The Need of Financial Analysis for Managers - Essay Example

Financial Analysis for Managers College: Name: Students ID: Date: Course Name: Unit Code: Time: Instructor: Terms of Reference Since the onset of the Eurozone crisis, the European aviation industry has endured nervous tension. Both AirFrance - KLM and Lufthansa PLC are national carriers which have been affected by the financial problems in the Eurozone area. This report details the analysis and comparison of the financial performance and status of both companies over a three-year period; 2010, 2011 and 2012. Financial ratios are used in the analysis. The main areas considered are profitability, efficiency, liquidity, and gearing of the companies along with a comparative analysis. The assessment of the trend of financial performance over the three-year period for both companies is also analysed. The analysis further includes the cross-sectional and time-series analysis of the estimated ratios. Executive Summary This paper is focused on the activities and the financial reporting of two flyer companies based in Europe. The companies are AirFrance - KLM and Lufthansa PLC. The paper describes an in-depth financial ratio analysis of both companies. The ratios focus on the profitability, efficiency, liquidity and gearing performance of each company. Other sections touch on the conclusions and recommendations and the references. Lufthansa PLC generally had a higher level of profitability than AirFrance – KLM. However, the company reported worse efficiency than AirFrance – KLM. Both companies recorded poor liquidity, even though Lufthansa PLC posted higher liquidity than AirFrance – KLM, apart from the cash ratio. AirFrance – KLM reported a higher level of debt compared to Lufthansa PLC across all measures, apart from the debt to equity ratio, over the three-year period. Of the two companies, Lufthansa PLC, in general, posted a better performance across the three-year period; 2010, 2011 and 2012. This could be attributed to the size of the company and its scale of operations, given that, Lufthansa PLC operates many other subsidiaries. Profitability Profitability ratios review earnings performance relative to sales or investment. The ratios try to gauge the management’s abilities and company’s actions by assessing various aspects of a business based on the income generated by the business (Drake). Analysis of BA AirFrance – KLM reported a declining profitability level from 2010 to 2012 based on all metrics used. Operating profit margin declined from a meagre 0.03 in 2010 moving to the negative territory of -0.01 in 2011 and a further -0.03 in 2012. The same downward trend was observed in the net profit margin and the return on assets. Net profit margin went down by 0.06 points, from 0.01 in 2010 to -0.05 in 2012. Return on assets shed off 0.05 points, from 0.01 in 2010 to -0.04 in 2012. Analysis of Lufthansa Plc Lufthansa reported a downward slump in profitability from 2010 to 2011 but profitability went up in 2012 as measured by the ratios calculated above. Operating margin went down by 0.03 points in 2011 from 0.06 in 2010; the ratio then went up to 0.05 in 2012. Net profit margin moved from 0.05 in 2010 to 0.00 in 2011 then went up to 0.04 in 2012. Return on assets too went down from 0.04 in 2010 to 0.00 in 2011 before moving upwards to 0.04 in 2012. Comparison of the Two Companies Lufthansa PLC reported higher levels of profitability over the three-year period across all ratios. Both companies reported a decline in profitability in 2011by almost the same number of points. However, in 2012 whereas Lufthansa reported a promising rise in profitability, AirFrance – KLM reported a further decline in profitability, albeit by a smaller margin than the decline posted in 2011 from 2010. Efficiency Efficiency ratios measure how well a company makes use of its assets. The ratios can be used to assess the gains produced by specific assets such as inventory, assets or debtors or all a company’s assets together. The measures generally assist interested parties to evaluate how successfully the company is engaging its investments (Bajkwoski). Analysis of BA AirFrance – KLM showed efficient use of its investments and resources. Stock turnover increased constantly from 2010 to 2012 moving from 24.71 in 2010 to 31.54 in 2012. Creditor’s turnover and average payment period went down in 2011 before recuperating by almost the same margin in 2012. Creditor’s turnover lost approximately 1.5 points in 2011 from 7.42 in 2010 before gaining almost the same points to go up to 7.41 in 2012. Also average payment period worsened by around 12 days to 61.14 days in 2011 then went up by just about the same number of days to 49.19 days in 2012. Analysis of Lufthansa Plc Lufthansa PLC reported a constant improvement in efficiency over the three-year period. Stock turnover gained 3.2 points in 2011 to reach 26.90 and gained a further approximately 1.2 points to reach 28.08 in 2012. Creditor’s turnover went up from 3.51 in 2010 to 3.96 in 2011 and gained almost 0.3 points to reach 4.24 in 2012. Average payment period improved from 104.11 days in 2010 to 92.21 days in 2011 and better still, 86.05 days in 2012. Comparison of the Two Companies AirFrance – KLM reported higher efficiency than Lufthansa PLC across all measures of efficiency used over the three-year period. Whereas Lufhtansa PLC reported a constant improvement in efficiency from 2010 to 2012, AirFrance – KLM reported a slight decline in efficiency of two measures; creditor’s turnover and average payment period in 2011 before regaining in 2012. Liquidity Financial managers and other users of financial statement information use liquidity ratios to evaluate whether a company can meet up its short-term debt commitments as and when they fall due. The users look at the liquidity ratios keenly given that any company that faces difficulties in meeting its short-term debt time and again is highly expected to face bankruptcy. The ratios therefore offer a fine way of determining whether a company is projected to keep on as a going concern at ease (Martin & Fernando, 2002). Analysis of BA AirFrance – KLM reported a poor level of liquidity as of 2010 through to 2012. The current ratio was way below the accepted industrial standard of 2:1 with the company posting 0.77:1, 0.70:1 and 0.77:1 in 2010, 2011 and 2012 in that order. The quick ratio was also below the accepted industrial standard of 1:1 with the company posting 0.71:1, 0.64:1 and 0.72:1 in 2010, 2011 and 2012 in that order. The cash ratio was lost 0.11 points to 0.25 in 2011 before moving up to 0.35 in 2012. All ratios declined in 2011 then moved up by almost a similar margin in 2012. Analysis of Lufthansa Plc Lufthansa PLC also reported a poor level of liquidity over the three-year period. In 2010 the current ratio was 1.05 before losing 0.08 points to 0.97 in 2011 then rose to 1.00 in 2012. Quick ratio was close to the industrial norm of 1:1 at 0.99, 0.93 and 0.95 in 2010, 2011 and 2012 respectively. Cash ratio was the poorest at 0.11 in 2010 then 0.09 in 2011 and 0.15 in 2012. All ratios declined in 2011 before rising again in 2012. Comparison of the Two Companies Apart from the cash ratio, Lufthansa PLC reported a stronger level of liquidity than AirFrance – KLM. For both companies, liquidity declined in 2011 and then went up in 2012. The margin that was lost in 2011 was almost equal to the margin that was gained in 2012. AirFrance – KLM reported a higher cash ratio across the three-year period than Lufthansa PLC. Gearing Gearing ratios measure the debt structure of a company against its investments. Financial statement information users, make use of these ratios to assess whether a company may possibly face difficulties convening its debt repayment plan, and the possible risk of bankruptcy. It is important to understand the amount of debt a company holds, particularly, with variable interest rates. This is because once the interest rates increase abruptly, the company possibly will have to deal with a severe interest payment trouble (Steven, 2006). Analysis of BA AirFrance – KLM had a debt structure that is manageable over the three-year period. The debt to asset ratio increased steadily from 38.30 percent in 2010 to 41.04 percent in 2012. The debt to equity ratio lost 0.07 points to 3.23 points in 2011 and gained 0.22 points to 3.45 points in 2012. The interest cover also increased steadily from 0.97 in 2011 to 1.51 in 2012. In general, the company’s financial leverage has been on the rise over the three-year period. Analysis of Lufthansa Plc Lufthansa PLC financial leverage was not so high over the three-year period. The debt to asset ratio moved down from 24.50 percent in 2010 to 22.88 percent in 2011 then rose to 24.31 percent in 2012. The debt to equity ratio followed the same trend losing 0.65 points in 2011 then 0.39 points to 5.87 points in 2012. The interest cover ratio increased steadily from 0.97 points in 2010 to 1.14 points in 2012. Comparison of the Two Companies AirFrance – KLM reported a higher level of debt compared to Lufthansa PLC across all measures, apart from the debt to equity ratio, over the three-year period. Although AirFrance – KLM reported a steady increase in debt to asset ratio, for Lufthansa PLC the ratio declined in 2011 before rising again in 2012. For both companies, the debt to equity ratio went down in 2011 before edging up in 2012. The interest cover increased steadily for both AirFrance – KLM and Lufthansa PLC. Conclusions and Recommendations AirFrance - KLM and Lufthansa PLC reported a poor financial performance over the three-year period. Both companies reported the worst performance in 2011 with a marginal increase in performance in 2012. Therefore, the Eurozone crisis had a severe impact on the European aviation industry given that both companies are the leading carriers in Europe, particularly Lufthansa PLC, which is the largest carrier. Profitability and liquidity for both companies was very low as measured up to against the industrial norm. To overcome the crisis, the companies could consider other international markets that are not affected by the crisis, such as Australia. Australia is favourable because it came out of the global financial crisis strong. China is also a potential target given its rapid economic growth. References AirFranceKLM, 2013, Annual Report 2012, retrieved 7 February 2013, AirFranceKLM, 2013, Annual Report 2011, retrieved 7 February 2013, John Bajkowski, Financial Ratio Analysis: Putting the Numbers to Work, viewed 3 February 2014, Lufthansa Group 2013, Annual Report 2012, retrieved 7 February 2013, Lufthansa Group 2013, Annual Report 2011, retrieved 7 February 2013, Martin, S.F and Fernando, A 2002, Financial Statement Analysis:  A Practitioner's Guide, 3 edn, John Wiley & Sons Pamela Peterson Drake, Financial Ratio Analysis, viewed 6 February 2014, Richard Loth, Financial Ratio Tutorial, viewed, 5 February 2014, Steven, M.B, 2006, Financial Analysis: A Controller's Guide, 2nd edn, Wiley Steven, M.B, 2012, Business Ratios and Formulas: A Comprehensive Guide, 3rd edn, Wiley Read More