Making Financial Decision Based on Financial Information - Case Study Example

?Topic:  Making Financial Decision Based on Financial Information Analyze the budget of British Airways and make appropriate decisions: Budget analysis: Budget analysis is the systematic evaluation of budget. “It involves the collection, study and interpretation of budget data, the correlation of budget data to other relevant information such as state policies and programs, and the establishment of findings and results” (Diokno 1999). Its intention is to offer information and analysis that is reliable, or available to a broad range of audiences, and makes contribution to the policy debates on a timely basis. It discusses the issues of budget, and determines the results that are to be achieved. British Airways Plc and Iberia had merged to form a new leading airline group named International Airlines Group (IAG). IAG is formed, and its shares were listed on London Stock Exchange, on 24 January, 2011. As a result of the merger with Iberia, British airline’s revenue has increased up 17 percent (to ?9,990 million), and the operating profit increased to ?518 million in 2011 (12 months to 31 December) when compared to the profit of 2010 i.e. ?342 million. Profit before tax in 2011 was ?679 million and in 2010 they had a loss of ?32 million. Fuel costs went up to ?3 billion in 2011. 2011 saw noteworthy hikes in the prices of fuel in opposition to the background of slow recovery of global economy.  British Airways was not resistant to outside factors distressing the aviation industry, but the IA Group which spent a great deal of 2011 in delivering powerful operational and financial performance, was able to establish firm foundations for a brilliant future. The hike in the operating profit was delivered, regardless of fuel costs in the period, beyond ?3 billion, and up to 34 per cent annually. On the contrary, the cost of non-fuel units went down by 4.2 percent. The operating outcome for 2011(31 December) included charges of restructuring amounts ?12 million and they were chiefly concerned with its divisions. The restructuring charges of ?6 million in 2010 are chiefly relating to the costs of lease exit. The taxation charge for 31 Dec, 2011 was is ?7 million; and in nine months which ended on 31 December 2010 the credit was about ?13 million. Diminutions in corporation tax rate in the UK were substantively passed in 2011. The major rate of corporation tax was condensed to 26 from 28 percent with effect from 1st April 2011, and to twenty five per cent from 1 April 2012. “Net debt comprises the current and non-current portions of long-term borrowings, less cash and cash equivalents, and other current interest-bearing deposits” (Annual Report and Accounts 31 December 2011 n.d). The position of cash remains powerful with the cash and the cash equivalents to ?1,829 million.  Decisions: The current ratio of British Airways, according to the budget analysis for 2011 is 0.75 (Current Assets/ Current liability, 2774/3683). This means that the company has faces some difficulty in the repayment of its bill on timely basis. “Current ratio is a financial ratio that measures whether or not a company has enough resources to pay its debt over the next business cycle (usually 12 months) by comparing the firm's current assets to its current liabilities” (Current radio Interpretation 2009). Even though there is hike in the price of oil, British Airways preserves a strong focus on controllable costs, by functioning strongly with the suppliers. On the whole, the operational performance of British Airways is much stronger. It flights are punctual, and passenger are aware of it. 2. Explain the calculation of unit costs and make pricing decisions using relevant information The unit cost is the cost per standard unit supplied, which can be a single sample of a specified number. When purchasing above a single unit, the total cost will rise with the number of units, other than it is general for the unit cost to reduce as quantity is increased. This discount in long run unit costs which occur from an increase in production is caused by the fixed costs being huge over further products, and it is called economies of level. If the industry has determined to launch the product, its possibility is as minimum as an essential considerate of the costs concerned; or else, there may be no profit to be achieved. The unit cost sets the lower limit of what the organization may charge, and it influences the profit margin at high costs. “The use of breakeven and minimum-cost-point formulas requires the collection of unit costs. Unit costs can be divided into subunits, each of which measures the cost of a certain part of the total” (Cost Control in Forest harvesting and road Construction n.d). The formula of using the unit cost is total costs divided by cost per unit. Costs – 4042(total costs of 2011) Unit costs per 100 units = 4042/100 = 4.042. “The price of a product or service is the outcome of the interaction between the demand for the product or service and its supply” (Pricing Decision and Cost management 2000). The three major influences on pricing decisions are  1. Customers: they play the most important role in the pricing decisions of an airline. Industries must always observe pricing decisions through the eyes of their consumers. Too high a cost can cause consumers to reject an organization’s product. 2. Competitors: They affect costs throughout their procedures. Substitute products of a competitor may be in more demand, and this force a business unit to lessen its prices. Variations in the exchange rates of diverse countries currencies also influence pricing decisions. 3. Costs: costs influence pricing, for the reason that they influence supply. The lesser the cost relation to the price, the larger the amount of product the organization is willing to supply. “British Airways said ending the subsidies on user charges would penalise passengers by increasing ticket prices and would encourage airports to develop more retail space at the expense of airport facilities” (Jack 2002). Most of the pricing decisions are short run or long run. Short run decisions normally have a time horizon of below a year. It contains pricing a one-time-only particular order and regulating output volume and product mix. Long-run decisions include a time horizon of a year. It contains costing a product in the main market, and where cost setting has a substantial leeway. The pricing strategy of British airways can be used to draw travelers into the market with extremely low prices, whereas offering reasonable prices to most of the consumers all through the booking period, and keeping some facility for a number of high yielding values in the last days of booking. The information has exposed that, rationally low values are obtainable until the previous two weeks proceeding to departure. The consumers could currently create reasoned trade-offs between schedules and timing, as all values are freely obtainable. Cost receptive business travelers can choose a better agenda, in additional to paying a higher value; price responsive passengers create sensitive decisions. 3. Assess the viability of a project using investment appraisal techniques: Most of the companies invest in assets like acquiring useful facilities in non trading stocks and shares, or depositing in a bank in acquiring equipment or machinery, or in manufacturing new plants. This is done with the aim of increasing productivity and efficiency. Investment appraisal is about measuring the income flow, besides the cost of the investment. Investment decision is the firm’s decision to invest the existing funds most efficiently in assets, with the anticipation of the expected flow of benefits over a number of years. The following are the investment appraisal techniques: Payback Period: It is the most widely used method and it is also easy to calculate. The payback period is the length of the time taken for cash inflows to equalize the original cost of investment. British Airways is said to have made an outstanding return on its initial investment of ?25m, over the three years it possessed the airline. Accounting Rate of Return (ARR): This method of investment is based on the monetary accounting system of the company for calculating the annual profits. Internal Rate of Return (IRR): The IRR is an absolute calculation compared to the absolute measure ensuing from net value calculations. If the IRR goes beyond an objective rate of return, the project is worth undertaking. Profitability Index: “The Profitability Index (PI) is the ratio of present value of cash inflows to the present value of cash outflows” (Madumathi n.d). Net Present Value (NPV): This assesses the change in shareholders wealth as the end result of undertaking a project. If the NPV is positive, the cash inflows from a project will create a return in surplus of the cost of capital, and as such, the project can be undertaken. Retrieving the cost of capital is the organization’s target rate of return. The cost of financing investment in British airways is based on the government’s individual cost of financing. British Airways primarily started issuing a complete cash-flow statement in the mid-nineties, but now the forecaster is recognizable with these categories. The discounting, financing cash flows at NPV would wrongly illustrate the value formation. The ?management is required to highlights its investments and its functioning relatively, than the system the airways has adopted. The NPV method is broadly taught and in any case it is partly understood in the industry, it creates critical problems for examining the investments of the airways; there are serious relations between investment and financing choice. The general result is to unnaturally increase the discount rate, to balance for the risks of the project. The risks include competition, currency and interest fluctuation, consolidation or deregulation, brand reputation, debt funding, employee relations, economic conditions, etc. It helps the managements responsibility to handle risk, and to pay no attention to the possible upturn, if market circumstances are excellent. On the monetary phase, the managers must calculate the cost of equity and the cost of debt applying the tools available, however defective they might be. For this reason, the NPV idea generally used in project finance is shaped on the view of evidently differentiating the cost of debt, and the cost of equity. All project cash flows in investing, operating, and financing are economical at the cost of equity. In the years to come, most of the airlines will be further worried about accessibility than the cost of financing. The profit of applying well-established valuation techniques will explain the basic ideology of airways which cautiously judge the risks and rewards of financing options. Reference List Annual Report and Accounts 31 December 2011 (n.d). BRITISH AIR WAYS PLC. [Online] Available at [Accessed on 18 May] Cost Control in Forest harvesting and road Construction (n.d). FAO CORPORATE DOCUMENT REPOSITORY. [Online] Available at [Accessed on 18 May] Diokno, MSI. 1999). A Rights-Based Approach towards Budget Analysis. [Online] Available at [Accessed on 18 May] Current radio Interpretation (2009). CCDCONSULTANCE. [Online] Available at [Accessed on 18 May] Jack, RS. (2002). British Airways Plc- Strategic Analysis. BRITISH AIRWAYS. [Online] Available at [Accessed on 18 May] Madumathi, R (n.d). Capital Budgeting. Indian Institute of Technology madras. [Online] Available at < http://nptel.iitm.ac.in/courses/IIT-MADRAS/Management_Science_II/Pdf/2_4.pdf > [Accessed on 18 May] Pricing Decision and Cost management (2000). Prentice Hall Business Publishing. [Online] Available at < http://www.alicoskun.net/09-10/PRICING.pdf> [Accessed on 18 May] Read More