Qantas Airways' Financials Essay: Solvency And Liquidity Analysis.

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Group Assignment

You are allocated to research an Australian listed company. Please write a well-structured professional report to advise a high net-worth individual who intends to invest in the company. You may consider the following questions in your report.

1. Complete the table below and assess the company’s performance over the last three years.
2. Evaluate long-term solvency of the company over the last three years.
3. Assess the liquidity position of the company as at the latest financial year.
4. Discuss the quality of the financial statements.

Qantas is the one of the famous Airline service industry in the Australia. It is one of the largest airlines in the Australia and the Qantas Airways is the largest company by the fleet size, flights and the destinations it operates at. The Qantas Airways is the old brand and the airline and the third largest among the other airlines in the world. The major competitors of the Qantas are KLMM and Avianca. The total operating income of the company is A$1.59 billion and the revenue of the company is A$16.1 billion in the financial year 2017 (Qantas, 2018). This report performs the analysis of the long term solvency of the company over the last three years and also assesses the liquidity position of the company as at the latest financial year. Apart from this the qualitative nature of the company is also discussed in detail.

	Year  End  (3 years)
Ratios and  Other Analysis Measures	2015	2016	2017
ROE  and DuPont Ratios
ROE   (NI / OEavg)	31.6%	24.1%	24.8%
ROA	6.2%	5.0%	6.2%
Profitability (NI / Sales )	6.5%	5.4%	5.9%
Efficiency (Turnover = Sales / Assets avg)	1.20	1.15	2.24
Leverage (Leverage = Assets avg  / OEavg)	0.44	0.43	0.46
Additional Profitability Ratios
Gross Profit Margin % [(net Rev - COGS)  / net Revenue]	58%	59%	59%
Selling General andAdministration % (SGandA  expense / net Revenue)	34%	34%	33%
Important Expense Percentage* (Important Expense / net Revenue)	8%	9%	9%
Additional Efficiency Ratios
AR Turnover (Sales / ARavg)	11.49	11.17	23.69
Days Receivables Outstanding (DRO) [ARavg / (Sales /365)]	18.26	19.69	9.97
Inventory Turnover (COGS  / Inventoryavg)	4.81	4.61	9.73
Days Inventory (DI)  [Inventoryavg / (COGS/365)]	18.55	19.79	18.76
AP Turnover (Purchases / APavg)	0.82	0.74	1.49
Days Payables Outstanding (DPO) [365  / (Purchases / Accts  Payableavg)]	447.47	491.78	245.36
CASH CONVERSION CYCLE (DI - DPO  + DRO)	-410.67	-452.30	-216.64
PPE Turnover (Sales / Net PPEavg)	0.16	0.20	0.65
Additional Leverage Ratios
Debt-to-Equity (total Liabilities / total OE)	0.94	0.89	1.10
Times Interest Earned (Earnings  before Interest  Expense and Taxes  / Interest  Exp)	5.01	5.03	6.05
Return on Financial Leverage (ROE - ROA)	25.5%	19.2%	18.5%
LT Debt-to-Assets (LT Debt,  including current portion / total Assets )	0.60	0.59	0.76
Cash  Liquidity  and  Cash  Sources and Uses
Working Capital (CA - CL)	-3570000	-3976000	-3884000
Current Ratio (CA / CL)	0.49	0.44	0.49
Quick Ratio [(Ca s h + ST Securities + AR) / CL)]	0.39	0.36	0.34
OCFCL (Operating CF / CL)	-0.187	-0.245	-0.181
OCFCX (Opera ting CF / Ca pi ta l Expenditures )	-0.17	-0.23	-0.17
Free Cash Flow (Ca s h from Ops  – Net Ca p. Expend.)	8756000	9028000	9551000
Growth
Sales growth [(cy net Rev - py net Rev)/  py net Rev]		-0.66%	6.05%
NI Growth [(cy NI - py NI )/ py NI ]		-17%	15%

Financial Performance Analysis

From the above table it can be analysed that the Qantas Airways performed satisfactorily. Qantas Airways has faced the high levels of the capacity growth in case of the broader market. The underlying EBIT is 1424000 and it has a 2% increase in the revenue and the company continue to diversify the things. The group met all the goals and objectives within the financial framework set up by the AASB. The Qantas has underpinned this result and the profitability of the company has also remained stagnant. The selling and the general expenses have also been constant.

The company maintained a leverage of 0.44 to the 0.46 in the year 2017. The return on the equity has also decreased from 31.6% to 24.8% due to the less number of the equity investors (News Corp Australia Network, 2017). The cash decreased by 286000 in the year 2017 in a period of last three years and therefore after the analysis of the financial statements of the last three years.

Solvency and Liquidity

The long term solvency analysis includes the financial analysis of the Solvency and the liquidity ratios. Solvency ratio is one of the key metrics that is used to analyse the ability of the company, whether it can meet the obligations and pay off the current liabilities. The solvency ratio basically determines the cash flow of the company and decodes whether the current liabilities are payable or not (Venkatesh and Gugloth, 2017). The basic notation for the company is that, the lower the solvency ratio of the company, the higher is risk of the default on the debt obligations. The formula for calculating the ratio is

Solvency Ratio		Net income (After tax) + Depreciation
		Short term liabilities + Long term liabilities

Solvency and Liquidity Analysis

Solvency ratios

The solvency ratio is the comprehensive measure of the cash flow rather than its income by including the depreciation to make the clear assessment of the capacity of the company. There are different forms of the solvency ratio such as Debt to equity ratio, times earned ratio, Return on financial leverage and long term debt to assets. The solvency ratio higher than the 20% is an ideal ratio is considered as the benchmark (Zainudin, Zainudin, Hashim and Hashim, 2016). This ratio is not assessed in the isolation; rather it is compared with the other companies operating in the similar industry.

Debt-to-Equity (total Liabilities / total OE)	0.94	0.89	1.10
Times Interest Earned (Earnings  before Interest  Expense and Taxes  / Interest  Exp)	5.01	5.03	6.05
Return on Financial Leverage (ROE - ROA)	25.5%	19.2%	18.5%
LT Debt-to-Assets (LT Debt,  including current portion / total Assets )	0.60	0.59	0.76

Debt to equity

Debt to Equity ratio determines the total liabilities by the stakeholders. The Debt to Equity ratio indicates how much debt the company is maintaining to finance the assets which are relative to the value of the shareholder’s equity.

Debt to Equity Ratio		Debt
		Equity

If a lot of the debt option is used is to finance and increase the financial operations. The major reason for the company is that it could generate more earnings as it would have done without the help of the company to outsource the finance (Baker, Jabbouri and Dyaz, 2017). If the earnings are increased by the greater amount than the shareholders will have the most benefit, on the other hand if the cost of debt is more than the company may also lead to the bankruptcy. The debt to equity ratio of the Qantas Airways is 0.94 in the year 2012 and it decreased to the figure to the 0.89. The fall in the debt to equity ratio is that debt is less than the equity.

However, the company has again increased the ratio to 1.10 in the year 2017 (Australian Government, 2018). A high debt to equity ratio suggests that the company has over utilized debt to support the growth of the company. The interest level of the company has also increased as it can be observed from the income statement. The interest expense increased from 7532000 to 8023000 in the year 2017. Therefore it is advised to the company that the interest shall be reduced and the debt to equity shall be revamped.

Total debt to Total assets

The total debt to assets ratio refers to the long term and short term liabilities which are being compared to the total holdings of the company. The major risk to company arise when the company uses more debt to finance the total assets (Bierman and Smidt, 2014).

Total debt to assets ratio		Total debt
		Total Assets

Debt-to-Equity Ratio

The greater risk occurs when the financial risk is from the banks and the creditors. the total debt to assets of the company is 0.60 and it reduced by hardly 0.1% in the year 2016. The same ratio is increased to 0.76. Though the company is still under safe zone as the debt is not utilised much yet the company shall be aware. The degree of the leverage shall be the major concern for the Qantas Airways and therefore the value of the current assets shall be increased (Gurufocus, 2018).

Interest coverage Ratio

The interest coverage ratio is the metric which keeps the record of the interest payments which arise parallel with the outstanding debt. The business owner the Earnings before interest and tax shall be divided by the interest expenses (Borgonovo, 2017).

Interest Coverage Ratio		EBIT
		Interest Expense

The interest coverage ratio is basically a source to the public which can be a clear indicator of the fact that how much interest expenses the company is under the fact to pay to the debt holders. After the payment of the interest and the taxes the final income is given to the shareholders therefore, the company will be requiring to keep the interest income low so the income can be distributed to the shareholders (Colloquy, 2015). The lower the interest coverage ratio, the more its debt expense is going to affect the going concern of the company and it will create a burden for the company. The company with the interest coverage ratio of 1.5 or less is considered to be unstable (Shapiro, 2008).

From the above graph it can be analysed that the times interest ratio of the company is sound and the company is performing better (Daunfeldt and Hartwig, 2014). The interest coverage ratio of the company in the year 2015 was 5.01 and it increased to 5.03 and finally increased to 6.05 in the year 2017. The interest coverage ratio can be improved if the interest expense can be improved. Moreover the interest coverage ratio below 1 is considered as a highly danger situation and in comparison to the benchmark the Qantas Airways performed extremely well (Bragg, 2012).

Return on Financial leverage

When a business realises the financial leverage which means the Qantas Airways will be earnings more profit. The Return on the financial leverage is the difference between the return on equity and the return on assets (Gotze, Northcott and Schuster, 2016). The ROA is the useful ratio and it is used in interpreting the profit. The return on financial leverage of the company is 25.5% and it reduced to 18.5% in the year 2017. Every investor wants to get a higher return on the investment and if the return on financial leverage is going to decrease this will ultimately hamper the performance of the company and the count of the number of the investors is low. Henceforth it is advised to the company that the return on financial leverage shall be improved (Gibson, 2011).

Return on Financial Leverage

ROE-ROA

Total Debt-to-Assets Ratio

Liquidity ratios are another type of the financial ratios that are used by the investors and determine the ability of the debtor to pay off the current debt of the company without taking the assistance of the external capital. Liquidity ratios are basically the metrics that measures the current ratio, quick ratio, operating cash flow (Godwin and Alderman, 2012). Current liabilities are analysed in relation to the liquid assets to assess the time period of the short term debts. The analysts as well as the mortgage holders use the liquidity ratios more to make the valuation of the going concern issues. This ratio also helps to indicate the cash flow positioning of the company. This information is also used to measure the strategic strength of the company in comparison to its competitors.

The liquidity ratios of the Qantas Airways can be analysed from the following table.

	2015	2016	2017
Cash  Liquidity  and  Cash  Sources and Uses
Working Capital (CA - CL)	-3570000	-3976000	-3884000
Current Ratio (CA / CL)	0.49	0.44	0.49
Quick Ratio [(Cash + ST Securities + AR) / CL)]	0.39	0.36	0.34
OCFCL (Operating CF / CL)	-0.187	-0.245	-0.181
OCFCX (Opera ting CF / Capital Expenditures )	-0.17	-0.23	-0.17
Free Cash Flow (Cash from Ops  – Net Cap. Expend.)	8756000	9028000	9551000

Current Ratio

Current ratio is the kind of the liquidity ratio which is used to measure the ability of the company to pay short term liabilities as well as the long term liabilities. To cover this kind of the liability the current ratios takes into the consideration that the total assets of the company and its relation to the current liabilities of the company. From the table below it can be analysed that the company is maintaining its current ratio from 0.48 to 0.50 consistently or the past three years (Higgins, 2012). The company shall increase its ratio to 2:1 which is also considered as the ideal ratio as per the standards of the industry. It is advised to the company to get rid of the useless assets that are not beneficial to the company, and also the company shall also control the overhead expenses to which the major cost cutting is possible.

Current Ratio		Current Assets
		Current Liabilities

Quick Ratio

The quick ratio also known as the liquid ratio or the acid test ratio is used to determine the ability of the fir to generate the cash to pay back to the current liabilities and the obligations. The quick ratio is basically the tester that determines the value of how much cash the company can generate within the stipulated period of the 90 days. The assets and the marketable securities are the quick generator of the cash and therefore this ratio reflects the ideology of the quick sources of the cash (Jenter and Lewellen, 2015). The major difference between the quick ratio and the current ratio is that not all the current assets are convertible into cash within the given time frame. For example inventories.

Quick Ratio		Cash Equivalents + marketable securities+ accounts receivable
		Current Liabilities

Interest Coverage Ratio

From the main table above it can be analysed that the quick ratio is decreasing. The decrease is from 0.39 to 0.34 in the period of the three years. The decrease in the quick ratio is not a good sign for the company as there would not be enough cash to generate to pay off the earlier debts.

Working capital

Working capital is the liquidity ratio which measures the ability of the firm to pay off the short term as well as the long term liabilities. The working capital is the difference between the current assets and the current liabilities (Kimmel, Weygandt and Kieso, 2010).

Working Capital		Current Assets-Current Liabilities

From the above table it can be analysed that the working capital of the company that the company’s working capital is negative in all the three years. The company saw the negative working capital of -375000 and it rose to -388400 in the year 2017. The current liabilities are more than the current assets and hence the company is not able to pay the liabilities within the period of one year.

At times the negative working capital is a good sign as the company’s customers make the upfront payment rather than keeping large cash on their hands. As can be seen from the balance sheet the cash is also decreasing.

Operating cash flow with the current liabilities

The operating cash flow is the metric that measures how much amount of the money has the inflow and the outflow from its business activities and that too within a stipulated time. The profit and loss measures the entire profit of the company; however, the cash flow measures the change in the money available which the company can use to invest. There can be a variety of the reasons for the negative cash flow and the ratio with the current liabilities. The company received a negative cash flow and in the year 2015 the cash flow ratio was -0.187 and increased to -0.245, the ratio than changed to -0.181 in the year 2017 which was a fall. The changes in the working capital are the reason due to which the cash flow decreases (Venkatesh and Gugloth, 2017).

Operating cash flow with the capital expenditures

The capital expenditure is basically the expense that cannot be paid off during a period of one year. However the company treats this expenditure as the benefit expenditure as this expenditure includes the purchase of the plant and equipment, property, and other capital assets. These assets give the capital benefit in the near future. This ratio is also known as the capex ratio. The capital expenditure in the cash flow includes the cash from the investing activities. The company reflects the negative cash flow in the financial year 2015 to 2017.

Recommendations

In general a high CAPEX is good sign as the capital expenditures are the driver of the growth and hence it is advised to the company to improve the capex cash flow. The company had -0.17 in the year 2015 which increased to more negative view in the next year. However, the company pulled itself back and reduced the ratio from -0.23 to -0.17. Yet the position of the company is not sound it should work to bring the ratio to the positive (Wall Street, 2016).

Free cash flow

Free cash flow is the cash flow which represents that cash which is used by the company to generate the cash after all the investments are made by the company and the cash is available to expand the existing business. The free cash flow is further segregated into the cash flow from firm and equity. The company maintained enough cash flows as it can be observed from the table above. The cash flows in the year 2015 that were free after all the expenditures were 8756000 and they increased by 4% till the year 2017. The amount of free cash flow in the year 2017 is 955100 (Gurufocus, 2018).

Quality of the financial statements

The financial statements reflect the financial position of the company. It is basically a record of the company's financial affairs. Such financial statements help in keeping the record of the company's income and expenses. Such statements also help in analysing and controlling the expenses of the company which may result in an increase in the profits of the company. The financial statements of the company include the balance sheet, profit and loss account, income statement and cash flow statement. The statements of the company should also be qualitative, in other words the financial statements of the company should be understandable where all the information should be presented clearly and such information must of the relevance of the company’s financial matters (Qantas, 2018).

The statements should be free from all the errors and omission. The information given in the financial statement should indicate the events which lead to such transaction and such information must be matched to the financial period where the transaction took place. The financial reports of the Qantas Airways have provided all the relevant information which are necessary for a transaction (Wall Street, 2016).

The financial statement is not only reliable but also very relevant. The financial statement of Qantas Airways is very reliable as the statements and transactions very clear and easy to understand because the statements are served with all the additional information such as footnotes which describes the transaction. The incomes and expenses are fairly segregated in the income statement and the footnotes prove its relevancy. Qantas Airways has applied all the accounting rules and standards which are mentioned in the law. The financial statements were audited by the proper auditing authorities and are free from errors and mistakes (TCS consultancy, 2017).

References

Australian Government, (2018) Airline On Time Performance, 2017-18 Financial Year Report

Baker, H.K., Jabbouri, I. and Dyaz, C. (2017) Corporate finance practices in Morocco. Managerial Finance, 43(8), pp. 865-880.

Bierman Jr, H. and Smidt, S. (2014) Advanced capital budgeting: Refinements in the economic analysis of investment projects. Oxon: Routledge.

Borgonovo, E. (2017) Sensitivity Analysis: An Introduction for the Management Scientist (Vol. 251). Switzerland: Springer.

Bragg, S. M. (2012) Financial analysis: a controller's guide. New Jersy: John Wiley and Sons.

Daunfeldt, S.O. and Hartwig, F. (2014) What determines the use of capital budgeting methods?: Evidence from Swedish listed companies. Journal of Finance and Economics, 2(4), pp.101-112.

Gibson, C. H. (2011) Financial reporting and analysis. USA: South-Western Cengage Learning.

Godwin, N., and Alderman, C. (2012) Financial ACCT2. USA: Cengage Learning.

Gotze, U., Northcott, D. and Schuster, P. (2016) INVESTMENT APPRAISAL. (2^nd ed.). New York: Springer.

Guru focus, (2018) Qantas Airways Ltd  (OTC)PK:QUBSF) Intangible Assets: $834 Mil (As of Jun. 2018)

Higgins, R. C. (2012) Analysis for financial management. New York: McGraw-Hill/Irwin.

Jenter, D. and Lewellen, K. (2015) CEO preferences and acquisitions. The Journal of Finance, 70(6), pp.2813-2852.

Kimmel, P. D., Weygandt, J. J., and Kieso, D. E. (2010) Financial accounting: tools for business decision making. New Jersy: John Wiley and Sons.

News Corp Australia Network, (2017) Qantas announces $852m profit, second best in airline’s 97-year history

Qantas, (2018) QANTAS GROUP FULL YEAR 2017 FINANCIAL RESULT

Shapiro, A. C. (2008) Capital budgeting and investment analysis. India: Pearson Education.

Venkatesh, M., and Gugloth, D. (2017) A Review of Capital Budgeting Techniques. 

Wall Street, (2016) What are accounting polices?

Zainudin, E.F., Zainudin, E.F., Hashim, H.A. and Hashim, H.A. (2016) Detecting fraudulent financial reporting using financial ratio. Journal of Financial Reporting and Accounting, 14(2), pp.266-278.