Finance Evaluation of the Airlines - Report Example

This report will reveal the financial analysis techniques used to evaluate the financial performance of the two Airline Companies, airline A and airline B, and evaluate the company’s worthiness. The paper is divided into two sections. The first section is the analysis of the company’s profitability, liquidity and efficiency of the company, which is the main body of the paper. The second section, Appendix A, includes as a reference contains the actual financial ratios, showing the company’s performance from 2000 to 2005. Using these appendices to support the financial analysis ideas expressed in the memo, the reader should feel that they have a complete set of facts to substantiate these ideas and provide a reference for them. First we take a look at the financial performance ratios of the two companies. The return on assets ratio of the company shows how well the company is in generating revenues from their assets. i.e.how many dollars of EBIT (earnings before interest and taxes) they can achieve for each dollar of assets they control.the data shows Airline A has return on assets AIRLINE A FINANCIAL RATIOS 2005 2004 2003 2002 2001 2000 Return on Total Assets (%)  4.22  4.69  4.57  6.72  7.90  8.49 If we analyze the return on assets we will fin that the Airline A in FY 2000 is really high that it means the company is generating good revenues from the assets on the company but going on in the FY 2005 the ratio is dropped to 4.22 which is really observing for the company. The airline B has the return on assets ratio of AIRLINE B FINANCIAL RATIOS 2005 2004 2003 2002 2001 2000 Return on Total Assets (%)  3.66  1.90  1.05  -1.46  1.10  0.04 The airline B has a worse ratio as the company is not able to generate good returns from their assets. After comparing the two ratios we will analyze that the airline A is better in generating revenues from their assets of the company than airline B. Return on capital employed is the main ratio that analusis the company’ performance over the long term capital invested the ratio of the two companies are Return on Capital Employed (%)  5.60  6.16  5.94  8.89  10.17  12.57 Return on Capital Employed (%)  4.97  2.52  1.35  -1.91  1.44  0.05 By analysing the above figures we have concluded that airline A is more efficient in using its capital to generate revenues that airline B. Now we look at the return on equity ratios of the companeis . Return on Equity (ROE, Return on average common equity) measures the rate of return on the ownership interest (shareholders equity) of the common stock owners. ROE is viewed as one of the most important financial ratios. It measures a firms efficiency at generating profits from every dollar of net assets, and shows how well a company uses investment dollars to generate earnings growth .the ratio of the company A is AIRLINE A FINANCIAL RATIOS 2005 2004 2003 2002 2001 2000 Return on Shareholders Funds (%)  8.09  7.88  6.79  9.84  12.68  33.63 And for the company B AIRLINE B FINANCIAL RATIOS 2005 2004 2003 2002 2001 2000 Return on Shareholders Funds (%)  16.84  10.37  6.56  -9.92  4.67  0.16 By analysing the above ratio we have calculated that the company A has not a better viw of the return on equity as the ratio decreases over the period of six years. On the other hand the company B has done ecxeptional performance in returns generated from the funds over the period of six years. By comparing the two we have analyzed that company B more efficient in using their funds. High ROE yields no immediate benefit. Since stock prices are most strongly determined by earnings per share (EPS). The benefit comes from the earnings reinvested in the company at a high ROE rate, which in turn gives the company a high growth rate. Net margin or net profit margin is the measure of the effeciency of the company’s sales into revenue. The industry with barrier in entry have high margins so airlines industry also have high profit margins . If we look at the margins of airline A and B 2005 2004 2003 2002 2001 2000 Profit Margin (%)AIRLINE A  5.06  5.70  5.53  12.97  11.25  8.38 Profit Margin (%)AIRLINE B  5.31  3.04  1.76  -2.40  1.62  0.06 If we loock at the profit margin ratio the two companies we will find that the trend in conpany A after 2002 is worse as the margins falls by 6.5% from 2002 to 2005 but in company B the trend shows that they have worked effectivly on the margins and there is an increase of 5.2% from 2000 to 2005. Gross margin ratio tells us that how the company is doing to reduce the cost of revenue by looking at the gross margin ratio of the two companies we have analysed that airline B is doing more better than airline A as there is high gross margin ratio of airline A in 2000 and there is much decline in over 5 years. on the other hand airline B has very low grossmargin in 2000 but they have reduced their costs and thus increaese in gross margin. Gross Margin (%) A  13.05  14.82  16.83  25.12  25.56  27.46 Gross Margin (%) B  8.67  7.30  5.53  0.59  6.11  2.92 A business is concerned with the debtors ratio as this ratio will tell that how long the credit customers take to pay the amounts owed to the company . this ratio also tells that how well the company is in collecting the amounts from the credit customers. Debtor Collection (days) A  28.22  33.19  29.85  28.50  26.34  30.42 Creditors Payment (days) A  1.80  5.89  8.07  17.79  17.09  16.42 Debtor Collection (days) B  32.00  32.64  28.34  33.79  33.56  36.30 Creditors Payment (days) B  41.91  40.56  46.62  47.75  47.64  47.32 After analysing the debtors and creditors payment ratio we have concluded that the airline A is not so efficient in collecting the amounts due from the customers however their creditor payment is very short .it means that airline A have problems in maintaining suppliers ralationship. On the other hand airline B is very efficient in collecting the amounts due and paying their creditors The asset turn over ratio gives an idea about how well the company is using its assets in generating revenues the ratio for the two companies are Net Assets Turnover A  1.11  1.08  1.08  0.69  0.90  1.50 Net Assets Turnover B  0.94  0.83  0.77  0.80  0.89  0.88 The asse turn over ratio of the above two companies shows that airlinr A is more efficient in generating revenues from their assets that airline B. Now we are going to take a look at the liquidity and solvency ratio of the two companies .first we check the current ratio of the company ,the current ratio is ratio between current assets and current liabilities however most people suggests that ideally this ratio should be 2. The current ratio for company A is AIRLINE A FINANCIAL RATIOS 2005 2004 2003 2002 2001 2000 Current Ratio  2.25  2.18  1.83  2.01  2.57  0.65 And for company B is AIRLINE B FINANCIAL RATIOS 2005 2004 2003 2002 2001 2000 Current Ratio  0.95  0.92  0.94  0.80  0.74  0.77 By the above information we have analyzed that the company has very good current ratio as we have said that ideally the current ratio should be 2 or more in the year 2000 the company has this ratio of 0.65 this means that the company has not enough assets to cover its current liabilities but after 2000 the company manages its current ratio and take it to the 2.25 in FY 2006. on the other hand company B has not good current ratio as the company has not enough current assets to pay its current liabilities. After ratio analyses we have conclude that the airline A is more efficient that airline B in many cases by performance, asset utilization, profitability. Other factors should also be considered: Besides doing this detailed financial ratio analysis, it would critical to research the annual reports for six years and read the explanatory notes and other financial information. There we would find an inside look at organization beyond the numbers, and the bases for how these financial reports were assembled. These notes contain essential information about its significant accounting policies In addition to all this, we would want evaluate such things as the performance of the company’s competitors, the standard average financial ratios for the industry this company is in, and measure Company’s performance against these averages. Other factors would be the company’s image in the community, any possible litigation the company is involved in either as plaintiff or defendant, customer testimonials (good and bad), the market behavior of the market the company is in, any offshore threats to competition, workforce demographics and availability, and a detailed review of the company leadership, including the executive staff (president and vide presidents), and the board of directors. Limitations of the ratio analysis 1.  There is considerable subjectivity involved, as there is no “correct” number for the various ratios. Further, it is hard to reach a definite conclusion when some of the ratios are favorable and some are unfavorable.  2.  Ratios may not be strictly comparable for different firms due to a variety of factors such as different accounting practices or different fiscal year periods. Furthermore, if a firm is engaged in diverse product lines, it may be difficult to identify the industry category to which the firm belongs. Also, just because a specific ratio is better than the average does not necessarily mean that the company is doing well; it is quite possible rest of the industry is doing very poorly.  3.  Ratios are based on financial statements that reflect the past and not the future. Unless the ratios are stable, it may be difficult to make reasonable projections about future trends. Furthermore, financial statements such as the balance sheet indicate the picture at “one point” in time, and thus may not be representative of longer periods.  4.  Financial statements provide an assessment of the costs and not value. For example, fixed assets are usually shown on the balance sheet as the cost of the assets less their accumulated depreciation, which may not reflect the actual current market value of those assets.   5.  Financial statements do not include all items. For example, it is hard to put a value on human capital (such as management expertise).  And recent accounting scandals have brought light to the extent of financing that may occur off the balance sheet. 6.  Accounting standards and practices vary among countries, and thus hamper meaningful global comparisons. References www.wikipedia.org : financial ratios Shukla,Grewal. Advanced accounting: ratio analysis 2005 India Read More