Question

The Firm in Question is Southwest Airlines.

The purpose of this assignment is to evaluate the financial condition and performance of the firm you and your CLC group members have selected for analysis.

Refer to Tables A-1 through A-5 in Appendix II of the text for the operational definitions of and formulas for numerous common financial ratios, including profitability, liquidity, leverage, activity, and shareholders' return. Using these formulas, complete at least one ratio from each of the five categories, though you may apply as many of the ratios for which you can find the required information in the firm's financial reports. On your calculations page, specify for which formulas you are solving.

In an assessment of approximately 250 words, address the following:

Considering today's financial climate, how likely is it that the organization could acquire the capital necessary to support an aggressive value-enhancement strategy? From where would that capital originate? Compared to current interest rates, what do you believe is a realistic interest rate the firm might incur? Which of the liquidity ratios will be impacted by the influx of capital, if borrowed?

A-1 Profitability Ratios
return in total assets
1	22.07
return on stockholders equity
2	23
return on common equity
3	30
operating profit margin
4	13
net profit margin
5	25.83
A-2 Liquidity Ratios
current ratio
1	0.67
quick ratio
2	0.61
investor to net working capital
3	45
A-3 Leverage Ratios
debt to assets
1	14.79
debt to equity
2	0.27
long term debt to equity
3	28.72
times interest earned
4	0.39
fixed charge coverage
5	69
A-4 Activity Ratios
inventory turnover
1	33.22
fixed assets turnover
2	0.86
total assets turnover
3	0.18
accounts receivable turnover
4	0.45
average collecting period
5	17.67
A-5 Shareholders Return Ratios
dividend yield on common stock
1	1.59
price earnings ratio
2	12.65
dividend payout ratio
3	0.16
cash flow per share
4	7.4

Answer 1

Value drivers differ from industry to industry. However, the company(Southwest Airlines) would want to look at factors that influence the revenue growth and those which mitigate potential risk exposures for the business.

For the company to go in for an additional influx of capital, the following ratios would be helpful to analyze the efficiency of its current operations and where it stands in relation to the current competition.

1. Current ratio:

The current ratio is calculated by dividing the total current assets by the total current liabilities.

The ratio is a measure of the ability of a company to pay short-term obligations using current assets such as cash, marketable securities, inventory, etc. A general rule of thumb is to have the current ratio at 2:1.

In this case, the ratio is 0.67 which would mean that the company is somewhat lacking in enough liquid assets to cover its liabilities in the short-term.

2. Return on total assets:

The return on total assets (Net Income / Total Assets) is 22.07 which is high and shows that the firm has the required ability to generate revenues against assets that can be used to maximize shareholder's earnings.

3. Debt-to-equity ratio:

This is an important determinant of the capital structure of the company The debt to equity ratio shows the percentage of company financing that comes from creditors and investors.

With a debt-equity ratio of 0.27, Southwest Airlines seems to be more of a financially stable organization with less dependence on debt financing. But this ratio may be different for different industries. Considering that the aviation sector is a hugely capital intensive industry, SouthWest Airlines may use its stable financial position to attract more investors to cover its debt and operational costs such purchase of planes, fuel charges, repair costs of planes, etc.

4. Interest coverage ratio or fixed charge coverage:

The interest coverage ratio is calculated by dividing the EBIT, or earnings before interest and taxes, by the interest expenses.

A low-interest coverage ratio could mean a lack of sufficient profits to meet the interest charges on debt. However, while a high ratio indicates the presence of profitability to service its debt obligations, but also shows the conservative approach of the firm is investing enough towards research or development.

With a fixed charge coverage ratio of 69, the company seems poised for healthy growth avenues in the near future, but it should also consider investing in more innovative or disruptive technologies that can give it a competitive advantage.

5. Operating Profit margin:

The operating margin is calculated by dividing the operating income by the total sales during a period.

The operating profit margin is a performance ratio that serves as one of the crucial indicators for stakeholders to analyze if business operations are being run efficiently. Operating income is obtained by deducting operating expenses such as rent, insurance, and supplies,etc., as also depreciation, and amortization from gross revenues.

A company has lesser control over the direct costs of material inputs and hence the way in which the company manages its fixed costs could be an indicator of efficiency or performance.

In the case of the SouthWest, the operating profit margin stands at 13%.

While it varies from industry to industry, depending upon the scale of business, competition, and capital structures, as per reports, an operating profit margin of 15% and higher is considered healthy for most businesses, and a good indicator of financial soundness and efficiency.

Based on an analysis of how the company is presently leveraged, and the current investor regulations and banking covenant restrictions, the company could go in for either equity, debt, private investors, or manufacturer's financing.

The company has a sound debt-equity ratio and is able to manage operations quite efficiently due to reasonable operating profit margins.

However, given the capital intensive nature of the company, the organization should consider debt financing to invest more in innovation and technological advancements to bring down the cost of operations. The liquidity ratios impacted would be working capital and cash ratios. Interest rates would vary upon the method of financing used.

Sources:

https://www.fool.com/the-blueprint/operating-margin/

https://www.pwc.com/im/en/publications/assets/shipping-aircraft-space/pwc-aviation-finance-fastern-your-seat-belts-pdf.pdf