Executive summary
This paper seeks to compare the financial ratios of two companies namely-Qantas Airways Limited (QA) and Virgin Australia Holdings (VAH). Looking at the profitability ratios it is apparent that QA is performing way better than VAH. Ratio analysis is a very important tool that can be used to compare the performance of two companies for the purpose of investment. This is because an investor would prefer to invest in a company that enjoys a high level of profitability. However, it is important to appreciate that ratio analysis is also fraught with a number of challenges which would, to some extent, hinder their efficiency in comparing the financial performance of the two companies. For this reason, there is a need to consider other factors to ensure the comparability of the information provided by the financial statements.
Introduction
Virgin Australia Holdings (VAH) is the company that runs Virgin Australia. Previously, it used to be in charge of Pacific Blue Airlines and the Polynesian Blue. Polynesian Blue was later acquired by Virgin Australia towards the end of 2011. The company’s major shareholder is the Virgin Group (‘Airlines Industry Profile: Australia’ 2011).
On the other hand, Qantas airways limited (QA) is the largest airline in Australia. It is postulated that it has a market share of about 65% of the Australia domestic airline industry. Additionally, it is said that Qantas airways limited is the second oldest airline in the world. The major hub for this airline company is at Sydney Airport (‘Qantas Airways Limited’ 2012).
The main aim of this analysis is to compare the financial performance of the two companies. This information can be very critical in enabling the investor to make the appropriate investment decisions.
The analysis of the financial performance
The gross profit margin ratio
According to Steiman (2008), the gross profit margin ratio is used to show the profitability of the company. For this reason, a higher gross profit margin ratio is preferable to a lower one. Looking at the computed figures for the gross profit margin for the two companies, it can be seen that the Virgin Australia Holdings recorded a decline, from 9.8% in 2010 to 6.3% in 2011. On the other hand, Qantas Airways Limited registered an increase, from 10.97% in 2010 to 11.39% in 2011. This shows that the profitability of virgin Australia Holdings declined compared to that of Qantas Airways limited, which indicated an increase in its profitability. In addition, Qantas Airways recorded a higher gross profit margin ratio for the two years than that of the Virgin Australia Holdings. The company with the high gross profit margin is considered to be more efficient than the company with a low gross profit margin ratio.
The net profit margin ratio
According to Gibson (2010), the net profit margin is an indication of the extent to which the company’s sales revenue is translatable into profit. A high net profit margin is indicative of high profitability for the company, and it is desirable than a low net profit margin. A high net profit margin shows that the company has been able to control its costs efficiently. When comparing the net profit margin of two companies, it is important to consider other factors for example, long term loan that may lead to a decline in the net profit margin.
Looking at the net profit margins for the two companies, it can be seen that the net profit margin for Virgin Australia Holdings declined from 0.60% to -1.21%. This is indicative of declining profitability for the company. On the other hand, the net profit margin for Qantas Airways increased from 1.24% to 1.76%. Additionally, the net profit margin for Qantas is higher than that of virgin Australia holdings. This is supported by increased profit that was recorded by Qantas Airways.
Return on equity
Madura (2006) contends that this ratio indicates the amount of profit that the company has been able to generate using the money invested in the company by the ordinary shareholders. Looking at the ratios for Virgin Australia Company for the two years, it can be seen that it declined from 1.93% to -4.28%. On the other hand, the ratio for Qantas Airways shows an increase form 2.88% to 4.26%. The ratios for the Virgin Australia declined as a result of an increase in the total equity of the company. On the other hand, the return on equity ratio for Qantas increased on account of increased profit. Given that the two companies are in the same industry, it can be concluded that Qantas Airways is more efficient in the manner in which it uses the funds invested by the ordinary shareholders, compared to Virgin Australia Holdings.
Asset turnover
According to Albrecht, Stice, and Stice (2010), the asset turnover for VAH indicates an increase from 76.86% to 85.08%. On the other hand, the asset turnover for QA increased from 69.17% to 71.41%. However, in comparing the ratios for the two companies, it can be seen that VAH shows a higher asset turnover ratio as compared to QA.
The asset turnover ratio is used to measure the extent to which a company is able to use its resources make profits. The asset turnover is affected by the net sales of the company. For this reason, since VAH is showing a high asset turnover, it follows that is utilizes its assets more efficiently than QA.
Return on assets
The return on assets for VAH shows a decline from 1.98% to 0.51%. However, the return on assets for QA indicates an increase from 1.76% to 2.28%. Comparing the ratios for the two companies, it can be seen that QA has a higher return on asset ratio as compared to VAH. A company that is having a higher return on assets ratio is able to earn higher income using lesser investments. This implies that QA is very effective at using its assets to generate considerably higher income (Albrecht et al 2010).
Inventory turnover
Wahlen, Stickney and Brown (2010) adduce that inventory turnover shows the average number of times that the stock is changed and sold in the course of the year. The inventory turnover for VAH increased from 0 days to 0.57 days. On the other hand, the inventory turnover for QA increased from 8.45 days to 9.12 days. Overall, it can be seen that QA registered a higher inventory turnover period as compared to VAH. A low level of inventory turnover indicates that the company could be overstocking. However, a high level of inventory turnover indicates that the company could be purchasing its inventory in small quantities, which shows inefficiency in the manner in which the inventory is procured.
From this, it can be concluded that VAH has a very low level of inventory turnover, which is indicative of inefficiency in the manner in which the inventory is procured, while QA is having a comparable higher inventory turnover that could be indicative of higher sales.
Debtor turnover days
According to Ranganatham and Madhumathi (2004), the debtor turnover days indicate the average number of days that the debtors take to pay up their financial obligations to the company. A longer debtor turnover indicates that the debtors are very slow in honoring their financial obligations. This could have a negative effect on the cash flow position of the company. The debtors’ turnover days declined from 10.72 days to 11.46 days for VAH. On the other hand, the debtors’ turnover days reduced from 21.17days to 20.6 days for QA. However, it can be seen that QA has a comparably longer debtors turnover days as compared to VAH. This could indicate that VAH could be having a better cash flow position than QA.
Creditors’ turnover days
The creditors’ turnover ratio indicates the average number of days within which the creditors require their payments to be made in respect to supplies and services rendered to the company. A shorter creditors’ turnover period indicates that the creditors are getting paid on time. This could have the effect of shoring up the credit worthiness of the company. However, it is also indicative of the fact that the company may not be making good use of the credit terms that are being provided by the creditors.
The creditors’ turnover days for VAH show an increase from 39.7 days to 44.2 days. In addition, the creditors’ turnover period for QA declined from 46.4 days to 12.6 days. However, it can be seen that VAH has the highest creditors’ turnover ratio for 2011 as compared to QA. This implies that VAH is not paying up their creditors on time, which could have the effect of denting its credit rating (Ranganatham and Madhumathi 2004).
Current ratio
Gitman and McDaniel (2008) are of the view that current ratio shows the extent to which the company is prepared to meet its short term financial obligations. It facilitates effective comparison of the company’s current assets against the current liabilities. A higher current ratio is preferable as it shows that the company is in a better position to meet its short term financial obligations.
Looking at the current ratios for the two companies, it is apparent that the current ratios for VAH declined marginally from 0.76% to 0.65%. In addition, the current ratios for QA declined marginally from 0.93% to 0.90%. However, QA has the highest current ratio as compared to VAH. This implies that the company is in a better position, than QA, to meet its financial obligations that are falling due within the next 12 months.
Quick ratio
According to Gitman and McDaniel (2008), the quick ratio indicates the ease with which the assets that can be converted to cash can be used to pay up the current liabilities. As the ratio increases, the capacity of the company to meet all its needs increases as well. The figures for VAH indicate that the quick ratio declined marginally from 0.76% to 0.64%. Additionally, the quick ratio for QA declined from 0.88% to 0.85%. Nonetheless, QA has a higher quick ratio than VAH. This shows that the company has a better liquidity level than VAH.
Debt asset ratio (total debt)
According to Leach and Melicher (2011) the debt asset ratio shows the portion of the assets of the company that is possessed by non owners. The general rule is that if the debt asset ratio is less than one, then the implication is that a large proportion of the company’s asses have been financed using equity. A debt asset ratio that exceeds one implies that debt capital is the major source of income. Companies with higher debt asset ratios are said to be financed with debt capital. This could be problematic in a situation where the creditors’ obligations fall due at once.
The debt asset ratio for VAH declined marginally from 75.9% to 75.89%. Additionally, the debt asset ratio for QA decreased from 69.93% to 70.5%. However, VAH indicates a higher debt asset ratio as compared to QA. VAH has a very small debt asset ratio of less than one. This shows that equity has been used in most payments. Therefore, the implication is that VAH is preferable to QA in that it assets have been financed using more equity.
Debt equity ratio
According to Baker and Powell (2005), the debt equity ratio shows the relationship between the outsiders’ funds and the funds from the equities held by the shareholders. Additionally, it shows the extent to which the creditors can lay claim to the assets of the company. The interpretation of this ratio is such that if it shows the ordinary shareholders have a larger stake in the company than that of the creditors, the financial policy of such a company is deemed to be sound, and the company is taken to be highly solvent.
The debt equity ratio for VAH declined from 191.56% to 177.04%. During the same period, the debt equity ratio for QA increased from 95.6% to 98.05%. This shows that VAH has a higher level of debt asset ratio. This higher rate of debt asset ratio indicates that the creditors have a bigger stake in the company than the ordinary shareholders. For this reason, it can be concluded that the company’s financial policy is not sound, and therefore it should be reviewed.
Times interest earned
The times interest earned ratio indicates the ability of the company to pay the interest on its debt on a pre-tax basis. For this reason, the higher the ratio, the higher the possibility that the company can pay up its interest expenses in respect of the debt taken to finance the various aspects of the business. A high level of times interest earned indicates that the company is generating enough income that can enable it to service its debt (Baker and Powell 2005).
The times interest earned ratio for VAH declined from 1.55 times to -0.38 times. During the same period, QA times interest earned declined from 4.16 times to 3.96 times. Overall, QA has a higher times interest earned ratio. Compared to VAH, QA is in a better position to pay the interest accrued using the income it earns.
Limitations of using the financial ratio analysis
Most of the financial ratios are computed on the basis of the figures that are found in the balance sheet. As such, they are not representative of the year round financial position of the company since they are as at the date indicated on the balance sheet. In addition, the financial ratios do not take into account the qualitative information about the company. Additionally, they may not provide the best basis for comparison as different companies could be using different approaches. Moreover, different financial analysts have different ways of interpreting the financial ratios. For this reason, those ratios are subject to varying interpretations, and could bring about confusion (Baker and Powell 2005).
Conclusion and recommendations
Overall, Qantas Airways limited seems to be the best investment for the investors. Going by the profitability ratios, the company shows a greater potential for increasing its profitability as compared to Virgin Australia Holding Ltd. However, ratio analysis should not be the only basis for determining the viability of investing in a given company, since there are other factors that might not be taken into account by those ratios, and which could influence the performance of the company in future.
References
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