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BrAPP/University of Wales Postgraduate Course in Pharmaceutical Medicine. Financial Management, Budgeting, Cost Behaviour, and Management Skills 14 th June 2012. Roadmap. Introduction & Overview Finance in Context The Cost of Clinical Trials What Cost? Workshop Financial Management

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Brapp university of wales postgraduate course in pharmaceutical medicine

PGCPM 14th June 2012

BrAPP/University of WalesPostgraduate Course in Pharmaceutical Medicine

Financial Management, Budgeting, Cost Behaviour, and Management Skills

14th June 2012


Roadmap

Roadmap

  • Introduction & Overview

  • Finance in Context

  • The Cost of Clinical Trials

    • What Cost?

    • Workshop

  • Financial Management

    • The Financial World

    • The Credit Crunch

    • The Accounting System

  • Financial Organisation and Control


Introduction and overview

Introduction and Overview

PGCPM 14th June 2012


Introduction overview

Introduction & Overview

  • Who am I?

    • Neil Serjeant

    • Chartered (Global) Management Accountant

    • CEO Shared Services for the Department for the Environment, Food and Rural Affairs (Defra).

    • Worked extensively in the pharmaceutical industry with Huntingdon Life Sciences, Pharmaco and most recently with Quintiles Transnational


Brapp university of wales postgraduate course in pharmaceutical medicine

  • Health Warning!

    • Finance can be excruciatingly boring

      • I will try and keep it interesting and relevant to you

      • Interact with me (laugh at my jokes….please)

      • Ask questions as we go

      • Please sleep quietly so as not to disturb others!


Finance in context

Finance In Context

PGCPM 14th June 2012


Finance is central to business success

Finance is Central to Business Success

  • The ability to measure success is pivotal to success and good management:

    • If you don’t measure it how will you know you’ve achieved it?

    • Without objective data on performance, business decisions will be poorly informed.


Finance in context1

Finance in Context

  • However

    • “Measurements that do not spell out the assumptions with respect to the non-measurable statements that are being made - at least as boundaries or restraints - misdirect and misinform.”

    • “Yet the more we can quantify the measurable areas, the greater the temptation to put all out emphasis on these. And the greater therefore the danger that what looks like better controls will actually mean less control, if not a business out of control altogether.”

      MANAGEMENT - Peter F Drucker, Butterworth/Heinemann Oxford 1992.


Finance in context2

Finance in Context

  • “There seemed to be a common belief that everything could be measured and that, if only the accountancy systems were better, and we embraced such concepts as discounted cash flow, success would automatically follow.”

  • “The difficulty is that there can never be any single correct solution for any management problem, or any all-embracing system which will carry one through a particular situation or period of time.”

    MANAGING TO SURVIVE John Harvey-Jones

    Heinemann, Oxford 1993


Finance in context3

Finance in Context

  • So Finance and measurement of the financial performance is PART of the management process and is NEITHER a panacea NOR an end in itself.


The cost of clinical trials

The Cost of Clinical Trials

Financial Management of Clinical Trials

PGCPM 14th June 2012


Financial control of clinical trials

Financial Control of Clinical Trials

  • Why?

  • How?


Brapp university of wales postgraduate course in pharmaceutical medicine

Why?

  • In the context of the pharmaceutical company, to maintain costs within budget.

  • In the context of the CRO to deliver financial returns to the shareholders


How the cro model

How? - the CRO model

  • Understand how it works in the context of the CRO

  • Apply the principles in other contexts


Cost drivers in clinical trials

Cost Drivers in Clinical Trials

  • Time

    • hours

    • rates

  • Investigator Grants

    • fees

    • patient visits

  • Travel and Other Disbursements

  • Overheads


Types of contract

Types of Contract

  • Fee for Service

  • Fee for Service (with a cap)

  • Fixed Price

  • Fixed Unit Price


Fee for service

Fee for Service

  • Generally no fixed budget

  • The contract will specify rates for levels of staff provided, or activity undertaken

  • Fees invoiced in accordance with contract at volume x rate.

  • Advantages

    • Protects CRO from scope changes

  • Disadvantages

    • Rewards CRO inefficiency

    • Discourages innovation


Fee for service with a cap

Fee for Service with a “cap”.

  • Same as Fee for Service above but with a financial limit

  • Fees invoiced in accordance with contract

  • Renegotiation to commence when the budget cost is expected to be exceeded

  • Advantages

    • Limits financial exposure of client

  • Disadvantages

    • Limits upside but not downside for CRO

    • “Worst of all worlds”


Fixed price contracts

Fixed Price Contracts

  • Price negotiated at a fixed budget e.g. £1m

  • Costs exceeding budget due to “Out of Scope Work”: Sponsor pays

  • Cost exceeding budget due to CRO problems: CRO pays

  • Project Budgets only amended for client approved renegotiation

  • Fees invoiced on a milestone basis


Fixed price contracts1

Fixed Price Contracts

  • Advantages

    • Encourages CRO to innovate and be efficient

    • Client has fixed exposure

  • Disadvantages

    • Frequent (and frequently arduous) negotiations on changes of scope


Fixed unit price

Fixed Unit Price

  • Risk is shared

  • Price negotiated for each unit of work, eg

    • Price per monitoring visit

    • Price per evaluable patient recruited

    • Price per evaluable patient completing treatment

    • Price per page data entry

  • Billed according to progress

  • Advantages

    • Reduces need for contract renegotiation

    • Encourages efficiency & innovation


  • Pause for thought objective

    Pause for thought: objective

    • A quality clinical trial delivered on [ahead of] time and at [below] budget.


    Cro finances

    CRO Finances

    • A CRO earns revenue from the work it performs for its customers. Revenue recognised in each period is the value of work performed on each contract.


    Cro finances1

    CRO Finances

    • A CRO incurs costs from performing its work. Major costs are people-related (salaries, benefits, travel).

    • Under the accruals concept, costs and revenues must be matched in each reporting period to provide investors (and managers) with a fair view of the financial performance of the organisation.


    Financial control case study the cro model

    Financial Control Case StudyThe CRO model

    REFERRING to FINANCIAL WORKSHEET

    CONTRACT DETAILS

    • B: ORIGINAL PRICE is the price at which the CRO has contracted to perform the project for its client.

    • C: MODIFICATIONS shows the increase or decrease in the contractual price once the change has been formally agreed between the CRO and the client.

    • D: TOTAL PRICE is the sum of the original price and any agreed modifications (ie B+C)


    Brapp university of wales postgraduate course in pharmaceutical medicine

    VALUE OF TIME WORKED is the number of hours booked by CRO staff to the project multiplied by their hourly selling rate.

    • E: BUDGET is the CRO’s internal estimate for its work on the trial, based on the number of hours and the rate at which those hours are sold.

    • F: THIS MONTH is the number of hours worked this month multiplied by the rates at which those hours are sold.

    • G: CUMULATIVE is the number of hours worked on the project to date multiplied by the rates at which those hours are sold.

    • H: EAC – Estimate at Completion - is the latest projection by the CRO of the total number of hours to be worked on the project by the time it is completed, multiplied by the rates at which those hours are sold.


    Brapp university of wales postgraduate course in pharmaceutical medicine

    I: % COMPLETE is calculated as the value of time worked to date (cumulative) divided by the EAC (ie G/H). It represents one way of assessing objectively how much of the project is done and how much remains to be done.


    Brapp university of wales postgraduate course in pharmaceutical medicine

    REVENUE RECOGNITION is the amount of the total contract price the CRO can book as income based on the % complete.

    • J: Cumulative Revenue Recognised in a Fixed Price Contract is calculated as the % Complete multiplied by the Contract Value (ie D x I).

    • K: This Period Revenue Recognised is simply this month’s cumulative number less last month’s cumulative number.


    Case study

    Case Study

    Therapeutic Pharmaceuticals

    And

    Rapid Outsource Partners

    PGCPM 14th June 2012


    Suggested lessons learned

    Suggested Lessons Learned

    • Open bidding

    • Communicate! Communicate!! Communicate!!!


    From within the industry

    From within the industry

    • Project Budget

      • complete

      • accurate

      • timelines

    • Unspent budget at the and of the year may not be carried forward!


    Financial management

    Financial Management

    1. The Wonderful World of Finance

    PGCPM 14th June 2012


    Speculate to accumulate 1

    Speculate to Accumulate - 1

    • An entrepreneur mortgages his home to fund equipment for his new business.

    • The business fails

    • The creditors take possession of the entrepreneur’s home

    • Results:

      • unhappiness

      • entrepreneur becomes an accountant!


    Speculate to accumulate 2

    Speculate to Accumulate - 2

    • An entrepreneur persuades 100 people to invest £100 with limited liability in his new company

    • The company fails

    • 100 people lose £100

    • The creditors receive only some of what’s owed them

    • Results

      • 100 disappointed investors

      • Somewhat unhappy creditors

      • The entrepreneur tries again

      • The investors invest again


    Speculate to accumulate 3

    Speculate to Accumulate - 3

    • An entrepreneur persuades 100 people to invest £150 with limited liability in his new company

    • The company succeeds

    • 100 people receive a dividend on their investment. They find they can sell their £150 stake for £200.

    • Results

      • 100 happy investors are incentivised to invest some more.

      • The company expands and creates new jobs


    Limited liability

    Limited Liability

    • Under limited liability, investors stand to lose only their stake in the event of the failure of the company in which they invested.

    • Limited liability is a relatively new concept dating back to around 1600 when the East India Company was founded. It started 2 “big things”

      • The owners stood to lose only what they invested, not the shirt off their back.

      • The company had professional managers who were not the owners of the company.

    • These 2 fundamental principles characterise the capitalist business world today.


    Stocks and shares

    Stocks and Shares

    • The owners of a limited liability company own some or all of the company through share ownership.

    • A company issues SHARES in exchange for cash. If there are 1,000 shares, each shareholder owns one thousandth of the company.

    • Collectively shares are referred to as stock.

    • Shares may be privately held (eg “Acme Ltd”) or publicly traded (eg Acme PLC/Plc/plc)


    Stocks and shares1

    Stocks and Shares

    • The company uses the cash received to purchase materials and invest in plant and machinery.

    • With these is makes its product and sells it (hopefully) for a profit.


    Stocks shares

    Stocks & Shares

    • Profits are:

      • re-invested in the business to fuel growth, and/or

      • shared with the shareholders by way of a DIVIDEND

    • DIVIDENDS reward shareholders for the risk they have taken in investing and the utility they have foregone in not having their cash available.


    Stock market

    Stock Market

    • Publicly traded shares are bought and sold on a stock market.

    • Shares of a successful company will be in demand; the share price will rise.

    • Investors feel good; they anticipate being able to sell at a higher price than they paid. Rising prices are a further reward to shareholders (who can sell their shares for more than they bought them).

    • The proceeds from a rising stock price do not directly benefit the company.

    • A rising stock market is known as a “Bull” market; the early 2000s saw bull markets in Europe and the US.


    Stock market1

    Stock Market

    • Shares of a failing company will not be in demand; the share price will tend to fall.

    • Investors feel bad; they may have to sell their shares a lower price than that at which they bought them.

    • A company’s financial position does not suffer directly when its share price falls. However the value the market is placing on it is falling.

    • Falling stocks characterise a “Bear” market such as we saw between mid 2008 and early 2009.


    Ftse index 3 year trend

    FTSE Index 3-year Trend


    Health warning

    Health Warning!

    • Savvy investors make money in Bull and Bear markets.

    • You can lose money in Bull and Bear markets.


    Company ownership

    Company ownership

    • The shareholders are the owners of the company.

    • They appoint the board of directors to run the company for them, and hold them to account at the Annual General Meeting.

    • They have a vote on key issues relating to the business, including executive pay, and appointment of independent auditors.

    • In the UK, most shares are held by institutional investors, eg pension funds. In other economies, the number of private investors is greater, eg France, USA.


    Investor protection

    Investor Protection

    • The South Seas Company scandal (reporting stock as income and paying dividends from capital) led to the South Seas Bubble Act in 1720. This was the first attempt to regulate misleading accounting practices.

    • Most company legislation is designed to protect investors, including requirements provide them with objective information on the financial performance of their company.

    • Much of this objective information is provided by way of company accounts, which are prepared to national and international standards.


    Financial management1

    Financial Management

    2. The Credit Crunch


    The perfect storm

    The perfect storm

    • “The main lesson to draw from the events of the credit crunch is that in the economy, when the hurricane strikes the earthquake is not far behind. When things go wrong, everything goes wrong at once.

    • It's worth having an understanding of this variant of Murphy's law because in general, when life is stable we are good at imagining all sorts of things that can turn sour. But what we are not good at preparing for, is everything turning sour in one go.”

      Evan Davis


    Brapp university of wales postgraduate course in pharmaceutical medicine

    • I suspect the reason that bad news comes in waves is that economic systems are far more integrated than most of us realise. You change one piece of the machine (turn house price rises to house price falls, for example) and more things are affected than you could have imagined.

    • And in the economy, because so many different variables are upheld largely by confidence or sentiment, a knock to confidence in one area can easily be the trigger for a knock in confidence somewhere else as well.. (for example, sub-prime disasters in the US damage confidence in the reliability of UK banks .. so no-one lends to them for non-sub-prime mortgages).

      Evan Davis


    Paradigms lost

    Paradigms Lost

    • the confidence of the financial sector has taken a knock, and with it the presumption that the future of our economy lies in expanding the city ever further

    • the reliance on consumer spending in the UK (and US) is no longer seen as being able to carry on sustaining the economy - saving is cool again

    • the unipolar economic world order, centred around the United States, has been significantly diluted as Asia strengthens in relative terms, and the US even depends on exports to Asia to cushion its slowdown.

    • the idea that raw materials can permanently be cheap has been challenged - commodity price hikes have alerted the world to possible shortages

      Evan Davis


    Financial management2

    Financial Management

    3. The Accounting System


    Brapp university of wales postgraduate course in pharmaceutical medicine

    PGDPM/BrAPP 6th June 2007


    Not something new

    Not something new

    1340: Venetian merchants noted to use double entry bookkeeping: the City of Massri Treasurer’s Accounts are in double entry form.

    1485: Codified by Luca Pacioli in his“Summa de ArithmeticaGeometricaProportionalita”

    1500s: Concepts of “Going Concern” and “Accruals” develop.

    1673: Code of Commerce in France requires biannual balance sheet reporting.


    4 key principles

    4 key principles

    • Going concern

    • Prudence

    • Matching

    • Consistency


    Double entry bookkeeping

    Double Entry Bookkeeping

    • Every transaction is recorded as a movement of funds from one account to another.

    • One account is debited (dr), the other is credited (cr) - “double entry”

    • These transactions are recorded in the Journal or Day Book as they happen, and are numbered consecutively #1, #2, #3, etc


    The accounting system explained

    The Accounting System Explained

    • When a company starts it has an opening Balance Sheet reflecting what it consists of (“what is has, where it came from”)

    • It trades. The results of the trading are reflected in the Income Statement

    • At the end of the year the company’s Balance Sheet shows the effect that trading has had on what it has and where it comes from.

    • The Budget is our map to get from the beginning to the end.


    The accounting system explained1

    The Accounting System Explained

    • The BALANCE SHEET

      • is a snapshot at a point in time

      • tells us what a company has and where it got it from

    • The INCOME STATEMENT

      • tells the story of a period of time

      • demonstrates how we moved from one BALANCE SHEET to the next


    The accounting system simple

    The Accounting System - Simple

    Opening Balance

    Sheet

    Income

    Statement

    Transactions

    Closing Balance

    Sheet


    The accounting system less simple

    PGDPM/BrAPP 6th June 2007

    The Accounting System - less Simple

    Opening Balance

    Sheet

    Management

    Accounts

    Transactions

    Income

    Statement

    Closing Balance

    Sheet

    Annual Budget

    Cash Flow


    Financial management3

    Financial Management

    4. Financial Statements


    Financial statements

    Financial Statements

    • All firms produce Financial Statements

      • income statements

      • balance sheets

      • cash flow statements

    • Financial statements form the context for measuring financial performance

      • of the firm

      • of units (divisions, profit centres, cost centres) within the firm

      • of projects


    Financial statement uses

    Financial Statement—Uses

    • To manage the business (internal)

    • Provide information to shareholders (external)

    • Meet statutory reporting requirements for governments and taxing authorities (external)


    Financial statements required

    Financial Statements - Required!

    • Financial statements are required country by country, and requirements are different from country to country.

    • So, for example, Quintiles produces

      • Local country Financial Statements to meet statutory requirements in individual countries

      • Consolidated US Financial Statements for its primary investors.


    Mind the gaap

    Mind the GAAP!

    • Generally Accepted Accounting Principles (GAAP)

    • Vary from Country to Country

    • International Financial Reporting Standards (IFRS)


    The income statement profit and loss account

    The Income Statement(“Profit and Loss Account”)


    Income statement content 1

    Income Statement Content (1)

    • A CRO

      Gross revenue

      less: Pass-through Expenses

      Equals: Net revenues - prime external measure

      less: Direct or Variable Expenses

      Equals: Contribution Margin

      less: Overheads

      Equals: Operating Income


    Income statement example cro

    Income Statement - example CRO


    Income statement content 2

    Income Statement Content (2)

    • A Pharmaceutical Company

      Sales

      less: Cost of Sales

      Equals: Contribution or Margin

      less: R&D expense

      less: Selling, General and Administrative Costs

      Equals: Operating Income


    Income statement content 3

    Income Statement Content (3)

    • Beyond Operating Income

      Operating Income

      less: Other Costs/Income (eg FX, Interest, etc)

      Equals: Earnings Before Tax

      less: Tax Charge

      Equals: Net Earnings

      divide by: Number of Shares

      Equals: Earnings per Share (EPS)


    Brapp university of wales postgraduate course in pharmaceutical medicine

    PGDPM/BrAPP 6th June 2007


    The balance sheet

    The Balance Sheet


    Balance sheet

    Balance Sheet

    • The key...

      • The Income Statement presents the story for a period of time

      • The Balance Sheet provides a snapshot of the business at a point in time


    Balance sheet1

    Balance Sheet

    • The Balance Sheet tells us:

      • What we have (“assets” or “debtors”)

      • Where is came from (“liabilities” or “creditors”)

    • It also distinguishes assets which are readily available for use or conversion (“current”) from those which are not (“fixed” or “long term”)


    Balance sheet assets debtors

    Balance Sheet - Assets (debtors)

    • What we have:

      • Fixed Assets

        • tangible

        • intangible

      • Current Assets

        • cash (in hand; at the bank)

        • accounts receivable (money I am owed)

        • inventory


    Balance sheet liabilities creditors

    Balance Sheet - Liabilities (creditors)

    • Where it has come from:

      • Current Liabilities

        • overdrafts and loans (“from the bank”)

        • accounts payable (“from our suppliers”)

        • tax payable (“from HM Revenue & Customs”)

      • Long-term liabilities

        • share capital (“from the shareholders”)

        • retained profits (“from trading”)


    Brapp university of wales postgraduate course in pharmaceutical medicine

    PGDPM/BrAPP 6th June 2007


    Cash flow

    Cash Flow


    Brapp university of wales postgraduate course in pharmaceutical medicine

    "Annual income: Twenty pounds, Annual expenditure Nineteen pounds nineteen and sixpence: result happiness. Annual income Twenty pounds, Annual expenditure: Twenty pounds ought and sixpence: result misery".

    Wilkins Micawber

    Debtors’ Prison


    Cash flow1

    Cash Flow

    • Cash is the lifeblood of any company.

    • Cash Outflow > Cash Inflow = Trouble!

    • Profitable companies fail because they have inadequate cash flow


    Cash flow example

    Cash Flow - example

    Traditional Fee for Service Billing

    0

    Day

    75

    90

    45

    60

    Work

    Performed

    30

    Invoice

    Paid

    Invoice

    rendered

    Best case scenario: Days Sales Outstanding = 75 days


    Cash flow2

    Cash Flow

    • To neutralise its cash flow the CRO will need to collect 60 days or more UP FRONT (adjusted throughout project)

    • Customers are keen to hand on to their money until they have the results.


    Finance and corporate governance

    PGDPM/BrAPP 6th June 2007

    Finance and Corporate Governance


    Corporate governance the new world

    Corporate Governance - the new world

    • The roles of the audit committee and the Finance Director have changed in the post-Enron/-WorldCom/-Tyco world.

      • The Sarbanes-Oxley Act (Sarbox) requires CFO and CEO of US companies with publicly traded stock or debt to sign the numbers: “These numbers are correct, but if they’re not please send me to prison”.

      • Audits focus on “True and Fair” view AND, separately, on the adequacy or otherwise of internal controls.

      • In the UK, Derek Higgs has encouraged better practice in the transparency and visibility of corporate reporting.


    Internal control

    Internal Control

    • The board of directors has a fiduciary duty (“duty to demonstrate good faith”) to the owners of the company

      • Formally the responsibility of board of directors

      • Personified in the Finance Director or Chief Financial Officer


    The audit committee

    The Audit Committee

    • Small group of non-executive directors

    • Works closely with Finance and Auditors to assure financial control

      • solid processes

      • “encourage” whistle-blowers

      • brake on executive greed


    Internal control1

    Internal Control

    • The processes by which the company decides things, and particularly by which payments and financial commitments are approved.

    • Examples of Internal Controls

      • Authorisation limits

      • Chart of Accounts

      • Credit Policy

      • Capitalisation Policy


    Final questions

    Final Questions?


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