A business is established to achieve certain goals: profit and performance are foremost of them. Goals are achieved thru some defined strategy. Strategy is a long-term plan, which in business is also called as a business strategy. In business management, there are certain financial and performance indicators that measure a company’s business strategy. These indicators serve as metrics that assist the management to examine: (1) if the company is approaching its goals, or (2) goals and strategy have to be redefined. This report uses Emirate Airlines as the case study to examine how strategy of a company translates into financials and performance indicators.
Emirates, a Dubai based world’s second most profitable among 20 largest international airlines. Since its modest opening in 1985 with just with two aircrafts now its fleet consists of 192 operating airplanes. Since its launch, the company was extended 280 international awards in recognition of its efforts to provide unrivalled levels of customer service. The airline experienced steady growth and always has been profitable, keeping on average 23% growth in passenger carrying during the years 2006 – 2012.
Balance sheet and capital structure
Balance sheet is an object consists of parameters that define a company’s overall financial activities. Balance sheet includes the key parameters of a business: assets, liabilities and equity. The concept “balance” in the balance sheet indicates: Assets = Liabilities + Equity. Each parameter of this formula represents different variables. These variables are integral parts of a balance sheet, and they serve as performance indicators. Capital structure of a company includes: long-term debt, short-term debt, and equity. Analysis of the parameters of a balance sheet and capital structure illustrates if the company is approaching its goal, which is set up by the business strategists. A company cannot remain in business without satisfying both short-term and long-term obligations. A short-term obligation is measured thru liquidity and long-term thru solvency. Working capital is calculated as a difference between current assets and current liabilities. Solvency is calculated as a ratio between assets and liability. In working capital management, analysts are interested primarily in current assets and certain current liabilities focusing primarily on receivables and payables rather than prepaid items and unearned revenue.
This drop resulted increase in account payables and borrowings, which increase the liabilities irrespective of 16.5 % revenue increase in 2012 with respect to 2011. In 2012 passengers carrying increased by 8 % with respect to the year 2011. In 2012, Emirates also opened 11 new destination cities. This shows that the company kept the growth irrespective of a small negative value of working capital. Working capital ratio analysis shows that the management until 2009 it was over 1.0; however, during 2009-2012 it is around the number 1.0.
The concept leverage is used in physics, from where entered to the finance as a term solvency. In mechanics, the concept leverage explains how a slight downward force can raise some heavy item. In finance, companies use leverage to increase return on owners’ equity (REO). There are two types of financial leverages (FL): operational and financial. FL = Total assets / Equity. In the balance sheet, debt belongs to an asset. Debt, in the balance sheet, is a member of non current assets. A right mix of borrowed money and owner’s financing can affect the company favorably while too much debt can be unfavorable. FL in the capital structure increases ROE = Earning / Equity. In 2011 and 2012, Emirates used leverages respectively corresponding to 3.58 and 3.13. This produced respective Revenue / Equity equal to 14.42 and 16.8. Irrespective of growth of passengers carrying and revenue, company net profit, dropped substantially, which is referred to unstable oil price.
Emirates currently has 192 active aircrafts in its fleets, out of that 118 are Boeing 777. Though, some aircrafts are in operation for 15 years in the fleet, but most of them are within 10 years age range. Sales and leasing of commercial aircraft is done thru aircraft lesser corporation. These organizations market used commercial airplanes to different buyers. Small airline companies, those who cannot afford purchasing new planes use these organizations to lease aircrafts. The airliner that leases the aircraft is called “Lessee”. Airline companies obtain aircrafts on the basis of an operating lease or a finance lease. An operating lease is a short lease and does not usually exceed more than 5 years. An operating lease is also called capital lease. The aircraft, with an operating lease does not appear on the Lessee's balance sheet. Finance lease is also called capital lease. Capital lease process allows the Lessee to select the asset (aircraft), use it for the time of lease, pay the rentals, and Lessee has right to obtain the title by paying the last rentals. The lesser, in this term, purchases the asset, recovers the cost of the asset and earns interest. If the term of lease, in case of an operating lease, is 2-7 years then for finance or capital lease it is 75 % of the asset’s life. From an accounting viewpoint, an aircraft is a fixed asset. These assets along with other parameters generate revenue. The concept of acquiring of a plane and a plant is the same from the accounting viewpoint of assets. Like in any other business, an airline company based on its financial ability and requirement decides whether to purchase an aircraft or lease it, and choose the lease option. From an accounting viewpoint, an aircraft should be considered as a motorized transportation vehicle, both of which go thru the air. Car, if used for business, expenses are depreciated. Aircraft deprecation measures the amount of value lost by an airplane used for business purposes over the time of its usage. The amount of depreciation impacts on company’s tax payment. However, different aircraft components depreciate at a different rate. For example, the mechanical structure is depreciated based on a 25-year life expectancy while engines and spare parts have 10-year expectancies. Nevertheless, aircraft depreciation depends on several factors established by a country’s tax regulation. In the USA, the IRS considers the time that an aircraft was used for business purposes. When aircraft is owned thru co-ownership (lease) and yields an income as a rental property, then this factor will be considered in determining depreciation. That is why; aircraft depreciation may not be in the form of straight line as it is considered in other fixed assets. In aircraft depreciation, one key feature is its current value, which changes from year to year, and this parameter is considered while calculating aircraft’s accounting depreciation.
The model ROE exhibits how management using shareholder’s investment. ROE, PM (profit management), and ATO (asset turnover) are evaluated using data from the income statement and balance sheet. The embedded concept, in REO, PM, and ATO, is to determine the return on investment. Return on investment is the profitability of the company. In Emirates Airline case, we observe that in 2009 operating profit dropped from 1.38 billion to 0.20 billion. The company started increasing borrowings, thus increasing the capital structure and financial leverage. This strategy paid off. In 2010 operating profit with compare to 2009 rose from 0.2 billion to 0.99 billion, and in 2010 it rose to 1.49 billion. This shows that the company management is efficiently using capital structure.
Hedging is a method to transfer the risk. There are many organizations, including established commercial banks that take part in this gambling. Risk is a part of any business. Corporation like Emirates faces uncertainty due to exposure to different factors like foreign exchange rates, interest rates, commodity price, and stock price. Hedging is done for this risks which are traded. Fuel for airlines is the primary commodity. Without the use of fuel, there is no business operation in the airline industry. However, in recent years fuel price is extremely unstable. According to Chairman Sheikh Ahmed of Emirates Airline, volatile fuel price forced the company to pay an additional $1 billion in its half year of 2012 fiscal year. According to the Chairman, Emirates is now planning to its hedging program to help guard against soaring fuel costs.