ABC is a private popular low cost airline in Pakistan and provides cheap 'no-frills' flights to a wide range of Pakistani and international Customers. Since the company was launched in 1995 it has grown from strength to strength. Some of the key business highlights for 2012 were as follows:

Ø Record profit before tax of 129 million, up 56 per cent from 83 million in 2011.

Ø  Passenger numbers rose by 11.5 per cent to 33 million.

Ø  Passenger revenues increased by 5.9 per cent or 2.13 per seat, driven by strong summer trading.

Ø  Additional revenues improved significantly in all areas, rising by 34 per cent or 0.86 per seat.

Ø Unit costs excluding fuel fell by 1.5 per cent or 0.42 per seat from 28.78 to 28.36.

Ø Unit fuel costs increased by 33 per cent to 2.48 per seat.

Ø  58 new routes and 11 new destinations were launched, expanding the network to 262 routes and 74 airports in 21 countries.

Ø  The fleet grew to 122 aircraft with an average of 2.2 year, making it one of the most modern and environmentally friendly fleets in Asia.

Ø  The balance sheet remains strong with cash of 861 million and gearing at 31 per cent. The table below shows some financial information for ABC extracted from the income statement and balance sheet in in 2012.

 

Years

2012

2011

Revenue

1619.70

1314.40

Profit *

117.8

66.2

Capital employed†

1614.60

1215.30

Net assets

982.90

863.40

Current assets

1087.20

890.90

Current liabilities

509

414.50

* earnings before interest and tax

† Long-term capital employed (equity + non-current liabilities)

 

 

 

 

Required:

1.     Explain how ratio analysis can be used to interpret accounts from the perspective of two stakeholders.

2.     According to the key business highlights, gearing for ABC was 31 per cent in 2012. Interpret this figure.

3.     Calculate the following financial ratios for 2012 and 2011:

a.      Net profit margin

b.     Current ratio

c.      Return on capital employed (ROCE)

4.     To what extent do the results in Question 3 support the view that ABC has "grown from strength to strength"?

Ratio analysis helps the users of the financial statements to analyse the different angles of the company by comparing two or more figures at the same time. It is used by various stakeholders from management to creditors to investors to assess the position of the company.

Step-by-step explanation

Explain how ratio analysis can be used to interpret accounts from the perspective of two stakeholders.

 

The ratio analysis is a tool to evaluation the performance and position of the company. The ratios can be used to compare the figures of the same years and for different years as well. There are many stakeholders in a company who wants to safeguard their interest in the company. For example, a creditors wants to know the liquidity of the company so that he can get his money back on time. An investors wants to measure the profitability and growth rate of the company to have a better rate of return on his investment. Ratio analysis fulfils the major needs of the stakeholders.

 

Ratio analysis can be used in the following manner to interpret the accounts from the perspective of creditors and investors:

 

-       The creditor of a company may be interested in determining the liquidity of the business and for this, he will be looking at the current ratio, quick ratio, cash ratio, etc. of the company. A current ratio of more than 2 indicates that company has sufficient fund available with it to pay off its current obligations.

-       An investors may be interested in knowing the profitability of the company and may be interested in profitability ratios like net margin, return on investment, return on equity, etc. He may also be interested in knowing the earnings per share of the company. The profitability ratio indicates how efficiently a company is using its resources to generate the profit.

 

Therefore, different stakeholders may be interested in different types of ratio as per their need and requirements.

 

According to the key business highlights, gearing for ABC was 31 per cent in 2012. Interpret this figure.

 

The gearing ratio indicates the comparison between debt and equity of the company. The gearing ratio is computed by dividing the total debt by its total capital or shareholders equity. A gearing ratio of 31% indicates that debt level in the company is just 31% of the total capital which is considered good. It indicates that company has taken less loan as compared to its capital. The gearing ratio of a company can also be compared with the same ratio of the industry. It gives a better idea whether the company is scoring high in comparison to its peers.

 

Calculate the following financial ratios for 2012 and 2011:

 

Net Profit Margin

 

Net Profit Margin = Net Income / Revenue

 

Net profit for 2011 = 66.2

Revenue for 2011 = 1314.40

Net Profit Margin

= 66.2/1314.40

= 5.03%

 

Net profit for 2012 = 117.8

Revenue for 2012 = 1619.70

Net Profit Margin

= 117.8/1619.70

= 7.27%

 

Current Ratio

 

Current Ratio = Current Assets / Current Liabilities

 

Current Assets for 2011 = 890.90

Current liabilities for 2011 = 414.50

Current ratio for 2011 = 890.90 / 414.50 = 2.15

Current Assets for 2012 = 1087.20

Current liabilities for 2012 = 509

Current ratio for 2012 = 1087.20 / 509 = 2.14

 

Return on capital employed (ROCE)

 

Return on Capital Employed = Net income / Capital Employed

 

Net Income for 2011 = 66.2

Capital employed for 2011 = 1215.30

Return on Capital Employed for 2011 = 66.2 / 1215.30 = 5.45%

 

Net Income for 2012 = 117.8

Capital employed for 2012 = 1614.60

Return on Capital Employed for 2012 = 66.2 / 1215.30 = 7.3%

 

To what extent do the results in Question 3 support the view that ABC has "grown from strength to strength"?

 

A company is considered "grown from strength to strength" it has improved in all the areas including profitability and position. The company's net margin has increased from 5.03% in 2011 to 7.27% 2012. It means company is able to generated net income with its revenue which is a good sign.

 

The current ratio of the company is also good at 2.15 in 2011 and stayed at same level in the next year as well. It indicates that company is operating with sufficient fund and will have any difficulties in paying off its current obligation. Its Return on Capital Employed (ROCE) has also increased from 5.45% in 2011 to 7.3% in 2012 which is also a good indicators that company is generating regular and increased income.

 

All these ratios indicate that the company is growing from strength to strength.