoz business model continues to
improve despite the COVID effects. Novartis anticipates that the group's core operating profits
will rise by a "low double-digit" percentage in 2023. This is up from the previous projections of a
high single-digit increase (Burger 2023).
Novartis seeks to improve its value per molecular unit from its extensive pipeline and to deliver
better finances with a +4% sales CAGR until 2027 and a Core Ops Inc. margin of 40 percent or
more in the middle-long term.

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2. Ratio Analysis
2.1 Profitability Ratio

a) Return on Capital Employed (ROCE) = Profit before deducting interest and taxation x100/(Share capital+
Reserve+ Non-Current Liabilities)
Year 2018 2019 2020 2021 2022
8403𝑥100 9086𝑥100 10152𝑥100 11689𝑥100 9197𝑥100
ROCE =7.24 =10.08 =10.25 =11.51 =10.36
115956 90106 99000 101587 88797

𝐺𝑟𝑜𝑠𝑠 𝑃𝑟𝑜𝑓𝑖𝑡
b) Gross Profit Ratio = 𝑥 100
Revenue

Year 2018 2019 2020 2021 2022

Gross 31,589 34,252 34,777 37,010 36,342
Profit 𝑥 100 𝑥 100 𝑥 100 𝑥 100 𝑥 100
44,833 47,498 48,659 51,626 50,545
Ratio =70.459% = 72.113% = 71.471% = 71.689% = 71.900%

𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝐼𝑛𝑐𝑜𝑚𝑒
c) Operating Profit Ratio = 𝑥 100
Revenue

Year 2018 2019 2020 2021 2022

Operatin 8,403𝑥100 9,086𝑥100 10,152𝑥100 11,689𝑥100 9,197𝑥100
g Profit 44,833 47,498 48,659 51,626 50,545
Ratio =18.74% =19.13% =20.86% =22.64% =18.20%

Comparison of Profitability Ratios

80.00%
70.00%
60.00%
50.00%
40.00%
30.00%
20.00%
10.00%
0.00%
2018 2019 2020 2021 2022

Gross Profit Operating Profit

Figure 1: Comparison of Profitability Ratios

Observations: ROCE investigates the interrelationship between operating profit with the average
long term capital invested (Atrill and MacLaney, 2019). For Novartis we can see that ROCE stable
year on year which signifies operational efficiency, stronger profitability and better utilization of
assets. The Gross Profit Margin remains relatively stable around the 71-72% mark. This indicates

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that the cost structure of the company's primary business remained consistent during these years.
The Operating Profit Margin increased from 2018 to 2021 but took a dip in 2022. This could be
due to increased operational costs or other factors affecting operating income.

2.2 Liquidity Ratio

𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝐴𝑠𝑠𝑒𝑡𝑠
Current Ratio =
Current Liabilities

Liquidity 2018 2019 2020 2021 2022

Ratio
Current 35,563 29,504 29,673 45,718 36,907
= 1.20 = 1.04 =0.90 = 1.51 =1.29
29,607 28,264 33,059 30,208 28,656
Ratio

𝐶𝑢𝑟𝑟𝑒𝑛𝑡 𝑎𝑠𝑠𝑒𝑡𝑠 𝑒𝑥𝑐𝑙𝑢𝑑𝑖𝑛𝑔 𝑡𝑜𝑡𝑎𝑙 𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑖𝑒𝑠

Acid Test Ratio =
Current Liabilities

Liquidity 2018 2019 2020 2021 2022

Ratio
Acid 28607 23522 22542 39052 29735
= 0.97 = 0.83 = 0.68 = 1.29 = 1.04
29607 28,264 33,059 30,208 28,656
Test
Ratio

Comparison of Liquidity Ratios

1.6
1.4
1.2
1
0.8
0.6
0.4
0.2
0
2018 2019 2020 2021 2022

Current Ratio Acid Test Ratio

Figure 2: Comparison of Liquidity Ratios

Observations: The Current Ratio, which measures the company's short-term liquidity, dipped
in 2019 and 2020 but has shown recovery in the following years. A ratio below 1 (like in 2020)
indicates that the company might have issues settling its short-term obligations if they all came
due at once. On the other hand, Acid test ratio shows significant progress after 2020.

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2.3 Efficiency Ratio
𝐴𝑣𝑒𝑟𝑎𝑔𝑒 𝑖𝑛𝑣𝑒𝑛𝑡𝑜𝑟𝑖𝑒𝑠 𝑥 365
Average Inventories Turnover Period =
Cost of Sales
Efficiency 2018 2019 2020 2021 2022
Ratio

Average 6911.5𝑥365 6469𝑥365 6556.5𝑥365 6898.5𝑥365 6920.5𝑥365

Inventories 14510 14425 15121 15867 15486
Turnover = 173.86 =163.69 = 158.26 = 158.69 =163.11
Period
𝑁𝑒𝑡 𝑆𝑎𝑙𝑒𝑠
Assets Turnover Ratio =
Average Total Assets

Efficiency 2018 2019 2020 2021 2022

Ratio

Assets 44833 47498

=0.36 48659 51626 50545
=0.41
131966.5 124624
Turnover 139321 125214.5 129786.5
Ratio = 0.32 = 0.39 = 0.40

Comparison of Efficiency Ratios

200
180
160
140
120
100
80
60
40
20
0
2018 2019 2020 2021 2022

AITP Assets Turnover Ratio

Figure 3: Comparison of Efficiency Ratios

Observations: Inventory turnover is an important key performance indicator for Novartis. We
can see mostly it decreased slightly from 2018 to 2022 from 173.86 days to 163.11 days. This
is due to slight increase in cost of sales. Assets turnover ratio also increased from 2018 to 2022
showing a positive trend towards efficient utilization of assets to generate sales.

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2.4 Solvency Ratio

𝑇𝑜𝑡𝑎𝑙 𝐿𝑖𝑎𝑏𝑖𝑙𝑖𝑡𝑖𝑒𝑠
Debt to Equity Ratio =
Total Equity
Solvency 2018 2019 2020 2021 2022
Ratio

Debt-to- 66,871 62,819

=1.13 71,112 63,973 58,030
=0.98
55,551 = 0.94 59,423
Equity Ratio 78,692 56,666 67,822
= 0.85 = 1.25

𝑃𝑟𝑜𝑓𝑖𝑡 𝑏𝑒𝑓𝑜𝑟𝑒 𝑖𝑛𝑡𝑒𝑟𝑒𝑠𝑡 𝑎𝑛𝑑 𝑡𝑎𝑥𝑎𝑡𝑖𝑜𝑛

Interest Coverage Ratio =
Finance Cost (Interest Charge on Debt)

Solvency 2018 2019 2020 2021 2022

Ratio

Interest 8403 9086 10152 11689 9197

=9.02 =10.69 = 11.68 = 14.41 = 10.99
932 850 869 811 837
Coverage
Ratio

Comparison of Solvency Ratios

16
14
12
10
8
6
4
2
0
2018 2019 2020 2021 2022

Debt to Equity Ratio Interest Coverage Ratio

Figure 4: Comparison of Solvency Ratios

Observations: The Debt to Equity Ratio increased from 2018 to 2020, indicating a rising
proportion of financing from debt relative to equity. However, it started decreasing in 2021 and
2022, indicating that the company might be relying less on external liabilities. From the interest
coverage ratio we can see that the company has sufficient amount of profit to service its interest
on debt.

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3. Impact of Specific Accounting Practices
Novartis's accounting policies emphasize various financial aspects. For instance, foreign currency
assets and liabilities are converted at year-end rates, with net exchange gains and losses reflected
in financial income or expenses. Derivatives are used for hedging and valued at fair value,
employing hedge accounting when necessary. Financial assets are assessed at acquisition cost
minus adjustments, and investments are initially recognized at cost, adjusting annually if there's
impairment. Goodwill and intangible assets are capitalized and amortized over 5 to 20 years, with
annual impairment reviews. Bonds are valued at nominal value with any premium accrued over
their lifespan. Provisions are set aside for general business risks. In 2019, a significant
development was the spin-off of Novartis's Alcon business. Approved by shareholders in February,
it was executed in April through a dividend distribution of Alcon Inc. shares, where each Novartis
shareholder received one Alcon share for every five Novartis shares held. As of April 9, Alcon
Inc. was listed on the SIX Swiss Exchange and the NYSE. The book value of Alcon Inc. at
distribution was CHF 17,288 million, comprising primarily of goodwill and investments in Group
subsidiaries. The distribution was recognized as a reduction to free reserves and legal capital
reserves. Additionally, 2019 witnessed extraordinary expenses related to the Alcon spin-off
transaction costs.

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4. Forecasted Financial Statement

Scenario (I) – With Expansion Plans:

Expansion Plans are Ratified and Announced in September 2023:

 Announcement of expansion will lead to increased investor confidence. This may result in

short-term stock price appreciation.

 Expansion will likely lead to an increase in capital expenditure and potentially increased

financing in the form of either debt or equity.

 Revenue might see a more significant growth rate as the expansion unfolds, but initially, there

could be a higher operational cost, impacting profit margins.

Scenario (II) - No Expansion Plans:

 Business continues as usual, with the given growth rate of 4%.

 Capital expenditure remains consistent, with no significant spikes.

 Profit margins remain relatively stable, as there won't be any significant costs associated with

expansion.to

Five year forecast

Income Statement (Only Important Objects)
Year Sales Operating Income Net Income
Scenario (I) Scenario (II) Scenario (I) Scenario (II) Scenario (I) Scenario (II)
2023 52,568 52,568 11,750 11,750 8,813 8,813
2024 56,752 54,670 12,000 12,100 9,000 9,075
2025 61,318 56,857 12,500 12,450 9,375 9,338
2026 66,295 59,130 13,050 12,800 9,788 9,600
2027 71,717 61,495 13,650 13,200 10,238 9,900

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Cash Flow (Only Important Objects)
Year Net Cash from Net Cash from Investing Net Cash from Financing
Operations
Scenario (I) Scenario (II) Scenario (I) Scenario (II) Scenario (I) Scenario (II)
2023 9,513 9,513 -5,500 -4,800 -3,000 -3,000
2024 10,500 9,788 -6,050 -4,992 -3,300 -3,060
2025 11,525 10,072 -6,655 -5,192 -3,613 -3,122
2026 12,601 10,375 -7,320 -5,400 -3,944 -3,182
2027 13,736 10,689 -8,052 -5,616 -4,291 -3,250

Balance Sheet (Only Important Objects)

Year 2023 2024 2025 2026 2027
Current Scenario (I) 38,220 41,503 45,348 49,779 54,714
Assets Scenario (II) 38,380 39,915 41,512 43,172 44,899
Total Scenario (I) 124,453 133,880 144,330 156,055 169,262
Assets Scenario (II) 124,453 129,351 134,525 140,066 145,869
Current Scenario (I) 29,500 31,580 34,090 36,955 40,204
Liabilities Scenario (II) 29,700 30,848 32,082 33,405 34,821
Total Scenario (I) 61,453 65,300 69,242 73,500 78,058
Equity Scenario (II) 61,753 64,503 67,528 70,828 74,348

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5. Projected Fundamentals Based Valuation

For Fundamentals Based Valuation we try to use discounted cash flow (DCF) method. The DCF

method takes future free cash flows and discounts them back to the present value to determine the

company's intrinsic value. The formula is:

𝑭𝑪𝑭
𝑷𝑽 = (𝟏+𝒓)𝒕 Where: PV is the present value of the cash flows.

FCF is the Free Cash Flow in year t. r is the discount rate. t is the year .

Let's assume a hypothetical starting point:

Net Cash from Operations (2023) = 5,000 m

Net Cash from Investing (2023) = 1,000 m

We will calculate Free Cash Flow (FCF) as:

𝑭𝑪𝑭 = 𝑵𝒆𝒕 𝑪𝒂𝒔𝒉 𝒇𝒓𝒐𝒎 𝑶𝒑𝒆𝒓𝒂𝒕𝒊𝒐𝒏𝒔 − 𝑵𝒆𝒕 𝑪𝒂𝒔𝒉 𝒇𝒓𝒐𝒎 𝑰𝒏𝒗𝒆𝒔𝒕𝒊𝒏𝒈

We can assume growth in FCF due to expansion. Let's assume, based on the details provided

earlier, that the net cash from operations increases by 12% yearly due to expansion, and net cash

from investing also increases but at a rate of 8% yearly.

For FCF & PV 2024 would be:

FCF (2024) = (5000 x 1.12) – (1000 x 1.08) = 5600 – 1080 = 4520m
4520
PV = = 4185.19
(1 + 0.08)1

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5.1 With Expansion Plan
Now Expansion plan Scenario (I)
Year Net Cash from Operation Net Cash from Investing FCF
2024 5,000 x 1.12 = 5,600 1,000 x 1.08 = 1,080 4,520
2025 5,600 x 1.12 = 6,272 1,080 x 1.08 = 1,166 5,106
2026 6,272 x 1.12 = 7,025 1,166 x 1.08 = 1,259 5,766
2027 7,025 x 1.12 = 7,868 1,259 x 1.08 = 1,360 6,508
2028 7,868 x 1.12 = 8,812 1,360 x 1.08 = 14,69 7,343

Year FCF PV
2024 4,520 4,520 / 1.08^1 = 4,185.19
2025 5,106 5,106 / 1.08^2 = 4,377.57
2026 5,766 5,766 / 1.08^3 = 4,577.24
2027 6,508 6,508 / 1.08^4 = 4,783.57
2028 7,343 7,343 / 1.08^5 = 4,997.52
Total PV for Expansion Plan 22,921.09m
With the expansion plans ratified, the total present value for the years 2024-2028 for Novartis

(based on our assumptions) would be 22,921 million.

5.2 Without Expansion Plan

No Expansion plan Scenario (II) (Assuming growth 2% and 4700 for 2023)

Year FCF PV
2024 4,700 x 1.02 = 4,794 4,794 / 1.08^1 = 4,438.89
2025 4,794 x 1.02 = 4,890 4,890 / 1.08^2 = 4,192.39
2026 4,890 x 1.02 = 4,988 4,988 / 1.08^3 = 3,959.64
2027 4,988 x 1.02 = 5,088 5,088 / 1.08^4 = 3,739.83
2028 5,088 x 1.02 = 5,190 5,190 / 1.08^5 = 3,532.23
Total PV for No - Expansion Plan 19,862.97m

So the projected value from the DCF for the expansion scenario is approximately 22.921 million,

while without the expansion, it's approximately 19.862 million. So we can say that the expansion

scenario projects a higher valuation, this suggests the expansion could create value for

shareholders.

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6. Underlying Assumptions & Limitations

Assumptions:
Stable Economic Environment: Our projections assume a consistent economic environment
without unforeseen shocks, such as pandemics, geopolitical conflicts, or financial crises.
Company's Competitive Position Remains Steady: The Company maintains its competitive
advantage, and there's no drastic change in its market share due to unforeseen competitive
pressures or new entrants.
Historical Trends Continue: Many forecasts assume that past trends in revenue growth, margins,
and costs are indicative of future performance. This may not always be the case.
Discount Rate and Growth Rate: The discount rate we used and the terminal growth rate are based
on broad estimates. Changes in these rates can significantly alter the valuation.
Constant Regulatory Environment: No significant changes in the industry's regulatory
environment that could impact the business's profitability or operational capabilities.

Limitations:
Inherent Uncertainty: By nature, all forecasts are based on estimates and assumptions, and actual
results will likely differ, potentially significantly, from forecasts.
Dynamic Business Environment: Changes in consumer preferences, technological advancements,
competitive pressures, regulatory shifts, or other external factors can rapidly alter a company's
financial trajectory.
Financial & Non-Financial Risks: Our model does not factor in potential non-financial risks such
as reputational damage, legal issues, or specific industry risks unless previously mentioned.
Limitations of the DCF Model: The Discounted Cash Flow model, while widely used, depends
heavily on the accuracy of the projected cash flows and the chosen discount rate. Small changes
in these inputs can lead to large variations in valuation.
Reliance on Publicly Available Data: If our forecast is based only on publicly available data, we
might miss out on nuances or strategic shifts known only internally to the company.

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Historical Data Might Not Predict Future: Just because something has happened in the past doesn't
guarantee it will continue in the future, especially in rapidly changing industries.
Time Horizon: The longer the forecast period, the greater the uncertainty. Predicting the next year
might be somewhat reliable, but predicting five years or more into the future adds layers of
uncertainty.
Cannibalization and Synergies: In scenarios where expansion or mergers are considered, often,
models might not fully capture potential product cannibalization or the synergies achieved from
such moves.
Macroeconomic Factors: Global economic conditions, interest rate changes, geopolitical tensions,
and other macroeconomic factors can impact the company's performance, which are hard to predict
accurately.

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7. Closing Thoughts

While financial forecasts and valuations are essential tools in decision-making, it's crucial to
approach them as guidance rather than absolute predictions. Given the inherent limitations and
uncertainties, it's often recommended to use a combination of models, seek expert opinions, and
continuously update forecasts as new data becomes available.

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8. References
1. Burger, L. (2023). Novartis raises 2023 forecast, maps out Sandoz spin-off. Reuters. [online] 18 Jul. Available at:
https://www.reuters.com/business/healthcare-pharmaceuticals/novartis-raises-full-year-outlook-launches-new-share-
buyback-scheme-2023-07-18/.

2. Novartis. (n.d.). Novartis unveils new focused strategy, underpinned by eight potential multi-billion dollar peak
sales brands & deep pipeline, at Meet the Management event. [online] Available at:
https://www.novartis.com/news/media-releases/novartis-unveils-new-focused-strategy-underpinned-eight-potential-
multi-billion-dollar-peak-sales-brands-deep-pipeline-meet-management-event.

3. Novartis. (n.d.). Novartis delivers strong sales growth, robust margin expansion and raises guidance. Announces
USD 15 billion share buyback and Board endorses Sandoz spin-off1˒2. [online] Available at:
https://www.novartis.com/news/media-releases/novartis-delivers-strong-sales-growth-robust-margin-expansion-and-
raises-guidance-announces-usd-15-billion-share-buyback-and-board-endorses-sandoz-spin-off12.

4. Novartis. (n.d.). Novartis announces new organizational structure to accelerate growth, strengthen pipeline and
increase productivity. [online] Available at: https://www.novartis.com/news/media-releases/novartis-announces-new-
organizational-structure-accelerate-growth-strengthen-pipeline-and-increase-productivity.

5. Novartis. (n.d.). Novartis delivers solid sales and profit growth. Strong performance of in-market brands supports
confidence in mid-term growth outlook. [online] Available at: https://www.novartis.com/news/media-
releases/novartis-delivers-solid-sales-and-profit-growth-strong-performance-market-brands-supports-confidence-
mid-term-growth-outlook#:~:text=Basel%2C%20April%2026%2C%202022%20%2D [Accessed 15 Sep. 2023].

6. Novartis. (n.d.). Novartis delivers continued strong momentum of key growth brands, progress on strategic
initiatives and confirms FY’22 Group guidance. [online] Available at: https://www.novartis.com/news/media-
releases/novartis-delivers-continued-strong-momentum-key-growth-brands-progress-strategic-initiatives-and-
confirms-fy22-group-guidance#:~:text=22%20Group%20guidance- [Accessed 15 Sep. 2023].

7. Novartis. (n.d.). Novartis unveils new focused strategy, underpinned by eight potential multi-billion dollar peak
sales brands & deep pipeline, at Meet the Management event. [online] Available at:
https://www.novartis.com/news/media-releases/novartis-unveils-new-focused-strategy-underpinned-eight-potential-
multi-billion-dollar-peak-sales-brands-deep-pipeline-meet-management-event.

8. Novartis’ (2023) Wikipedia. Available at: https://en.wikipedia.org/wiki/Novartis (Accessed: 12 September 2023)

9. Berk, J. and DeMarzo, P., 2020. Corporate Finance, 5th ed. Essex: Person education limited.

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