Analysis Of Financial Statements Of Qantas Limited And Virgin Australia Limited

Short-term Solvency Analysis

Discuss about the Effectiveness and Board Gender Diversity.

In this report analysis of financial statements of two companies has been done i.e. of Qantas Limited and Virgin Airlines Limited. Both Qantas Limited and Virgin Airlines Limited has been operating under same industry i.e. airlines and having same industry standards. As an investment manager, the main objective of this report is to provide advice to prospective investors in terms of investment decision making. Advice to prospective investors is based on the different parameters and each is related to select two companies. In this report, five parameters have been used to analyse financial performance and they are; short-term solvency, long term solvency, asset utilization, profitability ratios and market value ratios. In this report, ratio analysis technique has been used for the analysis for the year ended 2016 and 2017. In this report, 11 different types of ratios have been used for the analysis and on the basis of such ratios recommendations has been provided in terms of most favourable business organization for the investment.

Qantas Limited is one of the three oldest airline companies in the world. It is considered to be largest airline company in the world in terms of fleet size, international destinations and international flights. It is established flight carrier founded in 1920 in Australia.

These are the ratios that represent the solvency of the company in a set of 12 months which is a particular accounting year. It helps in evaluating if the company can pay off its current liabilities that are due within next 12 months with the amount to be realized from current assets in 12 months (Gibson, 2011).

Current ratio- it is the ratios that taken into consideration entire current assets while estimating the amount available for payment of current liabilities. Current ratio analyses the liquidity position of the business organization by comparing available current assets with current obligations at the end of the year (Brigham & Ehrhardt, 2013).

Current assets of the company have decreased from .49 to .44 in the year 2017 as compared to 2016. In both fiscal years, the current ratio of the company is very low as the company doesn’t even have the current assets to pay half the current liabilities. Hence it can be said that short-term solvency position of the company is weak. On the other hand, liquidity position of Virgin Australia is also not up to the mark as compared to industry standards. From the above table, it can be analysed that, during both the years Virgin Australia is not having sufficient funds to repay their current obligations. As compared to 2016, a current ratio of 2017 has shown some improvement because management has invested some funds in current assets including inventories.

Current Ratio

Quick ratio- quick ratio is a further extension of current ratio that compares the value of quick assets with current for payment. Quick assets are the assets that can be converted into cash easily in the market (Fridson and Alvarez, 2011). Quick ratio analysis liquidity position in deeper and extensive manner because it does not consider already incurred or uses current assets.  

Similar to current ratio, the quick ratio of the company is also weak which is evident from the fall from .44 in 2016 to .39 in 2017. As far as Virgin Australia Limited is concerned, they are also sailing in the same boat but with improved results as compared to Qantas Limited (Oler and Picconi, 2014). A quick ratio of Virgin Australia Limited in both the years is not much different from its current assets, this shows Virgin Australia Limited has made a low investment in inventories (since there are no prepaid expenses).

To both the companies it is recommended to invest some more funds in current assets or formulate better credit policy in terms of receivables and payables. Better management of current assets is required in both the companies, so as to increase current ratio and to attract investors (Oler and Picconi, 2014).

These ratios help in understanding the capital structure components and cost related to such costs. Here, the focus will be given on two ratios that will analyse long term liquidity of the Qantas limited and Virgin Australia that are capital gearing ratio, interest coverage ratio and debt to total assets ratio.  

Capital gearing ratio- It is a ratio that established between fixed interest-bearing capital and fixed cost bearing capital. Therefore it can be said that this ratio forms relations between common equity capital and debt component of the capital structure of a company (De Franco, Wong & Zhou, 2011). Capital gearing ratio identifies the balance between long terms capital employed and short-term capital employed in the business operations by the business organizations. This ratio has increased from .736 to .803 in 2017. It shows that fixed cost capital is higher as compared to equity capital. This is a preferable situation for the company as the general overall cost of fixed cost bearing capital is considered lower as compared to equity.

From the above table, it can be analysed that in 2016 Virgin Australia Limited has been using optimum level of fixed cost bearing and variable cost bearing capital employed for the business operations. But in 2017, their capital gearing ratio suggest adverse situation as their capital gearing ratio have increased from 0.619 times to 1.036 times. This situation suggests that Virgin Australia is using more of variable cost bearing funds i.e. more of outside funds or more debt is employed in business (Whitfield & Duffy, 2013).

Quick Ratio

Interest coverage ratio- It shows off the organization is able to pay its fixed interest cost or not. It shows a margin of safety that an organization has, to pay off its interest expenses in a particular financial year. Interest coverage ratio is used to measure the ability to business organization to repay their financial cost and is majorly used by outside stakeholders like financial institutions, investors, etc.

In case of Qantas Limited interest coverage ratio has increased from 26.205 to 29.360 in the financial year 2017 which shows that company will have no issues with payments in relation to fixed interest expenditures. Qantas Limited has adequate liquidity or profits to replay their interest obligations. On the other hand, Virgin Australia Limited has been suffering from lack of profitability or availability of funds to repay their interest obligation Whitfield & Duffy, 2013. In 2016, their interest coverage ratio is considerable but in 2017 it has fallen down to adverse level i.e. 0.659. This shows non-availability of profits from the business operations to repay their interest obligations.

Debt to total asset ratio- This ratio represents the weight of a total asset that is financed with the help of debt component of capital structure. There should be a proper balance between debts used for procuring assets of the business organization because more use of debt for procuring debt will lead to higher risk of business failure. In case of Qantas Limited, in both these financial years, this ratio is almost similar to each other which represents that around 25% of total assets are financed by debt. This is a good proportion as higher ratio can increase the overall cost of the company in for of interest cost. On the other hand, in case of Virgin Australia Limited, their debt to total asset ratio reflect adverse result since their assets are backed by more of outside debt. Most of the business failure has the same reason and management need to consider this serious i.e. to back business assets more from internal funds.

Majority of the investors evaluate profitability ratios to determine whether they will be able to get sufficient returns on their profit or not. It is also an essential ratio from the perspective of an organization as they represent the net income generated by them with their core activity (Higgins, 2012).

Gross profit ratio- This is the ratio that shows the margin of profit earned by the company from its core income after charging only direct expenses. Gross profit of the business organization reflects the efficiency of business organization to generate funds from sales revenue. This ratio of Qantas limited has decreased in the current year as compared to last financial year. This shows that operational efficiency of the company has decreased in the current financial year. The company should evaluate whether this ratio is due to valid reason or not. On the hand, Virgin Australia Limited has shown favourable figures or results in generating adequate gross profit. Gross profit level of Virgin Australia Limited will attract more investors because their business operations have shown strong earnings.   

Long-term Solvency Analysis

Net profit ratio- net profit ratio, similar to gross profit ratio, has decreased in a current financial year from 6.35 to 5.312. This shows that an indirect expense of the company has also increased together with direct expenses of the company (Brochet et.al, 2013). Qantas shows evaluate what are the changes in a cost structure that have arrived in the current financial year as compared to last year. They should try to control both these cost in coming financial years.

In case of Virgin Australia Limited, they are not able to generate profit in both the years’ i.e. 2016 and 2017. In 2016 their net loss was 4.48 % and in 2017 it is 3.68 %, this reflects inability in relation to cost management by the managers and by top management. Net loss during these years will negatively impact goodwill among investors both existing and proposed. Management of Virgin Australia Limited needs to use cost-cutting strategy in their expenditure to overcome the net loss. The current position of Virgin Australia Limited is adverse and they are not able to save funds or profit for their existing shareholders or investors (Ehrhardt and Brigham, 2016).  

It is evident that most valuable source of generation of income for any organization is assets of the company as they are used by the organization for manufacturing or providing services to the customer. These ratios help in determining utilization efficiency of these assets by management (Chen et.al, 2018).

The stock turnover ratio is the ratio that shows that the number of times the company has sold its entire inventory. This ratio represents the efficiency with a stock of the company is rotated by the company. Higher or lower stock turnover ratio can result in excessive storage cost or stock ordering cost. From the above ratio calculation, it can be said that company is selling its entire stock 42 times in a within a period of 365 years. It can be said that due to this regular rotation of stock, storage cost would be lower but it can also result in higher carrying cost. On the other hand, Virgin Australia Limited has also shown inadequate results in terms of inventory turnover i.e. management is able to turnaround in 52 days  in 2017 and 57 days in 2016 during the one year period (Minich-Pourshadi, 2010). This shows lower efficiency in terms of inventory management.

Another asset utilization ratio is total asset turnover ratio that is used to analyses efficiency of total assets of the business organization in terms of generating sales revenue during the year. This ratio should be kept high, which means assets are more efficient since this denotes fewer business assets are used to generate higher sales revenue during the year.

Capital Gearing Ratio

In case of Qantas Airlines, asset utilization ratio shows inadequate results since in both the years it does not reach to 1 time. Qantas Airlines is using higher level or value of assets as compared to sales revenue generated during the year. In both the years, they are able to generate approx. 0.90 or 90 % of sales revenue as compared to total assets value. On the other hand, Virgin Airlines Limited has also shown adverse results i.e. in both the years their asset utilization ratio is not able to reach to 1 time (Dumas, La Rosa, Mendling, and Reijers, 2013).  On the other hand, Virgin Airlines Limited has more adverse asset utilization level in their business operations. In 2016 they are able to generate 83 % and in 2017 79 % sales revenue as compared to their total assets.

Earning per share- Earning per share of the company has increased from 151.900 cents to 154.300 cents in the period of 2017. This shows that company is paying a good return on investment done by the shareholders (Scott, 2014). There is a chance that it would attract more shareholders to invest in the company through which company can raise additional capital whenever required. In case of Virgin Airlines limited, their EPS has shown negative amount i.e. they have not earned a net profit during the year and had incurred net profit (Huang, You & Hsiao, 2017). Negative EPS is a negative sign of goodwill and interest of investor in the business organisation will be shaken.

Price per cash flow- this ratio represents the cash generated by the company as compared to its share market price at the end of financial year. It is considered to be better indicator while making an investment decision. This ratio is slightly decreased in the current financial year as compared to last year. Virgin Airlines limited has generated a lower amount of cash as compared to their market price of a share or market value. Price per cash flow of Virgin Airlines limited has been adversely decreased in 2017 as compared to 2016; this shows a decrease in value of shares and of business and inability to generate adequate cash from business operation. 

Short-term liquidity- the Current ratio of the Virgin airline is better as compared to Qantas limited by a good margin because the amount of current assets in case of Virgin Australia is higher. Similarly, in case of quick ratio, the situation of Virgin Australia is better in comparison. A quick ratio of Virgin Australia is almost double as compared to Qantas which shows availability of current assets other than inventory and prepaid expenses (Williams, 2014). In nutshell, it can be said that Virgin Australia is much more liquid as compared to Qantas limited.     

Interest Coverage Ratio

Long term liquidity- from ratio analysis it can be said that fixed cost capital in case of Qantas limited is higher as capital gearing ratio in Qantas is less than 1. It is good sigh as it is better to have more debt component in the organization as excessive equity can dilute the ownership of shareholders. Another problem with Virgin Australia is that majority of its assets are financed with the help of debt (Deegan, 2013). This ratio is .75 in case of Virgin whereas it was just .25 in case of Qantas which shows that debt component almost triple in respect of financing its assets.

Profitability- From the perspective of gross profit ratio, Virgin Australia is in a superior position as it is around 50 percent in case of virgin and only 35% in case of Qantas limited. But it is not the same in case of net profit ratio as Virgin Australia has incurred losses in a current financial year whereas Qantas has maintained a net profit margin of 5%. This shows that profit earing capabilities are better in case of Qantas limited and Virgin Australia is required to control its indirect expenses to maintain positive net profit ratio.

Asset utilization- stock is rotated with a higher rate in case of Virgin Australia as compared to Qantas limited. It can be concluded from this ratio that demand of services of Virgin Australia is higher as compared to Qantas (Deegan, 2012). But it also means that ordering cost of stock in case of Virgin Australia would be high as the Stock turnover ratio is higher.

Market valuation- As Virgin Australia has incurred a loss in the current financial year; therefore EPS of the company is also in negative whereas Qantas has paid a dividend of 153 cents per share which is very high in comparison. It should that value of Qantas would be higher in the market as compared to Virgin Australia.

Conclusion

From the above report, it can be concluded that there are different ratios that are used for the analysis of financial performance and financial position of the selected business organisation. In this case, Qantas Limited and Virgin Airlines Limited have been selected for the analysis. It can be concluded that solvency ratio has reflected adverse result for Virgin Airlines Limited as their current ratio and quick ratio is a negative side. It can be concluded that net profit ratio and gross profit is used to measure the profitability of both the business organizations. At last, the recommendation has been provided in the separate section of this report and it is recommended for prospective investors to invest in Qantas Limited because it has a more strong financial position as compared to Virgin Airlines Limited.

Debt to Total Asset Ratio

Table showing favourable business organisation from the analysis of different ratios:

Form the analysis of above table and analysis made above section,            Qantas Limited is considered to the best business organisation as compared to Virgin Australia Limited. It can be analysed that in terms of liquidity in the business activities, Qantas Limited is able to manage their cash and cash equivalents more effectively and therefore recommended to be more liquidity business organisation as compared to Virgin Australia Limited (Palepu, Healy and Peek, 2013). From the profitability perspective, Virgin Australia Limited has shown adverse results in terms of generating profit from business activities during both the years. Qantas Limited is able to manage litter amount of profit during both the years as compared to Virgin Australia Limited, incurred a net loss in both the years. From the solvency point of view, Qantas Limited is considered to best because their solvency position in terms of interest coverage ratio and capital gearing ratio is favourable. On the other hand, Virgin Australia Limited does not have funds to repay interest cost of the year and top management has used more external funds i.e. debt in the business operations (Ward & Forker, 2017).

According to asset utilisation ratios, it is recommended to invest in Qantas Limited because they are able to generate more sales revenue from their existing total assets as compared to Virgin Australia Limited.

Overall recommendation: From the above analysis and table shown above, it is recommended to prospective investors to invest in Qantas Limited.

References

Brigham, E.F. and Ehrhardt, M.C., 2013. Financial management: Theory & practice. Cengage Learning.

Brochet, F., Jagolinzer, A.D. and Riedl, E.J., 2013. Mandatory IFRS adoption and financial statement comparability. Contemporary Accounting Research, 30(4), pp.1373-1400.

Chen, C.W., Collins, D.W., Kravet, T.D. and Mergenthaler, R.D., 2018. Financial statement comparability and the efficiency of acquisition decisions. Contemporary Accounting Research, 35(1), pp.164-202.

De Franco, Gus, Wong, M.H. Franco & Zhou, Yibin, 2011. Accounting adjustments and the valuation of financial statement note information in 10-K filings.(Report). Accounting Review, 86(5), pp.1577–1604.

Deegan, C., 2012. Australian financial accounting. McGraw-Hill Education Australia.

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Ehrhardt, M.C. and Brigham, E.F., 2016. Corporate finance: A focused approach. Cengage Learning.

Fridson, M.S. and Alvarez, F., 2011. Financial statement analysis: a practitioner’s guide (Vol. 597). John Wiley & Sons.

Gibson, C.H., 2011. Financial reporting and analysis. South-Western Cengage Learning.

Higgins, R.C., 2012. Analysis for financial management. McGraw-Hill/Irwin.

Huang, C.-S., You, C.-F. & Hsiao, H.-F., 2017. Dividends and Subsequent Profitability: An Examination of a Dual Dividend Stock Market. Review of Pacific Basin Financial Markets and Policies, 20(1).

Minich-Pourshadi, K., 2010. Financing Options. Health Leaders, 13(6), pp.42–43.

Oler, D.K. and Picconi, M.P., 2014. Implications of insufficient and excess cash for future performance. Contemporary Accounting Research, 31(1), pp.253-283.

Palepu, K.G., Healy, P.M. and Peek, E., 2013. Business analysis and valuation: IFRS edition. Cengage Learning.

Qantas Limited. (2017). Qantas Limited, Annual Report. Australia: Qantas Limited.

Scott, W.R., 2015. Financial accounting theory (Vol. 2, No. 0, p. 0). Prentice Hall.

Virgin Australia Limited. (2017). Virgin Australia Limited, Annual Report. Australia : Virgin Australia Limited.

Ward, A. & Forker, M., 2017. Financial Management Effectiveness and Board Gender Diversity in Member-Governed, Community Financial Institutions. Journal of Business Ethics, 141(2), pp.351–366.

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Williams, J., 2014. Financial accounting. McGraw-Hill Higher Education.

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