Annual Financial Report Analysis for British Airways PLC - Case Study Example

INTRODUCTION Introduction To The Report This report exhibits a thorough analysis of the annual report and financial ments of British Airways Plcfor the year ended 2005. It demonstrates the use of a wide range of profitability ratios obtained from the FAME database. These ratios are applied to the financial results of the company to better evaluate the company’s financial performance and position and to compare and contrast these results for the year 2005 with those of the previous year to identify any improvements, hindrances, cut backs or decline in the company’s performance over the years und the light of the important sections in the company’s annual report i.e., notes to the accounts, statement of accounting policies, directors’ report, operating and financial review statement, chief executive’s statement, chairman’s statement and the press releases of the company in order to illustrate the impact of any of the company policy, market and environment on the company’s financial performance during the year. At the end of the report, important factors critical to the company’s future growth and financial performance have been presented based on the analysis. Introduction To The Company British Airways is the worlds second largest international airline, carrying more than 27 million passengers, and one of the worlds longest established passenger brands. In the financial year to 31 March 2004, more than 36 million people chose to fly on flights operated by BA. An average of 51,939 staff were employed by the group worldwide in 2003-2004, 85.0 per cent of them based in the UK. Unlike some of the worlds other airlines, BA is owned entirely by private investors - with around 260,000 shareholders, including some 49 per cent of the companys own employees (British Airways Plc, accessed 6.12.2005) The main activities of British Airways Plc and its subsidiary undertakings are the operation of international and domestic scheduled and charter air services for the carriage of passengers, freight and mail and the provision of ancillary services (1) BAs main business is the provision of scheduled passenger services, which accounted for approximately 83% of the Companys turnover during the fiscal year ended March 31, 2005 (fiscal 2005). The Company also provides other services to outside parties, such as aircraft maintenance. The Companys operations also include certain ancillary airline activities, including air cargo (British Airways, accessed 5.12.2005) -- Products British Airways Group fleet as at 31 December 2004 comprised 293 aircraft - one of the largest fleets in Europe. The fleet currently includes 57 Boeing 747s, 43 Boeing 777s, 21 Boeing 767s, 13 Boeing 757s, 66 Airbus A319/320/321s, 34 Boeing 737s and 59 smaller aircraft used in the companys regional business (British Airways Plc, accessed 6.12.2005). -- Market The airline industry in Europe is on the upswing again after the setbacks of 9/11 attacks. The planes once idled are back in the air and orders for new planes are stacking up to meet the demand of more passengers. However there has been a shakeout of smaller regional European low-cost carriers as growth in the sector boomed in the last several years then busted. Players like Ryanair and easyJet stand to gain as the market self-adjusts. As fuel prices creep ever higher a shakeout in North America is almost assured. In the first half of 2005 the 10 largest airlines together lost nearly $5 billion. Bankruptcy hovers like a hungry buzzard over legacy and low-cost carries alike. US Airways and UAL (parent company of United Airlines) have already done hard time in bankruptcy court (the former has gone through bankrupt twice and the latter has been in Chapter 11 for three years). Delta Air Lines and Northwest Airlines have also filed Chapter 11 as the fuel price spike resulting from Hurricane Katrina rubbed salt in their wounds. Despite all the bad news there are some success stories. Low-cost pioneer Southwest Airlines is doing quite well, thanks in large part to its aggressive hedging of fuel prices. Fellow low-cost carrier JetBlue is also profitable. After more than a year since the merger took off, the Air France-KLM marriage seems to be working due to exploiting synergies, eliminating redundancies, and an effective fuel hedging policy. But altogether, the airline industry is expected to shrink over the time (Airlines Industry Profile, accessed 5.12.2005) PERFORMANCE EVALUATION A cursory glance over the annual report of British Airways Plc for the year ended 2005 shows tremendous financial results. According to the company’s financial statements, its total turnover has increased by 3.35%, operating profit has increased by 33.33%, Profit Before Interest and Taxation has moved upwards by 35.17% and finally the net profit for the period has almost doubled this year showing an increase of about 105% as compared to the previous year. But, for the purpose of getting a deep insight into the company recent financial performance and position, just looking at the figures in financial statements does not suffice. For this purpose, the company’s annual reports and financial statements is analysed on the basis of financial ratios and the company’s previous performance. The in-depth analysis of the financial performance and position of British Airways Plc for the year ended 2005, as indicated by the company’s annual report and the financial profitability ratios obtained from FAME database (Profitability ratios, accessed 4.12.2005) is provided below: Profit Margin 2005 2004 5.31% 3.04% The profit margin ratio assesses the returns earned by a company after accounting for all the costs except for taxes. The profit margin for British Airways Plc for the year ended 2005 is 5.31%, while it was 3.04% for the year 2004. It shows that the company’s profit margin has increased by about 75% over the year. The company’s total turnover was £7,560m in 2004, which increased to £7,813 in 2005 whereas the profit before taxation was £230m in the previous year that increased to £415m in 2005. Group operating revenue improved in the year by 3.3 per cent to £7,813 million. For the twelve-month period, airline operations revenue improved by 0.4 per cent to £6,982 million on a flying programme 3.2 per cent larger in ATKs. Operating profit in the year, at £540 million, was £135 million better than last year. The operating margin of 6.9 per cent was 1.5 points better than last year. The improvement in operating profit primarily reflects improvements in turnover, which was up 3.3 per cent and partially offset by increased operating costs, in particular fuel (3). Return on Shareholders Funds 2005 2004 16.84% 10.37% This ratio analyses the profit earned by the company on the funds invested by the shareholders. It exposes how well the company utilises the shareholders’ funds toward the generation of profit for them and for the company itself. In 2005, British Airways earned 16.84% profit on shareholders’ funds, which was 10.37% in 2004. According to the companies’ Balance Sheet, total shareholders’ funds were £2,187m in 2004, which increased to £2,465m in 2005 Thus it increased by about 62% over the year, showing management’s efficiency in utilising the shareholders’ funds in a profitable way. Return on Capital Employed 2005 2004 4.97% 2.52% This ratio indicates the profit earned on the total capital employed by the company. It is another measure to assess the capability of the company’s management to generate profit on the total capital put into the business. In 2004, the total return generated by the company’s management was 2.52% of the total capital employed, which increased to 4.97% in the year 2005. Thus, it shows the efficiency of the company’s management in utilising the total capital to acquire more profit year after year. Return on Total Assets 2005 2004 3.66% 1.90% The return on total assets also helps a company’s management to generate profit out of the company’s investment in total assets. Therefore, it is yet another measure to analyse the management capability and performance towards company’s financial prosperity. The return generated by British Airways Plc on its total assets has increased substantially in 2005. The company’s investment in total assets has declined from £12,132m in 2004 to £11,336m in 2005 because of sale and disposal of fixed assets. On the other hand, the company’s profit before taxation has increased at a high rate, which has caused this ratio to rise considerably. Interest Cover 2005 2004 2.52 times 1.82 times The interest cover ratio gives an indication of the company’s longer-term solvency and financial risk by assessing its ability to meet its interest commitments from its profits. It indicates the vulnerability of interest payments to a drop in profits. The financial results of the year ended 2005 illustrate that British Airways has the ability to pay interest to its lenders and creditors about 3 times after accounting for all the costs incurred by the company throughout the process of sales. This figure is even greater than the last year’s ratio of almost 2 times. Thus, it shows that the company can be termed as solvent by its long-term lenders. This is mainly due to a considerable decline in the company’s net interest payable as referred to in the annual report as: Net interest expense for the year was £157 million, £43 million lower than the previous year. This included a credit relating to the revaluation of yen debts (used to fund aircraft acquisitions) of £31 million, compared to a credit the previous year of £16 million. The revaluation that is a non-cash item required by standard accounting practice, results from the weakening of the yen against sterling. Excluding the revaluation, the improvement in interest expense reflected lower gross debt and exchange benefits offset by higher interest rates (4) Stock Turnover 2005 2004 93.01 times 99.47 times This ratio measures the company’s efficiency in terms of the number of times it becomes able to convert its entire stock into sales during the year. In 2005, British Airways finished its entire stock about 93 times and generated sales out of it whereas the company did the same about 99 times during the previous year. This shows that the company has been less efficient in generating sales for the business out of its investment in stock. Debtors Turnover 2005 2004 11.41 times 11.18 times This ratio analyses the extent of debtors’ control by the company. It evaluates the number of times the company has been able to generate sales and profit by allowing credit to its customers. The ratio has been stable over the two years, which shows that the company is generating sales for about 11 times on funding the customers’ purchases. In other words, it can also be said that there has been 11 times sales in the company, on average, for every one debtor during the year. Debtor Collection 2005 2004 32.00 days 32.64 days This ratio is used to evaluate how quickly the company collects cash from the credit sales. In 2005, the company took around 32 days to collect cash from its debtors, which was around 33 days in the previous year. This shows that it is the company’s policy to receive payments from its creditors in a month’s period. Creditors Payment 2005 2004 41.91 days 40.56 days This ratio shows how long it takes the company to pay off its liabilities towards the creditors and suppliers. The financial results of British Airways Plc for two years show that the company took 42 and 41 days to pay off its creditors in the year 2005 and 2004 respectively. By comparing the two ratios of debtor and creditor days, the company’s position can be assessed in terms of the credit period it gets from its suppliers and the credit period it allows to its debtors. Therefore, the comparison shows that the company obtains longer credit period from its suppliers than the period it allows to its debtors. The company took 10 more days in 2005 to pay off its liabilities, which has improved from 8 days in 2004. British Airways is a signatory to the Confederation of British Industry (CBI) code of practice on supplier payment and is committed to the payment of its suppliers to agreed terms. The number of days’ purchases in creditors as at March 31, 2005 in respect of the company is calculated in accordance with the provisions of the Companies Act 1985 and was 55 days (5) Net Assets Turnover 2005 2004 0.94 0.83 The total sales generated by the business on its investment in net assets can be assessed with the help of this ratio. British Airways Plc’s annual report and financial statements for the two years show that the company’s net asset turnover has improved over the years. According to the company’s Balance Sheet at the year-end 2005, British Airways Plc’s net assets were £2,397m in 2004, which increased by 12% as £2,684m in 2005. The company generated sales for the business about 0.94 times of its net assets during the year 2005, which was 0.83 in 2004. Fixed Assets Turnover 2005 2004 0.92 0.81 This ratio assesses the turnover generated by the company on its investments in fixed assets. According to this ratio, the turnover of British Airways Plc was 0.92 times of its fixed assets, while it was 0.81 times in 2004. Although the numbers seem to be improving, but this also shows that company’s current turnover is less than its total investment in fixed assets. Furthermore, the company’s investment in tangible fixed asset has declined through the year 2005 by disposal and sale of these assets. As referred to in the annual report as: Losses on disposals of fixed assets and investments for the year were £26 million, compared with losses of £46 million last year, which included an £83 million loss on disposal of dba. The losses on disposal in this financial year primarily reflect the disposal of the investment in Qantas in (£11 million) September 2004 (6) Salaries/Turnover 2005 2004 24.59% 24.27% This ratio exposes the relationship between the remuneration paid by the company to its employees and the total turnover. The total remuneration paid by British Airways Plc to its employees is 24.59% of the total turnover for the year 2005, which was 24.57% in 2004. This reflects that the company has been paying its employees at a stable rate for the last two years. Gross Margin 2005 2004 8.67% 7.30% The gross margin ratio evaluates the profit obtained by a company after accounting for the cost of sales. Therefore, it assesses the company’s performance and profitability in managing the production and distribution affairs. British Airways Plc’s gross margin has increased from 7.30% in 2004 to 8.67% in 2005, showing a rise in company’s total turnover and gross profit. According to the company’s Profit and Loss account, British Airways Plc’s cost of sales has also increased from £7,008m in 2004 to £7,136 in 2005. But this increase has not affected the company’s gross margin, because of increasing sales and turnover. The company has been able to cope with the increasing cost of sales due to rising fuel prices by increasing the rates of long distance flights. British Airways increased the fuel surcharge on its long haul flights on Monday September 12, 2005 as a result of further rises in the price of fuel. The long haul fuel surcharge on tickets sold and issued in the UK was increased from £24 per sector to £30 per sector (£60 return trip). However, the short haul fuel surcharge has remained unchanged at £8 per sector and £16 a return trip (Press Office, accessed 5.12.2005) EBIT Margin 2005 2004 8.81% 6.73% The Earnings Before Interest and Taxation margin evaluates the profitability of a company after accounting for all the operating costs incurred. The Earning Before Interest and Taxation margin for British Airways Plc shows that the company has generated a higher percentage of profit after considering all the operating expenses borne by the company. The company’s total operating expenses has increased to 8.81% in 2005 from 6.73% in 2004. According to British Plc’s Profit and Loss account, the total expenses incurred by the company amounted to £7,155m in 2004 that increased to £7,273m in 2005. Employee costs increased by 4.3 per cent to £2,273 million as pension and wage increases and the cost of the Employee Reward Plan were only partially offset by manpower reductions and other efficiencies, Depreciation costs increased by 1.2 per cent to £687 million, Fuel and oil costs increased by 22.3 per cent to £1,128 million due to a 44.4 per cent increase in fuel price, Landing fees and en route charges increased by 1.3 per cent to £556 million (7). But this has not affected the company’s profit margin because the other income generated by the company has also increased together with total turnover. EBITDA Margin 2005 2004 17.33% 15.71% The Earning Before Interest, Taxation, Depreciation and Amortisation assesses a company’s profit margin before accounting for any interest, tax, depreciation and amortisation expenses. It is thus, a measure for assessing a company’s core profitability and operational efficiency. According to the British Airways Plc’s annual report for 2005, the depreciation and amortisation cost incurred by the company has increased by 1.2% to £687 million (from £679m last year) reflecting a £16 million charge relating to the impairment of the BAe 146 aircraft at British Airways CitiExpress, following the decision to exit the fleet in 2005. This was partially offset by exchange due to the weaker US Dollar (8) Turnover per Employee 2005 2004 157,870 units 145,555 units This ratio has been used to evaluate the company’s ability to utilise its employees towards generation of sales. It also shows efficiency on the part of employees to generate sales for the business. The company generated sales of 145,555 units per employee in 2004, which increased to157, 870 units in 2005. The reason for increase in this ratio has been a decline in number of employees and a rise in the company’s turnover. In 2004, the number of employees in British Airways was 51,939, which decreased to 49,490 in 2005 (9). British Airways announced plans to re-structure its business with a 35 per cent reduction in the number of its 1,715 managers by March 2008. The figure comprises a 50 per cent reduction in senior managers from 414 to 207, and a 30 percent reduction in middle managers from 1,301 jobs to 911 jobs. This brings the total number of job cuts to 597. The proposed management job cuts are set to save the airline £50 million as part of its drive to achieve a £300 million cost reduction programme by March 2007, announced in January 2004 (Press Office, accessed 5.12.2005) Average Remuneration per Employee 2005 2004 38,816 35,330 According to this ratio, the average revenue per employee has increased in the year 2005. Although the number of employees in the company has decreased as compared to the previous year, but the average remuneration per employee has increased. The average remuneration per employee increased by 9.87% as compared to the previous year. The company paid £1,921m for wages, salaries, social security costs and pension schemes in 2005, which was £1,835m in the precious year (10). Profit per Employee 2005 2004 8,386 4,428 This ratio shows how well the company has utilised its employees towards the generation of profit for its business. British Airways Plc has utilised its employees in a profitable way during the year 2005 as the profit per employee has increased by 89.38% this year. The profit per employee in 2004 was 4,428 units, which increased to 8,386 in 2005. Although the number of employees has decreased in the year 2005, due to company policy but still the company has been able to utilise them efficiently and generate profit for its business. CONCLUSION The analysis presented above has well illustrated the financial position of British Airways Plc for the year ended 2005. However, there are some factors that are identified as being critical to the company’s financial growth and performance for the years ahead. These factors and concerns are discussed below: Turnover The annual turnover of British Airways showed an increasing trend; even after the company ahs increased its surcharge on long haul flights due to rising fuel prices. The company’s annual report (11) indicates that the company had been facing a declining rate of turnover over the years. This has improved during 2005 especially in Far East and Australia, Africa, Middle East and Indian sub-continent and the Americas, which is a positive sign for the company. However, the company’s turnover has been declining at the same rate in Europe, even in 2005. If this trend continues, the company will gradually lose its market in Europe. Reduction in the Number of Employees The company has reduced the number of employees by 4.72% during the year 2005 in order to cut down its employee costs that has been influencing on the total operating costs borne by the company. According to the company’s press releases, it is expecting to cut down on its number of skilled employees much further. Although, it is being done to reduce the employee costs, but the company can lose a great part of its skilled workers contributing to the sales and profit generation. This may hinder the future growth of the company, as it is the skilled employees and manpower on which a company relies for its success and prosperity being the real wealth of a company. Increasing Operating Costs The major operating costs borne by the company has been rising continuously over the past years. In 2005, these costs increased by 1.6% (12). The highest of these costs are the employee costs and fuel costs. These costs have been affecting and off setting the increase in company’s turnover. Although the company’s management is taking steps to cut down these costs, but if they continue to rise, they can affect the company’s profit margin adversely. Disposal of Investments The company has sold and disposed off many of its investments in 2005 including the shareholding in Qantas and agreement with Swiss International Airlines, to pay off its debts and strengthen the balance sheet. This may cause the company to lose a considerable income in future (13). Dividends As indicated by the British Airways’ annual report for the year ended 2005 (14), as per the company’s policy, it has not paid any interim or final dividends to its shareholders in 2005. The company has been following the same policy for the last four years (15) in order to strengthen its Balance Sheet. This can lead to a loss in investors’ trust in the company and they might not choose to invest in the company any further, which will make the company lose most of its funds resulting into a deteriorated financial position. References Airlines Industry Profile, accessed December 5, 2005 from: http://biz.yahoo.com/ic/profile/770_1600.html British Airways Plc, Company Information, accessed December 6, 2005 from: http://www.northcote.co.uk/default.asp?SDL=NI00443 British Airways, Brief Description, accessed December 5, 2005 from: http://today.reuters.com/stocks/overview.aspx?country=GB&ticker=BAY.L&mxid=100008427&coname=BRITISH+AIRWAYS+PLC&cotype=1 Press Office, Management re-structure announced, accessed December 5, 2005 from: http://www.britishairways.com/travel/bapress/public/en_gb Appendix (1) Directors’ report, Principal Activities, p13 (2) FAME Database, Profitability ratios, accessed December 4, 2005 (3) Operating and Financial Review, Turnover, p6 (4) Operating and Financial Review, Net Interest Payable, p8 (5) Directors’ report, Payment Policy, p18 (6) Operating and Financial Review, Profit/loss on disposal of Fixed assets and Investments, p8 (7) Operating and financial review, Operating Expenses, p6 (8) Operating and financial review, Operating Expenses p6 (9) Notes to the accounts, p40 (10) Notes to the accounts, Employee costs and numbers, p30 (11) Five-year summaries, Geographical analysis of Group turnover and operating profit/(loss), p64 (12) Operating and Financial Review, Operating Expenses, p6 (13) Chairman’s Statement, Disposals and Investments, p2 (14) Directors’ report, Results for the year, p13 (15) Five year summaries, Group profit and loss account, p66 Read More