Financial Statements of Etihad Airways and Emirates Airways - Case Study Example

SHORT RUN AND LONG RUN ANALYSIS: A CASE OF EMIRATES AIRLINES AND ETIHAD AIRWAYS Contents Introduction 3 Theoretical Framework 3 Emirates and Etihad 5Profit Maximisation 7 Bibliography 9 Introduction Firms present two types of financial statements – statement of financial position (balance sheet) and statement of financial performance (profit and loss account). Whereas the former examines the long-run position of the firm, the latter (financial performance) provides important information about the short-run utilisation of the firm’s resources. Short-run and long-run information is important and significant in business-decision making and vital analysis in microeconomics. This paper will critically examine the two main time periods of Economics – the short run and the long run. It will review the theoretical aspects of these concepts and apply it to two firms in the global aviation industry, Emirates Airways and Etihad Airlines. This will fundamentally focus on the short-run aspects of these firms and provide a comparative analysis. Finally, elements of the long-run elements of the two firms will be examined and reviewed in relation to diminishing returns and similar matters. Theoretical Framework Production decisions are made on the basis of the resources of a firm or organisation. This consists of two basic elements cost and revenue. The difference between these two items, cost and revenue, defines the profitability of a firm. Cost for the purpose of these forms of Economic analysis consists of the expenditure incurred in producing a particular product or service. By nature, cost can be analysed over the short-run and the long-run (Aryasri, 2012). The long-run is seen as a period of adequate length within which all factors of production can be changed or are variable (Myers, 2012). In the short-run, such a degree of flexibility is non-existent and some variables of costs are fixed whilst some variables are can be changed or are variable (Jan, 2013). From the production side of the equation, it can be said that in the short run, at least one factor of production cannot be varied. In other words, one factor of production, particularly capital cannot be increased in the short run. Typical examples include land and assets. These elements of production cannot be increased or decreased and output can only be altered if the other flexible costs (eg. Labour) is varied. In the long-run though, all factors of production can be altered. This is because the fixed factors like land and assets can be altered over the long-run, hence production is somewhat flexible rather than fixed over the long-run. This discussion brings to the fore, two elements of production: Fixed costs andVariable costs. Fixed costs are in total constant within a relevant range or the short-run (Hansen, Mowen, & Guan, 2009). An example of fixed cost is the case of a production plant for a firm that does not have enough capital to purchase a new one. Within a stated period, they cannot increase the capacity of this production plant because it is part of fixed asset and the firm will need to raise capital to fund the expansion and this is not normally going to happen with the short run. However, the firm can vary other flexible elements like raw materials and labour. In the long-run though, the firm can raise enough capital and expand its production plant to double its capacity. Outputs Outputs P3 P3 P2 P2 P1 P1 L0 L1 L2 Input S1 Input Figure 1: Fixed Cost in Long Run Figure 2: Fixed Cost in Short Run Curve The diagram above shows the levels of inputs for fixed costs over the long run and the short run. In the short run, fixed costs remain at S1 and they do not change. On the other hand, in the long run, what is classified as fixed cost can be varied from L1 to L2 and this will create a stepped situation where outputs will increase sharply with inputs after there is an increase in input. Emirates and Etihad Emirates and Etihad are both airlines from the United Arab Emirates. Emirates operate from the emirate of Dubai whilst Etihad operates in Abu Dhabi. They both have different cost structures and this provides different short-round period links. In recent times, the Emirate of Dubai went through major financial challenges and difficulties. Hence, the airline did not get financial support and asset injections from the government. Due to the impact of the global financial crisis which hit Dubai, Emirates Airlines faced serious limitations on working capital and asset injections. Rather, the airline sought to expand its routes and attain better productivity in order to gain more profits in by 2015. Emirates will have its fixed costs relating to the capacities and competencies that it cannot change within the next year or few circumstances. On the other hand, there are some variable elements like working capital and labour that can be change output significantly. Therefore, the data for Emirates looks to be like this: Fixed Inputs (‘m $) Average Variable Inputs (‘m $) Dubai Terminal Rights 400 Terminal Rights in 70 airports 4,900 Working Capital 1,870 Labour 200 Fleet 8,000 Short-Run and Long-Run Inputs of Emirates Airlines From the table above, Emirates’ right to the Dubai Terminal and 70 terminals are fixed. This is because they include contracts that have been signed over the past years and will subsist for several years to come. Also, their fleet is fixed and they do not intend to increase or improve until after 2015. This is because these airlines are not going to be increased. Hence, this represents a fixed cost variable. On the other hand though, labour and working capital are variable in the period from now to 2015. This is because it can be varied and increased over the period . On the other hand, Etihad sought in this period sought to expand and grow their routes within this period by voting a huge amount of money into acquiring new terminal rights outside their Abu Dhabi terminal hub. Also, they injected more money into acquiring new aircraft. The data from their financial statements include: Fixed Inputs (‘m $) Average Variable Inputs (‘m $) Abu Dhabi Terminal Rights 300 Existing Terminal Rights 35 Airports 3,200 New Terminal Rights 2,400 Labour 1,100 Working Capital 300 Existing Fleet 4,500 New Fleet 2,500 Short Run and Long-Run Inputs of Etihad Airlines In this case, the fixed inputs include the existing terminal rights but new terminal rights become a variable input because it is going to have a direct impact on the results Etihad will attain within the period. However, the existing terminal is fixed and will be ran with costs that are inevitable and will be borne by Etihad irrespective of the production capacity. Things like labour and working capital will directly affect demand in the next two years (ie before 2015) because that is the period within which this is prepared and there is likely going to be a change if these items are varied. Profit Maximisation Profit maximisation refers to the long run and short run process by which a firm determines a price and output level that provides the greatest profit possible (Carbaugh, 2013). In the short run, profit maximisation occurs at a point where marginal revenue is equal to marginal cost (MR = MC). In the short run, marginal revenue refers to the addition to total revenue from the sale of another unit of output (Carbaugh, 2013). Marginal cost refers to the addition to total cost of producing another unit of output. Where marginal revenue is above marginal cost, it means the marginal profit is positive and there is the potential to produce more goods for greater levels of profits. This implies there is the possibility of producing more because there is still room for the attainment of higher and better profits. Where marginal costs are above marginal revenue, it means the firm has reached a point where there is diminishing return. This is because any more inputs and additions to production, there will be a waste of resources because more and more inputs will attain lesser results and lesser profits and hence, production should cease at this point. At the output level where marginal revenue is equal to marginal costs, then marginal profits is equal to zero and this is a quantity where profit is at the highest. This is because total profits increases where marginal profit is positive and total profit decreases where marginal profit is negative. Thus, it is important to find a point where there is some kind of equilibrium and this will mean the resources of the firm is put together in the most optimal point and optimal level. In most firms, where there is profit maximisation in the short run, the firm expands its output and is affected by the law of diminishing returns. However, in the long run, the firm can move above these limitations that are placed upon the firm and the firm can transcend the limits placed upon it. This is because it can expand its capacity and move up its outputs and competencies. This is because the firm is able to expand beyond certain elements and aspects that are limited and hence, they can increase their capacity significantly. Bibliography Aryasri, M. (2012). Managerial Economics abd Financial Analysis. London: McGraw Hill. Carbaugh, R. J. (2013). Contemporary Economics: An Applications Approach. Surrey: ME Sharpe. Hansen, D., Mowen, M., & Guan, J. (2009). Cost Management: Accounting and Control. Mason, OH: Cengage. Jan, S. (2013). Economic Analysis for Management and Policy. New York: McGraw Hill. Myers, D. (2012). Construction Economics: A New Approach. London: Routledge. Read More