Question

a) The following table reports various financial ratios for Qantas and Virgin for 2017

Ratio	Qantas Airways Limited	Virgin Australia Holdings Limited
Gross margin	17.93%	10.71%
ROA	5.02%	-3.31%
Debt to Equity ratio	136.78%	155.21%
Current ratio	0.44	0.76
Net profit margin	5.43%	-4.37%
Interest coverage ratio	6.03 times	-0.57 times

i. Given that the companies operate in the same industry, write a report explaining what the ratios suggest about the companies’ profitability, liquidity and capital structure.

ii. If you were contemplating an investment in Qantas Airways Limited or Virgin Australia Holdings Limited, identify two other items of information (non-financial) that would assist your investment decision and why this is important to you.

b) Discuss three limitations of ratio analysis as an analysis tool.

(c) Cash flow statement

i. Explain the purpose of a statement of cash flows?

ii. Outline the difference between the cash and accrual bases of accounting.

Answer 1

1. i. Given in the table are the profitability ratios like gross margin, net profit margin, return on assets, liquidity ratios like current ratio, interest coverage ratio and debt to equity ratio.

Profitability Ratios: Gross Margin shows that Qantas Airways has a much higher ratio than Virgin Australia Holdings. Qantas has a gross margin of 17.93% as compared to 10.71% of Virgini. It shows a better gross profit generating capability of Qantas, and has an advantage over Virgin.

Net profit Margin shows that the indirect expense is more in Virgin than Qantas, Qantas is able to handle its administrative expenses much efficiently than Virgin. The net profit margin is 5.43% for Qantas. However Virgin has net loss of 4.37%.

Return on Assets is also negative for Virgin, and in contract Qantas is doing good, it has a 5.02% return on Assets.

The liquidity ratios like current ratio shows that Qantas has a comparatively lower liquidity as compared to Virgin. Both have optimally utilized liquidity, as they have current ratio of less than 1.

Interest Coverage ratio of 6.03 times of Qantas is a very positive sign for the company, as the company is capable of covering its interest cost from its profit,It may also be a reflection as to using low debt or lower interest burden. However for Virgin its -0.57 times, which means it’s a very grave situation and analysts should be cautioned that the company’s profit is unable to even meet its interest cost by -0.57 times.

Debt to Equity ratio shows that its 136.78% for Qantas, which as already discussed is lower use of leverage, if it uses more leverage it can give boost to its profitability. Whereas Virgin is using higher debt as compared to equity. Its debt to equity ratio is 155.21%.

ii. Apart from the information given in the table, In order to see that it’s a good option to invest or not, I would definitely look for operational ratios which can show the operating efficiency of the organization. Also I would like to see the solvency ratios, which could give me a correct picture of the solvency of the firm.

b) Ratio Analysis shows the historical data: It’s a limitation for ratio analysis, as the data reflected is historical in nature, it can only help you analyse the situation of the past, but the current position of the firm couldn’t be ascertained. The correct position of the organization can only be reflected by present situation, its not mandatory that the historical situation should repeat in the future also.

Its difficult to generalize about whether a ratio is good or not.

Seasonal factors can also distort ratios.

(c) Purpose of Cash Flow statement:

The purpose of cash flow statement is to provide complete information to the management and the stakeholders about the company’s gross receipts and payments for a specified period of time. Also the Net Cash Position of the business at a given period of time.

In addition to the cash amounts being reported as operating, financing and financing activities, the cash flow statement must disclose the other information including the amount of interest paid, income taxes paid, and any other significant investing and financing activities which did not require cash flows.

ii). Cash Basis: The entries are recorded as and when the cash is received from customers and expenses are recorded as and when the cash is paid to the outside parties.

Accrual Basis: The entries are recorded as and when incurred, even if there is no cash payment for the transaction immediately, but expected to be paid in the future. And similarly the expenses are recorded as and when consumed.