British Airways Finance - Case Study Example

TABLE OF CONTENTS Serial No. Page No Introduction 2 2. Information required for Budget Formulation 3 3. Factors that would impinge Budgetary preparation for 2006/2007 6 4. Provisional Results - 2007 9 5. Press Release 10 6 Final Conclusion 11 7 Recommendations 12. Financial Report – British Airways P.L.C. Introduction In a highly competitive environment in which British Airways operates today, it becomes increasingly essential to control Costs and attain optimum efficiency levels in all major areas of corporate accountability. Since the Airline is now facing relentless competition, and reduced profitability, due to reduced margins in both in UK’s domestic sector from no frills airlines, which control nearly half of all UK’s domestic air traffic, and also from the Overseas markets rival airliners like Japan Air lines, Air France, Lufthansa etc, with whom there are no strategic alliances or consolidations. British Airways is not in a position to hike the ticket prices, except pass on the excess Fuel Surcharge Costs on to the travelers. It has become necessary to control costs in all major areas so that the 10% Operating costs could be ensured, and also, net savings of £450 Million in the next two years could also be achieved.” Profit for the year attributable to members of British Airways Plc (‘the Company’) amounted to £451 million during 2006, against a profit on the same basis of £377 million in the previous year i.e. year 2005.” (Directors’ report and business Review: British Airways. 2005/2006) Higher profits during the current year could be achieved by controlling Operating Costs and enhancing value for money to travelers, thus increasing sales off takes. The following Budgets would be necessary in order to implement the cost-reduction policies and achieve the desired objectives of profitability: Information Required For Budget Formulation 1. Passenger Revenue Budgets: For this it is necessary to know the routes and destinations to which the Airlines operate, the capacities of the planes carrying passengers, the passenger load factor, and the sectors which need to be concentrated for enhanced revenue generation. It would also need to examine the pricing and ticketing strategies adopted by competitors and no frills airlines, and how we could achieve competitive edges over them in terms of revenue generation. The Budget would also consider the discounts to be given to passengers to match the rates of competitors. 2. Cargo Revenue Budget: The total revenue from cargo servicing needs to be enhanced in order to meet the target of 10% operating margin in future. For preparation of this budget, the sectors in which additional cargo could be gained, the competitive rates for cargo bookings and the sectors it serves should be considered. Also our strategic partnerships with other Airliners in Cargo Handling needs to be reviewed and methods discussed with them for enhancing cargo revenue for British Airways. Strategic alliances with major worldwide airliners gives wider destination choices to attain economies of large scale operations. It also throws open new opportunities for consolidation. For this, it is necessary to know the capacity for enhanced cargo trade, the present demand and projections of demand, the different routes in which the cargo flights operate and also the analysis of competitors’ activities, including their sector wise rates, load capacities and discharge facilities. Other Revenues including Fuel Surcharge Budgets: By far, the most important costs which erode profitability of airlines are the spiraling prices of fuel. During 2006, for the airlines, there has been “an increase of 44.7% in fuel prices as compared to year 2005.” (Lim, Yunsuk. 2005). It has now touched £1632 Million .This was mainly due to the sharp increase in the prices of fuel prices which increased by 38% during the year 2006. The budget seeks to offset this rise in fuel prices by increasing the Fuel surcharge. Also certain steps would have to be taken in order to effectively utilize expensive and scarce fuel costs by eliminating flights into unprofitable sectors, better utilization of fuel through conservation and optimum usage and seeking alternative outsourcing, wherever possible. The use of strategic alliances with other airliners through consolidation and joint ventures would also help increase profitability through their services since they could operate flights in sectors where British Airways do not operate. “BA extends its network via code-sharing relationships, chiefly with AMRs American Airlines and other members of the One world global marketing alliance, such as Cathay Pacific Airways, Iberia, and Qantas.” (Answers.com). Employee Budgets Coming to the costs, we would need to prepare an employee cost budget in which would be required to have the details of employees, including engineers and pilots and the per head salary costs per person. The employee cost budget would include ways of rationalizing the staff costs and introducing greater employee efficiencies Depreciation, Amortization and Impairment Budget This would account for the planes which have surpassed their useful lives and also the need for inducting new aircrafts. Regular inspection of the flying aircrafts have to be made to assess their technical soundness. Care needs to be exercised when ordering for new aircrafts since the benefits of acquiring, in terms of revenue generation have to assessed with the capital costs involved. As has already been mentioned, the Fuel and oil Budget has to be drafted carefully, considering the future increase in fuel prices due to the rising prices of oil. The Engineering and Other Aircraft Costs Budget This has to take into account the flying hours rendered by the aircrafts, its depreciated written down values, its remaining useful lives and total flying hours rendered by it. The landing fees and enroute charges budget has increased in year 2006, compared to year 2005. However in the future years, it is budgeted that it would reduce during the next financial year, considering the restructuring of the travel agents commission and savings in marketing. The Handling, Catering and other Operation Cost Budget The actual expenses incurred would have to be known sector wise, and the budgets prepared keeping in view the traffic in the particular routes. In heavy traffic routes like US and Europe, the handling expenses would be comparatively high and necessary projections for this have to be made. The cost-benefit ratios would have to be analyzed in these budgets and comparisons made between costs and passenger demands. The selling costs budgets mainly deals with sales promotional and maintenance of Agency infrastructure in principal cities of the world. Now, that the Travel agency commission has been restructured and other relevant factors streamlined the budgets would have to consider these aspects also. The Accommodation, General equipment and IT expenses This has reduced by 2% compared to the earlier year 2005, by around ₤ 585, and there has been a general expenses reduction which has partially offset adverse Exchange rates fluctuations. This time the budget has to take into consideration, methods by which substantial reduction could be made in this head of expenses. Therefore, it could be said that the main objective of the budget would be to enhance revenue and curtail costs, and thereby achieve the twin objectives of 10% operating margin and also attain a savings in costs of ₤450 in the next two years. Factors that would impinge Budgetary Plans for 2006-07 The major aspects that would impinge the Budget 2006-2007 would be: 1. Pension Deficits 2. Spiraling Fuel Prices 3. Iraq war and terrorist activities which have made air travel more risky. 4. Governmental controls.5. Terminal 5 Operations. Pension Deficits: The 2003 actuarial Valuation has shown that there is a deficit of ₤ 928 Million, despite the Governments injection in the form of additional capital. It is believed that this deficit would increase in the years to come, spurred by a lower long term interest rates and also increased life expectancy. This would widen the pension deficits in the years to come Spiraling Fuel Prices: The oil prices have become a major issue for the airlines industry. The oil prices had, at one point of time, risen to almost ₤ 70/Barrel which is an all time high, and there is also a great deal of uncertainly regarding the movement of the oil prices in future, given the inability of OPEC to hold the oil price line, which would significantly affect the airlines industry .The fuel constraints had led to suspension of flights to economically unviable destinations and curtailed others services also. Since fuel cost savings form a major determinant of profitability for airlines industry, it is very essential that fuel consumption is controlled to manageable and viable limits, and greater emphasis is laid in flying low fuel airliners for long haul flights, and also in non-premium segments. Iraq war and threats of global terrorism: The Iraq war and escalating tension in the Middle East and other Muslim countries has had significant impact on international travel and has reinforced the fear of flying in many people, thus significantly reduced air traffic. Especially to US destinations, in the aftermath of 9/11/2001. The health epidemics, including SARS, did not also present encouraging results for the airlines industry. These has led to increased world wide security and insurance costs, since the targets of terrorists attacks are unknown and these supervening costs have impacted bottom line figures of airline companies and “fears of terrorist attacks had damaged business in the first three months of this year.” (Operating and Financial Statistics – Continuing Operations. Third Quarter Results 2006 - 2007). Governmental controls: Airlines operate under a heavily regulated environment and have to abide by the rules set out by the various Federal and State laws of the countries in which they fly. There are regulations to commercial activities of airliners with respect to areas like taxation laws, route flying rights, fare setting and landing permission in major airports. These factors could curtail the authority, autonomy and decision making process due to supervening Governmental regulations. Normally, as far as Airlines Companies are concerned, it is the Government of the countries in which the flights touch down which decides about the regulations, and airline companies have to abide by them at all costs or decide to discontinue operational services in these sectors. Terminal 5 at Heathrow Airport. It is widely believed that the standards provided by Heathrow Airport in London is far below the infrastructural facilities provided by other international airports in other European countries. Thus, it has been decided to open a New Terminal 5 at Heathrow at a total cost of£4.3 Billion, which is expected to become operational by 2008. The ‘Fit for 5 ‘ has become a major issue in terms of total change of logistical activities to this new terminal which would pose challenging and facilitative, and once operational, is expected to resolve imbalances in London’s air travel permanently .”The terminal, which will be capable of handling 30 million customers a year, will enable us to provide new levels of customer experience.” (Operating and Financial Statistics – Continuing Operations. Third Quarter Results 2006 – 2007). British Airways would also be fully utilizing the services of Terminal 5 and therefore, necessary facilities have to be initiated in order to provide a smooth transition of flights into Terminal 5 to ease air traffic and relieve congestion at Heathrow Airport and make air travel a more pleasurable experience, especially for international travelers. Provisional Results for 2007 For the 2006-07, it is evident from the data relating to April 2007 the passenger capacity has risen by 0.5 % compared to the same period last year. Traffic was lower by 2.2%. This has resulted to passenger load factor down by 2.1points. to 70.9%. (Traffic and Capacity Statistics. 2007). There does not seem to be much of other market changes as compared to same period last year. However, the Airways has increased its Long Haul Fuel Surcharge as follows effective 2.5.20007: On flights of less than 9 Hours, from ₤30 (₤60 return) to ₤ 33 (₤ 66 return) and on flights of more than 9 hours from ₤ 35(₤70 return) to ₤ 38₤ (₤ 76 return). (Investor Relations Home. 2007). The Board of Directors of British Airways plc has approved of the delisting of the Company from the New York Stock exchange (NYSE) and the consequent deregistration of the Company and the resulting non-requirement on its part for Reporting its Annual Reports under Securities Exchanges Act 1934. Necessary notice has been given to the NYSE to this effect. Press Release The major problem facing the management is the net deficit of £2.1 Billion in the pension fund account. However, it would make a “net off payment of £800 m to the Pension Fund for the 33,500 people who hold a Company Pension. Its Annual Cost would be about £ 280 M for the next decade.” (Berry, Mike. 2007). The Airline Company is now gearing for construction and commissioning of Terminal 5 at Heathrow Airport slated to be completed by 2008. Tickets for the first flight from Terminal 5 have already started being issued by the Airways. The concept of FSS (Future Size and Shape) is “to cut the number of different seating configurations to be operated, as well as the number of different aircraft types.” (Future Size and Shape Plan. 2000). The enhanced margins for a giant airlines company can only be achieved by fleet rationalization, constant commitment to excellent customer services and competitive prices in this era of open skies. During the year 2006/07 the airlines is committed to seek compliance in the following areas: 1. Building an effective cost base with a prime target of achieving ₤ 450M over the next two years and also increase the current operational margin to 10% 2. Institute cost rationalizations in long haul premium classes of travel and the induction of ba.com, that is, upgrading technology which allows the use of e-ticketing and also travelers are allowed to print their own boarding passes at home before embarking the flight. 3. British Airways is preparing itself for Fit for 5 that would make it competitive in 1998. 4. The areas of cost base and NAPS Pension Funds need to be addressed to before long term investment in Long Haul Aircrafts are undertaken. But as the detractors of British Airways says” But it will require significant management skill to achieve headline savings of £650m a year without losing operational effectiveness.” (Profile: British Airways. 2002). Final Conclusion The formal opening of the Terminal 5 at Heathrow Airport for international air traffic is expected to revolutionalize air traffic, beginning March 2008, and would reinstate the airport’s claim of the British tradition, of being one of the finest airports in Europe. This, coupled with major Cost Reduction programmes, especially in areas of Pension Funds, Labour Union litigation settlement costs, fuel consumption and unproductive staff and labour administrative costs, and ageing aircrafts maintenance costs, through tough budgetary controls, and effective variance analysis, could go a long way in serving the financial interests of the stakeholders of British Airways and reverse its financial fortunes in the years to come, in terms of making it a dividend paying company Recommendations The methods in which the objectives of British Airways could be achieved are as follows: 1. British Airways would have to endeavour to make itself the best UK airlines network catering to a large cross section of fliers – business or tourists class. 2. In order to stay ahead in business, it is vital not only to understand our customers more than the competitors do but also to provide his needs at no extra costs. 3. Although British Airways has an excellent brand image it needs to be sustained in the future in the face of cut-throat competition from smaller airlines companies. 4. It should develop a competitive and rationalised cost structure in tune with the changing economic trends and dynamics keeping the view the strategies and market gains of competitors both in domestic and long haul flights. 5. It needs to enter into reciprocal strategic alliances with local airlines in countries where British Airways is not well represented in order to be truly called a global airlines and also restructure flight schedules to fly in profitable sectors and high premium flights. 6. Fleet rationalization and inclusion of fuel effective wide-bodied Boeing Aircrafts with higher load capacity for long haul flights needs to be introduced. Works Cited Directors’ report and business Review. British Airways. 2005/2006 Annual Report & Accounts. http://media.corporate-ir.net/media_files/irol/69/69499/Report_2006.pdf (accessed May 17, 2007). Lim, Yunsuk. 2005. Korean Air Posts Loss despite Hedge on Fuel. Herald Tribune. Bloomberg News. http://www.iht.com/articles/2005/08/11/bloomberg/sxkorair.php (accessed May 17, 2007). Answers.com. http://www.answers.com/topic/british-airways-plc-adr (accessed May 17, 2007). Operating and Financial Statistics – Continuing Operations. Third Quarter Results 2006 - 2007. British Airways. http://library.corporate-ir.net/library/69/694/69499/items/229464/Q3_BA_Results.pdf 48260 (accessed May 17, 2007). Traffic and Capacity Statistics. 2007. http://www.airlineupdate.com/news_bucket/may_news/030507ba.htm (accessed May 17, 2007). Investor Relations Home. 2007. British Airways. Bashares.com – Investor Relations. http://www.bashares.com/phoenix.zhtml?c=69499&p=irol-index (accessed May 17, 2007). Future Size and Shape Plan. 2000. v Bulletin. Jelsoft Enterprises Ltd. http://forum.airwise.com/forum/archive/index.php/t-860.html (accessed May 17, 2007). Profile: British Airways. 2002. BBC News. Business. http://news.bbc.co.uk/1/hi/business/1818514.stm (accessed May 17, 2007). Berry, Mike. 2007. British Airways Agrees Pension Deal with Main Union. Personneltoday.com. http://www.personneltoday.com/Articles/2007/01/08/38800/british-airways-agrees-pension-deal-with-main-unions.html (accessed May 17, 2007). Read More