Financial Statements for Two Airlines - Case Study Example

Running Head: A RATIO ANALYSIS OF FINANCIAL STATEMENTS FOR TWO AIRLINES Student’s Name Subject Professor University/Institution Location Date Executive Summary This is an analysis of the financial data of the two airlines. This financial analysis is capable of helping investors and creditors to make informed decisions on whether to help the two companies in investment and finances and also to determine which of the two companies is more stable and viable when it comes to investing. The financial analyses of both Virgin Australia Holdings and Qantas Airline will be used in this paper to assess the potential for investments and also to evaluate how credits deserving both companies are. This report will particularly look at three main factors namely; Profitability, efficiency and financial stability of the three companies. Table of Contents Running Head: A RATIO ANALYSIS OF FINANCIAL STATEMENTS FOR TWO AIRLINES 1 Executive Summary 2 Table of Contents 3 Financial Data 4 Introduction 5 Discussion 5 Profitability 5 Efficiency 8 Financial Stability both Long term and Short Term 9 Additional Information 10 Component Percentage 10 Limitations of the Report 11 Conclusion 11 Recommendations 11 Appendices 12 List of References 12 A ratio analyses of financial statements for Virgin Australia Holdings Ltd. And Qantas Airways Ltd Financial Data Introduction Managers need to know how the companies they are managing are performing. This will enable them to determine when the existing capacity in terms of assets will be exceeded and whether a larger capacity will be required. Investors use ratio analysis of the financial statements of a company or companies to forecast how well the securities of a company will perform in comparison with those of another company (Cudd & Duggard, 2000). Ratio analyses of financial statements of a company are also used to determine whether one of the company securities that are being looked at is riskier, and also to establish which one is riskier than the other (Horngren et al, 1996). Many other issues related to a company’s performance can be determined through the use of the ratio analysis of the financial statements of that company. This paper is aimed at establishing the ratio analysis of the financial statements for two airlines namely; Virgin Australia Holdings Ltd and Qantas Airways Ltd. This paper will start by doing a general financial analysis before looking at the relevant financial ratios. The above data will be used herein to establish the profitability, efficiency and financial stability of the two airlines and to see which one is more viable when it comes to investment. Discussion Profitability This is the level to which a business is capable of being profitable or capable of making profit. In this case, the profitability of the two companies will be measured using their Return Ratio. Also known as the profitability ratio, this is basically the rates of returns a company is capable of making from its investments and it is one of the basic factors that are used in financial analysis of a company. In our case here, it is the net profit of a company or the surplus that a company makes after paying off its debts and after subtracting other expenditures. As seen above, Virgin Australia Holding is incapable of paying all its interest and principal loans let alone having a surplus making it incapable of making any profits. Qantas airways Ltd on the other hand is able to pay its debts and remain with a surplus. This is a good indication that Qantas is a better company to invest in because its capability to make a profit is a guarantee that a stakeholder will be able to get a return on his investments. The coverage ratios of both companies will also be used in the companies to make profits in the sense that coverage ratio is the assessment of the ability of a company to satisfy a certain obligation. It could be the ability of the company to meet its debt obligations, or it could be the company’s Interest Coverage Ratio (Damitio et al, 1995). This part will discuss two types of coverage ratios related to the two companies under discussion in relation to the data provided namely; Interest Coverage Ratio and Debt Coverage Ratio. The Interest Coverage Ratio is another factor that can be used to measure how capable a business is of making profits. Though indirectly linked to profitability, the capability of a company to pay interest on its debt is an indicator that the company is making profits. This is a ratio that shows how easily a company is capable of paying interest on an outstanding debt. The interest coverage ratio is achieved by dividing the cash that the company earns before interest and tax (EBIT) (in our case here it is the gross profit) by the company’s interest expenses (Gardiner, 1995). In our case here, the ability of the two companies to pay interest on their debts can only be judged from the Debt equity ratios of both companies. Debt equity ratio here is the measure of the ability or inability of the company to stay debt free or its ability to fund its growth with less debt. Virgin Australia holding Ltd has a debt equity ratio that is quite high which means that the company has been insistent on funding its growth with debt. This simply means that it has a high debt equity ratio at an interest coverage ratio of 191.56% for the year 2010 and that of 177.04 for the year 2011. This simply means that the airline is in high debt making it harder for it to pay good interest on its debt. This is an indication for lenders and even investors that the company is not going to be debt free any soon and this means that its returns are likely to stay very low for a long time because of debt financing. Qantas airways Ltd on the other hand has a Debt equity ratio that is quite low compared to Virgin Australian Holdings Ltd at 95.60% in 2010 and 98.05% in 2011, which basically put means that Qantas is capable of financing a bigger part of its growth budget free of debt making it more capable of paying bigger interest on debt which is a good sign for both lenders and investors. It would be good to note that high debt isn’t necessarily that bad, because a company could achieve more business profits by funding its activities through debt but at the end of the day debt tends to eat into those profits because the higher the debt, the higher the interest that the company has to pay and the lower its net profit. Another factor that will be used in this paper to measure the profitability of both companies is the Debt (service) Coverage Ratio. This ratio is also not directly linked to profitability but like the interest coverage ratio, it is an indicator of the capability of a business to make profit. This is the amount of cash that is available for a company to be able to pay both its yearly interest and principal on debt including insurance funds (Ketz et al, 1990). In our case here, this will be measured in terms of the net profit margins of both companies. At net profit margins of 0.60% in 2010 and -1.21% in 2011 for Virgin Australia Holdings Ltd is an indication that the airline is not even capable of fully financing its interest and principal debt including its insurance for both years. On the other hand, Qantas is better off at 1.24% for 2010 and 1.76% for 2011 because the airline is capable of financing its interest and principal debt and still remains with a surplus cash flow. This is an indication that in case of any unexpected circumstances such as a financial crisis the company is at a lower risk of succumbing to the pressure because it is capable of sustaining itself Efficiency This is basically the level to which a company is capable of effectively using its resources to generate sales and profits for the business. This paper will use the Inventory Turnover Ratio of both airlines to measure how capable both airlines are capable of using their resources to generate sales and profits. Both companies have an inventory turnover ratio/ Stock turnover ratio which is low. Every company should be capable of maintaining a certain level of inventory when it comes to finished good. This inventory is supposed to enable the company to meet the needs of its business (Kaminski et al, 2004). However, inventory ratio level should neither be too high nor too low. An inventory ratio that is too high would mean higher carrying costs as well as higher risk of the stock becoming obsolete (Gardiner, 1995). An inventory ratio level that is too low on the other hand means that the company is at a higher risk of losing business prospects (Lock & Scrimgeour, 2003). Inventory ratio should therefore be balanced to avoid both risks. In the case of the two airlines in question, both their inventory ratios are quite low. In 2010 and 2011 for instance, Virginia Australia Holdings Ltd had an inventory turn over of 0 and 0.57 days. This means that the rate at which the company was turning its stock into cash was too high making its inventory turnover ratio too low. This means that at that particular point in time, the airline was capable of losing in terms of business opportunities due to lack of stock. Qantas airways Ltd on the other hand seems to be having a more balanced inventory turnover ratio because its rate of turning its assets into cash stands at 8.45 days in 2010 and 9.12 days in 2011. This means that, the company has an average inventory turnover ratio which is neither too low nor too high meaning that it is not likely to lose much in terms of business opportunities. Virgin Australia Holding Ltd here seems to be in trouble when it comes to maintaining its inventory and that is very risky and this always reflects on the profits of the company due to loss of business opportunities and as seen in the financial statements above. Financial Stability both Long term and Short Term This part will use the current ratio of both companies to establish the companies’ financial stability. A current ratio basically shows how many times over that company is able to pay its debts. The current ratio is usually based on the current assets of a company (Hilton et al, 2000), and it establishes the liquidity of a company or in other words how swift a company is capable of turning its assets into cash. From the details above, Virgin Australia Holdings’ Limited current ratio for 2010 was 0.76% while that for 2011 was 0.65%. The one for Qantas was at 0.93% in 2010 and at 0.90% in 2011. Therefore, this means that both Virgin Australia Holdings Ltd and Qantas airways Ltd are not able to pay their debts over and therefore both airlines have a liquidity that is lower than expected. However, Qantas airways Ltd has a liquidity that is higher than that of Virgin Australia Holdings Ltd and that makes it more liquid. When the liquidity of a company is low, it means that the airline is not able to meet its short term liabilities which are in most cases in terms of bills using its short term assets such as receivables, inventory and cash. A ratio that is below 1, in our case here below 1% means that both airlines would have been incapable of paying their short term obligations by the end of both 2010 and 2011 if they were to be due by that time. However, this does not mean that the airlines were at the verge of going bankrupt, because there are many ways though which the companies can meet their short term obligations but this is not a good sign at all. Judging from the liability analysis and comparing the two, Qantas seems to be in a better position than Virgin Australia Holdings and is more likely to recover from this kind of situation faster, making it more viable as a business investment entity. The current ratio of a company is also an indication of how capable it is of maintaining its operation cycles and how capable it is of turning its products into liquid cash. A company like Virgin Australia Holding here, which seems to be having trouble making money out of its receivables, is likely to fall into liquidity problems easily. Additional Information Component Percentage This is basically how both companies compare in terms of all the factors discussed in this paper. It is clear that Qantas Airways Ltd is more capable of giving returns on investment from all angles and is therefore a more viable entity for an investor and even a lender. Limitations of the Report This report was limited to three areas of concern when it comes to the viability of the companies in question namely; Profitability, Efficiency and Financial stability. The report was also limited to two companies in the airline industry for just two years. The report also tried to establish how viable the two airlines are when it comes to investor and credibility levels and only to those factors that are related to this. Conclusion This paper has analyzed the financial statements of the two airlines in an effort to establish their viability as investment grounds. The paper has dealt with a few of the hundreds of financial ratios that are available for financial analysts. The financial ratios chosen for this particular paper are those related to credit worthiness considering that the two companies are airline companies as not all ratios can be used for all types of analyses and companies. Recommendations This information is very important for investors and based on the analysis from the financial statements of the two airlines, this paper recommends that; Qantas Airways Ltd is a more viable company in terms of profitability, efficiency and financial stability because it’s capable of making better returns on investments and it is also capable of turning its investments into cash faster. Virgin Australia Holdings Ltd on the other hand shows a greater affinity of funding its business activities with debt making it vulnerable in terms of profitability. The airline also seems to have trouble keeping its inventory which is a sign that it is capable of losing business opportunities due to lack of stock. This in turn makes it lose credibility as a company where an investor can put his money and expect to make any meaningful profits. Appendices List of References Cudd, M., & Duggard, R. (2000). Industry distributional characteristics of financial ratios: An acquisition theory application. The Financial Review Vol 35 Issue 1 , 105-120. Damitio, J., Dennington, L., & Schmidgall, R. (1995). Financial statement analysis. The Bottom Line Vol 10 Issue 6 , 10-117. Gardiner, M. (1995). Financial ratio definitions reviewed. Management Accounting Vol 73 Issue 8 , 32-33. Hilton, R., Maher, M., & Selto, F. (2000). Cost management: Strategies for business decisions. Boston: Irwin/Mc Graw-Hill. Horngren, C. e. (1996). Introductioon to Financial Accounting. New Jersey: Prentice Hall. Kaminski, K., Wetzel, T., & Guan, L. (2004). Can financial ratios detect fraudulent financial reporting? Managerial Auditing Journal Vol 19 Issue 1 , 15-23. Ketz, J., Doogar, R., & Jensen, D. (1990). A cross-industry analysis of financial ratios: Comparabilities and corporate performance. Greenwood: CT. Lock, S., & Scrimgeour, F. (2003). Testing the consistency of New Zeeland SME financial ratios across industry groups. Journal of American Academy of Business Vol 3 Issue 1 and 2 , 164-166. Read More